Charitable Remainder Trusts:
A Win/Win Solution to the Estate Tax Dilemma

The Charitable Remainder Trust ("CRT") is once again in vogue. The fear of increased estate and income tax exposure is resulting in a resurgence in the use of CRTs and other advanced estate planning techniques. The CRT is one of the most popular types of charitable giving techniques. It results in an win/win solution to the estate tax dilemma. You, the contributor, may give away your assets to your favorite charity or charities during your lifetime and continue to enjoy the use of the income (a percentage or fixed amount) from the trust during your lifetime. Your spouse or other family members may enjoy the use of income during their lifetime as well. The ultimate charitable beneficiary enjoys the use of the remainder of the trust principal at the termination of the trust. Your family members (who will not inherit the funds passing to the charity) may benefit from this arrangement through the creation of a Wealth Replacement Trust.

This article will focus on the conceptual use of a CRT in estate planning. The technical complexities of a CRT are beyond the scope of this article. However, it is worth noting that there are two types of CRTs. There is the Charitable Remainder Unitrust ("CRUT") and the Charitable Remainder Annuity Trust ("CRAT"). The CRUT provides that a particular percentage of the assets in the trust, determined annually, shall be distributed to the income beneficiary, while the CRAT provides that a fixed amount of the trust shall be distributed annually to the current income beneficiary. Your particular estate plan will dictate which type of CRT or alternative charitable giving technique is appropriate for your situation.

The advantages of a CRT are numerous: the contribution to a CRT may provide you with a current charitable income tax deduction, charitable gift tax deduction, increased liquidity, and reduced estate taxes. Additionally, upon the termination of the trust, the designated charity or charities will receive the remainder of the trust.

An obvious disadvantage of the CRT is the permanent transfer of wealth from the family to the charity. A solution to this dilemma is the creation of a Wealth Replacement Trust ("WRT"). The trustee of the WRT receives annual gifts under the annual gift tax exclusion. The trustee uses the contributed property to purchase insurance on your life or the joint lives of you and your spouse. The annual gifting is made possible by the increased liquidity which is provided by the CRT. Upon the death of the insured, the insurance proceeds are paid to the trustee of the WRT, hence replacing the wealth which passes to the charity.

The following simple hypothetical family fact pattern will help illustrate how the CRT and the WRT fit into your overall estate plan. Mr. and Mrs. Phil Anthropist have a net worth in excess of $2 million. Their estate tax burden will be great. To reduce the tax bite, they decided to contribute a substantial amount of assets to their favorite charity. As noted above, their heirs (as well as the IRS) will lose out (i.e., the estate tax dilemma). They are also frustrated because they own substantially appreciated stocks and real estate that produce little income. They will not sell these assets because of the capital gains tax. If they die, the capital gains problem vanishes (under current law).

One solution is the creation of a CRT followed by contribution(s) of appreciated assets. The transfer to the CRT will result in a current income tax deduction based on the present value of the property passing to the charity. The trust is a tax exempt entity, and therefore, upon the sale of the stocks or real estate by the trustee of the CRT, the trust will not have to pay any tax on the capital gains. The trustee may then reinvest the proceeds from the sale into appropriate income producing investments. Pursuant to the trust, the contributors will receive either a percentage (CRUT) or a fixed amount (CRAT) of the trust assets each year. Whereas, if the contributors sell the appreciated property, the amount which they may reinvest will be reduced by the capital gains tax. Here, the trustee is able to reinvest 100 percent of the proceeds and invest that money in an appropriate income producing property, which will provide the liquidity for the distributions from the CRT. This income from the trust provides increased liquidity to the contributors, which they will then be able to use to fund the WRT (if the contributors so desire). At the termination of the trust, the remaining assets in the trust pass to the charity. Upon the contributors' deaths, their estate does not include the amounts transferred to the CRT. Therefore, their estate tax is substantially reduced.

The WRT is created to receive the increased liquidity, or a portion thereof. The trustee of the WRT independently purchases life insurance on the contributors' life, or a joint and survivor type policy on both lives. When the insurance policy is paid at the death of the insured, the proceeds, under current law, would flow income-tax free into the WRT and the proceeds would not be included in either contributors' estate, if they owned no incidence of ownership at their death. The charity wins, the contributors win, and their children (or other heirs) win.

The technical requirements for the creation and operation of a CRT are rather detailed. There are numerous taxes and other variables that must be considered, including income tax, gift tax, estate tax, generation skipping transfer tax, state income, transfer and intangible taxes. Therefore, your estate plan should be designed with the assistance of a team of financial advisors, including your attorney, accountant, life insurance consultant, financial advisor and corporate or individual trustee.