Looking for a way to give your chapter a significant gift? If you have built up a sizeable estate and are also looking for ways to receive reliable payments, you may want to check out the advantages of setting up a charitable remainder trust.
The unitrust pays you, each year, a variable amount based on a fixed percentage of the fair market value of the trust assets. The amount of your payments is redetermined annually. If the value of the trust increases, so do your payments. If the value decreases, however, so will your payments.
How Does It Work?
You can establish a charitable remainder unitrust by irrevocably transferring assets to a trustee, who then invests the trust’s assets and pays you and/or other beneficiaries an annual variable income. At the end of the trust term, the assets remaining in the trust are distributed to the chapter for the purpose you designate.
A unitrust is an excellent vehicle for gifts of appreciated stock or property, because the trust is tax exempt and does not pay capital gains tax when it sells the assets. The full sales proceeds remain in the trust to provide a payout to the income beneficiaries. The amount of the payout for the income beneficiaries will depend on whether the charitable remainder unitrust is set up as a standard unitrust, net income unitrust, or flip unitrust (see below). The payout distributed is generally taxable to the income beneficiaries. Upon establishing a charitable remainder unitrust, you are entitled to a current income tax deduction for a portion of the value of the gift transferred to the trust, which is often between 30 and 60 percent of the value of the assets transferred.
Benefits
- Variable income, based on a percentage of the fair market value of the trust assets, revalued each year
- Federal, and possible state, income tax charitable deduction
- Pay no immediate capital gains tax on the transfer of appreciated assets
- Reduce or eliminate estate taxes
- Diversify your investments
- Make a gift to the chapter
Chapter as Trustee
When you establish a charitable remainder unitrust, you will select who will be the trustee of the trust. The chapter is willing and qualified to serve as trustee, if certain requirements are met. There may be a minimum funding amount to establish a charitable remainder unitrust with the chapter as trustee, with the actual minimum determined based on the term of the trust and the payout rate.
Assets Used
Cash, securities, real estate, or other assets.
Types of Charitable Remainder Unitrusts
There are three types of unitrusts: a standard unitrust, a net income unitrust, and a combination or “flip” unitrust. The income from each trust will vary from year to year, and the right choice will depend on your goals. You can name yourself and/or other beneficiaries to receive income for life and/or for a term of up to 20 years.
Standard Unitrust
Standard unitrusts are the most common type of unitrust. They provide an income that is based on a fixed percentage (“the unitrust percentage”) determined at the time the trust is created. The unitrust percentage must be at least 5 percent and is multiplied by the fair market value of the trust assets at the beginning of each year to determine the annual payout to the income beneficiaries. If the trust investments grow beyond the amount paid to the income beneficiaries, the annual distributions will increase. However, it is important to know that if the trust investments do not produce sufficient investment returns in any given year, the annual distribution for the following year will decline. A standard unitrust provides the most flexible investment options and is usually invested for a total maximum return.
EXAMPLE
John Doe, age 65, owns stock with a current market value of $200,000, which he bought some years ago for $20,000. It is paying a small dividend of about 1%. Mr. Doe would like to sell the stock, but he would have to pay federal capital gains tax of $27,000. He is in the 35% federal income tax bracket for ordinary income and the 15% bracket for long-term capital gains.
By transferring the stock to a 5% unitrust, he receives an income of 5% of the fair market value of the trust assets, revalued annually, for life ($10,000 in the first year, a significant increase from the previous stock dividend). In addition, he receives a charitable income tax deduction of about $89,000 (based on an IRS discount rate of 1.2%). This saves him about $31,150 in federal income tax, and he avoids paying now the capital gains tax that would have been assessed if he had sold the stock.
After Mr. Doe’s lifetime, the chapter will use the assets according to his wishes to create an endowed scholarship fund in his name.
Net Income Unitrust
Net income unitrusts provide annual payments in the lesser of two amounts: 1) the fixed percentage (the unitrust percentage) of the trust’s annual value described above, or 2) the net income of the trust. Younger donors who are not seeking large payments immediately but want to build a fund for potentially higher payments in the future may find this appealing. A net income unitrust initially can be invested in assets that produce little interest or dividend income. When income beneficiaries want a higher income, the investments can be changed to produce a higher income.
EXAMPLE
John and Jane Doe, both age 50, own stock worth $500,000, for which they paid $50,000 many years ago, which they would like to sell. To do so would incur federal capital gains tax of $67,500. They are not interested in receiving much income now, but they may need it later. They are in the 35% federal income tax bracket for ordinary income and the 15% bracket for long-term capital gains.
They transfer the stock to a 5% net income unitrust. Their charitable contribution deduction of about $86,750 (based on an IRS discount rate of 1.2%) gives them an immediate federal income tax savings of roughly $30,362, and they avoid paying now the $67,500 federal capital gains tax.
Until the Does are in need of income, the trust assets can be invested for capital growth and low income. Later, when the couple would like more income (for example, after retirement), the trust assets can be invested for higher income, resulting in a greater payout to them.
After their lifetime, the chapter will use the trust assets according to their wishes.
Flip Unitrust
A combination or “flip” unitrust is a good option when an illiquid, non-income producing asset, such as real estate or closely held stock, is being used to fund a charitable remainder unitrust. The trust agreement for the flip trust provides that the trust begins as a net income unitrust, paying only any actual earnings (for example, rents from real estate) to the income beneficiaries. The trust agreement further provides that at a date in the future, such as on the date of the sale of assets used to fund the trust, the trust “flips” to a standard unitrust. As of January 1 after the flip date, the unitrust pays the income beneficiaries the unitrust percentage multiplied by the fair market value of the trust assets, revalued each year. A flip unitrust may also be a good option if you wish to plan for retirement because the flip date could be set for a date when you expect to retire.
EXAMPLE
John Doe, a widower age 90, owns a vacation home that he inherited more than 30 years ago when it was valued at $500,000. Since then, he has used it as an investment property, frequently renting it out. It has appreciated enormously in value and is now worth around $5,000,000. If it were sold, it would generate around $675,000 in capital gains taxes. No one else in Mr. Doe’s family is interested in taking over management of the property. He gives it to the chapter through a 6% ?ip unitrust, naming himself as the primary bene?ciary and his only child, Judy, age 65, as the successor bene?ciary. The trust agreement provides that the ?ip is triggered by a sale of the property. He makes the gift establishing the unitrust in December, which allows him to claim a substantial income tax deduction for that year. The chapter, in its role as trustee, is not able to sell the property until the following August. In the interim, the property is rented out twice and the income generated (net of expenses) is paid to Mr. Doe. Beginning the following January 1, the trust will begin making regular 6% payments to Mr. Doe, and then, after his death, to his daughter. Upon Judy’s death, the trust will end, and the remaining assets will be used by the chapter.
Learn how you can support your chapter by contacting Matt Noble of Fraternity Management Group at matt.noble@fmgtucson.com.