Articles From the December 1995 Unification News


Easing the Capital Gains Tax Bite with a Charitable Remainder Trust

by Garry Barker

With the stock market having reached an all-time high, many investors may be faced with a new concern-capital gains taxes on appreciated assets. Even though they would like to take gains from appreciated assets and diversify into other areas which have the potential for appreciation or which may potentially provide higher yields, some investors feel "locked in" to ownership of appreciated assets because of the resulting federal and state capital gains taxes.

One possible solution for these investors may be a Charitable Remainder Trust (CRT). A CRT is used to gift appreciated assets to an investor's favorite charity, but before these assets are donated to the charity, the investor (grantor) enjoys several significant benefits, including freedom from capital gains taxes.

How a CRT Works

A CRT is created to provide lifetime or term payments to an individual, or other individuals such as a surviving spouse, with the remainder eventually payable to a designated charity. The payments may be in the form of an annual fixed annuity (annuity trust) or a variable annual payment (unitrust) equal to a percentage (at least 5%) of the value of the trust fund revalued each year.

Because the CRT is tax exempt, appreciated assets transferred from an individual to the trust can be sold by the trust free of capital gains taxes. Assets in the trust can then be reinvested into a high-quality, diversified portfolio, which can generate increased income. An immediate income tax charitable deduction, equal to the value of the charity's remainder interest, is generated by the gift to the charitable trust. In addition, the transaction can provide for significant estate tax savings.

A CRT Example

As a hypothetical example, assume that Mr. and Mrs. Smith, both age 54, own XYZ stock with a market value of $100,000. Their cost basis for this stock was $10,000. They are retiring and wish to diversify their investments as well as increase spendable cash flow.

XYZ's current dividend yield is 2%, or $2,000 a year. Sale of the stock would result in federal capital gains taxes of $25,200, based on the current federal capital gains tax of 28%. (At present, a proposal is pending in Congress to lower the capital gains tax. This proposal may or may not pass.) An additional $2,000 could go for state income tax. This could leave the Smiths with a balance of $72,800 to put to work toward their goals.

In addition, under the above scenario, upon the death of the survivor of the two spouses, it is assumed that Mr. or Mrs. Smith could face estate taxes which could reach 40% of the balance of their estate.

With a CRT, the Smiths would enjoy several immediate financial benefits. First, they would avoid capital gains taxes so that the entire $100,000 could be invested in a more diversified and income- producing portfolio. If the CRT is a unitrust and pays them a variable annual payment equal to 7% of the value of the trust fund each year, they would receive a $7,000 first-year payment, considerably more than the $2,000 they were receiving from the original asset's dividends. The $7,000 first-year payment could rise (or fall) depending on the investment performance of the remaining assets in the trust. In addition, the Smiths would receive an income tax deduction for their future gift to charity of approximately $13,859, assuming the IRS' interest rate is currently 7.4%.

Upon the death of the surviving beneficiary, the survivor's estate would enjoy a federal estate tax charitable deduction for federal tax purposes equal to the value of the trust assets which went to the charity. Thus, assuming the trust's value is $100,000 at the death of the survivor (and assuming the survivor's tax bracket at death is 45%), his or her beneficiaries would benefit from a $45,000 estate tax reduction because of the trust.

When considering CRTs, many investors are concerned about leaving assets to heirs. While assets in a CRT must go to the designated charity upon the death of the surviving beneficiary, the increased cash flow and tax savings which result from the trust may be used to purchase a life insurance policy in an irrevocable life insurance trust. With a properly structured life insurance trust, premiums are paid with part of the increased cash flow and with tax dollars which were saved by virtue of the charitable deduction. Proceeds of the policy are outside the estate and are not subject to estate or inheritance taxes. In addition, proceeds are received income tax free.

A Word of Caution

A Charitable Remainder Trust is an irrevocable trust. That means once you transfer money into the trust, you cannot take it back. Some of the money will eventually go to charity. Although the trust offers some flexibility-the charity can be changed, additional assets can be contributed (to a unitrust only), the trustee can be changed-it is important to understand how the CRT works for specific situations.

Whether the goal is to ease the capital gains tax bite, increase spendable income, make a contribution to a favorite charity, or a combination of the three, investors may wish to explore the opportunities available with a CRT. As one of the few remaining tax- saving financial planning alternatives, the Charitable Remainder Trust offers the investor benefits today, while providing financial and philanthropic benefits for tomorrow.

If you would like more information, please write, care of Unification News.

This article does not constitute tax advice. Investors should consult their personal tax advisors before making any tax-related investment decisions. Information and data in this report were obtained from sources considered reliable. Their accuracy or completeness is not guaranteed and the giving of the same is not to be deemed a solicitation on Dean Witter's part with respect to the purchase or sale of securities or commodities.


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