Charitable Remainder Unitrusts

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 five 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:

Jeremy Smith, 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 percent.

Jeremy would like to sell the stock, but he would have to pay federal capital gains tax of $27,000. He is in the 35 percent federal income tax bracket for ordinary income and the 15 percent bracket for long-term capital gains.

By transferring the stock to a 5 percent unitrust, he receives an income of 5 percent 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 0.6 percent). 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 Jeremy’s lifetime, Stanford will use the assets according to his wishes to create an endowed scholarship fund in his name.

Net income unitrusts provide annual payments equal to 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:

Louise and James George, 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 percent federal income tax bracket for ordinary income and the 15 percent bracket for long-term capital gains.

They transfer the stock to a five percent Stanford net income unitrust. Their charitable contribution deduction of about $86,000 (based on an IRS discount rate of .6 percent) gives them an immediate federal income tax savings of roughly $30,100, and they avoid paying now the $67,500 federal capital gains tax.

Until the Georges 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, Stanford will use the trust assets according to their wishes to create an endowed fund for cancer research.

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 the lesser of  (i) any actual earnings (for example, rents from real estate) or (ii) the unitrust percentage 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:

Rick Hsu, 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 $870,000 in capital gains taxes. No one else in Rick’s family is interested in taking over management of the property. He gives it to Stanford through a six percent flip unitrust, naming himself as the primary beneficiary and his only child, Alice, age 65, as the successor beneficiary. The trust agreement provides that the flip 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.

Stanford, 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 Rick. Beginning the following January 1, the trust will begin making regular six percent payments to Rick, and then, after his death, to his daughter. Upon Alice’s death, the trust will end, and the remaining assets will be used by Stanford to endow a fellowship fund in the names of Rick and his late wife.