Charitable Remainder Annuity Trust
1. What is a charitable remainder annuity trust?
A charitable remainder annuity trust (CRAT) is a trust that provides income distributions to you or other individual beneficiaries for life or a stated term of not more than 20 years. At the end of the trust term, the remaining trust property is distributed to the Church through your parish, the Archdiocese of Detroit Endowment Foundation, Sacred Heart Major Seminary or other archdiocesan institution or your favorite charities.
2. What is the required annual distribution rate?
Tax law requires that the trust agreement provide a rate for the annual distribution of income to beneficiaries. The rate must be at least 5 percent and no more than 50 percent of the value of the trust property.
3. When is the value of the trust property determined?
In a CRAT, the trust property is valued at the time you transfer the property to the trust. Therefore, the amount distributed each year is fixed at the time you establish the trust.
4. May property be added to the trust after it is established?
No, property may not be added to a CRAT. If you want to add property to a CRAT, you must establish a new trust.
5. Is there a minimum amount of the remaining trust property that the Church must receive when the trust terminates?
To qualify as a CRAT, the present value of the charitable remainder interest must be calculated to be at least 10 percent of the value of the property at the time the trust is established. The Office of Planned Giving can provide this calculation for you, using tables developed by the Internal Revenue Service.
6. Am I entitled to a charitable contribution when I establish a CRAT?
Yes, because the remaining trust property will go to the Church or your favorite charity when the CRAT terminates, you will be entitled to a charitable contribution deduction for tax purposes. The Office of Planned Giving can provide the calculation of this deduction for you, using IRS tables that reflect how long your CRAT is expected to last.
The charitable contribution amount is deductible in the year you transfer property to the CRAT. If you transfer cash, the amount is deductible up to 50 percent of your adjusted gross income. If you transfer appreciated property that you have held for more than a year, the amount is deductible up to 30 percent of your adjusted gross income. Any amount in excess of these limitations may be carried forward for five years, to be deducted subject to these same limitations.
7. May I amend the trust agreement after the CRAT is established?
No, a CRAT is irrevocable, so you cannot amend or revoke it once it is established. You must designate in the trust agreement a specific charitable organization or organizations to receive the remaining trust property when the CRAT terminates. However, you may retain, or give to another, the power to substitute another charitable remainder organization at a later time. The tax rules also require you to designate in the trust agreement an alternative charitable remainder organization in case one of the originally named organizations does not exist or qualify when the CRAT terminates.
8. Who may be the trustee of a CRAT?
Any individual or, in Michigan, any corporation with fiduciary powers may be the trustee of a CRAT. This generally limits corporate trustees in Michigan to financial institutions like banks and some investment firms. You as donor of property to a CRAT may act as trustee. If you name an individual as trustee, it is important that you also name a reliable successor trustee.
9. How are income distributions taxed to me and other beneficiaries?
The Internal Revenue Code provides for a four-tier system of income taxation to beneficiaries of a CRAT. The first tier is ordinary income. The second is capital gain. The third is tax-exempt income. The fourth is return of capital. Therefore, the taxation to beneficiaries depends on the type of investment income the trust generates. The first items distributed under this tier system would be such taxable income as dividends and interest.
10. Does a CRAT pay income tax?
No, a CRAT is tax-exempt and therefore does not pay income tax. For this reason a CRAT is an excellent vehicle for diversifying your investment portfolio since you can transfer appreciated property that you have held for more than a year to a CRAT without incurring capital gain tax. The CRAT can then sell that property to reinvest in assets that will generate enough income to provide the income distributions to beneficiaries. The CRAT will not pay any capital gain tax on the sale. However, depending on the stated CRAT distribution rate, some of the annual distributions to beneficiaries may be considered as coming from that accumulated capital gain, and therefore taxed to the beneficiaries under the distribution tier system described in No. 9.
11. What happens if the required rate of distribution to beneficiaries exceeds the income the CRAT is able to earn on its investments?
If the required distribution exceeds the income the CRAT earns on its investments, it will have to distribute trust principal to satisfy the annual distribution requirement. It is possible, therefore, that over time the trust property could be exhausted, resulting in neither the income beneficiaries nor the Church or your other favorite charities receiving anything from the CRAT. This demonstrates why your stated distribution rate should be modest enough to ensure continued existence of the trust as expected.
This situation does not change the amount of the required charitable remainder or charitable contribution deduction calculations discussed above. Those calculations are made when you establish the CRAT and are based on life expectancies and investment assumptions at that time.
12. May I establish a CRAT in my will or living trust to take effect at my death?
Yes. This technique is an excellent way to transfer some of your retirement plan benefits, for example, to the Church and still provide income to your family.
By establishing a CRAT in your will or living trust you forego any income tax charitable contribution deduction. However, if your estate is subject to estate tax at your death, it would be entitled to an estate tax charitable contribution.
The material presented on these pages is for your general information on stewardship, estate planning and charitable giving, and is not intended as legal advice. You should consult your attorney and tax and financial advisors for specific transactions of the points illustrated here.
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