Who can be trustee in charitable remainder trust ?

What is a Charitable Remainder Trust?

A Charitable Remainder Trust permits someone with charitable intent to set aside funds for a future gift
to charity, while reserving an annuitized payment stream for a period of up to 20 years or life. When the
annuity payments end, the named charity receives the balance of funds in the trust.

For example, a woman may create a trust that pays her an annuity with a fixed dollar amount from the
trust as long as she lives. Upon her death, the remainder of assets in the trust will be paid to a qualified
public charity. This is referred to as a Charitable Remainder Annuity Trust (“CRAT”). Alternatively, she
may create a trust that pays her an annuity with a fixed percentage amount from the trust –
recalculated each year – as long as she lives. The actual distribution amount may change from year to
year. This is referred to as a Charitable Remainder Unitrust (“CRUT”).

Other variations of the theme are available, including (1) the “net income” CRUT that pays out the lesser
of a Unitrust percentage or actual trust accounting income, and (2) the “flip” CRUT that can change from
a net income CRUT to a standard CRAT. Either variation can be used as a powerful and flexible
retirement planning vehicle.

Interpretation:

Charitable remainder trusts are useful tools for estate planning. You have the potential to earn an
income, reduce the amount of taxes you pay on your assets, and benefit a charitable cause
simultaneously. When creating your trust, you may wonder who will administer your assets in the event
of your death or once the trust terminates. This is the responsibility of the trustee.

How a charitable remainder trust works

A charitable remainder trust is a “split interest” giving vehicle that allows you to make contributions to
the trust and be eligible for a partial tax deduction, based on the CRT’s assets that will pass to charitable
beneficiaries. You can name yourself or someone else to receive a potential income stream for a term of
years, no more than 20, or for the life of one or more non-charitable beneficiaries, and then name one
or more charities to receive the remainder of the donated assets.

There are two main types of charitable remainder trusts:

Charitable remainder annuity trusts (CRATs) distribute a fixed annuity amount each year, and additional
contributions are not allowed.

Charitable remainder unitrusts (CRUTs) distribute a fixed percentage based on the balance of the trust
assets (revalued annually), and additional contributions can be made.
What assets may be donated to a CRT?

You can use the following types of assets to fund a charitable remainder trust.

Cash

Publicly traded securities

Some types of closely held stock (Note that CRTs cannot hold S-Corp stock)

Real estate

Certain other complex assets

3. What are the tax benefits of a Charitable Remainder Trust?

There are several potential tax benefits of establishing a Charitable Remainder Trust:
Income Tax Charitable Deduction. The donor receives an income tax charitable deduction equal to the
present value of the charitable remainder interest. The deduction amount must be greater than or
equal to 10% of the initial trust value in order to qualify.

Deferral of Capital Gains Tax. A Charitable Remainder Trust is tax exempt so it pays no income taxes. If
a donor transfers a property into the trust that would otherwise be subject to capital gains tax, the trust
can sell the property without having to pay the tax.

Tax-deferred Growth. Taxable income earned by the trust is taxable to the beneficiaries when it is
distributed, but not until then.

Estate Tax Deduction. The assets in a charitable remainder trust are excluded from the donor’s taxable
estate for estate tax purposes.

Interpretation:

The main differences between a CRT and other trusts are:

CRTs are tax-exempt.

The beneficiaries must include a non-charitable beneficiary.

The remainder beneficiaries have to be qualified charities.

The settlor must be entitled to claim an income tax deduction in the tax year the CRT is established.
The income tax deduction must equal the value of the remainder interest when the CRT is funded.

Many individuals set up a CRT to diversify in a tax-efficient way, receive an income, and/or benefit
charity.

4. Who Can Act as the Trustee for a CRT?

Almost anyone can act as a trustee of a charitable remainder trust; in most cases, you can appoint
yourself or a spouse as the trustee. Any of the beneficiaries, either charitable or non-charitable, may act
as trustees. However, if either charitable or non-charitable beneficiaries are appointed, there are special
rules regarding unmarketable assets. These assets must be valued by either an independent trustee or
appraiser.

It is also vital that the grantor must not be given any special powers as a trustee, such as changing the
beneficiaries of the trust or borrowing from the trust without proper security. If this happens, it could
result in the CRT being disqualified and deemed a Grantor Trust (where the IRS deems the grantor the
owner of the property and assets in the trust).

The IRS commonly sees those who are grantors and beneficiaries of the trust also named as the trustee.
However, self-dealing rules and taxes under IRC 4941 apply to charitable remainder trusts. In most cases
you can name yourself (and/or spouse) as trustee. As a matter of fact, according to a recent IRS Statistics
of Income Bulletin, trust grantors or beneficiaries were the most common listed trustee of charitable
remainder trusts. Most CRT documents grant trustmakers power to replace the trustee for any reason at
any time. Self trustee arrangements are supported legally and can be quite advantageous.

Interpretation:

The donor may serve as trustee of a Charitable Remainder Trust. However, it is common to name a
professional trustee familiar with administration of charitable trusts because of the complex tax
reporting and annuity calculations. You can be your own trustee or name another individual if you wish.
But you must be sure the trust is administered properly – otherwise, you could lose the tax advantages
and/or be penalized. Most people who name themselves as trustee have the paperwork handled by a
“third-party administrator.”

Because of the experience required with investments, accounting and government reporting, some
people choose a corporate trustee – that’s a bank or trust company that specializes in managing trusts.
Some charities are also willing to act as trustee.

If you set up a unitrust, the amount of your income will depend on the trustee’s investment
performance. So make sure the trustee you choose has a good investment record.

Select an Independent Trustee

While it’s possible to appoint yourself or a spouse as the trustee of your CRT, there are certain
circumstances where it’s in your best interest to appoint an independent trustee instead. An
independent trustee is someone who does not benefit from the assets contained in the trust. When the
trust’s beneficiaries are family members who are likely to disagree or a minor who cannot immediately
manage the assets, an independent trustee can handle the administration of the trust in good faith.

According to a recent IRS Statistics of Income Bulletin, nearly one in three charitable remainder trusts
name the trust grantor or income beneficiary as the trustee.

If you are eligible to serve as trustee, you can:

1. Take control of your CRT

2. Save money on trustee fees

3. Direct trust investments or hire your own investment manager

4. Handle trust distributions and pay trust expenses yourself

Unitrust

If you choose the unitrust and receive a percentage of the trust’s earnings, the amount of your annual
income will fluctuate, depending on investment performance and the annual value of the trust.

The trust will be revalued at the beginning of each year to determine the dollar amount of income you
will receive.
If the trust is well managed, it can grow quickly because the trust assets grow tax-free. So the amount of
your income will increase as the value of the trust grows.

Sometimes the assets contributed to the trust-like real estate or stock in a closely held corporation are
not readily marketable, so income is difficult to pay.

In that case, the trust can be designed to pay the lesser of the fixed percentage of the trust’s assets or
the actual income earned by the trust. Usually a provision is included so that, if the trust has an off year,
it will

Annuity Trust

You can elect instead to receive a fixed income, in which case the trust would be called a charitable
remainder annuity trust. This means that, regardless of the trust’s performance, your income will not
change. If you choose the annuity trust, the amount of your income does not fluctuate. This means it
will not decrease if the trust has an off year, but it also will not increase if the trust does well.

An annuity trust is usually a good option at older ages. While it does not provide protection against
inflation like the unitrust does, some people like the security of being able to count on a definite amount
of income each year. It is best to use readily marketable assets like stocks to fund an annuity trust. You
could also use cash.

Trust Income Options

Who can receive this income? There is some flexibility here. It can be paid to you for your lifetime or, if
you are married like Max and Jane, the income can be paid for as long as either of you lives.

The income can also be paid to your children for their lifetimes, or to any other person or entity you
wish, provided the trust meets certain requirements.* In addition, there are gift and estate tax
considerations if someone other than you or your spouse receives the income.

Instead of lasting for someone’s lifetime, the trust can also exist for a set number of years – up to 20.
And, income from the trust is generally taxable in the year it is required to be paid.

By the way, you don’t have to take the income now. You can set up the trust and enjoy the income tax
deduction now, but postpone taking an income until later. By then, the trust assets, with good
management, will have appreciated considerably in value, resulting in more income for you.

Income Tax Deduction

Now, how much will your charitable income tax deduction be?

That will depend on the amount of income you receive, the size and type of asset you gift, and the ages
and number of people who receive income from the trust.
Basically, the higher the payout rate, the lower your deduction will be.

In addition, your annual deduction is usually limited to 30% or 50% of your adjusted gross income.*

And, remember, if you cannot use the entire tax deduction in the year you make the gift, you can carry it
forward for up to five additional years.

*NOTE: The deduction will vary from 20% to 50% AGI, depending on how the IRS defines the charity and
type of asset involved. Generally, the deduction for appreciated property is limited to 30% of AGI and
unappreciated property to 50% AGI.

Replace Asset with Life Insurance

You can take the income tax savings and part of the income you receive from the charitable remainder
trust, as shown here, and fund an irrevocable life insurance trust. Each year you can give money to the
insurance trust and the trustee can purchase enough life insurance to replace the value of the asset for
your children when you die.

Life Insurance You Own Is Included In Your Taxable Estate

You may not know this, but as this chart illustrates, the life insurance you own is included in your taxable
estate, along with your other assets such as your home, other real estate, and so on.

So if you buy the insurance yourself, you just increase the value of your estate and the amount of estate
taxes that must be paid when you die. The estate tax is a very expensive tax. Historically, it has been 45-
55%. Remember, currently in 2010 there is no federal estate tax. However, it is scheduled to return in
2011 with a $1 million exemption and a 55% tax rate.

With a life insurance trust, the trust owns the insurance. for you. So this insurance will not be included
in your taxable estate…which will reduce the size of your estate and the amount of estate taxes that will
be owed when you die. Even if you don’t use a charitable remainder trust, you may want to have a life
insurance trust to keep your insurance out of your estate.

Life Insurance: Inexpensive Way To Replace Asset

Next, for most people, life insurance is the least expensive and quickest way to replace the asset you
transfer to the charitable remainder trust.

For example, based on their ages and health, it would cost Max and Jane only $93,258* in premium to
purchase $500,000 in life insurance. That’s enough to replace the FULL value of the asset transferred to
the charitable remainder trust. You can see that life insurance provides excellent leverage. For every
dollar they spend in premium, the Brodys can generate almost $5.40 in life insurance proceeds for their
children.
And remember, with life insurance, the proceeds are available immediately. So, even if both Max and
Jane die tomorrow, their children would receive the full $500,000, without probate, and completely free
from income and estate taxes.

*NOTE: Premium (for a male, age 65 and a female age 63) is based on a second-to-die policy, using all
whole life, from an AAA rated insurance company.

Benefits Of Irrevocable Life Insurance Trust

So, now you know that life insurance can be an inexpensive way to replace the gifted asset. Using a life
insurance trust will keep the proceeds out of your taxable estate, so the proceeds will go to your
children free of probate, with no income or estate taxes.

Using a life insurance trust will also give you more control.

You could name someone else as the owner of the policy – that would also keep it out of your taxable
estate. But then you would have no control over the insurance. The person you name as owner could
change the beneficiary, withdraw all the cash value or even cancel the policy.

With a life insurance trust, you minimize these risks. Plus you can keep control over when your children
will receive the proceeds. For example, instead of getting all that money at one time, you could have
them receive it in installments. You can keep the proceeds in the trust for years, making periodic
distributions to your children and grandchildren. And any proceeds that remain in the trust are
protected from irresponsible spending and creditors…even spouses.

Now, let’s look at how paying the insurance premium will affect the Brody’s income.

Benefits of a Charitable Remainder Trust

Convert an appreciated asset into lifetime income

Reduce your current income taxes with charitable income tax deduction

Pay no capital gains tax when the asset is sold

Reduce or eliminate your estate taxes

Gain protection from creditors for the gifted asset

Benefit one or more charities

Receive more income over your lifetime than if you had sold the asset yourself

Leave more to your children or others by using a life insurance trust to replace the gifted asset

Pitfalls

Items to check for before a client signs a trust

Before your client signs his trust, examine it for:

• the required governing instrument provisions;

• compliance with state as well as federal laws;

• provisions that are appropriate for the type of property used to fund

The trust (for example, separate, joint);

• the funding property isn’t encumbered;

• U.S. citizen or alien spouse beneficiary;

• the 5 percent minimum payout requirement;

• the maximum 50percentpayout requirement;

• the 10 percent minimum remainder interest requirement;

• the 5 percent probability test of Revenue Ruling 77-374 for charitable

Remainder annuity trusts;

• instructions to and monitoring of trustee to assure payments are timely;

• state law investment and diversification requirements;

• Scorp stock not used to fund trust;

• any Securities and Exchange Commission restrictions on transferring

securities to the CRT (restrictions turning marketable securities into

un marketable securities for required appraisals and valuations);

• the ability to substitute public charities for named private foundation

Remainder organizations ;and

• the spousal right of election obtained.

Computing the Charitable Tax Deduction for a Charitable Remainder Trust

The donor’s charitable contribution for funding a charitable remainder annuity trust (CRAT) is the value
of the property placed in the CRAT less the present value of the CRAT’s annuity payments. In the case of
a charitable remainder unitrust (CRUT), the value of the contributed property is reduced by the present
value of the unitrust interest for a term of years or for the life of the income beneficiary. The two
methods are different because the CRUT income stream fluctuates with changes in the value of the trust
property. The technicalities involved in determining the value of the income stream or the remainder
interest are much more complex for a CRUT.

Practice tip: Using commercial software for making these computations is recommended since it enables
practitioners to compute various what-if scenarios for testing various income payout rates, terms, and
frequencies of payments to assure that the 10% charitable remainder threshold is met.

Charitable Deduction for a CRAT

The rules for calculating the present value of the remainder interest in a CRAT are in Regs. Sec. 1.664-
2(c). Generally, the present value of the annual income stream is determined and subtracted from the
value of the property transferred to the trust to arrive at the value of the remainder interest. The factors
for determining the present value of an income stream payable for a term of years are in Publication
1457, Table B, Term Certain Factors . The factors for determining the present value of an income stream
payable for the life of the noncharitable beneficiary are in Publication 1457, Table S, Single Life Factors .
Special rules apply for valuing the annuity interest or for adjusting the valuation of the annuity interest if
the noncharitable annuity is payable other than annually at year end (e.g., at the first of each year or
semiannually, quarterly, or monthly). The applicable factor is multiplied by the amount of the annual
payment to compute the value of the income stream. Subtracting this amount from the value of the
property contributed produces the value of the remainder interest. The tables (except Table J) for
Publication 1457 are available here . Table J, Adjustment Factors for Term Certain Annuities , is in Regs.
Sec. 20.2031-7(d)(6).

The value of the remainder interest is normally determined by using the Sec. 7520 interest rate for the
month of the transfer to trust. However, the donor may elect to use the Sec. 7520 interest rate for
either of the two months preceding the month of transfer. All other things being equal, the higher the
Sec. 7520 interest rate, the larger the charitable contribution deduction for a charitable remainder trust
(CRT) (see Sec. 7520(a); Regs. Secs. 20.7520-2(b) and 301.9100-8(a)(1)).

Charitable Deduction for a CRUT

The rules for calculating the value of a remainder interest in a CRUT are in Regs. Sec. 1.664-4. Generally,
the present value of the remainder interest (i.e., the charitable deduction) in a CRUT is determined by
finding the present-value factor that corresponds to the trust’s adjusted payout rate. The present-value
factor for a CRUT with an income interest payable for a term of years is in Table D, Term Certain Factors,
of Publication 1458. The present-value factor for a CRUT with an income interest payable for the life of
the noncharitable beneficiary is in Table U(1), Single Life Factors, of Publication 1458. Most of both
tables is reproduced in Regs. Sec. 1.664-4(e)(6). If the income interest is payable for the lives of two
individuals, use Table U(2), Last-to-Die Factors, in Publication 1458, which is available here.

Unfortunately, the factors from the tables can rarely be used without first performing a complicated
interpolation. However, once the appropriate factor is determined, calculating the value of the
remainder interest (and the amount of the charitable contribution) is simply a matter of multiplying the
value of the property contributed by this factor.
The value of the remainder interest is normally determined by using the Sec. 7520 interest rate (i.e.,
120% of the federal midterm rate rounded to the nearest 0.2%) for the month of the transfer to the
trust. However, the donor may elect to use the applicable rate for either of the two months preceding
the month of transfer. The higher the applicable rate, the larger the charitable contribution deduction
(see Sec. 7520(a); Regs. Secs. 20.7520-2(b) and 301.9100-8(a)(1)).

Limitations on Charitable Deductions to a CRT

Generally, the charitable deduction for contributions to a CRT with a public charity as its remainder
beneficiary is limited to 50% of adjusted gross income (AGI). However, if the donor contributes capital
gain property to the CRT, the special 30%-of-AGI limitation applies. In addition, if the trustee, donor, or
income beneficiary has the power to change the charitable remainder beneficiary, the allowable
deduction is subject to the 30%-of-AGI limitation (Rev. Rul. 80-38; Letter Ruling 9452026).

Observation: If the possibility that the remainder interest will not go to a 50%-of-AGI-limit charity is so
remote as to be negligible (a subjective standard), then the 50%-of-AGI limit will apply for the taxpayer’s
transfer to the trust (Rev. Rul. 80-38).

For contributions to a CRT of capital gain property to a charity not qualifying under the 50%-of-AGI limit,
a 20%-of-AGI limit applies (Sec. 170(b)(1)(D)).

Taxation of a Charitable Remainder Trust

The key to the CRT is its tax-exempt status. CRTs with unrelated business taxable income (UBTI) do not
lose their exemption from income tax. Instead, they are subject only to excise tax on the UBTI, rather
than income tax on all undistributed taxable income (Sec. 664(c)). Note, however, that the excise tax is
equal to the amount of the UBTI, so in effect this amounts to a 100% excise tax on UBTI. Further, the tax
is treated as paid from principal rather than income, and the UBTI is considered income of the trust
when determining the character of the distribution made to the beneficiary (Regs. Sec. 1.664-1(c)).

Since the excise tax on UBTI is equal to the full amount of the unrelated business income, CRTs should
continue to avoid, whenever possible, investing in assets or engaging in transactions generating UBTI,
even though under the rules, a CRT with UBTI does not lose its exemption from income tax.

Generally, UBTI includes income the CRT earns from a trade or business that is not substantially related
to an exempt organization’s purpose, reduced by any expenses incurred in carrying on the business
(Secs. 512(a) and 513(b)). Thus, for example, trade or business income from a partnership of which the
trust is a member can create UBTI if the partnership is engaged in a business unrelated to the charity’s
exempt purpose (Secs. 512(c) and 514).

Income from a publicly traded partnership, limited partnership, or limited liability company may result in
UBTI if the entity conducts a trade or business. Thus, CRTs should avoid investing in passthrough entities,
to eliminate the possibility that they will be allocated income that is UBTI. Also, debt-financed income
(i.e., income produced by assets acquired with borrowed funds) is UBTI (Sec. 514). Therefore, investing
in partnerships that are not engaged in a trade or business may still result in UBTI if the partnership
incurs debt. Likewise, a CRT should avoid incurring debt on its own, since that can produce UBTI.

Taxation of Trust Distributions

The character of distributions received by current income beneficiaries of a CRT is determined using a
separate-tier system (Sec. 664(b)). This tier system establishes an order for the distribution of four
categories of income and corpus. Any distribution received by a beneficiary is deemed to have come
from the first category to the extent of current-year or accumulated income in this category. When all
current and accumulated income in the first category has been exhausted, the ordering proceeds to the
second category of income, and so on. The four categories of income are as follows:

Distributions are first taxed as ordinary income to the extent of the trust’s ordinary income for the
current year plus its undistributed ordinary income from prior years. When there are different classes of
income in this category (e.g., qualified dividends and other income taxed at the “regular” tax rates),
distributions are treated as coming first from the class subject to the highest tax rate and ending with
the class subject to the lowest tax rate. Thus, interest income is considered distributed before qualified
dividends. Any ordinary loss for the current year first offsets undistributed ordinary income from prior
years. Any excess loss is carried forward to reduce ordinary income in future years.

Distributions in excess of the ordinary income tier are taxed to the beneficiary as capital gains to the
extent of the CRT’s current or accumulated capital gains. The trust’s long-term gains and losses are
combined, as are its short-term gains and losses. If the result is a net long-term gain and net short-term
gain, the short-term gains are deemed distributed first. If short-term gains exceed long-term loss or
long-term gains exceed short-term loss, the net gain (either short-term or long-term) is deemed
distributed or carried forward. If the result is a net capital loss (short-term loss in excess of long-term
gain or long-term loss in excess of short-term gain), the net loss is carried forward.

Note: Qualifying dividends are treated as distributed before short-term capital gains, which are taxed
like ordinary income, and before any of the other higher-taxed categories of capital gain (25% or 28%).
In other words, even though qualified dividends are taxed at the lower capital gains rate, they are not
considered capital gains and are not allocated to the second tier.

Distributions in excess of the first two income tiers are taxed as other income exempt from tax to the
extent of current or accumulated tax-exempt income (Regs. Sec. 1.664-1(d)(1)(ii)(a)(3)). This category
includes tax-exempt interest and other nontaxable income (e.g., life insurance proceeds, gifts, and
inheritances).

Any remaining distributions are treated as made from principal

Assigning Classes Within Categories

Within the ordinary income and capital gain income tiers, items are assigned to different classes based
on the tax in effect when each type of income in that category is accounted for by the trust (Regs. Sec.
1.664-1(d)(1)(i)(b)). For example, a CRT could include a class of qualified dividend income and a class of
all other ordinary income (e.g., interest income and rental income) in its ordinary income tier. Likewise,
the capital gains tier could include separate classes of long-term capital gain taxed at 15% or 20%
(depending on the beneficiary’s ordinary tax bracket) and unrecaptured Sec. 1250 gain taxed at 25%.

After items are assigned to a class, the tax rates may change so that items originally assigned to two (or
more) separate classes would be taxed at the same rate in the year the income is distributed. If the
changes to the tax rates are permanent, any undistributed items in those classes are combined into a
single class. If the changes to the tax rates are only temporary (e.g., the new rate for a class will sunset
in a future year), the classes are kept separate and the order of that class with the higher future rate in
relation to other classes in the category with the same current tax rate is determined based on the
future rate or rates applicable to those classes.

Caution: CRTs are often advocated as a means to unlock the gain inherent in an appreciated asset and
receive a tax-exempt annuity in return. This is accomplished by having the donor contribute an
appreciated asset to a charitable remainder trust and take back an annuity or unitrust interest, then
having the trust sell the asset and reinvest the proceeds in tax-exempt securities. Assuming there is no
express or implied obligation on the trustee to sell the asset and reinvest in tax-exempt securities (Rev.
Rul. 60-370), it is often argued that this technique avoids the tax liability on the capital gain inherent in
the asset contributed and provides a tax-exempt income stream to the beneficiary. However, under the
tier system of allocating income to the beneficiary, the income stream received by the beneficiary will
be deemed capital gain income (due to the accumulated gain on the sale of the appreciated asset) until
the entire gain has been allocated. Only when this gain is exhausted will the beneficiary receive tax-
exempt income. Thus, although the gain is not immediately recognized, the income beneficiary will have
to report the entire gain before recognizing any tax-exempt income.