IRS issues guidance on charitable remainder annuity trusts
Planned giving (the giving of assets) can be an important part of an organization’s fundraising effort. The charitable remainder trust is a planned giving vehicle in which a donor transfers assets to an irrevocable trust and the trust can pay out an annual amount between five and 50% of the value of the assets. In addition, the trust must pass an actuarial calculation that shows that the charity would be receiving at least 10% of the value of the property at the end of the life income beneficiary’s life.
There are two kinds of charitable remainder trusts. The charitable remainder Unitrust (CRUT) provides that the trustee must recalculate the value of the assets each year. If the value goes up then the payout goes up. If the value goes down, then so does the payout.
The second type is the charitable remainder annuity trust (CRAT). The trust must meet the payout and 10% to charity requirements discussed above. The payout is different. This trust provides that the value of the property is calculated once, when the trust is funded. The payout is then calculated between 5 and 50% of the value. However, the dollar payout does not change. It has an additional requirement that the CRUT does not. The IRS requires that there must be less than a 5% probability that the charitable remainder annuity trust will be exhausted during the life of the life income beneficiary. If there is a greater than 5% probability, then the trust will not qualify.
This last requirement has been a major problem in a low interest rate environment. In a low interest rate environment, the value of the amount going to charity is lower. The IRS has issued Revenue Procedure 2016–42, to provide some relief from the “probability of exhaustion” test. The IRS has provided that if you add the provision listed in the revenue procedure, the trust will be considered to pass the “probability of exhaustion test”.
The provision provides for early termination if the value of the trust has declined to less than 10% of the original value as discounted. This requires that the trustee monitor the value of the assets from year to year to determine if the trust is about to exhaust. It also means that the life income beneficiary needs to know that his income stream may end prematurely.
While this can be helpful in some cases, but the CRUT will continue to be a far more popular vehicle than the CRAT. If you use the IRS form CRAT, make sure you add the provision now allowed in Revenue Procedure 2016-42.