Kill the CRTsKill the CRTs

Terminating a CRT prematurely should make a charity happy.

You may think that charities would be quite content to wait until CRTs died a natural death. You would be mistaken. Call your favorite charity right now and ask the fundraiser who answers the phone which she'd prefer — the potential of receiving a possibly larger dollar amount in the future or the certainty of receiving funds immediately?

Of course, she's going to say she prefers the certain, immediate gift over the uncertain future gift.

Why is the future gift uncertain? Isn't death a certainty?

Most grantors retain the power to change the ultimate remainder beneficiary of their CRTs. If a charity is currently named as the remainder beneficiary of a CRT, it typically has no assurance that it will still be named as a remainder beneficiary when the CRT terminates; another charity the grantor meets in the future may have overtaken the grantor's heartstrings.¹

Also, the CRT's payments to the grantor may make it unlikely that CRT funds will last until the time comes for distribution to the charity. Indeed, CRTs established with an annual payout to the grantor that is currently significantly greater than the projected future earnings of the CRT may not have any funds remaining to distribute to the charity.

You also have to think that the fundraiser on the other end of the phone has a quota to meet for revenue to the charity employing her. That fundraiser likes job retention as much as the next person and would be delighted to receive funds immediately.

Rare is the charity that cannot currently put funds to work. From an economic perspective, receiving the present value of funds is at least as appealing as receiving the future value of those funds later. It may be even more appealing in this economic environment, because the charity may feel as poor as the grantor currently does.²

Immediate extra cash would be embraced by many charities because many are hurting right now. Investments have taken a hit. Donations are down. Endowments have dropped.

In an early CRT termination, the charity eliminates the investment risk that it is exposed to while the CRT is alive and kicking. A dollar in a CRT one year ago may be worth a fraction of that today. Given the material diminution in asset values, the charity may be understandably disenchanted with the trusteeship of many CRTs.

But suppose the grantor is an introvert who's reticent to call his favorite charity and ask about receptivity to an early termination. What's a grantor like that to do? If the CRT document allows it, he can transfer his remainder interest to a supporting organization (SO). But beware, since the Pension Protection Act became law, most SOs (particularly Type IIIs) have become the redheaded stepchildren of charitable planning.³ (See “Not SO Bad: The proposed regulations for Type III supporting organizations could have been worse. Still, one new requirement may be disastrous,” by Gerald B. Treacy, Jr., p. 54).

Previously, the Internal Revenue Service allowed CRTs to be prematurely terminated and the remainder interest transferred to the grantor's private foundation. But Private Letter Ruling 200614032 put an end to that practice.⁴ As an alternative, grantors might consider funding a donor-advised fund with their CRT's remainder interest.⁵ This alternative keeps investment advisors happy, because they continue managing nearly the same amount of assets before and after the termination.

Killing a CRT should make its creator happy.

What? The creator is now the destroyer? Yes. Chances are the CRT was built in better times. The grantor may have been feeling flush and generous when the CRT was created. The grantor may have created his CRT when capital gains rates were in the neighborhood of 28 percent. The grantor may have formerly lived in a high tax state or municipality.

So where is the grantor today? Chances are he's poorer and would like to have some of the CRT funds back.⁶ The grantor may have retired to warmer climates, places like Florida, Texas or Nevada. Those locations, and others, have low or no state and local income taxes.

Chances are that the grantor is no fool; he had the wherewithal to amass significant wealth and the sophistication to build a CRT. This grantor, then, can sense one or more imminent tax increases coming his way. President Obama has promised⁷ a federal capital gains tax of at least 20 percent. Illinois residents have the prospect of an income tax increase of perhaps 50 percent.

If that's the case, why not kill the CRT now, before these tax increases land in the grantor's lap like a wet St. Bernard? Terminating the CRT now will cause the present value⁸ of the unitrust or annuity interest⁹ to be treated as taxable income for state and federal tax purposes. Also, because CRT asset values have likely plummeted, incurring the tax currently makes even more economic sense.

So, yes, the grantor should be happy to end his CRT because he'll obtain the CRT assets now. He'll avoid the coming federal income tax increase;¹⁰ he'll avoid the coming Illinois tax increase (or avoid any state income tax entirely if he has fled a high tax state).¹¹ After killing the CRT, chances are the grantor will feel better about his balance sheet.¹²

Ending the CRT won't upset the IRS

On numerous occasions, the IRS has issued PLRs approving of early terminations.¹³ The IRS has not generally concluded that the early termination of a CRT is an act of self-dealing nor does it mean a termination tax is due. Of course, the IRS could and should challenge any CRT termination that was conceived as a step-transaction in an effort to arbitrage tax rates or otherwise exploit the rules. And remember that while grantors and charities are feeling poor and favorably disposed to current liquidity, the government is in the same position — if not more so.¹⁴

The U.S. Treasury is delighted to receive more tax revenue now. Just as charities enjoy receiving the assets immediately (and eliminating the investment risk, the risk of unforeseen longevity, and the risk of being replaced by a younger or better-looking charity of the future), early CRT termination allows the IRS to collect currently and to eliminate the risk of the grantor dying prematurely. In that regrettable situation, the IRS would helplessly watch the CRT terminate without the government even getting its beak wet.¹⁵

It should be noted that if you're terminating a CRT established for the lifetime of one or more individuals, the written opinion of each individual's normal life expectancy from a medical doctor is required.¹⁶ Termination of CRTs with infirmed or older measuring lives is generally impractical. Note that early termination of a CRT still can make sense if there are multiple lifetime beneficiaries and one of them is materially younger than the rest.