8080 / What are the periodic payment requirements that apply to charitable remainder trusts (CRTs)?

The CRT must provide for periodic payments within limits set forth in the Code (see Q 8088, Q 8089) and based on the net fair market value of the trust assets. If the trust is a charitable remainder annuity trust (CRAT), the fair market value will be determined only once (at the inception of the trust) and the payout amount will be fixed based on that valuation. If the trust is a charitable remainder unitrust (CRUT), the fair market value will be determined annually and the payout amount (not the percentage) will vary from year to year as the value of the trust fluctuates. Most CRTs provide for a payout of between 5 percent and 10 percent. See Q 8100 regarding the taxation of these payments to the income beneficiary.

Obviously, the higher the payout and the greater the number of noncharitable beneficiaries, the lower is the value of the remainder interest the charity will ultimately receive. The value of the remainder interest passing to the charity must be at least 10 percent of the net fair market value of the property placed in the trust.¹ See Q 8088, Q 8089.

In the absence of authorization to the contrary, a charitable remainder trust may be forced to invade the corpus of the trust if the performance of its investments is such that income is insufficient to meet the payout requirement. One way to alleviate this problem is through the net income unitrust, which limits its payout to the trust’s net income, if that amount is less than the percentage payout called for by the trust. Another variation is a net income with makeup unitrust, in which a net income unitrust is permitted to make up payments that were called for in earlier years but were not made because trust income was less than the required payment. Both of these instruments are specifically authorized by the IRC.² Flip unitrusts are permitted under regulations, but only under very limited and narrow conditions (see Q 8089).³ However, no other variations from these prescribed payout structures are permitted.

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Planning Point: A common use of the flip unitrust is when a charitable remainder trust is funded with unmarketable assets, such as real property, closely held stock, or some other type of asset for which there is not a ready market. A flip unitrust is used so that the trustee will not be compelled to make a payment without sufficient liquidity to make the payment. In a properly structured flip unitrust, the trustee would not be required to pay the net income of the trust to the income beneficiary until the unmarketable property was sold and the trust’s assets became liquid. Ted R. Batson, Jr., MBA, CPA, Senior Vice President of Professional Services for Renaissance.

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The flexibility of the net income with makeup unitrust (sometimes called a “spigot trust”) has led to its use as a retirement planning tool. Under a typical arrangement, a client establishes a net income with makeup unitrust, which then invests the contributed property in growth assets with little or no income, such as zero coupon bonds. Additional contributions are made as often as the donor wishes; inside growth of the trust assets typically occurs tax-free (see Q 8103). In addition, the donor receives a charitable deduction for a portion of each contribution, based on the present value of the remainder interest (see Q 8099), assuming the trust otherwise qualifies as a CRUT (see Q 8089). When the donor nears retirement, trust investments are shifted to income producing assets, and the payout increases as the trust “makes up” the payments that were not made in earlier years.