The Charitable Remainder Annuity Trust (CRAT) is a tax planning measure designed to provide income to the donor who has transferred assets into a trust and other designated beneficiaries. Upon the termination of the trust, the trust assets are then transferred to a charitable organization. The term of the trust can be for the lifetime of the donor (and other beneficiaries as provided for by the trust document) or for a fixed number of years. The charitable organization can be of the donor’s choosing - your Alma mater, a hospital, a religious organization, etc.
The income received by the beneficiaries during the life of the trust is taxable income. Typically, it is considered ordinary income and you would be taxed at the ordinary income rate. However, depending on certain factors, such as the transactions performed by the trust during the taxable year, some of the income could be considered capital gains, tax-free, or even return of principal. The trust does not incur any tax liability unless it produces unrelated business taxable income (UBTI).
The tax benefits include reducing your taxable income if you transfer income producing property. For example, if you have rental property that you transfer to the trust, you are no longer taxed on the gross income received from the operation of that rental property since you no longer are the owner of that property.
Another tax benefit is to avoid the estate tax imposed by the federal government and some state governments upon death. If your assets are valued above the exclusion amount, your estate may incur an estate tax liability. The CRAT avoids this taxable event.
There are two types of trusts - revocable and irrevocable. A revocable trust may be altered at any time. You retain the right to make changes as you see fit and modify the trust document by means of an amendment to its provisions. However, the property held by a revocable trust is still considered the property of the person who retains the right to make those changes so the tax benefits are not as great for these types of trusts. The assets within this type of trust are still subject to the federal and state so called "death tax."
An irrevocable trust cannot be changed or modified. Once the trust is created, you cannot make any changes or undo any of its provisions. Since your control over the trust assets is relinquished, the tax benefits are greater. You no longer have any rights to the property transferred and therefore, cannot make decisions concerning the property.
A CRAT must be irrevocable and upon the termination of the trust, the assets must be distributed to a recognized non-profit organization. The charitable organization incurs no tax liability upon the transfer.
When creating a CRAT or any other type of trust, it is important to seek the advice of a qualified attorney who is knowledgeable in the creation of trust documents. This will avoid any unintended consequences. Once an irrevocable trust is created, you cannot rectify mistakes.
