Many of the charitable remainder trusts created during the high-flying 1990’s, especially those created prior to the imposition of the 10% remainder rule, have cratered along with the market decline. For those with net income type trusts, the inability to find suitable income investments means that most of those trusts are now seriously underperforming. What options exist for trustees and income beneficiaries with their trusts? Depending on state law, the controlling language of the trust document, and the trustmaker’s charitable inclinations, there may be a few options.
1. Some charitable remainder trusts are created with a charitable organization as one of the income beneficiaries. In this unusual case, this option to share the wealth exists as long as there is at least one tax paying entity receiving an income interest too.
2. For the trustee who no longer wants to deal with the hassle of a charitable trust, it may be possible to assign the income interest to charity, or terminate the trust entirely and accelerate the trust principal to charity now. This gift generates another income tax deduction based on the present value of the income interests given away. However, there may be state specific laws or spendthrift language in the trust document that would prevent the assignment of the beneficiaries’ income interest.
3. Make principal distributions from the charitable trust. While there is no additional charitable income tax deduction, for the charitable client who wants to tap assets for current gifts, this may work if the document allows its use. Otherwise, a letter ruling from the IRS may be necessary.
4. Seek court ordered termination of the trust and split the CRT into two portions, an actuarially calculated interest passing to the income beneficiary, and the remainder interest passing to charity. There is no added income tax deduction, and the income beneficiary receives a zero basis capital asset to reinvest and use as needed.
For example, Garth Books, 65 years old, created a NIMCRUT several years ago, but with declining bond rates, his trust produces less income than anticipated. However, the stocks inside the trust have appreciated, so Garth finds himself with a more valuable trust, but is unable to distribute enough income. His 8.5% income interest would not be prudent in todays environment, but he selected the higher payout anticipating continued double-digit interest rates. By cashing out the trust, Garth can reinvest the proceeds and use them to maintain his lifestyle.
5. Carrying the “split the blanket” philosophy one-step further, Private Letter Ruling 200152018 offers some insight into the IRS mindset about the sale of a CRT income interest in exchange for a more stable income through a charitable gift annuity. While splitting the two interests will not generate a tax deduction, the subsequent exchange of a gift annuity for the income interest will generate a deduction, as would the purchase of any CGA. The problem with basing any planning decisions on a private letter ruling is that it was issued to one taxpayer based on a specific fact pattern, and the IRS is under no obligation to act consistently. You cannot rely on it as a precedent. If you are contemplating doing something similar, seek your own letter ruling and be safe.
Charitable remainder trusts are irrevocable, but with suitable language tremendous flexibility in design and management is possible, and this is one significant reason to use a custom drafted document rather than an IRS prototype. Consider the advantages of setting up the trust properly:
§ Donor and/or Trustmaker may serve as trustee for the CRT
§ Modify trustee or use a special independent trustee
§ Revoke or modify charitable remainder interests
§ Use revocable, multiple, or non-spousal income interests
§ Distribute of principal to charity before the trust terminates
§ Use multiple charitable remainder interests
§ Define income for fiduciary accounting purposes
§ Accept closely-held or illiquid assets
§ Accept testamentary contributions
§ Distribute assets in kind
§ Unbundle the trustee, investment, and administrative functions
§ Modify investment objectives to improve tax efficiency