Written by David Wheeler Newman

Since its introduction into the Internal Revenue Code in 1969, the charitable remainder trust has been the “Swiss Army Knife” for charitable gift, financial and estate planners because of its flexible features that allow a balancing of financial planning or estate planning objectives with philanthropic objectives.  Those features include two CRT tax benefits provided in the Code – the charitable income tax deduction for the present value of the charitable remainder interest in the trust, and the general tax exemption of the trust.

The general tax exemption of the CRT allows donors with an appreciated asset to achieve an important financial planning objective, to be able to sell the asset in the tax-exempt environment of the CRT, and to be able to re-invest the sales proceeds in a diversified investment portfolio without diminution by capital gains tax.  Instead, that tax liability is effectively deferred until distributions are made to the income beneficiary of the trust.  There are major financial planning opportunities for tax deferral with one popular flavor of CRT, the net-income with make-up charitable remainder unitrust (NIMCRUT).

On May 25, the Administration released general explanations of its revenue proposals for the upcoming fiscal year, the so-called “Green Book”.  One major change in federal tax law proposed in the Green Book, as well as in tax legislation already pending in Congress, involves the transfer of appreciated assets to trusts.  Under current law, there is no general recognition of taxable gain when an appreciated asset is transferred into a trust.  Instead, the tax basis of the asset in the hands of the donor prior to the transfer carries over to the trust, and the appreciation in the asset will only be subject to tax when the asset is sold by the trust.  Proposals pending in Congress, and broadly endorsed in the Green Book, would generally tax that appreciation when the asset is transferred to the trust, with certain exceptions, including a lifetime exclusion for the first $1 million of untaxed appreciation.  Those exceptions are fleshed out in the Green Book, which includes this language:

“The transfer of appreciated assets to a split-interest trust would generate a taxable capital gain, with an exclusion allowed for the charity’s share of the gain based on the charity’s share of the value transferred as determined for gift or estate tax purposes.”

This provision, if included in tax legislation expected to be enacted later this year, would have a major impact on the attractiveness of CRTs.  Consider this example: an individual investor got in early on a start-up company that has done well and is now being sold to a much bigger company.  She bought her stock for $10 per share and it will be sold for $100 per share.  She used her $1 million exclusion for transfers of the stock in trust for her nieces and nephews. She would like to share the rest of her good fortune with the local food bank, while retaining an income stream for her life.  In other words, a textbook fact pattern for a CRT.  With a 20% deduction based on the unitrust percentage in the trust and the donor’s age, she gets an income tax deduction of $20 per share and the entire sales proceeds can go to work to fund her income stream and the eventual gift to the food bank.

If this provision is enacted, she would personally recognize taxable capital gain on the untaxed appreciation in the stock not attributable to the present value of the charitable remainder: 80% of $90 per share = $72 of gain per share. Because of her high income, this gain would be subject to federal tax of over 40% under the new capital gains tax rate in the legislative and Administration proposal.  Having to pay federal tax of over $28 per share, plus any state tax, to contribute the stock to a CRT, while the entire 100 proceeds of sale of the stock will be received by the trust and unavailable to pay that tax, is a substantial tax disincentive for her to fund the CRT.

The effective date of this proposal would be for CRTs funded after December 31, 2021.

Planners need to be aware that if this legislation is enacted, a few important blades will be removed from their Swiss Army Knife, starting next year.