Morningstar Magazine - October/November 2017 - 52

Strategies

When to Use Charitable Remainder Trusts
Under the right circumstances,
you'll be doing right for the client and
a good cause.

remainder annuity trust, or CRAT). For example,
let's assume that two CRTs have a value of
$1 million each on Jan. 1, 2018. The CRTs grow at a
rate of 7% per year. Bob's CRT is a CRUT, and
he has chosen to receive distributions of 8% per
year. Mary's CRT is a CRAT, and she has
chosen to receive $80,000 per year. Based on these
assumptions, distributions for Bob and Mary
are shown in the exhibit below.
Because the distribution rate exceeds the growth
rate, Bob's distributions will tend to decrease each
year, while Mary's remain constant.

TAX WISE

Sheryl Rowling

The purpose of a charitable remainder trust, or CRT,
is to provide a benefit to the donor (income
for life) and charity (distribution at death) while
receiving an immediate charitable tax benefit.
Before we get into CRT strategy, let's begin with a
basic definition. A CRT is a trust that:
3 Is funded with cash, securities, or other property.
3 Will provide ongoing income to the donor for life
(or a period of years).
3 At death, distributes to charity any amount
remaining in the trust.
Funding
CRTs can be funded with cash, securities, or other
property. In general, an operating business
cannot be owned by a CRT (due to the "unrelated
business" tax rules). For tax purposes, the
initial funding is valued at fair market value.
Obviously, cash value is dollar for dollar.
Traded securities are valued at stock market value
at contribution date. Other property, such
as shares in a closely held business or rental
property, require an appraisal.

It should be noted that initial appraised value
could differ from the selling price of the property.
For example, let's say that 20% of a closely
held company is contributed to a CRT on June 15,
2017. The company is sold on Aug. 1, 2017,
for $5 million. Thus, the CRT receives $1 million.
Although the shares are sold almost immediately
for $1 million, the appraised value on June 15

52

Morningstar October/November 2017

would likely be lower because of valuation
discounts, including:
3 Discount for lack of marketability.
3 Discount for minority interest.
3 Discount for small-company risk.

Therefore, it is possible that the appraised value at
funding could be much lower than $1 million.
Beware: When contributing securities or property
that will be sold, it is imperative that the CRT
be set up and receive ownership before a
transaction deal has been agreed upon. If the deal
has been agreed upon before contribution
to the CRT, the owner will recognize the income.
Ongoing Income
Most CRTs are set up to provide income to the
donor for life, although it is also possible to specify
a number of years. The income distributions
can be based on a fixed percentage of beginning
of year values (charitable remainder unitrust,
or CRUT), or a fixed dollar amount (charitable

Thus, choosing distribution rates and type of
trust is key to accomplishing the goals of
the donor.
Remainder to Charity
When the income beneficiary passes away,
whatever is left in the trust is distributed
to charity (remainder beneficiary). The remainder
beneficiary can be one or more charitable
organizations. Note that:
3 The CRT is irrevocable so that the remaining
principal must always go to charity.
3 Depending on how the trust is written, it
is possible to change charitable beneficiaries
during the donor's lifetime.

When CRT income distributions exceed the trust's
earnings, the charitable beneficiaries will
receive less than the original CRT value. Conversely,
when CRT income distributions are less than
trust earnings, the charitable beneficiaries will
receive more than the original CRT value.

CRUT or CRAT? Bob's distribution rate exceeds the growth rate, so his distributions
will tend to decrease each year. Mary's remain constant.
$
Bob (CRUT)

Mary (CRAT)

1,000,000

1,000,000

Distributions, Year 1

80,000

80,000

Growth, Year 1

70,000

70,000

990,000

990,000

79,200

80,000

Value of CRT, Beginning of Year 1

Value of CRT, Beginning of Year 2
Distributions, Year 2
Table of Contents for the Digital Edition of Morningstar Magazine - October/November 2017
