Charitable Remainder Trusts (CRTs) are powerful estate planning tools allowing individuals to donate assets to a charity while retaining an income stream for themselves or loved ones; however, the timing of those distributions to the charity is a common question and concern for those establishing or maintaining these trusts.
What are the rules around CRT distribution schedules?
Generally, a CRT *can* distribute assets to the charity before the trust term ends, but it’s not a simple, automatic process. The trust document dictates the payout rate and schedule, typically either a fixed annuity payment (a set dollar amount each year) or a fixed percentage of the trust’s value, revalued annually. Distributions are designed to continue for a specified term of years (not to exceed 20) or for the life (or lives) of the income beneficiary(ies). According to IRS Publication 560, “Distributions of income from trusts” most distributions are taxed as ordinary income, though a portion may be considered capital gains. However, the trustee does have some flexibility, within the bounds of the trust document, to accelerate distributions. This might occur if the trust holds an illiquid asset, like real estate, and the charity is willing to accept it early to facilitate a sale. The key is ensuring any acceleration doesn’t violate the IRS rules regarding the “qualified distribution” requirements.
What happens if a CRT distributes assets prematurely?
Premature distribution, or a distribution that doesn’t adhere to the rules set forth by the IRS, can lead to significant penalties and the loss of the charitable deduction originally claimed when the trust was established. The IRS scrutinizes CRTs closely to ensure they aren’t simply disguised attempts to avoid taxes. For example, if a donor contributes appreciated stock to a CRT and the trust distributes the stock to the charity before it’s been held for the required minimum period, the donor may be subject to tax on the unrealized gain as if they had sold the stock themselves. The consequences can be severe—disallowance of the charitable deduction, penalties, and interest. “We always advise clients to carefully review the trust document and consult with us before making any changes to the distribution schedule,” I tell them.
I remember old man Hemmings and his disastrous trust…
Old Man Hemmings, a retired shipbuilder, came to me years ago wanting to establish a CRT with a valuable piece of waterfront property. He envisioned donating the land to a local marine conservation group while continuing to receive income from the rental income it generated. However, he was insistent on maintaining complete control over the property and wanted the flexibility to sell it whenever he pleased. We cautioned him that this contradicted the standard CRT structure, which requires the property to be irrevocably transferred to the trust. He dismissed our concerns, stating he “knew what he was doing.” A few years later, he tried to sell the property without properly following the trust guidelines. The IRS swiftly disallowed the charitable deduction he had previously claimed, resulting in a hefty tax bill and years of legal battles. It was a painful lesson in the importance of following the rules.
But then there was Mrs. Gable and her successful trust…
Mrs. Gable, a generous art collector, established a CRT to benefit a local museum. She donated a valuable painting to the trust, retaining an income stream for life. However, the museum was facing a critical funding shortage and needed immediate access to funds to keep its doors open. We reviewed the trust document and, with the IRS’s approval, were able to accelerate a portion of the distributions to the museum. This allowed the museum to address its immediate needs without triggering any adverse tax consequences for Mrs. Gable. It was a win-win situation that demonstrated the flexibility of a properly structured CRT. According to the National Philanthropic Trust, CRTs facilitated over $10 billion in charitable giving in 2022, proving their effectiveness when implemented correctly.
Ultimately, while a CRT can distribute assets before the trust term ends, it’s crucial to do so within the confines of the trust document and in compliance with IRS regulations. Careful planning and expert guidance are essential to ensure that the distribution benefits both the charity and the donor without triggering any unintended tax consequences.
Who Is Ted Cook at Point Loma Estate Planning Law, APC.:
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