CRTs in unique planning situations.

Charitable remainder trusts (CRTs) have long been considered an important option in structuring financial plans for high-net-worth clients. The advantages for the client establishing a CRT include:

1. Tax-deferred growth of the trust assets;

2. Possible asset protection from creditors;

3. Ability to sell highly appreciated trust property at no immediate income tax cost;

4. Ability to diversify investments to reduce risk;

5. Ability to provide an income stream for life to the client or another person, or both;

6. Ability to provide a charitable legacy; and

7. Possible reduction in transfer taxes.

The ability of a charitable remainder unitrust (CRUT) to sell highly appreciated assets without the donor having to recognize gain has been a major factor in the overall appeal of these trusts. A CRUT's ability to reinvest the gross sales proceeds (without depletion for immediate income taxes) generally results in more favorable investment results than an outright sale by the client. Recent tax law changes have reduced the advantage of the sale of a CRUT's assets. The increase of the minimum required CRT interest from 5% to 10% and the decrease in personal Federal capital gains rates from 28% to 20% have narrowed the gap between these two techniques.

A client may find a CRT useful if he holds and wants to diversify highly appreciated and concentrated assets. If the client has no immediate cashflow needs, a CRUT with net income limitations and make-up provisions (NIMCRUT) (as provided for in Regs. Sec. 1.664-3(a)(1)(b)) can function as a "private pension plan." The client may contribute the highly appreciated asset to a limited partnership (LP), and donate LP interests to a newly created NIMCRUT.

Depending on the definition of trust income contained in the trust document, it is possible for the NIMCRUT to have little or no accounting income for several years. Some documents provide that trust accounting income includes partnership distributions, but not Schedule K-1 income. Therefore, until the LP makes cash or other distributions to its limited partners, there is no trust accounting income, and the NIMCRUT is prevented from making a unitrust distribution to its income beneficiary.

As the NIMCRUT is a tax-exempt entity, there is no current income tax liability on the K-1 income of the partnership units that it owns. This results in tax-deferred growth within the NIMCRUT. The trustee must carefully avoid unrelated business taxable income (UBTI) from partnership activities. The NIMCRUT would risk losing its exempt status in any year in which the partnership generates any UBTI. It is, therefore, preferable for the LP to hold only those assets that will not generate UBTI.

Under the final regulations, the allocation of precontribution gain to trust income is prohibited for NIMCRUTs. If permitted under local law, the trust document may allow for allocating postcontribution capital gains to trust income. For clients wishing to diversify their portfolios and defer their unitrust distributions for at least a few years, this restriction should not create an impossible hurdle.

Often, clients wish to provide for the financial security of their life-partners after the client's death. In the absence of a marital deduction (same-sex couples or unmarried couples of the opposite sex), the transfer tax cost of a lifetime gift or testamentary bequest can be staggering. A CRUT provides income for life for a client and his life-partner. A unitrust created during a donor's life rather than an outright bequest of an amount necessary to generate a similar income stream, significantly reduces the transfer taxes payable at the donor's death for the value of the income interest to the partner.

FROM BARBARA L. Cox, CPA, ANAHEIM, CA