IRS Provides Way To Receive

October 25, 2004
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GRAND RAPIDS — The U.S. Internal Revenue Service is best known for taking, but one provision of its code has a faint ring of St. Luke's injunction to give and, in return, receive.

The notion is embodied in a provision of the IRS code that provides for the device known as the Charitable Remainder Unitrust (CRUT).

As explained by Amie Vanover — an attorney with Warner Norcross & Judd — this form of trust is a way for a donor to make a substantial gift to charity and to receive, or direct to someone else such as a spouse or child, a certain amount of income in return.

And, Vanover said, if the donation happens to be an appreciated asset, the trust also can help the donor defer and spread capital gains over an extended period.

She said other tax benefits — such as a big charitable donation deduction in the year of the gift — can accrue to people using a CRUT, one of a variety of split-interest gifts.

But Vanover also warned that the IRS doesn't look kindly upon someone who tries to use a CRUT as a tax dodge.

"Besides that," she said, "the tax benefits aren't really the reason to use a CRUT. It's something for people with an impulse to make a charitable gift."

Moreover, she said, the IRS requires sufficiently complex reporting — the trust must file Form 5227, annually revaluing the donation's value to the charity — that using a CRUT pretty much calls for reliance upon professional accounting.

The charity for which the CRUT is established pays no taxes.

But Vanover noted that for recipients of distributions from the CRUT, taxes can be complex, depending on a range of factors such as whether the donation is cash or an appreciated asset.

The way a CRUT works, Vanover explained, is that the donor contributes an asset to an irrevocable trust, meaning the donor can never take back the donation. The donor can, however, change the charity that receives the gift.

"So you and the charity have an interest and you could pick a person or persons to receive an amount from the trust," Vanover said. "Then, on the termination of your interest, the charity would get the amount remaining in the trust."

She explained that a fairly typical example of the trust is found in an elderly person who has an asset he or she wants to donate to charity.

"You want to give that asset to charity," she explained, "but you are afraid to do that right now because you need income. So a CRUT would work well in that situation."

The donor, Vanover said, would spell out in the trust the percentage that he or she wants to receive annually from the trust — an amount that IRS rules permit to range from 5 percent to 50 percent of the original gift.

And the arrangement would work especially well, she said, if the asset in question were a piece of appreciated real estate.

Vanover explained that if the potential donor were to sell the asset, invest the proceeds and live off the income, there's a big problem.

"You'd take a huge capital gains hit if you sold it individually," Vanover said.

"But what you could do is give it to the trust." In doing so, the donor would receive a big income tax deduction in the year of the donation.

She cautioned that the donor cannot stipulate in the trust document that the trust will sell the asset.

"But what's going to happen," Vanover said, "is that the trust has to make that percentage distribution to you. And it probably is going to need to sell that asset to make that distribution. So the trust is going to sell the property and it's going to pay you income from it."

She stressed that the donor-recipient still doesn't elude capital gains taxes when the trust sells the donated asset.

But the arrangement, she said, does spread that tax over the period of years that it takes to distribute the capital gain to the donor. Meanwhile, the trust invests the remainder of the gain, so that it generates more income for the donor-recipient.

She noted that if the elder donor-recipient in the example above happens to die before receiving the entire capital gain and before paying the full tax thereon, the tax obligation simply terminates because the IRS cannot tax the receiving charity.

During the donor-recipient's life, Vanover said, taxation of the donor-recipient's income from the trust can be complicated because it involves a four-tier system (the heaviest, ordinary income taxes are paid first), which actually has tiers within those tiers.

In most cases, she said, this calls for professional assistance, a factor donors should consider in deciding whether to set up a CRUT.

Likewise, she said, establishing a CRUT can be costly, because the documents aren't standard legal boilerplate. Each is a plan custom-designed for the donor's particular circumstance.

Vanover said a CRUT can have a great deal of flexibility. The donor, for instance, can stipulate that income go to a spouse or a child or even a succession of people. If the money goes to a spouse as a one-time life gift, then that distribution is free of tax.

But, she stressed, setting up income for a child or successor recipients implies a longer term of income, diminishing the value of the charitable remainder. In the eyes of the IRS, that causes charitable income tax deduction to diminish commensurately

"The IRS has approved these trusts," she said, "and it doesn't have a problem with these instruments. But the IRS is very strict about the rules."

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