Charitable Remainder Unitrusts in New York – Basics, Benefits and Requirements

A charitable remainder unitrust is a type of tax-exempt split-interest trust. There are several split-interest trusts under IRC § 4947 such as charitable remainder trusts, charitable lead trusts, and pooled income funds. This article will focus on charitable remainder trusts, specifically charitable remainder unitrusts.

Although there are two types of charitable remainder trusts, namely the charitable remainder annuity trust and charitable remainder unitrust, this article will talk about the charitable remainder unitrust, as it is more popular, practical, preferred, and flexible than the charitable remainder annuity trust. In charitable remainder unitrust, one can avail of tax savings of highly appreciated property that is not available with the charitable remainder annuity trust.

What is a Charitable Remainder Unitrust

A charitable remainder unitrust is a split-interest trust because it has two beneficiaries: a non-charitable beneficiary who is normally the grantor or a person the grantor designates, and a qualified charitable beneficiary described in IRC § 170(c). It is an irrevocable trust because once made, the grantor cannot modify or revoke it anymore. The grantor, however, can add properties to the trust.

In this type of trust, the grantor gives to the non-charitable beneficiary an annual steady income stream for a number of years not exceeding 20 years or the lifetime of the beneficiary. This annual income stream is based on a percentage of the value of the property in the trust to be valued annually, which should not be lower than 5% and not higher than 50%. After the end of the period or life of the beneficiary (whichever has been stipulated in the trust), the remainder goes to the charitable beneficiary, which is no case should be lower than 10% of the value of the property at the time the property was contributed to the trust.

Benefits of the Charitable Remainder Unitrust

The benefits of the charitable remainder unitrust are: (a) immediate income tax deduction based on charitable contribution; (b) deferred income tax payments on capital gains; (c) avoidance of probate; and (d) steady income stream.

Practical Application of the Charitable Remainder Unitrust

To understand the benefits of a charitable remainder unitrust, providing an example of a practical application will be easier.

To illustrate, suppose John in 1990 purchased real property in New York City worth $50,000. Assume that in 2020, after thirty years, the real property’s market value is already $800,000. If John wants to sell the property in 2020, he will be taxed based on his capital gain of $750,000, computed as the selling price (which is the market value of $800,000) less his acquisition cost of $50,000. John’s tax rate on his long-term capital gain will depend on his taxable income. Assuming John’s taxable income in 2020 is between $40,000 to $441,450, John’s income from the sale of real property which is $750,000 will be taxed at 15%, or a whopping $112,500.

Now, John can get the assistance of an experienced estates lawyer to transfer the real property to a charitable remainder unitrust and ensure savings in the transaction.

As soon as John transfers the real property to the charitable remainder unitrust, John receives an immediate income tax deduction for his charitable contribution. This deduction is the present value of the remainder interest of the charitable beneficiary, which is computed based on the property value less the present value of the interest for the term of years or life of the income beneficiary. The charitable remainder’s interest is computed using Treas. Regs. § 1.664-4 and depends on whether the income beneficiary’s term is for a period of years (Table D, Publication 1458, Term Certain Factors) or during life (Table U(1), Publication 1458, Single Life Factors) or based on the life of two beneficiaries (Table U(2), Publication 1458, Last to Die Factors). Computer software is recommended to be used in computing the deduction for charitable contribution. The deduction normally ranges between 30% to 50% of the value of the property.

If John designates himself as the non-charitable beneficiary, there is no gift tax, but if he designates a third person as the non-charitable beneficiary, John will be liable for gift tax.

Because the charitable remainder unitrust is a tax-exempt entity, if it sells John’s real property at $800,000, the trust will not be taxed on its capital gains. The trust will only be taxed when such income is distributed to the non-charitable beneficiary. In this case, the tax is not avoided, but it is deferred and paid in increments over a period of years.

Because the charitable remainder trust now has $800,000 in cash, it is wise to choose a corporate trustee with a good investment history who can provide John with a good rate of return that is higher than inflation rate. Many people believe that they need to appoint a charity as a trustee, but there is no such requirement needed.

Suppose John stipulates in the charitable remainder unitrust that he will receive an income stream of 5% for the rest of his life, this 5% is computed annually based on the current fair market value of the trust assets.

At the end of the term, there must be at least 10% of $800,000 or $80,000 to be distributed to John’s designated charitable beneficiary. In order to meet this requirement of the Internal Revenue Code, the actuarial value of the charitable remainder interest must be 10%. The IRS will not allow a lifetime payout for a very young beneficiary and might even limit the payout percentage rate for older individuals in order to qualify as a charitable remainder unitrust, subject to the income tax deduction.

Ultimately, John will have savings of a $240,000 income tax deduction (estimated at 30% of $800,000, translating to $57,600 tax savings at a 24% income tax bracket) and deferral of the income tax on capital gains, as opposed to paying $112,500 at one time. If John receives the distribution from the trust at a time when he has retired, he will enjoy a lower income tax rate because of his lower income, which translates to additional savings.

Irrevocable Life Insurance Trust

One major concern about the charitable remainder unitrust is the risk that one may die soon after establishing the trust, thus leaving the entire asset with the charity with nothing left for the grantor’s family.

For this reason, the charitable remainder unitrust is combined with the irrevocable life insurance trust. The grantor/non-charitable beneficiary uses the income stream received from the charitable remainder unitrust to purchase a life insurance policy with an irrevocable trust as beneficiary. The amount of life insurance policy purchased is normally the same amount as the value of the asset in the charitable remainder unitrust. This minimizes, if not completely eliminates, the risk of early death of the grantor. In this case, even if the charity receives the remainder, the grantor’s beneficiaries in the irrevocable life insurance trust still receives something.

Types of a Charitable Remainder Unitrust

There are four types of charitable remainder unitrust: the straight unitrust, the net income unitrust (NICRUT), the net income unitrust with make-up provision (NIMCRUT), and the flip trust. The straight unitrust has already been previously discussed above.

The net income unitrust (NICRUT) gives the trustee the option to pay the beneficiary either a percentage of the market value of the trust assets or the actual income of the trust assets, whichever is lower. This ensures that the trust corpus is not disturbed. For example, if John established a NICRUT with a stated percentage of 5%, if the value of the trust assets at that time was $800,000 but the income earned by the trust for that year was only $20,000, John would receive only $20,000, the actual income, and not $40,000, which is 5% of $800,000.

The net income unitrust with make-up provision (NIMCRUT) is a net income unitrust with the additional provision that, in case the trust earned income less than the stated payout percentage, the trust is allowed to make up the payout deficits in the following years where it earns more income than the stated payout rate. In the same example, if John established a NIMCRUT and received $20,000, instead of $40,000 in one year, but the trust earned income of $60,000 for the following year, John will receive $60,000 for that year to make-up for the $20,000 deficit the previous year.

Lastly, the flip unitrust is a net income unitrust which later flips or becomes a straight unitrust. This is used by grantors when they transfer an illiquid asset, such as real property, into the charitable remainder unitrust with no plans of selling it until the occurrence of a triggering event, such as the grantor’s retirement. For example, John transfers real property to the net income unitrust with a stipulation that the real property will be sold upon John’s retirement. Before John’s retirement, if the real property did not have any income because John was living in it, the trust had no obligation to pay John anything. The net income trust flips to a straight unitrust when John retires, selling the real property, and giving John a steady income stream based on percentage of the trust assets during retirement.

Requirements of a Charitable Remainder Unitrust

A charitable remainder unitrust has to comply with both state and federal laws. Federal laws are provided under IRC § 664, which require a non-charitable and qualified charitable beneficiary, 10% remainder to the charitable beneficiary, and a fixed annual payout rate, not less than 5% and not greater than 50%, as previously mentioned above.
In New York, under EPTL 8-1.4, the trustee shall register the charitable remainder unitrust through Form CHAR001-RT with the Attorney General, so that the latter may exercise supervision over the charitable remainder interest.

In Florida, although there is no requirement to register the charitable remainder unitrust, the Attorney General requires notice or consent in certain cases, and is authorized to assert the rights of a qualified beneficiary with respect to a charitable trust having its principal place of administration in this state. Florida Statutes 736.0110.

Should you need assistance in establishing a trust, we, at the Law Offices of Albert Goodwin, are here for you. We have offices in New York City, Brooklyn, NY and Queens, NY. You can call us at 212-233-1233 or send us an email at [email protected].

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