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Sunday, April 28, 2024
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Case Studies |
"Cashing Out" Your Unitrust Income Stream
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Case:
William Rogers, 60, is a very charitable American. He consistently makes gifts each year to various causes he supports. Ten years ago, William created a Charitable Remainder Unitrust. He funded his unitrust with $500,000 of appreciated stock. The unitrust was drafted to have a 5% payout and a term of twenty years. In addition, William irrevocably designated a local hospital as the charitable beneficiary. William opted for a twenty-year trust over a lifetime trust for two reasons. First, he needed a large tax deduction, and, at age 50, a lifetime unitrust would produce a very small tax deduction. Second, he wanted the local hospital to receive the gift while he was alive. He thoroughly enjoyed giving, and wanted to ensure he would be able to see his gift at work.
William chose the termination date of his unitrust to coincide with the start of his mandatory IRA withdrawals. Therefore, he would have an uninterrupted income stream to support his living expenses. However, the local hospital has recently approached William about making a current gift to their new fundraising campaign. This new campaign is extremely important, and William is eager to help.
The hospital advises William that he can make immediate distributions from his unitrust to the hospital and receive a tax deduction for it (Ed. See prior Case Study "The Flexible CRT"). William unfortunately cannot utilize this strategy, because his income stream from the unitrust would decrease substantially. He is eager to help, but needs a strategy that does not produce a financial hardship upon him.
Question:
Can William terminate the unitrust early, and "cash out" the charity's and his share of the unitrust? What is the value to each party, and how is it determined?
Solution:
Under the reasoning of PLR 200127023, William, the trustee, and the charity may agree to terminate the unitrust early (provided state law does not prohibit this early termination and it is approved by court order). This agreement will entitle the donor and the charity to receive assets equal to their respective share of the unitrust value. In this instance, William will receive assets equal to the present value of his income stream. Here, the present value of William's remaining ten-year income stream on a $600,000 unitrust (the trust principal grew over the first ten years) is $235,000. Accordingly, the charity's present value of its remainder interest is $365,000. Therefore, the trust will terminate and William will receive $235,000, which he will use to supplement his income until the age of 70. Even better, the charity will receive an immediate distribution for its fundraising campaign! As you can imagine, William is very pleased with the flexibility and effectiveness of this solution. He is able to make a very large gift to a favorite charity now, yet maintain his retirement planning goals.
Editor's Note: Two additional considerations must be noted. First, the Service stated that an income beneficiary's receipt of the value of their income stream would be deemed a sale under Section 1001. Furthermore, it would be a sale of a capital asset, which in this case would be a long-term capital asset. Unfortunately, the Service concluded that there is no basis attached to the income stream value; thus, all $235,000 will be taxable gain. Second, William will not receive a charitable tax deduction for this transaction, because he is not making "another" gift. Here, William is merely accelerating each party's interest under the unitrust.
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