HNWElder Law, Estate Planning

By: Fredrick P. Niemann, Esq. a NJ Estate Planning Attorney

Besides being one of the few charitable-giving techniques that permit a donor to reserve an interest in the property that is given to charity, the charitable remainder trust has another unique feature that makes it attractive to donors who have low-basis property that they want to diversify without paying the capital gains tax.

A charitable remainder trust generally pays no income tax itself, so property can be contributed to a charitable remainder trust and sold by the rest of the trust without payment of capital gains tax; 100 percent of the property (unreduced by capital gains tax) can be reinvested in a more diversified asset mix to generate increased cash flow for the donor (and the donor’s spouse).

The donor can be the trustee, so the donor can control the trust investments.  The annual payments to the donor are taxable either as ordinary income or capital gain, depending on the nature of the income inside the trust.

In addition to the reservation of cash flow and the non-payment of income tax upon sales of assets, the creator of a charitable remainder trust receives an income tax deduction at the time the trust is created based upon the cash f low that is reserved, the donor’s age, and the Internal Revenue interest rate that is applicable at the time the trust is created.

Below is an illustration of how a Charitable Remainder Trust works:

Mr. A, age 68, is an employee of the ABC Corporation.  Mr. A purchased 10,000 shares of ABC Corporation at $1 per share, when shares were first made available to employees.  Mr. A’s shares are now worth $2 million and pay no dividends.  Mr. A is thinking of retiring, and would like to diversify his investment in ABC Corporation to reduce the risk of having a substantial portion of his assets in one stock and also to increase his cash flow by $100,000 per year to supplement other retirement income.

If Mr. A sells his ABC Corporation stock for $2 million, he will pay $497,500 in federal and state capital gains tax (assuming a 25% combined federal and state rate).  The sale would leave Mr. A with $1,502,500 to invest to generate $100, 000 per year retirement income.  Under current economic conditions, it would be difficult for Mr. A to achieve the almost 7% return that would be necessary to yield $100,000 per year.

Instead of selling the AC stock, Mr. A contributes it to a charitable remainder unitrust that pays him 5% of the annual fair market value of the trust assets each year during his lifetime, then following his death, the same percentage to his wife, age 66, for her lifetime, and upon the death of the survivor of Mr. and Mrs. A, whatever assets remain in the trust will be paid to the Leukemia & Lymphoma Society.

In the year the charitable remainder unitrust is created, Mr. A will be entitled to a charitable income tax deduction of approximately $800,000 which can be used up to 30% of his adjusted gross income in the year of the gift and five succeeding years.  Thus, a substantial amount of Mr. A’s retirement income can be sheltered over a six-year period.  Beginning with the year the charitable remainder unitrust is created, Mr. A will begin receiving $100,000 per year, hopefully increasing over time as the assets of the trust, which are now diversified, increase in value.

If Mr. A wanted to be certain that he and his wife received $100,000 per year for the balance of their lifetimes, irrespective of the investment performance of the trust assets, Mr. A could have created a charitable remainder annuity trust that would pay his wife and himself $100,000 per year, irrespective of asset performance.  Mr. A would have been entitled to an income tax deduction of approximately $860,000 in the year the trust was created, to be used to up to 30% of his gross adjusted income in the year of the gift, and five succeeding years.

Previous PostNext Post