The Charitable Remainder Trust: Who Uses It, How It Works

A charitable remainder trust (CRT) is an estate planning tool for people who want their estates to ultimately go to a registered nonprofit.

The person who creates the trust, and/or others listed as beneficiaries, draw(s) income from the trust for a period. At the end of the trust term (or when the last named beneficiary dies), assets go to charity.  

Who Is a Charitable Remainder Trust Good For?

It is often used by:

• Wealthy taxpayers. Trust creators may deduct part of the worth of the charitable interest in the trust in the first year, based on current IRS rates for the trust creator’s tax bracket.

• People wealthy enough to have to deal with estate taxes. CRT assets are removed from an individual’s personal estate, so there’s less in the estate to tax.

• People seeking extra retirement income, or dedicated to supporting a spouse or someone else.

• People who want to create a substantial charitable legacy. In some cases, the trust creator is using the CRT to support a foundation, or fund a named scholarship.

If you sense a pattern here, you’re right. The owner of a CRT trust tends to be wealthy. Steep fees will need to be paid to a legal expert if the trust creator cannot self-manage the trust.  

What Can I Place in a CRT?

You may transfer assets of many kinds into a CRT. If you name yourself as trustee, you decide how to invest the trust assets.

The assets you transfer into the CRT could be anything of significant and marketable value. They might be funds or stocks from your accounts, or an art collection, or the deed to a home.

Once in the trust, the assets belong to the trust, and not to the individual.

What Is the Timeline of a CRT?

Twenty years. The trust pays its living beneficiaries annual income for 20 years — or until the last named beneficiary dies.

Meanwhile, the trust generates an income stream for one or more living beneficiaries.

Finally, after 20 years or when the last named living beneficiary dies, what’s left in the trust goes to a registered nonprofit. (It can go to more than one nonprofit.)

Really important: The trust must keep at least 10% of its initial market value as the charitable donation at the end of the trust.  

How Is the Income Paid Out?

Beneficiaries get income from the trust in one of two ways:  

• A charitable remainder annuity trust (CRAT) pays a set amount of money annually.

• A charitable remainder unitrust (CRUT) pays a percentage of the value of the trust annually.

Some donors give to universities by setting up CRUTs with the entities. The plus side of this is having a safe, experienced trust management group, with relatively reasonable fees.

How Does the CRT Save on Capital Gains Taxes?

As it is tax-exempt, the CRT can sell assets that have risen dramatically in value — without being subject to immediate tax for the capital gains. So, a trust creator can take real estate or investments that have surged in value, draw income from that value, and avert a major tax bill for the year.

This is not a tax deduction. It is a tax deferral. In short, you may defer income taxes when your trust assets are sold.

When I or My Beneficiary Receives a Payment From the Trust, Is This Taxable Income?

Yes. Although the trust itself is tax-exempt, the income from the CRT is taxable.

So, the annual income received from the CRT by you, your family member, or any other “non-charitable beneficiaries” is taxed. Reporting requires Form 1041, Schedule K-1: Beneficiary’s Share of Income, Deductions and Credits as part of a personal tax return.

Use the carryover basis for reporting the trust assets’ basis. This is the value of the assets to the trustee when placed in the trust. (More on the IRS tax basis rules here.)

What Are the Possible Pitfalls of Setting Up a CRT?

Some people decide against forming a CRT because (a) it’s irrevocable; and/or (b) it takes so much money just to set up and maintain. Specifically:

• No takebacks! The trust creator can’t undo the placement of assets put into the CRT. On the bright side, though, a CRT can sell a major asset then reinvest the value into a diverse range of other investments. Also, you can always add more investments to the trust.

• No second thoughts! It’s not easy to change the draw period or the beneficiaries you’ve named. On the bright side, it can be possible to have second thoughts about which nonprofit will eventually receive the remainder of your wealth.

• No dipping in! No living beneficiaries may access the value of the trust assets — except as distributions, as directed by federal law. Dipping into the trust is called self-dealing, and it’s not allowed.

• It’s complicated! Establishing and running the CRT involves a lot of legal and administrative work. Expect heavy fees and costs through the life of the trust. Expect to need a professional accountant or lawyer on the job. One who can demonstrate experience with filing returns for CRTs.

And remember: At least 10% of the trust’s initially established value must go to charity, not to your beneficiaries. Oh, and your charity has to wait for it. Never give cash upfront to a nonprofit in order to advance its remainder interest.

What’s It Like to Report Taxes With Charitable Remainder Trusts?

To report a charitable remainder trust, you as the trustee — or, more likely, your lawyer or CPA — will file Form 5227: Split-Interest Trust Information Return. Another form is submitted together with Form 5227. This is Form 1041, Schedule K-1: Beneficiary’s Share of Income, Deductions and Credits.

Your completed returns will tell the Internal Revenue Service:

• The type of income generated, how much, and to whom.

• Any other movement of assets in or out of the trust.

• The past year’s and total trust income amounts.

• Tax deductions and penalties (if applicable).

Use caution. The CRT may not leave out any  information on sales of trust assets. The IRS makes a point of stating that its agents review CRT-related activities carefully.

Is There a Cheaper Alternative to a Charitable Remainder Trust?

Interested in keeping a commitment to a nonprofit when you pass on? Consider designating the nonprofit entity a beneficiary of an Individual Retirement Account (IRA). It’s certainly cheaper. And for most of us, it’s sufficient.

Important note: Use this article as a starting point for your further explorations. It is not legal or financial advice. When carrying out your due diligence, please note that laws surrounding this and other estate planning tools can and do change. See, for example, these: recent legislative changes that impact CRTs.