Case Study: Using the Charitable Remainder Trust to Simulate a Charitable Lead Trust

Case Study: Using the Charitable Remainder Trust to Simulate a Charitable Lead Trust

Case study posted in Charitable Lead Trust, Charitable Remainder Trust on 14 July 2009
audience: National Publication | last updated: 20 May 2014


Most charitable remainder trusts are created with the intention of providing an income stream to the donors for their lifetimes with the remainder passing to charity at the conclusion of the trust term. In this case study, Mr. and Mrs.  Allen take advantage of a seldom used option that enables them to provide current annual gifts to charity as well.

The Facts

Mr. and Mrs. Allen, age 55 and 53, have been generous donors of time and money to a charitable organization for a number of years.  They have a great deal of donative intent and would like to make a significant gift.

The Problem

The Allens have built a very successful business and believe they will sell it in the near future for approximately $10,000,000.  They started the business "on a shoestring" and have virtually no cost basis in the company stock.  Their tax advisors tell them that they will owe as much $1,500,000 in capital gains tax on the sale of the business.

A sale of the business would thus deprive them of a large portion of the earnings potential of their asset.  They don't like this prospect, but they don't want to pass up the opportunity to "cash in" the wealth they have created through their business.

A Solution

One of their advisors points out that they may be able to bypass capital gains tax and preserve all of the earning capacity of a portion of the stock, while making an eventual gift to the charity. This idea intrigues them.

It is proposed that prior to sale, the Allens would (1) donate 20% of the stock, valued at $2,000,000, to a 5% charitable remainder unitrust.  The trust would (2) pay an amount equal to 5% of the trust corpus as valued annually.  The value of the charitable remainder for (3) income tax deduction purposes is 22%.

Tax-Free Growth. The proposed trustee believes that over time a total return of 8% is reasonable, resulting in a tax-free build-up of 3% per year in the trust.  Under this projection, the trust corpus should eventually grow to over $5,000,000 by the time it is (4) received by the charitable remainder beneficiary(ies).

Current Income Tax Deduction. The Allens would be entitled to a charitable deduction of some $440,000.  They would also bypass capital gains tax of $300,000 or more on the assets just to fund the trust.  Their income the first year would be $100,000.  If they sold and reinvested, a 5% income on the after-tax proceeds of $1,700,000 would be just $85,000. 

Wealth Replacement. The future value of the additional income could be over $1,000,000, based on their joint life expectancy of some 34 years.  It is suggested that they use a portion of their additional income from the trust to purchase "wealth replacement" insurance to benefit their children.

The net result of this transaction is to provide for an eventual charitable gift of over $5,000,000 that will be received in 34 years if Mr. and Mrs. Allen reach their normal life expectancy.

Note that under this plan there will be no charitable benefit until the deaths of both Mr. and Mrs. Allen.  How might we suggest this gift be modified to result in useable charitable funds from the outset?

Annual Charitable Gifts. Suppose Mr. and Mrs. Allen were to assign 20% of their income from the trust be distributed for charitable purposes each year.  The first year, there would be (2) charitable distributions of $20,000 and (3) the Allens would receive $80,000. 

Why not just receive the income each year and make a charitable gift?

  1. The 50% limitation may make it difficult  to deduct their gifts
  2. The charity can make longer term plans, and donors will typically receive more recognition if they make their gift in this manner.

Over the years, the income interest of both the Allens and the charity will continue to grow.  At the end of nine years, at approximately the time they planned to retire, the income received by Mr. and Mrs. Allen will have grown to $100,000, equal to the amount they would have originally received had they not made the partial assignment of income.

By the end of their 34 year life expectancy, the Allens' income will have grown to over $212,000, while the charity's portion will have grown to $53,000.  Over the expected term of the trust, there will be distributions of more than $1,100,000 for charitable use.  At the termination of the trust, (4) the charitable remainder could be $5,000,000 or more.

See the following summary of benefits of the trust to the parties involved:

Note that a number of goals have been accomplished:

  • The Allens have avoided capital gains tax of $300,000.
  • They enjoy an income tax deduction of approximately $440,000.
  • They have provided annual income for charitable purposes that is projected to grow from $20,000 to more than $53,000  over their lifetime.
  • An eventual charitable endowment of over $5,000,000 has been created to fund future needs of the charity.

Is this plan similar to a charitable lead trust?  Is it better?  What caveat should accompany a proposal of this sort?  What might the Allens decide to do with the income they don't contribute back to the charity each year?  They might consider using the income to purchase wealth replacement insurance or contribute the income (net of applicable income taxes) back to the trust each year and thus build an larger income for themselves and the charity in later years.  Could they make the assignment on a revocable basis?

Disclaimer: This case study is intended to provide information of a general nature only and is not intended to provide legal, accounting, investment or other professional advice. Persons mentioned within this case study are fictional with any resemblance to real persons, living or dead, coincidental. Tax law rates and federal discount rates used in examples are based on those rates in effect at the time of publishing. Those viewing this case study should always check for latest tax and other relevant state and federal laws and regulations prior to completing charitable gifts.


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