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Charitable Remainder TrustsNO MORE CAPITAL GAINS TAXThose who waited for the Clinton Administration to pass a bill reducing capital gains taxes, were well rewarded. But there is a way to avoid capital gains taxes altogether, reduce or eliminate estate taxes, reduce your income taxes, and protect your assets from creditors; all in a manner that is not only legal, but is encouraged by the Federal government. What is this magical tool, that seems almost too good to be true? The Charitable Remainder Trust. Suppose a person, we will call him Taxpayer, intends to sell a capital asset(s); real estate for example, but it may be stocks, bonds, precious metals, gemstones, or any other capital good. Suppose further that this capital good was purchased for $50,000 and is now worth $100,000, amounting to a potential capital gain of $50,000. Suppose now that Taxpayer goes ahead and sells the property, taking his $50,000 capital gain. Assuming Taxpayer is in the 28% tax bracket, Taxpayer will pay $14,000 in capital gains taxes, and will have $86,000 for future investment. It must also be noted that Taxpayer's $86,000 is still in Taxpayer's estate, and is subject to creditor's claims and to estate taxes when he dies. If Taxpayer dies single, and his net estate is valued at $686,000 his estate taxes will be approximately $32,000, meaning that on the $100,000 sale, his heirs will net $54,000. On the other hand, if Taxpayer lives and invests his $86,000, Taxpayer will pay tax on the investment income. If his return is 10%, or $8,600 per annum; taxes will be $2,408, leaving him at the end of one year with a sum of $92,192; still subject to lawsuits and estate taxes of a minimum 37% on anything over $600,000. Now let's look at Taxpayer's brother, Wiseguy. Wiseguy purchased a similar property at a similar price and sold it at a similar price. The difference is that before he sold it, Wiseguy moved his property into a Charitable Remainder Trust, of which Wiseguy is the trustee, so that it was the trust that actually sold the property. The result is that Wiseguy pays no capital gains taxes, because he didn't sell the property; and the trust pays no capital gains taxes, because the trust is exempt from taxes. Moreover, Wiseguy is entitled to take a deduction on his personal income taxes in an amount equal to 30% or 50% of the value of the remainder interest of the trust. Wiseguy, as trustee of the trust has $100,000 for future investment. It is important to note that Wiseguy's $100,000 is not in Wiseguy's estate, and is not subject to creditor's claims and estate taxes when Wiseguy dies. On the other hand, if Wiseguy lives, and as trustee of the trust, invests the $100,000, neither Wiseguy nor the trust, will pay tax on the investment income. Suppose his return is 10%, or $10,000 per annum. At the end of one year, even after making the required payment to Wiseguy, as described below, the trust will still have approximately $105,000 for future investment as opposed to Taxpayer's $92,192. Is this too good to be true? No!! The concept is simple; the person wishing to avoid capital gains taxes simply donates the property to a Charitable Remainder Trust, retaining control over the property as Trustee. The donor takes a charitable deduction on his personal income taxes, and the trust pays no taxes on the sale of the property if and when it is sold. But there are tradeoffs that must be taken into consideration. The tradeoffs revolve mainly around the issue of who is to be the beneficiaries of the Charitable Remainder Trust. Catch No. 1.There must be at least one non-charitable beneficiary; and the non-charitable beneficiary(ies) must be paid an annual payment from the trust. Depending on the characterization of the funds paid to the non-charitable beneficiary(ies), this payment may be taxable. This "catch" may in fact be a blessing for those who need the income from their property. Catch No. 2.The remainderman, that is, the beneficiary that ultimately receives the property remaining in the trust when the non-charitable beneficiary(ies) pass on, must be a charitable institution as defined in Internal Revenue Code, Section 170(c). This catch can easily be overcome as described below. There are essentially two kinds of charitable remainder trusts; the charitable remainder annuity trust and the charitable remainder unitrust. The differences in the two types of trusts involve the way the mandatory annual payment is made to the non-charitable beneficiary(ies). The differences in the payout methods make for some interesting planning opportunities. These opportunities, as well as, further details of the workings of charitable remainder trusts will be examined below. For now, suffice it to say that the biggest drawback in creating a charitable remainder trust is that the children, if they know about it, are likely to scream foul, because upon the donor's death, anything left in the trust will go to the charity named in the trust, and not to the children. That could obviously put a crimp in the children's plans. The solution is fairly simple. Simply establish an irrevocable life insurance trust, funded with a life insurance policy on the life of the Donor, approximating the value of the property transferred to the charitable remainder trust, with the children as beneficiaries. The policy is owned by the trust, so it will not be included in the Donor's estate for estate tax purposes; and the proceeds will not be taxed as income when it goes to the children. This latter strategy may also be used by persons unable to establish an estate, but nevertheless want to leave something, or something extra, when they pass on. A second solution would involve setting up your own private foundation to act as remainderman to receive the proceeds of the charitable remainder trust. A private foundation may be established to accomplish almost any good cause, i.e. research, education, charity, etc. It is relatively simple to do, and it would permit your children or other heirs to control the foundation for their lifetime and to earn income from it. Payments to Non-charitable Beneficiaries.At least one non-charitable beneficiary must be named to receive taxable annual payments from the trust for the life of the beneficiary or for a term of not more than twenty years. This is how the government assures itself that it will receive at least some tax revenue. Typically, the Donor will name himself and/or his spouse as the non-charitable beneficiary; but if he wishes, he may name his children instead of himself or in addition to himself and his spouse. The differences between the two kinds of Charitable Remainder Trusts, the annuity Trust and the unitrust, make for some interesting planning opportunities. Amount of Payout.The major difference between the two kinds of trust, is that the annual payment from the annuity trust is at least 5% of the initial net fair market value of the trust property; whereas the annual payment from the unitrust is at least 5% of the net fair market value of the trust property as revalued each year. This, of course, means that the payments from an annuity trust are fixed and the payments of unitrust will fluxuate. Accordingly, the choice may be made, depending on the needs of the Donor, or his outlook for the economy. The payments from a unitrust are likely to keep pace with inflation, but if the Donor is dependant upon the income and would have difficulty with reduced payments in a deflationary time, the annuity trust might be more suitable. With either type trust the payments must be made for the lifetime of the beneficiary(ies) or a term not to exceed twenty years. If a fixed term is chosen, the trust may be drafted so that if the beneficiary passes away before the term has expired, his payout may go to his heirs for the balance of the term. At the end of the fixed term, or when the last beneficiary passes on, the remainder in the trust will go to the designated charity. Taxation of the Payout.Taxes to the beneficiary are, of course, computed in such a way as to maximize revenue for the government. Distributions are characterized according to the character of the trust's income. For example, a distribution is considered to be ordinary income to the extent of the trust's ordinary income, and all undistributed ordinary income from previous years. When all ordinary income is exhausted, income is considered to be capital gains, to the extent the trust had capital gains; next is "other income" and finally, if all income is exhausted, the distribution would be considered to be a payout of trust corpus. Alternative Remaindermen.The trust instrument must provide for an alternative charity, to be the beneficiary in case the designated beneficiary does not qualify as an organization described in I.R.C. 170(c). But one of the many factors that make this whole strategy so attractive, is that the trust instrument may permit the Donor to retain the right to remove a designated remainderman and name another qualified organization in its place. This means that if the Donor has always had the intention of setting up his own charitable foundation, but hasn't gotten around to it yet, he can go ahead and name any qualified charity for now, and then when his own foundation is in place, he can remove the designated remainderman, and name his own foundation as the charitable beneficiary. Conclusion.While the scope of this article does not permit an exhaustive discussion of all the details and nuances of charitable giving, it should be evident that both types of trusts offer substantial tax and practical benefits to the Donor. Given the relatively low cost of implementation, it is obvious that the immediate tax savings, along with the long term benefits, are more than enough to offset the cost of creating the trust and any inconvenience raised thereby. CLICK HERE For The Cost Of Establishing a Charitable Remainder Trust Copyright ©1997 |
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