What is the generation skipping transfer tax, and when does it apply?
A charitable remainder trust is an irrevocable trust that lets a donor transfer cash or appreciated property into the trust, keep an income stream for life or for a term of up to 20 years, and leave the remainder to one or more qualified charities at the end.
The trust must pay at least annually, the payout must generally be between 5 percent and 50 percent, and the charity’s remainder interest must be worth at least 10 percent when the trust is funded. In Trust and Estate Planning, this structure can convert donated assets into ongoing payments while preserving a meaningful charitable benefit.
The estate tax charitable deduction available when funding a charitable remainder trust is not based on the full value of the assets transferred. Instead, it is generally determined by the present value of the charitable remainder interest expected to pass to the qualified charitable organization after the income interest ends. The deduction is typically larger when the actuarially calculated remainder going to charity is greater and smaller when the payout rate is higher or the noncharitable income interest extends for a longer period. The calculation is based on IRS actuarial assumptions, including the applicable Section 7520 interest rate.
Payments to the noncharitable beneficiary follow a four-tier ordering rule under section 664(b). First, distributions are taxed as ordinary income to the extent of current and accumulated ordinary income. Second, they are taxed as capital gain to the extent of current and accumulated capital gains. Third, they are treated as other income, including tax-exempt income. Fourth, any remaining amount is treated as corpus, which is principal rather than income. In plain English, the trust pays out its most taxable layers first. This ordering is central to charitable tax planning because it determines how much of each payment is currently taxable.
A charitable remainder annuity (CRAT) trust pays a fixed dollar amount each year, based on the initial value of the assets contributed. A charitable remainder unitrust (CRUT) pays a fixed percentage of the trust’s value as remeasured each year, so payments can rise or fall with investment performance. A fixed annuity often fits someone who wants predictability. A unitrust often fits someone comfortable with variable payments and potential growth.
A CRT often delivers the most value when a donor holds appreciated assets, wants an income stream, and has genuine charitable intent. It can be especially useful when the donor wants to diversify assets inside the trust without immediate trust-level income tax on the sale, while still receiving a partial charitable deduction and preserving a future gift to charity. It may also fit legacy planning where lifetime transfers or testamentary transfers are being coordinated with Gift Tax Returns and charitable objectives, provided the trust is drafted to satisfy section 664 and related deduction rules.
For more than four decades, Bennett Thrasher has provided businesses and individuals with strategic business guidance and solutions through professional tax, audit, advisory, and business process outsourcing services. Contact Jonathan Swartz, partner in Bennett Thrasher’s Trusts & Estates Planning, or call us at 770.396.2200.
Back to Q&A
Never miss an update. Sign up to receive our monthly newsletter to unlock our experts' insights.
Subscribe Now