Charitable Remainder Trust: $80K Income Tax Deduction Realized

Charitable Remainder Trust: $80K Income Tax Deduction Realized

Executive Summary

A client holding significant appreciated stock wanted to reduce their current income tax burden while also making a substantial charitable contribution. Golden Door Asset advisor Diana Rossi established a Charitable Remainder Trust (CRT) to address this challenge. The CRT allowed the client to donate the appreciated assets, receive income payments over a defined term, and realize an immediate $80,000 income tax deduction, all while supporting their philanthropic objectives.

The Challenge

Mr. and Mrs. Thompson, a retired couple in their late 60s, approached us with a multifaceted financial challenge. They held a substantial portfolio of publicly traded stock, acquired years ago at an average cost basis of $20 per share. The current market value had soared to $120 per share, representing significant unrealized capital gains. While they were generally comfortable financially, they were becoming increasingly concerned about the tax implications of eventually selling this stock.

Beyond the capital gains tax issue, the Thompsons were also deeply committed to supporting a local children's hospital. They had been making annual donations, but wanted to find a more impactful and tax-efficient way to contribute a larger sum. Their current annual income placed them in the 32% federal income tax bracket, and they also faced state income taxes of 5%. This meant a considerable portion of their income was being directed towards taxes, reducing the funds available for both their own needs and their charitable giving.

Specifically, they were facing an estimated federal capital gains tax liability of $264,000 ($120-$20 = $100 gain per share * 2,640 shares taxed at 20%, plus the 3.8% net investment income tax) if they were to simply sell the stock and donate the proceeds. They also desired to maintain a stream of income throughout their retirement to supplement their social security and pension income. Finding a strategy that addressed both their charitable goals and their tax liabilities was crucial. They needed a solution that provided immediate tax relief, long-term income potential, and a mechanism for fulfilling their philanthropic aspirations.

The Approach

Diana Rossi, a seasoned advisor at Golden Door Asset, carefully analyzed the Thompsons' financial situation, their risk tolerance, and their philanthropic goals. After a thorough consultation, Diana recommended the establishment of a Charitable Remainder Trust (CRT).

The strategic rationale behind this recommendation was threefold:

1. Tax Deduction: By donating the appreciated stock to a CRT, the Thompsons would be eligible for an immediate income tax deduction. The amount of the deduction would be based on the present value of the remainder interest that the charity would receive upon the termination of the trust.

2. Capital Gains Tax Avoidance: Because the stock was donated to the CRT, a tax-exempt entity, no capital gains tax would be triggered at the time of the transfer. This avoided the immediate $264,000 capital gains tax liability.

3. Income Stream: The CRT would be structured to provide the Thompsons with a fixed or variable income stream for a specified term, typically their lifetimes or a fixed number of years (not to exceed 20 years). This income stream would be generated from the sale of the donated stock within the CRT and the subsequent investment of the proceeds.

Diana, working in conjunction with a tax attorney specializing in estate planning, carefully considered the type of CRT that would best suit the Thompsons' needs. After evaluating their risk tolerance and income requirements, a Charitable Remainder Annuity Trust (CRAT) was chosen. A CRAT provides a fixed annual income payment, offering predictability and stability, aligning with the Thompsons' conservative investment approach.

Technical Implementation

The implementation of the CRT involved several key steps:

1. Trust Document Preparation: The tax attorney drafted the CRT document, ensuring it complied with all applicable IRS regulations, including the requirement that the charity receive a remainder interest of at least 10% of the initial fair market value of the assets transferred to the trust. The document specified the annual annuity payment, which was set at 5% of the initial fair market value of the contributed assets, and the designated beneficiary (the children’s hospital).

2. Asset Transfer: The Thompsons transferred 2,640 shares of the appreciated stock, valued at $120 per share (totaling $316,800), into the newly established CRT.

3. Sale of Stock: Upon receiving the stock, the CRT trustee (managed in partnership with Golden Door Asset) immediately sold the stock at its market value. No capital gains tax was incurred due to the trust's tax-exempt status.

4. Investment Management: The proceeds from the sale were then invested in a diversified portfolio of bonds and dividend-paying stocks, carefully selected to generate sufficient income to meet the annual annuity payment obligation. Diana utilized Golden Door Asset's AI-powered portfolio optimization tools to construct a portfolio that balanced income generation with capital preservation, considering the Thompsons' risk tolerance and investment horizon. The portfolio was designed to generate a minimum of 5% annual income.

5. Income Distribution: The CRT began making annual annuity payments to the Thompsons, calculated as 5% of the initial value of the assets transferred to the trust ($316,800 * 0.05 = $15,840 per year).

6. Tax Deduction Calculation: The charitable income tax deduction was calculated based on the present value of the remainder interest that the children’s hospital was expected to receive at the end of the trust term (the Thompsons' joint life expectancy). Using IRS-approved actuarial tables and prevailing interest rates, the present value of the remainder interest was determined to be $80,000. This amount represented the immediate income tax deduction available to the Thompsons.

7. Ongoing Monitoring and Reporting: Golden Door Asset provides ongoing monitoring of the CRT's performance, ensuring that the investment portfolio is aligned with the trust's objectives and that all required IRS filings are completed accurately and on time.

Results & ROI

The implementation of the Charitable Remainder Trust yielded significant financial benefits for the Thompsons:

• Income Tax Deduction: An immediate $80,000 income tax deduction in the year the assets were transferred to the CRT. At their 32% federal income tax bracket and 5% state income tax bracket, this resulted in an immediate tax savings of $29,600 ($80,000 * 0.37).
• Capital Gains Tax Avoidance: The $264,000 in capital gains tax was completely avoided. Had the Thompsons sold the stock directly, this would have significantly reduced the funds available for both their personal needs and charitable giving.
• Annual Income Stream: The Thompsons received an annual income stream of $15,840 from the CRT, supplementing their retirement income.
• Charitable Giving: The Thompsons were able to make a substantial future donation to the children's hospital, fulfilling their philanthropic goals.
• Estate Tax Reduction: The assets transferred to the CRT are removed from their taxable estate, potentially reducing future estate taxes.

Before establishing the CRT, the Thompsons faced a significant capital gains tax liability and were limited in their ability to make a substantial charitable contribution. After implementing the CRT, they achieved substantial tax savings, secured a reliable income stream, and fulfilled their commitment to supporting the children’s hospital. The ROI was clear: immediate tax relief, long-term financial security, and the satisfaction of making a significant charitable impact.

Key Takeaways

1. CRTs are powerful tools for clients with highly appreciated assets: Advisors should proactively identify clients who hold substantial unrealized capital gains and consider the potential benefits of a CRT.
2. Collaboration is key: Partnering with experienced tax attorneys and estate planning specialists is crucial for ensuring the proper structuring and implementation of a CRT.
3. AI-powered tools can optimize portfolio management within a CRT: Leverage technology to construct and manage investment portfolios that meet the specific income and risk objectives of the trust.
4. Focus on client's overall financial goals: The CRT should be part of a comprehensive financial plan that considers the client's income needs, tax situation, and philanthropic objectives.
5. Communicate the benefits clearly: Explain the complex tax and financial benefits of a CRT in a clear and concise manner to help clients understand the value proposition.

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