Charitable Remainder Annuity Trust
A transfer of assets (cash, securities, real estate, or other property) to a trustee. The trustee can sell the assets and invest the proceeds to provide a fixed income to the donor and a remainder to benefit Oxfam (the donor receives an immediate charitable income tax deduction upon establishing the trust).
What are some benefits of charitable remainder annuity trusts?
Sale of valuable assets through an annuity trust will avoid the capital gain tax on any appreciation, reduce or avoid estate taxes, and eliminate the need to probate assets placed in the trust. It is often more beneficial than either keeping the assets or transferring them in a taxable sale.
Income payments are a fixed amount, typically stated as a percentage of the initial market value of trust assets.
Transfers of assets to an annuity trust are deductible in part (correlating to the gift portion of the trust) for income tax purposes. Typically, the donor is entitled to an income tax charitable deduction in the year assets are transferred to the trust, plus up to 5 carryover years.
The period of the trust can be based on one or more lifetimes, or a term of years (up to 20 years). The trust enables an individual to be philanthropic while also meeting his or her own retirement or other needs with inflation-sensitive income payments.
Annuity trusts may allow donors to diversify assets tax-free while protecting them from creditors. They also are used to increase cash flow, generate tuition payments for children or grandchildren, or provide support for elderly or handicapped family members. At the same time, they create a sizeable future gift for Oxfam America.
What are some details and tax issues regarding charitable remainder annuity trusts?
Capital gains tax may be avoided when an asset is transferred to and later sold by the trustee of the annuity trust. The gift asset may also avoid federal estate and gift taxation if either the donor, donor's spouse, or the donor and donor's spouse are the designated income beneficiaries.
Payments to income beneficiaries are generally taxable. The minimum payout allowed is 5 percent at least annually. An additional calculation is required to ensure that the probability of the trust being exhausted prior to termination does not exceed 5 percent.
Payments may be set for life or a term of years not to exceed 20 years. A "term of years" trust may name as income beneficiary an individual or class of individuals, corporation, partnership, trust, or estate. Payments to income beneficiaries must come exclusively from the trust assets and may not be guaranteed by the charity.
Payments to income beneficiaries are taxed on the basis of the IRS rule that trust funds are deemed to be dispersed in accordance with the following tiered order of distribution:
a. first from ordinary income;
b. then from capital gain;
c. then other income (such as tax-exempt income); and
d. lastly, as a distribution of principal.
Under the above "four-tier system," when capital gain tax is avoided on the sale of an asset through an annuity trust and the proceeds are invested in tax-exempt bonds, the capital gain is deemed to be distributed prior to any distribution of tax-free income.
A charity may receive income payments if at least one individual is also an income beneficiary. The named income beneficiary must be alive when the trust is executed, unless the beneficiary is included in a designated class (e.g., "donor's children") in a trust for a "term of years." Pets do not qualify.
The income tax charitable deduction equals the present value of the remainder interest the charity is expected to receive in the future, based on IRS tables and a floating monthly interest rate.
The income tax charitable deduction is reduced to the extent of any income that would have been recaptured had the asset been sold rather than contributed to the trust. This applies to depreciable real property (to the extent the depreciation taken exceeds "straight line"), depreciable personal property, inventory, accounts receivable, trade or business notes, short-term capital gain property, certain copyrights, and other types of "ordinary income property."
The transfer of mortgaged property to a charitable remainder trust is generally inadvisable due to several potentially adverse tax consequences including disqualification of the trust. It should not be done without a careful and thorough analysis.
Income or gain realized by the trustee on debt-financed assets may, under certain circumstances, cause the trust to realize unrelated business taxable income (UBTI), thereby subjecting all trust income to taxation for the entire year in question.
In many cases, the donor may serve as trustee or choose to appoint (or remove) a corporate or individual trustee. The named charitable remainder beneficiary may be changed to another charity if the trust document reserves that right for the donor or the donor's designee.
Contact our gift planning specialist for more information.