Charitable Remainder Trusts: Generating Income While Giving to Charity

What Are Charitable Remainder Trusts?

A Charitable Remainder Trust (CRT) can be an effective tool for managing the tax implications of selling a business while also benefiting a charity. A CRT is an irrevocable trust that generates a potential income stream for you as the donor to the CRT or other beneficiaries, with the remainder of the donated assets going to your favorite charity or charities.

This charitable giving strategy generates income and can enable you to pursue your philanthropic goals while helping provide for living expenses. Charitable trusts can offer flexibility and some control over your intended charitable beneficiaries and lifetime income, helping with retirement, estate planning, and tax management.

How Does a Charitable Remainder Trust Work?

Let’s walkthrough an example of how a typical scenario might unfold, illustrating the benefits to the grantor (in this example, a business owner named John ) and the charitable beneficiaries.

Scenario

John owns a business valued at $5 million, which he intends to sell. Anticipating significant capital gains tax from the sale, John decides to use a CRT to mitigate these taxes and support his favorite charity.

Steps in the Scenario

1. Establishing the Charitable Remainder Trust: Before selling his business, John sets up a Charitable Remainder Unitrust (CRUT), one of the CRT types.
2. Transfering Business Assets: John transfers the business into the CRT before it’s sold. This step is crucial because the trust is a tax-exempt entity.
3. Selling the Business: The CRT then sells the business on behalf of John for $5 million. Because the CRT is tax-exempt, no capital gains tax is due at the time of the sale.
4. Investing the Proceeds: The CRT invests the proceeds from the sale to provide an income stream. The income stream benefits both John and the charity.
5. Annual Distributions: John receives a fixed percentage (say 5%) of the trust’s assets annually, recalculated each year based on the current value of the CRT’s assets. These distributions are taxable, but John benefits from spreading the tax burden over many years, potentially at a lower tax rate.

Benefits to the Charitable Remainder Trust Grantor (John)

• Tax Deferral: John avoids immediate capital gains tax on the sale of his business, as the trust does not pay these taxes upon selling the business.
• Income Stream: John receives an annual income, which can be particularly beneficial if he wants retirement income.
• Estate Tax Reduction: John potentially lowers his future estate taxes by moving the business out of his estate and into a CRT.
• Charitable Deduction: John receives an immediate charitable income tax deduction in the year he funds the CRT. The deduction is based on the net present value of the remainder of interest expected to go to the charity.

Benefits to the Charity

• Guaranteed Beneficiary: The charity is assured of receiving the remainder of the trust after the trust term ends (e.g., after John’s death or after a fixed number of years).
• Potential for Larger Donation: The assets in the CRT can grow tax-free, potentially resulting in a larger amount being available to the charity upon termination of the trust than if the business had been sold outside of a trust structure.

Timing of Benefits

• For the Grantor (John): Benefits begin immediately with the tax deduction in the year the trust is funded and continue with annual income distributions, which are usually for life or a specified term.
• For the Charity: Benefits are received only after the termination of the trust, which could be many years later. The timing depends on the length of the trust term or the beneficiaries’ lifetime.

Is a Charitable Remainder Trust Right for You?

Using a CRT in the sale of a business provides significant tax and income benefits to the grantor while also substantially supporting charitable goals. The CRT is a good option if you want an immediate charitable deduction but also need an income stream for yourself or another person. It’s a powerful example of how strategic charitable planning can meet both personal financial goals and philanthropic aspirations.