Charitable Remainder Trust Early Termination, Part 1

A charitable remainder trust (CRT) is an excellent charitable giving and income tax planning tool. A CRT is a trust established to benefit both charitable, tax-exempt organizations and non-charitable beneficiaries. During a CRT’s “term,” the trust makes distributions to the non-charitable beneficiary or beneficiaries (usually, but not always, the person who sets up the trust and/or their spouse). At the conclusion of the trust’s term, all assets remaining in the CRT are transferred to the charitable beneficiaries.

Charitable remainder trusts are most commonly used by individuals who desire an income stream for a number of years or over their lifetime, who have an appreciated asset they wish to diversify in a tax effective manner, and who want to benefit charity. Charitable remainder trusts can be structured in many different ways. As a result, they are flexible philanthropic vehicles. At the time a donor (referred to as a trust grantor or settlor) funds a CRT, they:

• generate a charitable income tax deduction that can be claimed on their tax return beginning with the year the trust is funded;
• can receive an income stream from the CRT’s term, which can be for a number of years (not exceeding 20), over a lifetime or times, or for a combination of year(s) and lifetime(s);
• establish a charitable endowment, since once the CRT’s term ends all assets remaining in the CRT are transferred to a charity or charities; and
• can defer payment of income tax on the sale of appreciated assets transferred to the CRT and then sold, as well as all future earnings within the CRT, since a CRT is a tax-exempt entity.

In future posts, I’ll discuss the different CRT varieties and their structures. However, this post is the first of two directed to those who previously established or are presently the income beneficiaries of a CRT but, because of changed circumstances, either no longer need the income stream or would prefer a lump sum payment in exchange for the income stream.

Terminating a CRT Before Its Term Runs

A CRT terminates naturally once the term of the income stream payable to the non-charitable beneficiary ends. When the term ends, any assets held by the trust are distributed to the designated charitable beneficiaries (the remainderman). But what if you would like the CRT to terminate prior to the end of the trust term established by the trust agreement? In many cases, if not most, it can be done. There are two primary methods of terminating a CRT before the date specified in the trust agreement. The first is to sell the CRT interest or interests. The second is to make a gift of the CRT income interest or interests.

The income beneficiary of a CRT can transfer by gift all or a portion of their CRT interest to the charitable remainder beneficiary. When the income interest is gifted to the remainder beneficiary, under most states’ laws the income and remainder interests are considered merged. When trust interests merge, the same trust beneficiary owns the entire trust and it is considered terminated. Once terminated, all assets held by the trust are distributed to the sole beneficiary – in this case the CRT charitable beneficiary. The CRT income beneficiary that transfers their interest by gift to the remainderman charity is entitled to a charitable income tax deduction equal to the actuarially determined value of the income interest transferred as determined on the date of the gift.

It is also possible to terminate only a portion of a CRT. If a CRT income beneficiary transfers by gift only a portion of their income interest to the remainderman charity, only an equivalent portion of the trust is considered merged by reason of the gift. Thus, only a portion of the trust is terminated, and the charitable remainderman will receive only a partial distribution from the CRT as a result of the gift (e.g., if the income beneficiary transfers fifty percent of their income interest to the charitable remainderman, the charity receives a fifty percent distribution of the trust assets as a result of the gift).

There are a number of considerations that enter into a successful CRT income interest gift. Among these are:

• What state’s law applies to your CRT? The ability to terminate a CRT prior to the date stated in the trust document and the process necessary for an early terminate are dictated by the law applicable to the CRT.
• How many CRT income beneficiaries are there? For a successful gift, all income beneficiaries must make a gift of their interest (or a portion of their interest).
• Are the charitable remainderman beneficiaries irrevocably named, or do you or someone else have the ability to change the charitable beneficiaries? For a successful gift, the charitable remainderman must be irrevocably designated prior to the gift.
• Are the charitable beneficiaries private foundations or does the trust agreement allow a private foundation to be a beneficiary of the CRT, and have the income beneficiaries held their interests in the CRT for a year or longer? The answer to this question affects the value of the charitable deduction generated by the gift of income interest to charity.

CRT Termination Can Increase Your Charitable Impact

As you can see, there are a number of issues surrounding the early termination of a CRT as the result of transferring the income interest by gift to the CRT’s charitable beneficiaries. However, for those CRT income beneficiaries that no longer need the cash flow generated by the CRT, a gift of the interest may help to fulfill their charitable goals today, while generating an income tax deduction in the tax year of the gift.

If you are the income beneficiary of a CRT, have the power to change the charitable beneficiaries of the CRT, and you are considering an early termination of the CRT by gift, a donor-advised fund sponsor such as DonorsTrust can give you additional flexibility in your giving.

To do this, simply name the donor-advised fund sponsoring organization as the sole charitable beneficiary of the trust and donating your income interest to it. When the trust terminates as a result of the gift, the entire value of the trust will be allocated to your donor-advised account. You may then recommend any number of charitable organizations receive grants from your donor-advised fund now. In this way, assets held in the CRT are put to use by charity today, rather than at some future date, and can be used to support a variety of charitable interest beyond a single organization.

DonorsTrust professionals have experience with early terminations of CRTs. We would be happy to discuss with you and your legal and tax advisors how we can assist you with an early CRT termination.

NOTE: The information contained in the following article is educational and informational in nature only, and not legal or tax advice applicable to any particular set of facts and circumstances. The post was not written to be used by any taxpayer to avoid penalties nor was it written to support the promotion or marketing of the matters addressed. Consult your legal and tax advisors for the tax impact on your situation prior to any personal action.