Ways to Give

Charitable Remainder Unitrusts

A Charitable remainder unitrust is an arrangement whereby income, generated by assets placed in trust, is paid to the donor and/or the donor's designated beneficiaries for life or a specified term of years (not to exceed twenty year), after which the trust assets pass to one or more charitable institutions.

A donor creates a charitable remainder unitrust by executing a formal trust instrument transferring assets to a trustee. The trustee may be the charitable institution, the donor an individual other than the donor, or a professional trustee. The assets are held separately and managed as an individual fund. Assets which are easily accepted into a unitrust include cash, marketable securities, closely held stock, and real estate.

The donor receives a charitable income tax deduction in the year the trust is established. The deduction is based on a charitable remainder factor calculation which takes into account the fair market value of the assets when transferred, the number and ages of the income beneficiaries (or term of years), and the payout rate of the trust. Any portion of the charitable deduction not used in that year may be carried over for up to five additional years, within the limitations of the tax law. If a donor transfers appreciated assets that have been held by the donor for more than one year to a charitable remainder unitrust, the donor will avoid any capital gains tax that would have been due if such assets had been sold.

The income payments made from a unitrust are based on a fixed percentage of the fair market value of the trust assets as valued at least annually. The donor determines the payout rate when the trust is established, which may not be less than five percent. A unitrust can be tailored to a donor's income and tax planning circumstances by allowing the donor to choose from three different income payout arrangements. The appropriate arrangement must be determined at the time the unitrust is established. They include the "straight" unitrust, the "net income only" unitrust, and the "net income only with makeup" unitrust.

Types of Unitrusts

The Straight Unitrust

Under this arrangement, the trust makes a payment each year based on a fixed percentage (five percent or greater) of the net fair market value of the assets of the trust. The assets must be valued at least once a year. Thus, if the net asset value of the increases, the annual payout also increase. Conversely, if the trust value declines, the annual payout is reduced. In this form of unitrust, if the annual income earned is insufficient to meet the payout obligation, the principal of the trust is invaded. If more than sufficient income is earned, the excess income normally reverts to principal. The payout percentage cannot be changed once the trust is established, although additional assets may be added by the donor at any time.

The Net Income Only Unitrust

Under this arrangement, the trust pays out either the fixed percentage of the net asset value of the trust or the actual net income earned, whichever is less. The principal of the trust will never be invaded to make payments to beneficiaries. The "net income only" unitrust is an ideal vehicle for gifts of non-income producing assets where there may be a delay in the sale of the asset and reinvestment for income. No payment to the beneficiary would be required until the trust assets produced income.

The Net Income With Makeup Unitrust

This type of unitrust follows the form of the "net income only" unitrust with the additional provision that any payment insufficiencies in the early years between the fixed percentage due and the actual net income earned and paid will be reimbursed to the beneficiary in future years if the trust earns income in excess of the fixed percentage due. Like the "net income only" unitrust, this form of unitrust is often used when funding a trust with real estate which may be illiquid for some time. This form of payout arrangement is also an excellent retirement planning vehicle. In the early years, the trust may be invested in non-income or low income producing assets expected to appreciate in value. Upon retirement, the appreciated trust assets may then be sol and reinvested to produce a larger income, giving the beneficiary the benefit of the annual payment due, plus any additional income in the satisfaction of the balance due for insufficient payments made in previous years.

Taxation of Income

Unlike the beneficiaries of a regular trust, whose income is characterized by the nature of the income of the trust for the year with respect to which a distribution is made, distributions from a charitable remainder are characterized for tax purposes by reference to the historic income of the trust since its . Income is paid out in four tiers in the following order: ordinary income (interest and dividends) to the extent of the trust's current and past undistributed ordinary income; next as capital gain income, to the extent of current and past undistributed gains (short-term first); next as "other" (tax-exempt) income, to the extent of the current and past undistributed other (tax-exempt) income; and finally as a return of trust principal. A return of principal is not subject too income tax.

Estate Tax Consequences

If the donor is the sole income beneficiary, no portion of the trust will be taxable in his/her estate. The life income interest of any surviving spouse is considered includable in the unlimited marital deduction of the estate of the first decedent. No portion of the retained income interest will be considered taxable in the estate of the surviving spouse, thus reducing estate taxes and associated probate costs. The remainder interest which will pass to charity is removed from the donor's estate. If a survivor interest is vested in someone other than a spouse, gift or estate tax may apply to the value of that income interest.

The Charitable Remainder Annuity Trust

Like the charitable remainder unitrust, the charitable remainder annuity trust is an arrangement which irrevocably transfers the remainder interest in donated assets to one or more charitable institutions upon the death of the income beneficiaries or the end of a specified term of years (not to exceed twenty years).

As its name implies, the charitable remainder annuity trust pays named beneficiaries a fixed dollar amount, or "annuity," annually. The amount must be specified in the trust instrument as either a dollar figure or a percentage of the initial fair market value of the asset(s) used to fund the trust. This amount may not be less than five percent of the initial value. Once the annual payment of an annuity trust is specified, it is fixed and cannot vary during the life of the trust. The amount payable has no relation to the amount of income earned by the trust. Unlike the unitrust, no additional contributions may be made to an annuity after the initial contribution.

If the trust produces an annual income greater than the amount of the required annuity, any excess will be added to the trust principal. Conversely, if the trust's investment income does not meet the required annuity amount, it must pay all or part of the annuity from the principal. Thus, it is possible to eventually consume and terminate an annuity trust depending upon the size of the annuity, the term of the trust, and investment results.

As with unitrust, income is payable and taxable to the beneficiary under the four tier system. Guidelines for trusteeship and estate and gift tax consequences are identical to those of charitable remainder unitrusts.

For information about Charitable Remainder Unitrusts, please contact Craig J. Dutra, CFSEMA President.