Protecting your finances from the grabby hands of the government is important to many high-net-worth individuals who are focused on accumulating wealth to support themselves and their loved ones. Making a savvy money move like setting up a charitable remainder unitrust (CRUT) can provide a source of regular income and make space for generous giving, not to mention the significant tax benefits.
But what are the charitable remainder unitrust rules you have to abide by to take advantage of the inherent benefits of the trust?
Before you meet with an expert trust attorney who can draft the conditions of your trust, here are the six rules you should keep in mind to ensure you get what you need.
1. You Must Abide by Distribution Rules
The first rule is one of the simplest, yet it can be difficult to follow without professional guidance. When you are ready to start taking distributions, all types of charitable trusts must abide by the IRS’s distribution rules.
For a charitable remainder unitrust, this means you must take a certain percentage of the fair market value of the trust. Generally, the payment must equal at least five percent and no more than fifty percent of the assets, valued annually.
In addition to this rule, there are a few things you cannot do that fall under the umbrella of taking legal distributions. You cannot give non-charitable beneficiaries any payment beyond prescribed annual income payments (a process known as self-dealing).
Additionally, you cannot pay personal expenses with trust funds or borrow money from your charitable remainder trust.
Once your assets and income are locked into the trust, the only way you can withdraw it is through legally permitted distributions which are set up at the inception of the trust by the grantor – usually you.
2. Distributions Could Be Taxable
Taking distributions also triggers another headache for many people: It spurs the IRS to send a tax bill for money withdrawn from the trust. In general, income from a charitable remainder unitrust is going to be taxed as ordinary income, but oftentimes it is considered a long-term capital gain. This applies if the trust had ordinary income throughout the year or had undistributed ordinary income in years past. Ordinary income must be paid out first.
If you reach a point where you no longer have ordinary income, then you might pay capital gains tax on the distributions instead. Even so, these taxes are distributed over several years rather than as a one-time hit.
If planned and administered properly, you can tailor your taxable distributions by avoiding creating ordinary income inside the CRT, since the rules follow a worst-in, first-out distribution (WIFO). If you used a CRT to avoid capital gains taxes, it can be possible to limit most of your tax distributions to long-term capital gain tax treatment.
3. You Must File with the IRS Annually
Wouldn’t it be nice to avoid having to file year-end taxes? Unfortunately, you will not be able to skirt the need to file annually with the IRS if you are pulling distributions from this type of trust.
A charitable remainder unitrust must annually file Form 5227 for split-interest trusts, and the income recipients will receive a K-1 from the trust to provide to their own tax preparer. Generally, no tax is due since the trust is tax-exempt, but the IRS likes to know what's going on.
You may want to consult with an accountant or tax expert to submit your filings. And you can expect to file an extension since you will need to wait until the trust can submit its return to the IRS and the K-1s to you and any other income beneficiaries.
4. You Cannot Change Beneficiaries
A charitable remainder unitrust is an irrevocable trust, meaning that you cannot make changes once the ink has dried on the paperwork. While irrevocable trusts come with many tax benefits for you, they also have one significant downfall: You usually cannot change or remove non-charitable beneficiaries once established. A non-charitable beneficiary cannot be changed, at least not without jumping through significant hoops.
One power that you can reserve to change is the charitable beneficiaries – in other words, the charity or organization that will receive your donation.
If you think that your situation is not set in stone, then you want to work with an attorney who can help you structure your trust properly from the beginning. An experienced professional can work flexibility into the verbiage to help future-proof your trust.
5. You Must Donate At Least 10 Percent
There is one major charitable remainder unitrust rule that all trust owners must adhere to if they want to maximize tax benefits associated with a charitable remainder trust. This rule is known as the 10 percent rule because it outlines exactly how much you must allocate to charity at the beginning of the trust's inception.
This is not to say that’s how much the charity will actually end up with – which could be more or less – but the present value of the charitable remainder interest must not be less than 10 percent.
When your term for receiving distributions is over or the fund is depleted, you must donate at least 10 percent of the trust’s fair market value to the charitable beneficiary of choice. That means that if you contributed $100,000 worth of assets to the trust, $10,000 would need to be donated to leverage the tax benefits in years to come.
Keep in mind that you can donate more than 10 percent if you choose. However, you will run into some serious issues if you neglect to donate the minimum proper amount. You will be on the hook for all the money you thought you saved because tax benefits are immediately forfeited.
6. The Charitable Beneficiary Must Be Qualified
Just because an organization declares itself a charity and seems to be doing good work for the local community does not necessarily mean they are a qualified charity. You will have to be careful where you donate the remainder of your trust, selecting only qualified 501(c)(3) charities.
The IRS keeps careful tabs on which charities meet the tax-exempt requirements and can receive tax-deductible contributions. Take note of this charitable remainder unitrust rule before establishing your paperwork, or else you will not be able to reap the tax benefits.
Do your homework before settling on which charity to bestow your gift upon in the years and decades ahead. One trick is to name a donor-advised fund (DAF) as your charitable beneficiary, as this will give you the flexibility to choose your charity or charities at a later date.
Establish Your Charitable Remainder Unitrust
When you are ready to take the next steps on structuring your charitable remainder unitrust, Magellan Planning Group can help. We provide comprehensive estate, financial, legal, and tax planning with the goal of a functional and beneficial trust in mind. We are your one-stop shop for all things related to managing your wealth with tax-exempt entities like CRUTs.
Reach out to us today to learn more about how we can help you set up a trust that benefits you and your beneficiaries for years to come!
For a comprehensive review of your personal situation, always consult with a tax or legal advisor. Neither Cetera Advisor Networks LLC nor any of its representatives may give legal or tax advice.
This material provided by Kevin Meaders was written by Axle Eight, a non-affiliate of Magellan Planning Group and Cetera Advisor Networks LLC.