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Charitable remainder trusts should flourish with increases in tax rates.

Charitable remainder trusts lost some of their appeal when tax rates were lowered in 1986. As tax rates again gradually increased, these trusts began to generate some interest, mostly from the very wealthy. But with tax rates expected to reach 36%-40% under President Clinton's proposals, charitable remainder trusts should again receive the attention of taxpayers, even those of modest wealth.

A charitable remainder trust enables a taxpayer to give income-producing property to charity while retaining the right to receive distributions from the trust for a period of time, generally, the donor's life expectancy or a number of years not to exceed 20. in the year the contribution is made, the donor receives a current deduction for the value of the interest that will pass to charity on termination of the trust. As tax rates increase, this deduction becomes more valuable. For example, giving away a remainder interest of $40,000 is worth $12,400 to a donor in the 31 % tax bracket (before state tax considerations). If tax rates increase to an effective rate of 40%, that same gift would be worth $16,000. In addition, the donor has a right to distributions for a period of time.

Sec. 664 contains a complex set of rules governing charitable remainder trusts. Despite the complexity, these rules allow much flexibility in how the terms of the trust are established. This makes charitable remainder trusts an excellent planning tool since the needs of the donor can be satisfied by a combination of terms and provisions. In certain situations, a charitable remainder trust can both satisfy a desire to give to charity and increase the economic return on the disposition of property. The comprehensive example on page 506 illustrates how this might work.

As stated earlier, charitable remainder trusts are not without complexity. Therefore, it is important to keep in mind the following points: * The donor cannot force the trustee to sell assets. * While there is much flexibility in setting the terms of the trust, the remainder value must equal at least 5% and the annual distribution to the income beneficiary must be at least 5%. * The trust terms cannot be altered to change payments to the noncharitable beneficiary.

In summary, a charitable remainder trust can be an excellent planning tool to increase cash flow, diversify investments and accomplish charitable goals.

Example: Advantages to Establishing a Charitable Remainder Trust

J is the developer of a successful software product. He took his company public a few years ago. B is a growth company, dividends are small, roughly 1 % per year. J's basis in his stock is negligible market value is significant. J wants to accomplish three objectives: 1. Increase the cash flow from his ownership in the stock. 2. Diversify his investments. 3. Honor a pledge to his university's computer science department.

J contributes $200,000 of his company's stock to a charitable remainder trust. (Assume this does n afoul of SEC restrictions.) The terms of the trust call for an annual payment to J of $20,000 per ye years. At the end of 12 years, the remaining trust assets go to his alma mater.

The value of the remainder interest is approximately $46, 1 00. This is calculated by statutory fo using discount rates found in Sec. 7520. Because this calculation is based on 120% of the applicable rate (AFR), the lower the AFR, the lower the value of the remainder interest. Note that J could have a longer or shorter term for the trust, or a different annual distribution. Both of these factors pl rate will affect the value of the remainder interest going to charity.

By establishing the trust, J gets an immediate deduction for the remainder value going to charity. a 36% tax rate, the deduction is worth more than $16,000. But J gets something even better: He gets $20,000 each year, primarily taxable at capital gains rates.

The trust can sell some or all of the stock and reinvest in diversified, higher yielding investmen incurring an income tax. J pays taxes on his distributions according to a tiered system under Sec. 6 This system taxes distributions in the following order. 1. Ordinary income of the trust. 2. Capital gains. 3. Tax-exempt or any other income. 4. Return of corpus, not subject to tax.

Assuming the trust reinvests in a diversified stock portfolio that yields 3%, the ordinary income will be approximately 30% of the total $20,000. The balance will be taxed as capital gain since the undistributed gains on disposition of the original stock.

In essence, J has created an annuity for 12 years based on a diversified portfolio. This helps him overall financial position even though he has given up the right to the remainder interest. Also, he $20,000 per year instead of the $2,000 (dividends being paid at 1%) he received before setting up th

Here is what J would have received if he sold his stock outright.
 Sales price $200,000
 Basis 0
 Gain 200,000
 Less tax at 28% (56,000)
 Available to reinvest $144,000

Assuming the $144,000 is reinvested in a diversified stock portfolio with the same 3% yield, J woul receive $4,320 per year. To equal the $20,000 annual distribution from the charitable remainder trus would need to withdraw nearly $16,000 in principal per year. At this rate, his funds from this trans would be depleted in approximately seven years. Compare this to the 12-year term of the trust, plus that J received a $16,600 tax savings up front for his contribution of the remainder value. Note: This analysis does not take into account any growth in the portfolio other than the 3% yield. the stock, the growth of the after-tax principal would be his. Under the charitable remainder trust, only his $20,000 per year for 12 years, no more and no less.

Here is J's after-tax situation using the trust.
 Annual annuity $20,000
 Term of years 12
 Total received 240,000
 Less tax at combined
 ordinary income/
 capital gains rate (30.4%) (72,960)
 Present value of above 107,115
 Tax savings from
 contribution 16,600

It is clear that J would have received more ($144,000 total) by selling the property. But by setti charitable remainder trust, J was able to make a contribution worth $46, 1 00 and keep $123,715. In words, the contribution really cost J about $20,000, the difference between the $144,000 he would re from a sale and the $123,715 from the trust.
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Article Details
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Author:Robbins, Valerie C.
Publication:The Tax Adviser
Date:Aug 1, 1993
Previous Article:Protecting assets from lawsuits and creditors while saving income and estate taxes.
Next Article:Property transfers to qualified plans.

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