Qualifying Your Charitable Remainder Annuity Trust

A charitable remainder annuity trust or CRAT as is it more commonly known is a type of irrevocable trust that is used to pass on property to a charity while still receiving an income from the assets in the trust. The way it operates is that a fixed amount of income or principal is paid from the CRAT to designated noncharitable beneficiaries, usually the grantor or creator of the trust. After a set term the remainder of the trust is payable to charity.

Multiple Tax Benefits

The CRAT comes with many tax benefits due to its charitable nature. The CRAT pays no income tax on its income. The CRAT is not taxed on any gain it realizes upon selling appreciated property either at the time of donation or any appreciation occurring after the donation. Furthermore the grantor of the trust created during his or her lifetime is entitled to an immediate income and gift tax deduction equal to the amount of the present value of the remainder interest passing to charity.

Strict Qualifications

The laws regarding CRATs were originally set up in 1969 by Congress in order to address perceived abuse by people claiming deductions based on gifts of remainders to charities. Therefore in order to claim such exemptions and benefit from the CRAT, the trust must meet two specific tests.

First, the initial present value of the charitable remainder must be at least 10 percent of the initial value of the trust. This standard is set in place in order to ensure that the amount left to charity is not a paltry amount. It would be unfair for a person to gain major tax benefits while only leaving a pittance to charitable interests.

Second, on the date a CRAT is created, there must be no more than a 5 percent probability the trust will be exhausted before it terminates. This is generally where most CRATs run into trouble. Under the complicated equation that the IRS uses to determine the validity of CRATs, many trusts will fail to qualify as being too likely to exhaust all of the assets in the trust before passing it onto charity.

Proposed Rule Changes

Thankfully for those looking to use the CRAT as a way to ensure an income while benefiting both themselves and charity the IRS has proposed a new set of regulations that would eliminate the 5 percent probability test and make it inapplicable to the CRAT. The new provision would instead require the trustee of the CRAT to pass a 10 percent test before making each annuity payment. If the CRAT would fail the test on making an annuity payment, the CRAT will terminate.

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