The CRT Split Advantage™
A New Tax Savings Approach for Managing
Charitable Remainder Trusts
The CRT Split Advantage is a new concept as well as a new product design that will become a new standard in the charitable remainder trust market.
The CRT Split Advantage allows the income beneficiary to receive more tax-advantaged income than he/she would receive from a traditional charitable remainder trust.
Tax-advantaged income is defined as income that is taxed at less than “ordinary income” rates.
In general, this new patent pending method splits a traditional CRT into two CRT’s with the objective of managing one of the trusts to maximize higher yield fixed income investments (which is subject to higher taxes), and managing the second trust to maximize long-term capital growth (lower taxes).
The need for the CRT Split Advantage arises from the potential tax disadvantage that exists because of the Code’s prescribed four-tier treatment of income distributions to the income beneficiary; first – ordinary income; second – capital gains income; third – other income; and fourth – return of principal.
This four-tier income distribution order creates a potential conflict between the individual “lifetime interest” beneficiary, and the “charitable remainder interest” beneficiary.
The individual “lifetime interest” beneficiary wants his income treated at the lower capital gains rate (especially if he/she believes that growth or equity investments will do as well or better than fixed income investments). Under this scenario, the income beneficiary wants the charity or trustee to invest only in growth or equity investments. The downside to this approach is higher risk that could result in a significant reduction of principal. The charity does not want this to happen.
The charity remainderman, on the other hand, wants to see safer investments that would insure the preservation of principal. They would prefer investments in low-risk fixed income investments such as CD’s, bonds, government securities, etc. For this reason, many charities only offer CRT’s with lower-income payout rates.
A Trustee or a CRT has a fiduciary responsibility to both parties. He has to be fair and equitable. Usually the Trustee will choose between fixed income and equity investments, with the emphasis on the fixed investments. Because of the four-tier treatment, the traditional approach almost always results in more income taxed at the higher ordinary income tax rate – not the most tax-advantageous strategy.
The CRT Split Advantage divides the trust funds of the traditional CRT into two CRT’s that are managed to maximize the capital gains tax advantage. One trust, investing in fixed income investments, produces ordinary income distributions. The other trust, investing in growth or equity investments, produces capital gains distributions.
By the very nature of this new design, the grantor will be able to maximize his/her receipt of capital gain treated income taxed at the lower 15% rather than 35%. The donor can also strategically allocate assets between the two trusts in a more diversified and properly balanced manner.
$1,000,000 in CRT earning 10% ($100,000) and
distributing 5% ($50,000) annually
$500,000 in fixed income investments
$500,000 in equity investments
Traditional CRT Approach
Income From Investments
$50,000 is ordinary income
$50,000 is capital gains
5% or $50,000 must be distributed and all must be
taxed at the ordinary income tax rate
(35% x $50,000 = $17,500 Tax)
CRT Split Advantage Approach
Two $500,000 trusts – one has ordinary income
investments and one has capital gains investments
Income From Investments
$50,000 is ordinary income – Trust 1
$50,000 is capital gains – Trust 2
5% ($25,000) of each $500,000 trust is distributed
Trust 1 distributes $25,000
Trust 2 distributes $25,000
$50,000 must be distributed, but
Trust 1 – $25,000 is taxed as ordinary income
Trust 2 – $25,000 is taxed as capital gains
Trust 1 – $25,000 x 35% = $8,750
Trust 2 – $25,000 x 15% = $3,750
CRT Split Advantage Tax = $12,500
Traditional CRT Tax = $17,500
TAX SAVINGS = $ 5,000