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Tuesday, May 7, 2024
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Case Studies |
Sinking Stock Market Signals Early End to Donor's CRT, Part 2 of 2
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Case:
Margaret Young, 85, created a one-life 7% net income with makeup charitable remainder unitrust for her only nephew, Randy. Margaret funded the NIMCRUT with $1 million of appreciated property. She wanted the trust to be invested for growth for a period of five years and then begin distributing income to Randy when he turned 65. Margaret wanted to help Randy financially during his latter years, since he had very modest retirement savings.
Randy turned 65 three years ago and the trust began making distributions. Unfortunately, like many other investments, the last three years have hit the trust investments extremely hard. In fact, the original $1 million trust has not grown at all over the years.
In fact, the NIMCRUT payout in recent years to Randy has averaged less than 3% of the trust fair market value. Not surprisingly, Randy is unhappy with the low NIMCRUT payouts. To resolve this problem, Randy wants to terminate the NIMCRUT and receive a lump sum distribution of his share of the trust assets.
Question:
Can Randy terminate the NIMCRUT early just because he is disappointed with its performance? If so, what dollar amount may he "cash out" from the 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 Randy to terminate his existing NIMCRUT. Because charity receives an immediate distribution and avoids further investment risk, they may consent to the NIMCRUT's early termination. Moreover, in most cases, the state attorney general will not contest the trust termination. Finally, Margaret most likely will not object since the current income stream is not providing Randy with the financial comfort she envisioned.
The trustee must now compute Randy's and the charity's share of the $1,000,000, 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 Sec. 7520 rate on the date of termination).
In this case, Randy's distribution will be approximately $600,000 and charity's distribution will be approximately $400,000. 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, Randy will have $600,000 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, Randy was able to make the most out of a difficult situation. Charity received a large gift early and Randy lived out his retirement years with added security.
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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