Overview of the CRT

1. Arthritis FoundationTexas ChapterPlanned Giving SeminarMay 20, 2010PLANNING WITH CHARITABLE REMAINDER TRUSTSR. Thomas Groves, Jr.Jackson Walker L.L.P.901 Main Street, Suite 6000Dallas, Texas 75202(214) 953-5813 (direct)(214) 661-6635 (direct fax)tgroves@jw.com

2. Overview of the CRT • Provides a current beneficial interest to at least one individual and a future remainder interest to charity • Provides a current deduction for income and gift tax purposes or estate tax purposes. • Must meet the requirements set out in IRC §644 and Treasury Regulations

3. Overview of the CRT • Current Beneficiaries • One or more “named persons” • Individuals must be living when trust created unless payments are to be paid for stated period of years • Can be successive current beneficiaries • Payments to trust for current beneficiary permitted only if current beneficiary is incompetent • Remainder Beneficiaries • Qualifying charitable organization under applicable income, gift, or estate tax charitable deduction provision • Caveat: May be different for different tax deduction purposes

4. Overview of the CRT • Term of Payments to Current Beneficiaries • Begin with first year of the CRT • Continue for the life or lives of the current beneficiaries (including successive current beneficiary) (not for life of another) or for stated number of years, not to exceed 20 • Effect of 10% requirement on term • Term may end early, on the occurrence of a specified contingency – contingency not considered in valuing remainder interest

5. Overview of the CRT • Types of CRTs • Charitable Remainder Annuity Trust (CRAT) • Charitable Remainder Unitrust (CRUT) • Primary difference is nature of payments to current beneficiaries • CRAT – Fixed dollar amount annually (constant payments during term) • CRUT – “Standard” or “Fixed Percentage CRUT:” amount equal to fixed percentage of fmv of trust assets, valued annually (variable payments during term) • NICRUT • NIMCRUT • Flip CRUT • One or the other but not both

6. Overview of the CRT • Time for Payment of Annuity or Unitrust Payment • Not less often than annually, at or before the close of the taxable year of the CRT • Payment can be made for any year after the close of that year under certain circumstances • NICRUT or NIMCRUT –may be made within a reasonable time after close of taxable year • CRATs and Standard or Fixed Percentage CRUTs • Created pre 12/10/98 – may be made within a reasonable time after close of taxable year if the fixed percentage or amount is 15% or less of the fmv of trust assets • Created 12/10/98 or later – may be made within a reasonable time after close of taxable year if special requirements met. • “Reasonable Time” • Late Payment

7. Overview of the CRT • CRT Investments • Trustee cannot be restricted from investing trust assets in a manner that could result in the annual realization of a reasonable amount of income or gain • CRT may not hold S corporation stock without disqualifying S corporation status • Some investments may create violations of applicable private foundation rules and imposition of private foundation excise taxes

8. Overview of the CRT • Federal Income Taxation • CRT • Income tax exempt • But 100% tax on UBTI • Income from trust-operated business • Borrowing funds to purchase investments • Holding mortgaged property • Investment in partnership having UBTI • Failure to timely make annuity or unitrust payment • Lien or trust real estate resulting from failure to pay taxes or assessments • Can have up to $1,000 classified as UBTI • Tax year: calendar year

9. Overview of the CRT • Federal Income Taxation • Current Beneficiaries – (Individuals) • Income taxation based on 4-tier system of deemed ordering of distributions • current ordinary income and prior years’ undistributed unordinary income • current capital gains and prior years’ undistributed capital gains • current “other income” and prior years’ undistributed “other income” (typically tax exempt) • corpus • character in hands of current beneficiaries carries over from CRT

10. Overview of the CRT • Federal Income Taxation • Current Beneficiaries – (Charities) • If paid portion of annuity or unitrust payment: same 4-tier system applies for purposes of determining character of distributions • If paid any amounts other than portion of annuity or unitrust payment – 4-tier system applies in reverse

11. Overview of the CRT • Must Meet Requirement of CRT and Function as CRT from Date of Creation • Date of Creation: Earliest time when neither grantor nor any other person treated as owner of entire trust under IRC grantor trust rules but in no event prior to transfer of property to trust • Grantor Trust Status • grantor/grantor’s spouse not treated as owner solely because of status as current beneficiary • retained power to revoke • Income applied in discharge of grantor’s legal obligations • Inter Vivos CRT • Testamentary CRT

12. Overview of the CRT • Private Foundation Restrictions • CRTs are treated as if they were private foundations for purposes of certain of the private foundation excise tax provisions of the IRC • The private foundation provisions do not apply to annuity or unitrust payments made to individual current beneficiaries

13. Overview of the CRT • Private Foundation Restrictions • Self-dealing • Taxable expenditures • Excess business holdings • Jeopardy investments

14. Overview of the CRT • Funding CRTs • “Best” property: cash or passive investment assets • Property with problems • Mortgaged property • Interests in businesses

15. Specific Considerations for CRATs • Annuity payment • At least 5% but not more than 50% of initial net asset value • Protects charitable remainder beneficiaries from inflation • Valuation of charitable remainder interest/charitable deduction • value of contribution less present value of annuity payments • Must be at least 10% of net fair market value of contributed property • No additional contributions • No amounts payable to noncharity other than annuity payments • 5% probability of consumption of principal test

16. Specific Considerations for CRATs • Advantages/Disadvantages • Deferred charitable giving for donor desiring consistent income stream • Generally a more attractive vehicle for tax deduction purposes when the assumed rates of return for purposes of computing the present value of the annuity payments are high • Generally produces a larger tax deduction than a comparable CRUT

17. Specific Considerations for CRATs • Advantages/Disadvantages • Can be used to provide stream of payments to persons other than donor, but present value of annuity payments to third person is gift for gift tax purposes or part of taxable estate for estate tax purposes • Can’t invade principal for current beneficiary except to the extent necessary to fund annuity payments • No additional contributions can be made to a CRAT • Recordkeeping/administration issues for CRAT are less onerous than for a CRUT

18. Specific Considerations for CRUTs • Unitrust payment • At least 5% but not more than 50% of net asset value each year • Protects current beneficiaries from inflation • Variations on standard or fixed percentage CRUT • NICRUT • unitrust payment is lesser of current income or fixed percentage • Protects interests of charitable remainder beneficiaries since principal is not invaded to fund unitrust payment • Useful when trust funded with illiquid assets with yield less than projected fixed percentage payments

19. Specific Considerations for CRUTs • Variations on standard or fixed percentage CRUT • NIMCRUT • NICRUT with additional feature: if current income in any year exceeds amount needed to fund fixed percentage unitrust payment, excess current income used to fund prior years’ “deficiencies” • Useful when trust funded assets with an anticipated yield, for at least some part of the term of the trust, less than anticipated income from trust assets, but at some point (e.g., on a sale of initial assets), yield may exceed the anticipated fixed percentage unitrust payment

20. Specific Considerations for CRUTs • Variations on standard or fixed percentage CRUT • Flip CRUT • Begins as a NICRUT or NIMCRUT but later “flips” to a fixed percentage CRUT • Flip “Triggers:” Must be on a specific date or by a single event the occurrence of which is not discretionary with or within the control of the trustee or any other person • Sale of unmarketable assets (real estate, closely held stock, unregistered securities with no registration exemption permitting public sale), marriage, divorce, death, or birth of a child • Flip must be effective at the beginning of the taxable year following year in which the flip trigger occurs • If a Flip NIMCRUT, any “makeup” amount is forfeited on the occurrence of the flip trigger

21. Specific Considerations for CRUTs • Allocation of Capital Gain to Income • In the context of a NICRUT, NIMCRUT, or Flip CRUT (while in the NICRUT or NIMCRUT stage), determination of what is “income” is important • Capital Gain • Gain on the sale of assets contributed to the trust must be allocated to principal, at least to the extent of pre-contribution gain • Gain on the sale of assets acquired by purchase by the trust must be allocated to principal, at least to the extent of the trust’s purchase price • Other capital gain may be allocated to income pursuant to the terms of the governing instrument, if not prohibited by state law • Trustee’s discretionary power to allocated capital gain to income may be granted to trustee under the governing instrument but only to the extent state law permits the trustee to make adjustments between income and principal to treat beneficiaries impartially • If capital gain is allocated to income, the annual valuation of the trust assets must be adjusted for the amount of any deficiencies from the fixed percentage unitrust payments in prior years

22. Specific Considerations for CRUTs • Allocation of Capital Gain to Income • Capital Gain • Other capital gain may be allocated to income pursuant to the terms of the governing instrument, if not prohibited by state law • Trustee’s discretionary power to allocated capital gain to income may be granted to trustee under the governing instrument but only to the extent state law permits the trustee to make adjustments between income and principal to treat beneficiaries impartially • If capital gain is allocated to income, the annual valuation of the trust assets must be adjusted for the amount of any deficiencies from the fixed percentage unitrust payments in prior years

23. Specific Considerations for CRUTs • Valuation of Charitable Interest (and Charitable Deduction) in CRUTs • Net income limitation on distributions in NICRUT, NIMCRUT, and Flip CRUT disregarded. • Determine “adjusted payout rate” from IRS tables • Determine valuation factor from IRS tables • Multiply valuation factor by net fair market value of contributed property • IRS will provide value where valuation cannot be made based on published tables • Must be worth at least 10% of net fair market value of contributed property

24. Specific Considerations for CRUTs • Additional Contributions to CRUT are Permitted • Governing document must contain special provisions regarding determination of unitrust payments in the event of additional contributions • If special provisions not included, document must prohibit additional contributions • No amounts payable to noncharity other than unitrust payments • Potential application of IRC sec. 2702 to NICRUTs, NIMCRUTs, and Flip CRUTs

25. Specific Considerations for CRUTs • Advantages/Disadvantages • Deferred charitable giving for donor desiring steady income stream, wants to benefit from increases in value of CRUT assets and is comfortable with the risk of decreases in value • Generally a more attractive vehicle for tax deduction purposes when the assumed rates of return for purposes of computing the present value of the charitable interest are high • Can be used to provide stream of payments to persons other than donor, but present value of unitrust payments to third person is gift for gift tax purposes or part of taxable estate for estate tax purposes

26. Specific Considerations for CRUTs • Advantages/Disadvantages • Generally produces a smaller tax deduction than a comparable CRAT • Can’t invade principal for current beneficiary except to the extent necessary to fund unitrust payments in a fixed percentage unitrust payement • Additional contributions can be made to a CRUT • Recordkeeping/administration issues for CRUT are more onerous than for a CRAT

27. Drafting the CRT • Governing Document Must Meet Requirements of IRC sec. 664 and Regulations • IRS Published Sample CRAT and CRUT Documents • Annotations and alternative provisions included • Reliance on sample forms • IRS will automatically recognize a CRT as qualified if • Trust operated consistently with terms of governing instrument • Trust valid under state law • Governing instrument is “substantially similar” to the applicable IRS published sample form

28. Applications for CRTs in Wealth Planning • Basic: Donor who wants to make eventual transfer to charity but needs or wants to keep (or wants to give another person) an income stream • Sales of appreciated property - generally • Avoid assignment of income • Avoid obligation of trustee to invest proceeds from sale in specific manner • Use of NICRUT, NIMCRUT, or Flip CRUT where delay in sale anticipated • Investment diversification • Enhancing annual return on assets • Income for retirement • CRT in connection with life insurance planning

29. Applications for CRTs in Wealth Planning • Some Controversial Applications • Depreciable property and CRTs • Donor with Capital Loss Carryforward

30. Planning Points and Traps to Avoid • Trustee/Trust Administration Issues • Avoid grantor trust status • CRUT with difficult-to-value assets • Independent trustee with valuation responsibility • Qualified appraisal requirements • Fiduciary Duties • Self dealing issues

31. Planning Points and Traps to Avoid • CRTs and Business Interest Redemption Planning • Private foundation rules, esp. self dealing • Transfer of closely held stock to CRT – 30% of contribution base limit unless value of stock reduced by 100% of appreciation • CRT trustee cannot be under any legal obligation to surrender the shares in a redemption at time of contribution

32. Planning Points and Traps to Avoid • Gift Tax Planning Issues • Creation of inter vivos CRT has gift tax consequences if an individual other than grantor has interest in annuity or unitrust payments • Value of gift • Gift tax annual exclusion: present interest requirement • Gift tax marital deduction • IRC sec. 2511 and completed gifts

33. Planning Points and Traps to Avoid • Estate Tax Planning Issues • Can a qualified testamentary CRT be created in 2010? • Potential inclusion in donor’s estate • Estate tax marital deduction • QTIP Trust as alternative to CRT for spouse (estate and gift purposes) • Advantages • QTIP: all income to spouse; CRT: only fixed amount or amount by fixed percentage • QTIP: principal can be invaded for spouse for stated purposes; CRT: principal can be invaded only to the extent necessary to fund annuity or unitrust payment • Disadvantages • No income tax charitable deduction for charity’s remainder interest in inter vivos QTIP • QTIP must pay all income to spouse, even if not needed; CRT income in excess of required annuity or unitrust payment is not distributed and is not subject to income tax to the CRT • QTIP: no requirement that principal be invaded for spouse; CRT: if CRAT or fixed percentage CRUT, principal will be invaded if income not sufficient to fund annuity or unitrust payment

34. Planning Points and Traps to Avoid • Changed Circumstances: “Fixes” • Division of CRT incident to divorce • Subsequent gift to charitable remainder beneficiary of donor’s retained annuity or unitrust interest • Transfer of annuity or unitrust interest in exchange for charitable gift annuity to increase income stream • Early termination of CRT term and distribution from CRT to current beneficiary of actuarial value of annuity or unitrust interest • Sale of annuity or unitrust interest to third person