Charitable Remainder Trusts
By Mark Horne of Horne, Coupar.
A charitable remainder trust (“CRT”) can be a very effective method of planned giving as a vehicle through which the donor reserves the right to receive the income off the donated property for his lifetime but confers a fixed interest in one or more charities to receive that property on the donor’s death. This arrangement is structured by means of a trust whereby the donor or some other trustee, often the charity involved, holds legal title to the assets that comprise the trust and pays the interest, dividends or other income earned on the trust investments to the donor on a regular instalment basis. The trust document will also specify which charities are to receive the investment capital of the trust on the donor’s death.
Because the charity has a fixed and irrevocable right to receive the capital of the trust when the donor dies, it has in fact received a “donation” when the CRT is established, which will result in issuing a charitable tax receipt for the present value of the donation. This is a relatively easily understood, if somewhat complex, calculation since the charity must wait until the death of the donor before receiving the capital of the gift. Thus, if the trust investment capital is $500,000 but the donor has a life expectancy of nineteen years, that value of $500,000 must be “discounted” to reflect the fact that it will not be received for the anticipated life expectancy of the donor. Most charities are equipped to make this calculation either with or without actuarial assistance, which involves applying a formula factoring in the life expectancy of the donor, the amount of the trust capital, and the discount rate, ie: what the funds could otherwise be expected to earn over the course of the donor’s projected lifetime.
To help you understand this better, we set forth an example below:
Amount contributed to trust
Donation receipt to (non-smoking) Mr. Generous – age 68 & a top rate tax payer (present value of $500,000 received at the end of 19 years (his life expectancy) using a 7% discount rate)
Tax credit (assuming a 42 % combined credit) to be offset against taxes in the year of the gift up to 75% of taxable income with 5 year carry forward of surplus
With this gift, Mr. Generous has:
- eliminated any tax on the income from the $500,000 gift (5% x 500,000 × 42% = 10,500 in tax) for up to 6 years
- still has a surplus tax credit of approximately $20,000 (83,112 – 63,500) to offset against other income tax
- thus, his cash flow has increased while at the same time he has made a significant future gift
Advantages of a Charitable Remainder Trust
The donor is still able to enjoy the income received from the capital that has been placed in the trust so, from a practical perspective, there will be no interruption in the donor’s cash flow. At the same time, the donor receives a charitable tax receipt for the present value of the gift as discussed above which will give rise to a credit against income taxes in the year that the gift is made, which may also be carried forward for up to five years until the value of the tax receipt is exhausted. For high rate tax payers, this will result in a significantly increased cash flow which of course can be reinvested and ultimately result in accumulation of additional capital. Additionally, the donor has the satisfaction of knowing that the charity will receive a fixed amount at some reasonably predictable point in the future and therefore has the satisfaction of having made the gift whilst still alive as opposed to by Will or otherwise on death. In B.C. there will also be probate fee savings (and no public record) in connection with the CRT since it passes outside the will of the donor.
Disadvantages of a Charitable Remainder Trust
Because it is a fundamental aspect of this structure that the donor cannot have any access to capital after the trust is established, it is not a suitable vehicle if the donor (or his advisors) feel that it is at all foreseeable that access to the capital might ever be required to maintain the donor’s lifestyle or in the event of sickness, accident or other emergency arising. This can be a difficult determination to make and the writer advocates what is known as the “greater comfort level” test whereby the donor agrees to be guided by the most conservative projection of his financial situation – in other words, whichever of the donor or his advisors feel that access to the capital sum involved might in some circumstances be required, determines the “comfort level” of the donor in either making or determining the amount of any gift by way of CRT. In addition, the longer the life expectancy of the donor the smaller the amount of the tax receipt generated by the CRT, since the charity’s receipt of the capital is deferred for a longer time.