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Sunday, April 28, 2024
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Case Studies |
The Flexible CRT, Part 2
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Case:
It has been three years since the Reeves created their CRUT, and they are still delighted with their decision. In fact, during a recent charity dinner, Ted was raving about all of the benefits his trust provided. A friend and fellow supporter of the hospital, Thelma Bost, was intrigued about the flexibility of the Reeves's Flexible CRUT. Specifically, Thelma wonders if her CRUT has the same 'special provision' as the Reeves. (Ed. See last week's Case Study).
Thelma and her now deceased husband, Roger, had created a $600,000 CRUT about seven years ago, which has now grown to $640,000 in value. At that time, they needed an 8% payout ($48,000/year) based upon their estimated living expenses. However, with Roger passing away three years ago, Thelma no longer needs that much yearly income. Her estimated expenses each year are $30,000. Furthermore, Thelma received $250,000 from the life insurance company when Roger died. She then invested the life insurance proceeds, which yields about 4% annually ($10,000). As a result, Thelma has more taxable income than she feels is necessary. Moreover, she does not like to pay "all that tax" each year. She would love to lower her income, pay less tax, and, if possible, make some gifts to the hospital.
Question:
Thelma wonders if she could decrease her 8% payout CRUT to 5% ($32,000 = $640,000 x 5%), thereby lowering her taxable income each year. Thelma also asks if she could receive a tax deduction for doing so. Finally, Thelma inquires if her CRUT has the special provision which would allow her to make current gifts to the hospital.
Solution:
Charitable Remainder Trusts are irrevocable trusts, and, as a general rule, cannot be amended (except in very limited cases and with court approval). Therefore, it is not recommended that Thelma adjust her payout in her trust document. However, her attorney did draft her CRUT with the same special provision the Reeves's CRUT contained. This special provision allows for immediate distributions from Thelma's CRUT to the hospital. As a result, Thelma can elect to make contributions to the hospital whenever she so desires. In addition, Thelma will be entitled to a charitable tax deduction for making such a contribution (based upon the reasoning of PLR 9550026).
Although Thelma's attorney stated that she could not amend her trust to pay 5% instead of 8%, Thelma can in essence achieve a similar result when she makes immediate distributions to the hospital. For instance, Thelma's CRUT has assets valued at $640,000. If she decides to make a distribution of $240,000 to the hospital, her CRUT would then have assets valued at $400,000. Therefore, Thelma's payout would be $32,000 (8% x 400,000), which is exactly what 5% of $640,000 would be. Thus, Thelma can achieve the result she wants; namely, less taxable income, current gifts to the hospital, and a tax deduction. Her tax deduction would be computed by determining the present value of her 8% income stream on $240,000. In this case, Thelma would receive a charitable income tax deduction of $126,588.
Thelma then met with her accountant to discuss the plan. Thelma's accountant informed her that based upon her income, she might not fully utilize the entire income tax deduction even if she spread it over six years. In addition, despite her modest income needs, it would be safer for Thelma to gradually decrease her income over a period of time as opposed to a one time sharp decrease. Therefore, after this discussion with her accountant, Thelma decided to "phase-in" her new plan. Instead of an immediate distribution of $240,000 this year, Thelma would make a $40,000 distribution each year for the next six years. This "phase-in" would allow Thelma to deduct all of her charitable contributions, and would give her more financial security in the event her income needs change in the future. Thelma is elated with this solution. Not surprisingly, at the next charity dinner event, she touted all the wonderful benefits of her trust to the Reeves!
Editor's Note: The special provision referred to in the Case Study is described in Treasury Regulation Section 1.664-3(a)(4). It states that the document may allow trust assets to be distributed to charity currently or at someone's death. This language is standard in Crescendo's documents because it provides donors with a greater amount of flexibility and control.
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