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Stock transfers to a CRAT

Stock transfers to a CRAT

Uncoordinated Investments Wreak Havoc

Malpractice Coverage – IX

Don’t Leave Home without It

(ninth in a series on design and implementation issues)

 

image Joseph Pickering, a stockbroker, has an older client, Iris Harper, who has expressed an interest in contributing her stocks to an annuity trust to benefit her college’s endowment fund. Pickeringhas convinced her that he would be in a better position to manage her investment portfolio if she would just consolidate all of her investment accounts with his brokerage firm.  While there’s nothing wrong with his desire to have more money under management; after all, Joe is paid to help clients accumulate and manage money more efficiently, he’s not all that sure “he knows what he knows” about a §664 remainder trust.  Since Joe hasn’t worked with a CRAT before, he eagerly completed the paperwork directing the competing brokerage firms to transfer shares from his client’s various portfolios into the trust account he set up for the express purpose of managing her CRAT.  As is common in the investment banking business, those stocks have slowly trickled into her CRAT account over a period of a week.  In one case, one of the other brokerage firms sold Mrs. Harper’s stocks when they executed a sell order already on the books, and remitted the proceeds into his client’s account. 

 

What are the problems with the scenario above?  Firstly, a CRAT may accept assets just one time.  Having those contributed stocks appear in her charitable remainder trust account over a period of days is a serious problem, as it would require the use of multiple annuity trusts, and that is not an economical or practical way to plan.  If there’s any uncertainty about the timing of contributions, either consolidate the various brokerage accounts first into a client’s non-CRT account before making the contribution to CRAT or use a CRUT that is drafted to allow additional contributions.  Stockbrokers are not the only ones to make an error like this; an attorney once clipped a $10 bill to the document and memorialized its funding in the trust language that made it impossible to make an additional contribution to that CRAT.  The second major problem is with the sale of the stock and contribution of cash proceeds to the CRT by the broker trying to be paid on one last transaction before he lost the account.  That triggers taxable gain for Mrs. Harper and happens too often for it not to be a concern for brokerage firms that wind up paying for those errors.  Recognize that the funding mechanisms are difficult and create a plan so that multiple brokers, are aware that errors occur when each one is off doing his/her own thing – this uncoordinated approach is dangerous, so find a way to get everyone on the same page

 

imageIn most states, prudent investor rules govern the investment philosophy of the charitable trust.  Jeopardizing investments or assets that produce unrelated business taxable income are choices that the trustee might make that cause an otherwise exempt trust to become a complex, taxpaying entity.  Other problems appear during the drafting phase that may cause trust disqualification include language allowing the trustmaker to require certain investments inside his/her CRT.  [§1.664-1(a)(3)]  For example, a requirement that the trustee buy tax-free municipal bonds, a specific mutual fund, or any other restrictive investment is a problem, and may convert the tax-exempt trust to taxable grantor status.  [§675(4)(B)]  However, for trustmakers with strong concerns about having their trust invest imprudently or in “immoral” investment products (e.g., gambling, tobacco, weapons, liquor, pornography, etc.), it is permissible to restrict investments in such a way as to preclude the use of those stocks.  Additionally, trustmakers may also express a preference that is non-binding on their trustees for types of investments, e.g., tax-free bonds, socially conscious funds, etc.  [GCM 37645, PLR 7913104]