A question for our readers: A charitable remainder trust can (a) benefit family members, (b) benefit charity, (c) help diversify assets in a tax efficient manner, or (d) all of the above? The answer is (d).

A charitable remainder trust (“CRT”) can provide you, your spouse, or other beneficiaries with lifetime income (annually either a fixed amount or a percentage of the trust’s value (which will increase or decrease as the value of the trust changes)). When your interest in the trust ends, the balance remaining passes to charity. At the time you set up the CRT, you receive a charitable income tax deduction for the value of the charity’s interest.

Significantly, a CRT is a tax exempt entity. As such, if you contribute appreciated property to the CRT, the sale of the property by the CRT does not incur income tax, i.e., capital gains tax can be avoided on such donated assets.

Consider the use of a CRT to provide a succession plan for your family business and to accomplish the following:

Provide retirement security to the senior generation;
Transfer ownership of the family business to the younger generation;
Transfer ownership at a minimum transfer tax (estate, gift and generation-skipping transfer (“GST”) taxes) cost;
Satisfy philanthropic goals; and
Obtain income tax benefits along the way.

For example, take Fred, age 68, who was the sole shareholder of Bedrock Inc., a corporation which provides marble, granite, and other high end stone finishes to builders. Fred’s son Jim was recently made president of the company, and was fully prepared to lead the company in the future. Son Jules was a constitutional law professor and had no interest in the family business.

Wilma, age 62, Fred’s wife, and the mother of Jim and Jules, was thrilled at the idea that Jim would take over the business and allow Fred to begin his retirement. Her biggest concern was assuring that she and Fred would be sufficiently provided for.

The business was valued at $50 million. Fred’s basis in his Bedrock shares was nominal and therefore a sale by Fred would cause significant capital gain. So Fred and Wilma decided to establish a charitable remainder trust, and retained the right to receive annually 6% of the fair market value of the assets of the trust. Fred gifted 95% of his Bedrock shares to the CRT (as a gift, the CRT’s basis in the stock was the same as Fred’s). Consequently, for the first year the couple would receive $2,850,000 based on the value of $47,500,000.

Fred’s remaining 5% of Bedrock, before discounts for lack of control and lack of marketability, were worth $2,500,000. After applying a 30% discount, Fred gifted Jim his shares with a gift tax value of $1,750,000, well within Fred’s available $5,430,000 gift tax exemption.

About two years after the shares were transferred to the CRT, the board of directors of Bedrock decided to redeem 95% of its outstanding shares for its then current fair market value. At that time, the business was worth $58 million, and 95% was, therefore, worth approximately $55 million.

Bedrock made its redemption offer to Jim and the CRT. The CRT accepted the $55 million offer, which Bedrock could afford, partially out of its retained earnings and partially through a bank loan. The company’s cash flow was such that it could comfortably repay the bank over a reasonable period. As a result of the redemption, the CRT ended up with $55 million in cash to invest, and Jim ended up as the sole owner of Bedrock. The CRT, being exempt from income tax, paid no income tax on the redemption, i.e., it kept the entire $55 million it received. With the $55 million in the CRT, Fred and Wilma would now receive $3,300,000 annually. Moreover, Fred and Wilma were able to assure that Jim obtained sole ownership of Bedrock, without incurring gift tax.

The major loose end is the fact that on the death of the survivor of Fred and Wilma, the trust fund will pass to charity. The answer is for Fred and Wilma to establish a life insurance trust which will purchase an insurance policy on their joint lives, payable to Jules upon the survivor’s death. The annual payment from the CRT will provide Fred and Wilma with sufficient cash flow to afford the premiums on such a policy. With Jules as the beneficiary, the insurance proceeds will allow Fred and Wilma to treat their sons equitably.