For charitably inclined clients interested in saving tax dollars upon the sale of an asset, a charitable remainder trust (“CRT”) is once again a desirable tax-savings tool. A CRT is a split-interest charitable trust, meaning it has at least one non-charitable income beneficiary, i.e., the client (and possibly his or her spouse), and one or more charitable remainder beneficiaries. The tax savings is derived from the fact that a CRT is a tax-exempt trust.
To illustrate, if a client sells an investment asset with an inherent gain of $1.0mm, he or she will owe a 20% capital gains tax, a 3.8% Medicare tax, plus a 4.63% Colorado income tax for a total tax bill of $284,300, nearly one-third of the gain. If the sale proceeds are settled 100% in cash, the entire tax bill is due the following April 15th. If settled by receipt of an installment sale promissory note, no tax is due until payments are received from the buyer, but the client is subject to the buyer’s credit risks.
Enter the CRT where the sale can be settled 100% in cash without incurring an up-front tax bill. Building on the above illustration, if the same client first contributed the asset to a CRT in advance of the sale, the client’s benefits will be threefold:
1) The client will benefit by an up-front income tax charitable deduction in the year of contribution equal to at least 10% of the value of the contributed asset
2) The client will benefit by deferring in the year of sale recognition of the $284,300 tax bill, thereby retaining that amount to generate greater long-term returns
3) He or she can receive a lifetime stream of income of no less than 5% or greater than 50% of the value of the CRT assets recognizing that deferred tax bill incrementally only as he or she receives payments over his or her lifetime
Thus, a CRT can eliminate the credit risks of an installment sale promissory note, defer immediate recognition of taxable gain and provide the client (and his or her spouse) with a lifetime stream of income, all in the context of fulfilling the client’s philanthropic goals.