Charitable Remainder Trusts (CRTs) are powerful estate planning tools, but their flexibility isn’t unlimited. While a CRT is designed to provide an income stream to a non-charitable beneficiary for a term of years or life, the question of *pausing* income entirely for specific years is complex. Generally, a standard CRT doesn’t allow for complete income pauses. The IRS requires a consistent, regular income payout. However, careful structuring and the use of specific CRT types, along with a bit of financial planning, can achieve a similar outcome, allowing for reduced or delayed income in certain years. Approximately 65% of high-net-worth individuals are seeking ways to balance current income with future charitable giving, making this a frequently asked question for trust attorneys like myself in San Diego.
How do CRTs typically distribute income?
Typically, a CRT distributes income annually, based on a fixed percentage of the trust’s initial fair market value (a fixed percentage CRT) or a fixed dollar amount (a fixed amount CRT). This payment schedule is established in the trust document and is largely inflexible. The IRS mandates that the payout rate be at least 5% but no more than 50% of the trust’s assets. A common misconception is that beneficiaries can simply *skip* a year’s payment; that’s generally not permitted without potentially jeopardizing the trust’s tax-exempt status. The underlying principle is that the trust is established with a clear income stream in mind, balancing the beneficiary’s needs with the ultimate charitable goal. Remember, the IRS views CRTs as a way to encourage charitable donations by providing a present income tax deduction.
What is a “net income only” CRT and how does it work?
A “net income only” CRT (NIMO CRT) offers the most flexibility when it comes to fluctuating income. Unlike a standard CRT, a NIMO CRT only distributes income if the trust actually *generates* income during a given year. If the trust assets produce no income (e.g., during a market downturn or if the assets are primarily depreciating), no payment is made to the beneficiary. This feature is particularly attractive to individuals with assets that don’t consistently produce income, like real estate or closely held stock. It’s important to note that NIMO CRTs typically provide a smaller initial income tax deduction compared to standard CRTs. For example, a standard CRT might offer a 30% deduction, while a NIMO CRT might only provide a 10% deduction. This is because the IRS rewards trusts with more predictable income streams.
Can a CRT be combined with other financial instruments to delay income?
While a CRT itself can’t directly “pause” income, it can be strategically combined with other financial tools to achieve a similar effect. For instance, a beneficiary could establish a deferred income annuity (DIA) within the CRT. The CRT would transfer funds to the DIA, and the DIA would begin making payments at a future date, effectively delaying the income stream. Another approach is to fund the CRT with a mix of income-producing and non-income-producing assets, and to strategically manage those assets to control the income flow. This requires careful planning and coordination with a financial advisor and a trust attorney. It’s akin to orchestrating a financial symphony, where each instrument plays a specific role to achieve the desired outcome.
What happened when a client tried to circumvent the income rules?
I remember a case involving an elderly client, Mr. Abernathy, who was determined to avoid paying income during his peak travel years. He funded a CRT with a significant amount of stock, but insisted we include a clause allowing him to “suspend” payments during certain months. We strongly advised against it, explaining the IRS regulations, but he was insistent. He believed he could simply “borrow” from the trust in those years and repay it later. As you might expect, the IRS flagged the trust during an audit, questioning the irregular payment schedule. It required extensive legal work and the payment of penalties to resolve the issue, and Mr. Abernathy ultimately had to accept a much smaller income tax deduction than he had hoped for. It was a painful lesson in the importance of adhering to the rules.
How can a client proactively plan for fluctuating income needs?
One of my clients, Mrs. Davies, was a retired teacher with a desire to donate to her alma mater but also wanted to maintain flexibility in her retirement spending. She approached me seeking a solution that would allow her to reduce income during years she planned extensive travel. We designed a plan that combined a NIMO CRT with a carefully managed portfolio of dividend-paying stocks and bonds. The NIMO CRT provided a base level of income, while the portfolio allowed for supplemental income during years she needed it, and reduced income when she didn’t. We also established a separate “travel fund” within the CRT, funded with a portion of the initial assets. This allowed her to access funds for travel without impacting the regular income stream. The key was proactive planning and a willingness to embrace flexibility. It wasn’t about circumventing the rules, but about working *within* them to achieve her goals.
What are the tax implications of structuring a CRT with flexible income?
The tax implications of structuring a CRT with flexible income are complex and depend on the specific structure and assets involved. Generally, the income received from a CRT is taxable to the beneficiary as ordinary income, to the extent it represents trust corpus. However, a portion of the income may be treated as capital gains if the trust sells appreciated assets. It’s crucial to understand the tax consequences of each income distribution, especially if the trust holds a variety of different asset types. A trust attorney and a tax advisor can help you navigate these complexities and ensure that the trust is structured in the most tax-efficient manner possible. Approximately 40% of clients underestimate the tax implications of CRT distributions, highlighting the importance of professional guidance.
What are the key considerations when choosing between a fixed-percentage CRT and a NIMO CRT?
The choice between a fixed-percentage CRT and a NIMO CRT depends on your individual financial circumstances and goals. A fixed-percentage CRT is a good choice if you want a predictable income stream and are comfortable with the risk of receiving lower payments during periods of market downturn. A NIMO CRT is a better choice if you want maximum flexibility and are willing to accept a potentially lower initial income tax deduction. Consider your risk tolerance, income needs, and the type of assets you plan to contribute to the trust. It’s also important to consider your long-term charitable goals and how the trust will fit into your overall estate plan. Don’t hesitate to seek professional advice from a trust attorney and a financial advisor to help you make the right decision. Remember, a well-structured CRT can be a powerful tool for achieving both your financial and charitable goals.
Who Is Ted Cook at Point Loma Estate Planning Law, APC.:
Point Loma Estate Planning Law, APC.2305 Historic Decatur Rd Suite 100, San Diego CA. 92106
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