As advisors and their clients are waking up to potential tax rate increases in 2011 or 2012, they're reconsidering a number of tax deferral strategies. One strategy being reconsidered is the use of charitable remainder trusts (CRTs).
For those lucky, charitably minded individuals who have highly appreciated financial assets, the incentive to contribute those assets to a CRT to defer the tax on the gain isn't that strong if the federal tax is only 15 percent on an outright sale. In addition, the future distributions of capital gain income from the CRT will be taxed at the then-current rates, which are likely to be higher.
Individuals with existing CRTs have different concerns. Some individuals who established a CRT as an income safety net have found that they really don't need the income. Others, due to the economic downturn, have found that they need more money, not less, and would like to access the value locked in the income interest in their CRT. Currently, I would say that the latter group substantially outnumbers the former.
Combining the incentive of the potential for increased tax rates on capital gain with the need for current cash, CRT income interest holders are taking a close look at terminating their CRTs by partitioning them, with the public holding the remainder interests. All the charities I've been involved with so far have been delighted to work with a CRT trustee and income interest holder on an early termination. And why not; many charities were unaware that they were named as a beneficiary, so the proceeds are truly “found money.” Other charities, who knew of the CRT, are still glad to turn a long-term illiquid asset on their balance sheet into a current liquid asset.
So what are the steps in termination? Obviously, both the income interest holder and the charity should have appropriate counsel. Be sure to check state law as the attorney general may need to be notified of the termination of the trust. If the CRT is measured by one or two lives, I highly advise the income interest holder to obtain a medical exam to confirm that the use of the IRS standard actuarial tables is appropriate. Although there may be some negotiation over the exact amounts, in my experience the typical split between the charity and the donor is fairly close to the amounts calculated as if the CRT were being established currently. Usually, any assets in the CRT are sold to facilitate a cash distribution to both parties. If there are any illiquid assets, such as investment partnerships, those would have to be valued (and usually are awarded to the income interest holder as part of his share).
No project is complete until the paperwork is done, and this situation is no different: A final return must be filed for the CRT reporting the termination. The individual donor reports his proceeds as capital gain at the current rates. Since it seems to take about 60 days of back-and-forth from idea to final cash distribution, I expect a year-end rush of terminations, either this year or next year, depending on Congressional action extending the 2010 rates.
Bob Kuhn's “Cooling Off Period,” painted in 2003 with acrylic on board and measuring 15 inches by 11.75 inches, sold Sept. 18, 2010, for $70,000 at the Jackson Hold Art Auction in Jackson, Wyo. — $20,000 more than its original estimate.