Despite the lingering global health pandemic and ensuing economic recovery, 2021 has been another strong year of stock market returns along with a flurry of business sales, IPOs, and higher and higher real estate values. Charitable gifting is again top of mind for families to help their favorite not-for-profits, advance racial and social injustice issues, and rebuild communities.
It proved to be extremely popular last year. Even amidst an unprecedented global health pandemic, 2020 turned out to be the highest year on record in the U.S. for charitable gifts. Giving USA 2021: The Annual Report on Philanthropy for the Year 2020 reported that individuals, bequests, foundations, and corporations gave an estimated $471.44 billion to U.S. charities in 2020. Total charitable giving grew 5.1% measured in current dollars over the revised total of $448.66 billion contributed in 2019. Of this amount, gifts from foundations (including charitable trusts) increased by 17%, to an estimated $88.55 billion.
Charitable vehicles for long-term generational planning can include private foundations, donor-advised funds, and charitable trusts. Our resource here will explore the opportunities using charitable remainder trusts to help clients get more mileage out of their gifts to charity. It’s worth noting that charitable lead trusts are also an option but will not be the focus of this article.
What is a Charitable Trust and When Does Creating One Make Sense?
A charitable remainder trust (CRT) is an irrevocable trust, typically funded with highly appreciated assets. The CRT is a popular vehicle because it generates a lifetime or a term of year’s income stream for you as the donor (or a select beneficiary), while the remainder of the trust assets go to charity.
CRT agreements offer flexibility in the drafting of the trust instrument and can offer payouts ranging from 5 to 50% of the initial trust value over the term of the trust, provided that at-least 10% of the trust value will be earmarked for charity. CRTs come in two types: Charitable Remainder Annuity Trust (CRATs) and Charitable Remainder UniTrusts (CRUTs). A CRAT would provide the donor with a fixed annuity from the trust, for a term of year, or for life, while the CRUT payouts will vary each year based on the beginning of year market value of trust assets. For example, assume a CRUT is initially funded with assets of $2 million with a 7% unitrust payout, first year distributions to the donor would be $140,000. If the trust later grew in value to say $3 million, the unitrust payout would increase to $210,000.
The donor of a CRT can pick a charitable remainder including a public charity, donor-advised fund (DAF), or foundation. Depending on the remainder beneficiary, the donor is entitled to a current charitable tax deduction (based on the present value of the remainder interest), limited to 30% of adjusted gross income (AGI) for DAF gifts and 20% for gifts of appreciated stock to the CRT if the remainder goes to a foundation. Gifts of cash to charitable trusts are possible with a current 60% AGI limit, however cash gifts are generally not the best asset to place in a CRT. The present value of charitable remainder interest for CRT purposes is based on the monthly IRC Section 7520 rate of interest, which is currently around 1-1.20%.
As tax-exempt trusts, CRTs can sell highly appreciated assets (often with low or zero tax basis) and the trust does not pay any capital gains or income tax based on the gain realized. This provides a great opportunity for clients with highly appreciated stock or real estate to diversify out (in trust) and spread the tax on those gains over many years.
Relevance to Today’s Environment
With Biden’s budget proposal suggesting a long-term capital gains rate of 43.4% on taxpayers with income over $1 million, a CRUT may be a compelling strategy to spread gains out over many years to fly under higher tax brackets.
Any income or capital gains passed out to the CRT donor on annual basis is taxed on the donor’s income tax return, based on a “worst in first out” basis. Properly managed CRTs, even with high annual payout percentages of 7-10%, will mostly pass out capital gains to the donor on an annual basis, which can help smooth out gains over many years (often in low tax brackets).
Finally, gifts to a CRT, along with any appreciation in trust assets may be out of the donor’s estate for both federal and state estate tax purposes providing additional transfer tax savings.
In summary, gifts of appreciated assets to a CRT have the following benefits:
- Diversification out of single asset risk
- Deferral of capital gains, often to lower tax years
- Lifetime or for a term of years (not to exceed 20 years) income stream
- Upfront charitable gift tax deduction and savings
- Asset protection in trust
- Leverage and compounding – remainder gift to charity is often much larger than the initial assets placed in trust
- Flexibility in terms/remainder charity can be changed
It should be noted that charitable trusts require a separate tax filing each year (Form 5227), legal set up, and related advice at the outset. In order for the extra compliance costs to pencil out, we generally encourage gifts in trust north of $2 million.
Example and CRT Modeling
The below is an illustrative example of how a CRUT might work.
Following a recent IPO, a serial entrepreneur and executive age 55 holds low basis highly appreciated stock in his/her company. Being charitably inclined, a CRUT is funded with $20 million of public stock, payable over the donor’s lifetime with the remainder of the CRUT going to a public donor-advised fund. The trust is a unitrust with a 5% annual payout, with the goal of investing the proceeds from the $20M sale in a diversified portfolio of public stocks expecting average annual returns of 8%. Life expectancy is 95.
CRUT Example Results
- Client receives annual income of $1,000,000 (possibly payable quarterly) for life.
- Long-term capital gains tax deferred is $4.76M, spread over the donor’s life (based on current capital gains rate of 23.8%).
- Diversification away from single stock risk is achieved.
- Income tax charitable deduction around $6.6M, tax savings range from 23.8 – 39.6%.
- Compound after-tax income to donor over life $48M (vs. non-CRUT strategy $36M).
- Value left to charity $65M with CRUT strategy vs. $52M without.
For initial exploratory conversations about CRTs, please reach out to your CBIZ team. The above modelling is an example and can change based on expected rates of return, marginal tax rates, age, life expectancy, and the IRC Section 7520 interest rate.
Assets That Can be Gifted to a CRUT
CRTs are very flexible in the assets that can be placed in trust. In fact, a recent question that came up in to our Seattle office was “Can a CRT accept Bitcoin or other cryptocurrencies?”. The answer was yes with the proper structuring. Assets may also include:
- Stock – public and private
- Certain closely held business or partnership interests – note: Charitable trusts cannot hold stock in an S Corporation
- Real estate and/or land
- Complex assets (cryptocurrencies, life insurance policies, art work, etc.)
In summary, CRTs may be a great way to defer capital gains tax, save taxes currently with a charitable deduction, and diversify out of single asset risk. Whether you need to develop gifting strategies, create a charitable trust or private foundation, or navigate philanthropic giving with direct gifts to your charity of choice, CBIZ has the team with the expertise to help. Contact a member of our team for more information.
Copyright © 2021, CBIZ, Inc. All rights reserved. Contents of this publication may not be reproduced without the express written consent of CBIZ. This publication is distributed with the understanding that CBIZ is not rendering legal, accounting or other professional advice. The reader is advised to contact a tax professional prior to taking any action based upon this information. CBIZ assumes no liability whatsoever in connection with the use of this information and assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect the information contained herein.
CBIZ MHM is the brand name for CBIZ MHM, LLC, a national professional services company providing tax, financial advisory and consulting services to individuals, tax-exempt organizations and a wide range of publicly-traded and privately-held companies. CBIZ MHM, LLC is a fully owned subsidiary of CBIZ, Inc. (NYSE: CBZ).