A couple wants to take income from highly appreciated assets, give some of those assets to charity, avoid capital gains tax on the transfer and reduce their taxable estate. Are they asking too much? If they use a charitable remainder annuity trust, then perhaps not. Further, if the CRAT allocates at least some of its assets to a deferred variable annuity paying a guaranteed minimum annuity income, then it can guarantee income for the couple and enable the couple’s charity to get a reasonable amount at their deaths.
Charitable Remainder Annuity Trust
A CRAT is an irrevocable trust with at least one non-charitable income beneficiary and at least one charitable remainder beneficiary. A donor transfers assets to the trust and receives an income during life or for a term of years (not exceeding 20).
Whatever remains at the donor’s death or at the end of the term goes to the charitable beneficiary. The transfer generates a charitable deduction for the donor, but only for the present value of the charity’s remainder interest. Only one transfer to a CRAT is allowed.
Highly appreciated assets work well as a transfer to a CRAT because the donor avoids capital gains tax on the transfer. CRAT income is set between 5% and 50% of the value of the original transfer and may not change. Income is further limited by a probability test designed to help ensure that something from the original transfer remains for the charity.
John and Mary Smith, age 65, are worth $5 million, $1 million of which is highly appreciated stock. They want an income from their portfolio, but also want to make a substantial donation to charity when they die. They additionally desire to remove the portfolio from their taxable estates and to avoid capital gains tax.
Their attorney drafts a CRAT into which John and Mary transfer their $1 million stock portfolio. The transfer avoids capital gains tax and removes the asset from their taxable estate. CRAT income is set at $50,000 (5% of the initial transfer) annually for their joint lives, an amount that will never change (assuming the trust’s investments perform well enough to sustain the income).
John and Mary’s CPA tests the 5% income requirement against the probability test and it passes. The CPA also tells them that their transfer produces a $393,490 charitable deduction, which is the present value of the charity’s anticipated remainder. To the extent the deduction does not exceed 50% of John and Mary’s adjusted gross income, they may use it in the present year. Otherwise, they may carry forward the unused part for up to 5 more years.1AE1511 1106