This article is the second piece of a two-part installment on Charitable Remainder Trusts (“CRTs”). Click here to read the first article in this series. CRTs are irrevocable, split-interest trusts that are ideal for certain philanthropic clients, and are increasingly popular in this climate of ever-rising real estate values. The previous segment covered general principles applicable to all or most CRTs; below in this second installment, we will review many of the most popular types of CRTs and explore their distinguishing characteristics.
Types of CRTs
There are two core types of CRTs: the Charitable Remainder Annuity Trust (“CRAT”), which pays a fixed sum based on the initial fair market value of trust assets, and the Charitable Remainder Unitrust (“CRUT”), which pays a fixed percentage based on the changing value of trust assets from year to year. Both trusts require distributions to be made to noncharitable beneficiaries at least annually. Both trusts also require that the value of the remainder interest at the time the CRT is created be at least 10 percent of the initial fair market value of the property contributed. The difference between the trusts lies in the character of these distributions: an annuity trust can be relied on to pay the same amount per period throughout the term of the trust, while a unitrust’s distributions will fluctuate based on the trust’s performance.
The distinctions between annuity trusts and unitrusts may help clients achieve different goals. The annuity trust’s static and dependable distributions make CRATs a better option for assets that are difficult or expensive to value, such as stock in a closely held corporation. A unitrust would require revaluing those assets every year in order to determine distribution amounts, while a CRAT, because its distribution scheme is based on the initial value of trust assets, does not require annual valuations. On the flip side, clients looking to capitalize on increases in the value of trust assets will benefit from the variable unitrust approach, which will yield higher distributions as the annual fair market value of the trust’s assets increases.
A CRAT distributes a specific amount each year, and the amount to be distributed is based on the initial fair market value of all trust property. One of the major advantages of the CRAT is that its distributions are static: the donor knows exactly how much the trust will distribute each year during the term of the trust, and this amount is fixed in the trust agreement. The amount to be distributed must be not less than 5 percent nor greater than 50 percent of the fair market value of the trust’s initial assets. No additional assets may be added to a CRAT once it is created and funded. Because a CRAT’s required distribution is fixed upon creation, the value of these distributions will be eroded over time by deflation and will not increase with the assets’ appreciation.
CRUTs are unitrusts, meaning that the distribution is a fixed percentage of the net fair market value of the trust’s assets valued annually. The fixed percentage to be distributed must be not less than 5 percent nor greater than 50 percent of the trust’s assets in a given year, and a CRUT’s distributions will vary with the fair market value of the trust’s assets year by year. Assets must be revalued annually to determine the distribution amount, and if assets appreciate, the required distribution increases; conversely, if assets depreciate, the required distribution decreases.
Net Income with Makeup Charitable Remainder Unitrusts (“NIMCRUTs”) differ from other CRTs in that they do not allow invasion of the trust’s principal to meet distribution requirements. Until years in which sufficient income exists, “makeup accounts” are maintained for beneficiaries, with the idea that they will eventually receive the income that would have been due to them in the lean years. Thus, NIMCRUTs are a good option when a donor wants a CRT that will not make distributions in years when no income is earned, and also wants deficiencies in income distribution from past years to be made up in later years.
A Flip CRUT can in some cases offer the best of both a CRUT and a NIMCRUT, and is a good option for a donor intending to sell property through a CRT. Using a straight CRUT risks that the trust will not sell the asset and will need to distribute a portion of the asset in order to meet its distribution requirement. A Flip CRUT allows the donor to establish a trust that starts as a NIMCRUT and does not require distribution until income is actually earned, and then converts to a straight CRUT upon either a fixed date or a fixed event (e.g., sale of a piece of property).