A charitable remainder trust can provide a multitude of benefits

If you’re charitably inclined but concerned about having sufficient income to meet your needs, a charitable remainder trust (CRT) may be the answer. A CRT allows you to support a favorite charity while potentially boosting your cash flow, shrinking the size of your taxable estate, reducing or deferring income taxes, and enjoying investment planning advantages.

How does a CRT work?

You contribute stock or other assets to an irrevocable trust that provides you — and, if you desire, your spouse — with an income stream for life or for a term of up to 20 years. (You can name a noncharitable beneficiary other than yourself or your spouse, but there may be gift tax implications.) At the end of the trust term, the remaining trust assets are distributed to one or more charities you’ve selected.

When you fund the trust, you can claim a charitable income tax deduction equal to the present value of the remainder interest (subject to applicable limits on charitable deductions). Your annual payouts from the trust can be based on a fixed percentage of the trust’s initial value — known as a charitable remainder annuity trust (CRAT). Or they can be based on a fixed percentage of the trust’s value recalculated annually — known as a charitable remainder unitrust (CRUT).

Generally, CRUTs are preferable for two reasons. First, the annual revaluation of the trust assets allows payouts to increase if the trust assets grow, which can allow your income stream to keep up with inflation. Second, you can make additional contributions to CRUTs, but not to CRATs.

The fixed percentage — called the unitrust amount — can range from 5% to 50%. A higher rate increases the income stream, but it also reduces the value of the remainder interest and, therefore, the charitable deduction. Also, to pass muster with the IRS, the present value of the remainder interest must be at least 10% of the initial value of the trust assets.

The determination of whether the remainder interest meets the 10% requirement is made at the time the assets are transferred — it’s an actuarial calculation based on the trust’s terms. If the ultimate distribution to charity is less than 10% of the amount transferred, there’s no adverse tax impact related to the contribution.

Handle with care

If the estate tax is repealed as part of tax reform as has been proposed, CRTs would become less beneficial from an estate tax perspective. But they could still help the charitably inclined achieve their goals. CRTs require careful planning and solid investment guidance to ensure that they meet your needs. Before taking action, discuss your options with us.

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Charitable giving pièce de résistance: Artwork donations

Charitable giving is a key part of estate planning for many people. If you’re among them and own valuable works of art, they may be ideal candidates for charitable donations during your life.

Generally, it’s advantageous to donate appreciated property because, in addition to gaining a valuable tax deduction, you can avoid capital gains taxes. Because the top capital gains rate for art and other “collectibles” is 28%, donating art can be particularly effective.

5 tax-saving tips

If you’re considering a donation of art, here are five tips that can help you maximize your tax savings:

  1. Obtain an appraisal. Most art donations require a “qualified appraisal” by a “qualified appraiser.” IRS rules contain detailed requirements about the qualifications an appraiser must possess and the contents of an appraisal. IRS auditors are required to refer all gifts of art valued at $20,000 or more to the IRS Art Advisory Panel. The panel’s findings are the IRS’s official position on the art’s value, so it’s critical to provide a solid appraisal to support your valuation.
  2. Donate to a public charity. To maximize your charitable deduction, donate artwork to a public charity, such as a museum or university with public charity status. These donations generally entitle you to deduct the artwork’s full fair market value (provided the related-use rule is also satisfied). If you donate art to a private foundation, your deduction will be limited to your cost.
  3. Understand the related-use rule. For you to qualify for a full fair-market-value deduction, the charity’s use of the donated artwork must be related to its tax-exempt purpose. So, for example, if you donate a painting to a museum for display or to a university for use in art history research, you’ll satisfy the related-use rule. But if you donate it to, say, an animal shelter to auction off at its fundraising event, you won’t satisfy the rule.
  4. Transfer the copyright. If you own both the work of art and the copyright to the work, you must assign the copyright to the charity to qualify for a charitable deduction.
  5. Consider a fractional donation. If you’re not ready to give up your artwork but are willing to part with it temporarily, consider donating a fractional interest. This allows you to generate tax savings while continuing to enjoy your art for part of the year. For example, if you donate a 25% interest in your art collection to a museum, the museum receives the right to display the collection for three months of each year. You deduct 25% of the collection’s fair market value immediately and continue to display the art in your home for nine months of each year.

Leave it to the professionals

The rules surrounding donations of art are complex. We can help you achieve your charitable goals while maximizing your tax benefits whether you wish to donate artwork or other valuables.

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Is now the time for a charitable lead trust?

Families who wish to give to charity while minimizing gift and estate taxes should consider a charitable lead trust (CLT). These trusts are most effective in a low-interest-rate environment, so conditions for taking advantage of a CLT currently are favorable. Although interest rates have crept up in recent years, they remain historically low.

2 types of CLTs

A CLT provides a regular income stream to one or more charities during the trust term, after which the remaining assets pass to your children or other noncharitable beneficiaries. If your beneficiaries are in a position to wait for several years (or even decades) before receiving their inheritance, a CLT may be an attractive planning tool. That’s because the charity’s upfront interest in the trust dramatically reduces the value of your beneficiaries’ interest for gift or estate tax purposes.

There are two types of CLTs: 1) a charitable lead annuity trust (CLAT), which makes annual payments to charity equal to a fixed dollar amount or a fixed percentage of the trust assets’ initial value, and 2) a charitable lead unitrust (CLUT), which pays out a set percentage of the trust assets’ value, recalculated annually. Most people prefer CLATs because they provide a better opportunity to maximize the amount received by one’s noncharitable beneficiaries.

Typically, people establish CLATs during their lives (known as “inter vivos” CLATs) because it allows them to lock in a favorable interest rate. Another option is a testamentary CLAT, or “T-CLAT,” which is established at death by one’s will or living trust.

Another issue to consider is whether to design a CLAT as a grantor or nongrantor trust. Nongrantor CLATs are more common, primarily because the grantor avoids paying income taxes on the trust’s earnings. However, grantor CLATs also have advantages. For example, by paying income taxes, the grantor allows the trust to grow tax-free, enhancing the beneficiaries’ remainder interest.

Interest matters

Here’s why CLATs are so effective when interest rates are low: When you fund a CLAT, you make a taxable gift equal to the initial value of the assets you contribute to the trust, less the value of all charitable interests. A charity’s interest is equal to the total payments it will receive over the trust term, discounted to present value using the Section 7520 rate, a conservative interest rate set monthly by the IRS. As of this writing, the Sec. 7520 rate has fluctuated between 2.35% and 2.55% so far this year.

If trust assets outperform the applicable Sec. 7520 rate (that is, the rate published in the month the trust is established), the trust will produce wealth transfer benefits. For example, if the applicable Sec. 7520 rate is 2.5% and the trust assets actually grow at a 7% rate, your noncharitable beneficiaries will receive assets well in excess of the taxable gift you report when the trust is established.

If a CLAT appeals to you, the sooner you act, the better. In a low-interest-rate environment, outperforming the Sec. 7520 rate is relatively easy, so the prospects of transferring a significant amount of wealth tax-free are good. Contact us for more details.

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