Are you looking for an additional income stream in retirement? Do you want to leave behind something for charity and cut your tax bill now and when you pass away? If the answer is yes, a charitable remainder trust might be right for you.
A CRT is an irrevocable “split-interest” trust that provides income to you and any designated beneficiaries for a specified number of years (up to 20) or for the rest of your life or a beneficiary’s, with the remaining assets donated to charity.
Between 5% and 50% of the trust’s assets must be distributed at least annually, but 10% or more of the CRT’s initial value must eventually go to charity.
There are two types of CRTs. With a charitable remainder annuity trust, or CRAT, a set amount is distributed to you or beneficiaries that aren’t charities each year. Once you set up a CRAT, you can not contribute more to it later.
With a charitable remainder unitrust, or CRUT, distributions are based on a fixed percentage of the trust’s value, which is redetermined annually. You can also put more into a CRUT after it’s created. Both types of CRTs have tax advantages.
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According to Jim Ferraro, vice president and trust counsel of Argent Trust Co., CRTs are first and foremost a “tool for reducing the estate tax for people who are charitably inclined.” That’s because assets contributed to these trusts are generally not included in your estate when you die. If they’re not part of your estate, they will not be subject to the federal estate tax.
You can also claim an itemized charitable deduction on your income tax return for the year you set up a CRT.
The deduction is for the projected amount that will go to charity. Because a charity’s future interest is not always clear when the CRT is created, a complicated formula is used to calculate it.
The formula is based on your age or the age of any other beneficiaries, whether a CRAT or CRUT is used, and the rate of distribution, among other factors.
You can also defer payment of capital gains taxes if you place appreciated capital assets, such as stock or real estate, in a CRT.
If you sell assets outside of the CRT, the tax is due when you file your income tax return for the year of sale. But if you transfer the asset to a CRT, the trust can sell it tax-free.
However, as Ferraro notes, the “character of the income or gain is trapped within the CRT” by IRS regulations that dictate how distributions are taxed.
Although there is the potential for some tax-free income, portions of the distribution also may be treated as ordinary income, capital gain or other income and taxed accordingly.
For capital gains, though, the tax bill will be delayed and you may owe those taxes only when you file your income tax return for years that you receive a distribution.
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