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Thursday, May 2, 2024
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Case Studies |
Sinking Stock Market Signals Early End to Donor's CRT, Part 1 of 2
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Case:
Two years ago, Margaret Young, 82, created a one-life 8% net income with makeup charitable remainder unitrust. Margaret funded the NIMCRUT with $1 million of non-income producing real property. With an estate of $5 million and modest living expenses, Margaret was not necessarily in need of additional income from her newly created trust. Therefore, she wanted her NIMCRUT to be invested for growth. Margaret's goals were to make a substantial gift to her local homeless shelter and, in addition, provide her with some flexibility. Specifically, the real property - while very valuable - provided no income and required too much ongoing attention from Margaret. Once the real property was sold tax-free inside the NIMCRUT, Margaret could sit back and relax knowing her three goals were being met - a substantial gift to charity, an income-producing investment, if needed, and a nearly hassle-free plan.
Unfortunately, like many other growth investments, the last two years have hit Margaret's NIMCRUT extremely hard. In fact, her original $1 million trust has fallen to a disappointing $600,000. Margaret has come to grips with this financial downturn in the markets (and her trust); however, she cannot bear to ride this financial - and emotional - roller coaster anymore.
After discussions with her children, Margaret wants to terminate her NIMCRUT and start making gifts to her children now in accordance with her estate planning goals. Since she does not really need any income from the NIMCRUT, she plans on giving her children whatever she can "salvage" from the trust.
Question:
Can Margaret elect to terminate her NIMCRUT early just because she is disappointed with its performance? If so, what dollar amount may she "salvage" from her trust? How is that amount to be determined?
Solution:
In general, most states allow for the early termination of trusts. For instance, many trust documents provide for the early termination of the trust. In the event that a trust document does not provide such language, state law provisions allowing for early termination may be considered as implied terms of the trust document. In many cases, state law also requires the consent of all vested beneficiaries before a trust may be terminated. With respect to charitable trusts, many times the state attorney general must be made a party to the court proceeding.
Therefore, pursuant to the trust document and state law, it is permissible for Margaret to terminate her existing NIMCRUT. Because the local homeless shelter receives an immediate distribution and avoids further investment risk, they choose to consent to the NIMCRUT's early termination. Moreover, in most cases, the state attorney general will not contest the trust termination.
The trustee must now compute Margaret's and the homeless shelter's share of the $600,000, which is the current fair market value of the trust assets on the date of termination. The trustee will use the tax regulation's formula for determining present values to calculate each party's interests in the NIMCRUT (applying the Section 7520 rate on the date of termination).
In this case, Margaret's distribution will be approximately $245,000 and the homeless shelter's distribution will be approximately $355,000. The present value of the income interest in a trust is a capital asset, but, unfortunately, the adjusted basis is disregarded and the entire interest is gain. In other words, Margaret will have $245,000 of capital gain to report.
After receiving court approval, the trustee terminates the trust and makes the appropriate trust distributions. While not a completely picturesque ending, Margaret was able to make the most out of a difficult situation. She made a very large gift to her favorite charity during her lifetime and transferred a large inheritance to her children.
Editors' Note: In PLR 200208039 and PLR 200127023, the Service approved the early termination of charitable remainder trusts. After these two letter rulings, it appears that a taxpayer has two different but favorable approaches in order to successfully terminate a charitable remainder trust early.
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