Charitable Remainder Unitrust (CRUT)

A charitable remainder unitrust, or “CRUT,” is an irrevocable trust which pays to the grantor (i.e., the creator or settlor of the trust), or beneficiaries selected by the grantor, or both the grantor and beneficiaries, a fixed percentage of the trust assets, the value of which is redetermined each year. At the end of the trust, the remaining assets of the trust go to one or more charities.

Why Use It?

The usual reason for creating a CRUT is that the grantor wants to make a gift to charity at his or her death, but wants a present charitable income tax deduction for the future gift. A CRUT can carry out that goal even though the CRUT is irrevocable because the grantor retains an income-like interest in the value of the assets transferred to the trust, and so continues to have the benefit of the assets during lifetime.

Another reason for a CRUT is that the grantor wants to provide an income for a child or other relative, or a friend, but wants the trust assets to go to charity following the death of the beneficiary.

A third reason for creating a CRUT is that CRUTs do not pay federal income tax, although income and gains that are earned by the trust become taxable to the beneficiaries of the trust when they are distributed. If a person who wishes to make charitable gifts has a valuble asset that has appreciated in value and is about to be sold, it may be advantageous to donate the asset to a CRUT before agreeing to the sale, so that the income tax on the capital gain is deferred until the gain is actually distributed in the future. This deferral of tax allows the pre-tax profit from the sale to be invested and produce future income, much like a retirement fund can defer income tax until retirement distributions are made. (When a trust is created to hold an investment producing very little current cash income, the CRUT can be created as an "net income" CRUT which later "flips" to require percentage distributions. See the explanation below of "NIMCRUTs" and "Flip CRUTs.")

Finally, a CRUT can be used as a kind tax-deferred retirement fund, which can accumulate and reinvest capital gains and defer the payment of any federal income tax until the capital gains are reinvested in income-producing investments and the income is distributed. (See the explanation of "NIMCRUTs" below.)

How Does It Work?

A gift to a CRUT results in a charitable deduction because section 170 of the Internal Revenue Code allows a charitable income tax deduction for the present value of the future charitable remainder in a trust described in section 664, which includes charitable remainder unitrusts. The same present value is also a federal gift tax deduction, so only the noncharitable interests are subject to gift tax. If the CRUT is created at death, then the present value of the charitable remainder is a federal estate tax deduction, so only the noncharitable interests are subject to estate tax.

Section 664 of the Internal Revenue Code also says that a CRUT is not subject to income tax, and that the income and gains of CRUT are taxable to the noncharitable beneficiaries of a CRUT only when they are distributed.

The present value of the charitable remainder is based on the precentage of the trust that must be distributed each year. So a CRUT for one year with a 5% payout would have a charitable remainder of 95% of the initial value of the trust, a CRUT with the same payout for two years would have a charitable remainder of 95% of 95%, or 90.25%, and so forth. When the CRUT is for the life or lives of the noncharitable beneficiaries, the value of the future remainders is based on the probabilities of the beneficiaries living or dying in the future years. When there is a delay between the annual valuation of the assets of the CRUT and the distribution of the percentage of that value, or the distribution is made in quarterly or other periodic installments, the valuation of the remainder is adjusted through a formula that takes into account the number of installments, the months from valuation to the first distribution, and interest on the delayed distributions.

The Internal Revenue Code and regulations impose a number of restrictions on CRUTs, the most signficant of which are the following:

• The payout percentage must be at least 5%, and cannot be more than 50%.
• The present value of the charitable remainder must be at least 10% of the contribution to the trust.
• The duration of the trust cannot be more than 20 years or until the deaths of the noncharitable beneficiaries.
• The trustees of CRUTs are subject to many of the rules that apply to private foundations, such as the prohibition on self-dealing.

NIMCRUTs and Flip CRUTs

There are variations on the regular CRUT known as "NIMCRUTS" and "Flip CRUTs."

"NIMCRUT" is an acronym for "Net Income with Makeup Charitable Remainder UniTrust." The Internal Revenue Code allows a CRUT to be created which distributes either (a) the specified percentage of the value of the trust assets or (b) the actual net income of the trust (e.g., interest and dividends, but not capital gains), whichever is less. The same trust can also provide for "makeup" distributions if trust income is less than the precentage amounts that could have been distributed, and the trust income later increases to more than the percentage amount, in which case the trust can distribute the amounts of excess income that will bring the total distributions up to what would have been the distributions if the percentage distributions had been made all along.

This net income limitation does not increase or otherwise affect the present value of the charitable remainder, but allows greater flexibility in planning the amounts and timing of distributions from the trust.

There are two principal uses for a NIMCRUT:

• As mentioned above, it might be desirable to transfer an appreciated property to a CRUT, so as to defer tax on the capital gains when the property is sold. However, there may be a delay before the property is sold, and the property might generate little (if any) income until it is sold, so the CRUT will be illiquid and unable to make cash distributions until the property is sold. Under those circumstances, it might be helpful to create the CRUT as a NIMCRUT so that distributions can be limited to actual income until the property is sold and the proceeds can be reinvested so as to create a larger income.
• As mentioned above, it might also be desirable to create a NIMCRUT and deliberately make investments that result in capital gains instead of ordinary income, or produce income that is not received until future years. Capital gains can be reinvested without immediate income tax liability, and income distributions can then be deferred to a future year, much like a retirement fund.

As taxpayers began using NICRUTs for these purposes, the Internal Revenue Service decided to make it easier (and not harder) by adopting regulations allowing a "flip CRUT," which is a NIMCRUT that can switch to being a regular CRUT upon the happening of a pre-defined event, or at a specified time. The differences between a NIMCRUT and a "flip CRUT" is that, after the Flip CRUT changes from a NIMCRUT to a regular CRUT, it (a) makes percentage distributions regardless of net income, and (b) cannot make any makeup distributions. So, for the examples described above:

• If a CRUT is created with a property that produces little or no current income, the CRUT document can direct that the trust will initially be a NIMCRUT, and then switch to become a regular CRUT once the property is sold.
• If the goal is to accumulate capital gains from trust investments until the noncharitable beneficiary retires and has less income, then the CRUT document can direct that the trust will initially be a NIMCRUT, and then switch to become a regular CRUT on the date that beneficiary reaches a specified age.

Benefits

The primary benefits of a CRUT are:

• The donor/grantor of the trust gets an immediate income tax deduction (or estate tax deduction in the case of a CRUT created at death) for the present value of the future remainder payable to charity.
• Because the distributions to the grantor or other noncharitable beneficiaries are a percentage of the value of the trust, which is revalued annually, the distributions can increase if the investment of the trust increase in value (or decrease if the investments decrease in value).
• The income and gains of the CRUT are not subject to income tax until they are distributed to the noncharitable beneficiaries.

Costs

The primary costs of a CRUT are:

• There may be a gift tax (or estate tax) cost for the present value of distributions to be made to beneficiaries other than the donor/grantor. (Although the gift tax cost of distributions following the death of the grantor can be postponed if the grantor retains the right to revoke the interests of those beneficiaries.
• Because the distributions to the grantor or other noncharitable beneficiaries are a percentage of the value of the trust, which is revalued annually, the distributions can decrease if the investment of the trust decrease in value (or increase if the investments increase in value).
• Because the CRUT can only distribute the unitrust percentage, and not any additional amounts, the grantor or other noncharitable beneficiaries will be unable to withdraw funds that might be needed for medical or other emergencies, or for other purposes which would be permitted for other kinds of trusts.
• There are also possible transactional costs:
• The legal fees or other costs of preparing the CRUT trust document.
• The costs of valuing the charitable and noncharitable interests in the CRUT for income tax and gift tax purposes, or for estate tax purposes, which costs would include the costs of valuing the assets being transferred to the GRAT and the costs of calculating the value of the remainder interests based on the values of the assets transferred to the CRUT. If real property, closely held business interests, or other properties with no readily ascertainable market values are transferred to the CRUT, appraisals might be needed for those properties.
• The costs of preparing any gift tax returns that may be needed to report the creation of the trust and the present value of the charitable noncharitable interests in the CRUT.
• The costs of revaluing the trust assets each year, and preparing the required income tax returns for the trust.
• The other costs (if any) of administering the trust. The investment costs of the CRUT should be the same as what the grantor would have paid for investment advisors if the CRUT had not been created, so the creation of the CRUT should not cause additional administrative costs beyond what might be required for accounting for the receipts and disbursements of the CRUT.

CRUT or CRAT?

There is another form of charitable remainder trust, and that is a charitable remainder annuity trust, or "CRAT." A CRAT is similar to a CRUT, except that instead of paying out a percentage of the value of the trust assets, a CRAT pays out a fixed dollar amount each year, regardless of the value of the trust assets.

A common question is, which is better, a CRUT or a CRAT? The answer depends on the goals and motives for creating the trust.

• The charitable deduction will be different for a CRUT and a CRAT even if they have what looks like similar payouts, so that the percentage payout from the CRUT is the same as the CRAT annuity as a percentage of the transfer to the CRAT. For example, there may be a significant difference between the charitable deduction for a $100,000 CRUT with a 5% payout and the charitable deduction for a $100,000 CRAT paying a $5,000 annuity, even though the annuity amount is 5% of the value of the CRAT. This is because of the differences in the ways that CRUTs and CRATs operate, and the different ways their charitable remainders are valued:
• The charitable remainder from a CRUT is valued based on the percentage payout, and the current and future assumed income yields, represented in other present value calculations by the §7520 interest rate, is almost irrelevant. So the remainder for a CRUT with a 5% payout may be pretty much the same regardless of whether current interest rates are 4% or 8%.
• The charitable reaminder from a CRAT is valued based on the assumption that the trust will earn the current §7520 rate, and the present value of the remainder will vary greatly based on the difference between (a) the annuity payment and (b) the income that will be earned by a trust earning the §:7520 rate on investments. So the present value of the remainder for a CRAT that pays an annuity that is 5% of the initial value of the trust will vary a great deal depending on whether the §:7520 rate is 4% or 8%.
• The distributions from a CRUT will increase if the value of the trust increases, because the trust has been able to produce income and gains that are greater than the percentage payout, and the distributions will decrease if the investments yield less than the percentage payout. However, a CRAT will always payout the same amount until the trust ends, whether due to its terms or because the trust fund has been depleted by the noncharitable distributions. The choice between a CRUT and a CRAT may therefore depend on (a) expectations of future investment returns and (b) the grantor's goals for the noncharitable and charitable beneficiaries.
• Optimism about future investment yields, together with a desire to benefit the noncharitable beneficiary, might lead to the choice of the CRUT in order to give the noncharitable beneficiary the potential for an increasing income. However, if the goal is to maximize the future remainder to charity, and a fixed income for the noncharitable beneficiaries is acceptable, then a CRAT may be the better choice.
• Pessimism about future investment yields would lead to the opposite conclusions. A desire to benefit the noncharitable beneficiary would lead to the choice of the CRAT in order to give the noncharitable beneficiary the fixed income even though it might reduce (or eliminate) the future charitable remainder. However, if the goal is to preserve the future remainder to charity, and a reduced income for the noncharitable beneficiaries is acceptable, then the CRUT may be the better choice because the noncharitable distributions will decrease if the value of the fund decreases.

Webcalculators can produce economic projections of both CRUTs and CRATs so that the results of different payouts and investments assumptions can be illustrated for both kinds of charitable remainder trusts.

Decisions

Because the terms of a CRUT are restricted by the Internal Revenue Code and regulations, there are usually only a few decisions to be made when a CRUT is created:

• Who are the noncharitable beneficiaries?
• Who are the charitable remainder beneficiaries? Are they named now, or will the grantor name them in the future? Or can the trustees of the CRUT name the charities to receive the remainder at the end of the trust?
• What is the duration of the trust? A term of years? The lifetimes of the noncharitable beneficiaries? Or a combination of the two (such a trust for the lifetime of the grantor and the grantor's spouse, or a term of twenty years, whichever is shorter). It may be necessary to limit the number of noncharitable beneficiaries, or the number of years the trust can continue, in order for the present value of the charitable remainder to be at least 10% of the transfers to the trust.
• What is the percentage payout from the CRUT? The payout must be at least 5%, but can be more than that (although larger percentages will reduce the present value of the charitable remainder). (Webcalculators can calculate the largest payout that will still result in a 10% charitable remainder.)
• If the property contributed to the trust, or the initial trust investments, will produce little cash income (e.g., interest, dividends, or rents), should distributions be limited to that trust income? If distributions are initially limited to trust income, should the trust "flip" upon the sale of the property (or other event) to require distributions of the full percentage the trust value? (Directing that the trust "flip" will eliminate any possibility of make-ups for past under-distributions caused by the income limitation.)