Parcion Private Wealth partners with business owners and their families to support them up to, through, and post life-changing liquidity events, such as the sale of a business. These transitions offer unique opportunities to make a meaningful impact on the causes they care about and think bigger about what's next. Through every phase of a transaction, Parcion collaborates with families and their tax advisors to develop a comprehensive Philanthropic Plan that aligns with their values while incorporating effective tax strategies.

One of these key strategies is a Charitable Remainder Trust (CRT), which offers an attractive, tax-advantaged method to diversify low-basis assets, generate income, and ultimately benefit charitable organizations. CRTs may also remain resilient in various economic environments, including periods of rising interest rates, making them a versatile tool for families seeking both financial security and charitable impact.

WHAT IS A CRT?

A CRT is an irrevocable trust that makes annual payments to one or more non-charitable beneficiaries for a period of years or the life of one or more individuals. Any assets remaining at the end of the term pass to charity. The trust can distribute a fixed percentage of the trust assets annually (Charitable Remainder Unitrust or CRUT), or a fixed annuity based upon the trust's initial funding amount (Charitable Remainder Annuity Trust or CRAT). In either case, the payout must be at least 5%—but not more than 50%—of the trust's value at payment or funding, respectively. Importantly, the payout must be structured to ensure that the charitable beneficiary is expected to receive at least 10% of the trust's initial funding amount.

Upon funding the trust, the donor will receive an immediate income tax charitable deduction for the present value of the remainder expected to pass to charity. Federal income tax law also treats CRTs as tax-exempt entities, allowing the trust to sell appreciated assets without triggering an immediate capital gains tax. Rather, the CRT's realized capital gains will pass to the trust's non-charitable beneficiaries over time as they receive annual distributions, producing a tax deferral benefit.

CASE STUDY: A CHARITABLE PAIR

Consider a 60-year-old couple, Tom and Katie, who live in a state that imposes a 5% tax rate on income and capital gains. As they near retirement, the couple is interested in converting some of their highly-appreciated assets into an income stream while supporting one of their favorite charities. Of the several options available to them, Tom and Katie are considering the following options:

• Sell the assets outright, paying the associated capital gains tax, investing the net proceeds and addressing their charitable goals separately, or
• Donate the assets to a CRT that will sell the asset, invest the proceeds, and benefit Tom and Katie while supporting their designated charity at the end of the term

For Tom and Katie, donating the assets to a CRT meets several of their goals. It allows them to defer the capital gains tax while leaving a sizeable gift to charity at the end of the trust's term. Now, they must make key decisions regarding the trust, including:

What Will the Trust be Funded With? CRTs provide maximum benefit when funded with low-basis assets. These low-basis assets are often concentrated or illiquid positions, making a CRT's ability to immediately diversify and defer capital gain more compelling. Common funding candidates include publicly traded stock, closely-held business interests, and real estate, with each carrying unique considerations impacting the payout structure.

How Long Will the Trust Last? A CRT may last for up to 20 years, or for the life of one or more individuals. The shorter the term, the larger the amount likely to pass to charity, and vice versa. Generally, the 10% remainder requirement will limit the use of lifetime CRTs for younger donors prioritizing a larger income stream. Fixed-term CRTs can be used to strategically align distributions with the donor's anticipated expenses or liabilities.

How Much Will the Trust Distribute? A CRT can be structured to distribute a fixed annuity for the term of the trust (CRAT), or a fixed percentage of the trust assets valued annually (CRUT). A CRAT's fixed payout protects the non-charitable beneficiary from decreasing distributions in a market decline, bringing with it the risk that the trust is depleted early, leaving the remainder charity with nothing. A CRUT, on the other hand, spreads the risks (and benefits) of market fluctuation between the charitable and non-charitable beneficiaries.

CRT IN ACTION

After consideration, Tom and Katie determine that they will donate a zero-basis asset having a fair market value of $20 million to a CRUT which will last for a term of 10 years, with an annual payout of 6%. Upon contribution, Tom and Katie will receive an income tax charitable deduction of nearly $11 million, representing the present value of the amount expected to pass to the remainder charity. To the extent the deduction exceeds current limits (up to 30% of AGI for long-term capital gain property), the excess may be carried forward up to five years until exhausted.

On the first anniversary of the trust's establishment, Tom and Katie will receive a distribution equal to 6% of the then-current fair market value of the trust, approximately $1.2 million.

While the CRUT does not pay income tax directly, Tom and Katie must pay tax on any capital gains and ordinary income passed to them via the distribution. The tax rate applied to the distributions depends on the character of income earned by the trust, generally a "worst in, first out" approach. That is, if after year 1, Tom and Katie's CRUT has $20 million of deferred long-term capital gain, $500K in ordinary income, $100K in qualified dividends, and makes a distribution of $1.2 million, Tom and Katie will report $500K in ordinary income, $100K in qualified dividends, and $600K in long-term capital gain. Given this, Tom and Katie will likely prefer to minimize the ordinary income generated within the CRUT. Parcion's team of advisors will work with Tom and Katie to build an optimized portfolio suited for their risk tolerance, cash flow needs, and their philanthropic goals. After 10 years, assuming a 7% annualized growth rate, Tom and Katie will have received $14M in payments and still leave $20M to their designated charity.

CONCLUSION

A Charitable Remainder Trust can be a powerful strategy for business owners and their families to unlock the true potential of their wealth. It can help them accomplish their philanthropic goals while maintaining an income stream and providing significant tax advantages. Parcion works closely with families and their team of professional advisors to carefully select the most suitable assets to donate, design an optimal payment structure, and build the trust's investment portfolio to maximize benefits for both the donors and the charitable cause(s) they aim to impact.

By thoughtfully incorporating CRTs into a well-designed Philanthropic Plan, donors can build a lasting legacy that honors their loved ones and the causes they care about.

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