Bypassing the Capital Gains Tax with Charitable Remainder Trusts (Part 2)

Part 1 of this article can be viewed here.

TABLE 2. COMPARISON OF CRT AND NON-CRT EARNINGS
Age	CRT Value	7% CRT Earnings	Total CRT Value	Non-CRT Fund Net Value	7% Non-CRT Fund Gross Earnings	25% Tax On Non-CRT Fund Gross Earnings	Non-CRT Fund Net Earnings	Non-CRT Fund After-Tax Value
55	$1,000,000	$70,000	$1,070,000	$775,000	$54,250	$13,563	$40,688	$815,688
56	$1,070,000	$74,900	$1,144,900	$815,688	$57,098	$14,275	$42,824	$858,511
57	$1,144,900	$80,143	$1,225,043	$858,511	$60,096	$15,024	$45,072	$903,583
58	$1,225,043	$85,753	$1,310,796	$903,583	$63,251	$15,813	$47,438	$951,021
59	$1,310,796	$91,756	$1,402,552	$951,021	$66,571	$16,643	$49,929	$1,000,950
60	$1,402,552	$98,179	$1,500,730	$1,000,950	$70,066	$17,517	$52,550	$1,053,499
61	$1,500,730	$105,051	$1,605,781	$1,053,499	$73,745	$18,436	$55,309	$1,108,808
62	$1,605,781	$112,405	$1,718,186	$1,108,808	$77,617	$19,404	$58,212	$1,167,021
63	$1,718,186	$120,273	$1,838,459	$1,167,021	$81,691	$20,423	$61,269	$1,228,289
64	$1,838,459	$128,692	$1,967,151	$1,228,289	$85,980	$21,495	$64,485	$1,292,774
65	$ 1,838,45			$ 1,838,45

Now, let’s assume you need to fund your retirement for twenty years to age 85. Assuming the same 7% constant earnings rate, you would receive approximately 20% of the CRT’s annual value as retirement income (total over 20 years: $2,812,485) and still leave $100,000 (10% of your original contribution) to charity. See Table 3.

TABLE 3
	With a Charitable Remainder Trust	Without a Charitable Remainder Trust

Asset Sale Price	$1,000,000	$1,000,000
Asset Purchase Price	$100,000	$ 100,000
Capital Gain	$900,000	$900,000
Capital Gains Tax Rate*	0%	25%
Capital Gains Tax	$0	$225,000
Net Proceeds From Sale	$1,00,000	$775,000
* All illustrations in this article ignore income tax on recapture of depreciation. The inclusion of such tax in the illustrations would obviously significantly increase the advantage of the sale via CRT over a private sale of appreciated assets. Additionally, all illustrations in this article assume a combined 25% federal and state capital gains tax rate.

Remember, if you planned your investment strategy carefully, invested for long-term capital growth and each year withdrew the appreciation plus some trust principal, the average tax rate on CRT distributions may be less than 10%. See Table 4.

TABLE 4. TAXATION OF CRT DISTRIBUTIONS
Age	CRT Value	7% CRT Earnings	CRT Gross Value	19.5% CRT Annual Distribution	25% Tax On 7% CRT Earnings	Annual CRT Distribution Net of Taxes	Effective Tax Rate On Total Distribution	CRT Net Value
65	$1,967,151	$137,701	$2,104,852	$409,394	$34,425	$374,968	8.4%	$1,695,458
66	$1,695,458	$118,682	$1,814,140	$352,850	$29,671	$323,180	8.4%	$1,461,290
67	$1,461,290	$102,290	$1,563,580	$304,116	$25,573	$278,544	8.4%	$1,259,464
68	$1,259,464	$88,162	$1,347,626	$262,113	$22,041	$240,073	8.4%	$1,085,513
69	$1,085,513	$75,986	$1,161,499	$225,912	$18,996	$206,915	8.4%	$935,587
70	$935,587	$65,491	$1,001,078	$194,710	$16,373	$178,337	8.4%	$806,369
71	$806,369	$56,446	$862,814	$167,817	$14,111	$153,706	8.4%	$694,997
72	$694,997	$48,650	$743,647	$144,639	$12,162	$132,477	8.4%	$599,008
73	$599,008	$41,931	$640,938	$124,662	$10,483	$114,180	8.4%	$516,276
74	$516,276	$36,139	$552,415	$107,445	$9,035	$98,410	8.4%	$444,970
75	$444,970	$31,148	$476,118	$92,605	$7,787	$84,818	8.4%	$383,513
76	$383,513	$26,846	$410,359	$79,815	$6,711	$73,103	8.4%	$330,544
77	$330,544	$23,138	$353,682	$68,791	$5,785	$63,007	8.4%	$284,891
78	$284,891	$19,942	$304,833	$59,290	$4,986	$54,305	8.4%	$245,543
79	$245,543	$17,188	$262,731	$51,101	$4,297	$46,804	8.4%	$211,630
80	$211,630	$14,814	$226,444	$44,043	$3,704	$40,340	8.4%	$182,401
81	$182,401	$12,768	$195,169	$37,960	$3,192	$34,768	8.4%	$157,209
82	$157,209	$11,005	$168,213	$32,717	$2,751	$29,966	8.4%	$135,496
83	$135,496	$9,485	$144,980	$28,199	$2,371	$25,828	8.4%	$116,782
84	$116,782	$8,175	$124,956	$24,304	$2,044	$22,260	8.4%	$100,652
TOTAL		$945,986		$2,812,485	$236,497	$2,575,988

On the other hand, without the CRT, assuming the same 7% annual earnings rate and assuming you also draw your available funds down to near zero by age 85, you would receive a total over 20 years of $1,487,380 — $1,325,105 less than from the CRT. Compare Table 4 with Table 5.

TABLE 5. TAXATION OF NON-CRT DISTRIBUTIONS
Age	Non-CRT Fund Net Value	7% Gross Earnings	Non-CRT Fund Gross Value	50% Non-CRT Annual Withdrawal	25% Tax On 7% Gross Earnings	Annual Non-CRT Withdrawal Net of Taxes	Non-CRT Fund Net Value
65	$1,292,774	$90,494	$1,383,268	$691,634	$22,624	$669,011	$691,634
66	$691,634	$48,414	$740,048	$370,024	$12,104	$357,921	$370,024
67	$370,024	$25,902	$395,926	$197,963	$6,475	$191,488	$197,963
68	$197,963	$13,857	$211,820	$105,910	$3,464	$102,446	$105,910
69	$105,910	$7,414	$113,324	$56,662	$1,853	$54,809	$56,662
70	$56,662	$3,966	$60,628	$30,314	$992	$29,323	$30,314
71	$30,314	$2,122	$32,436	$16,218	$530	$15,688	$16,218
72	$16,218	$1,135	$17,353	$8,677	$284	$8,393	$8,677
73	$8,677	$607	$9,284	$4,642	$152	$4,490	$4,642
74	$4,642	$325	$4,967	$2,483	$81	$2,402	$2,483
75	$2,483	$174	$2,657	$1,329	$43	$1,285	$1,329
76	$1,329	$93	$1,422	$711	$23	$688	$711
77	$711	$50	$761	$380	$12	$368	$380
78	$380	$27	$407	$203	$7	$197	$203
79	$203	$14	$218	$109	$4	$105	$109
80	$109	$8	$116	$58	$2	$56	$58
81	$58	$4	$62	$31	$1	$30	$31
82	$31	$2	$33	$17	$1	$16	$17
83	$17	$1	$18	$9	$0	$9	$9
84	$9	$1	$10	$5	$0	$5	$5
Total		$194,610		$1,487,380	$48,653	$1,438,727

It gets even better: Not only do you receive $1,325,105 more via the CRT, you pay $37,156 less in taxes ($236,497 total tax on annual CRT distributions versus $48,653 total tax on annual non-CRT earnings plus $225,000 tax on original sale of the asset).

Your benefits eclipse the $100,000 left to charity thirteen times over. Clearly the CRT wins.

Here’s how the numbers work out:

TABLE 6
	With a Charitable Remainder Trust	Without a Charitable Remainder Trust

Total Fund at Age 65	$1,967,151	$1,292,774
Total Withdrawals Before Tax	$2,812,485	$1,487,380
Capital Gain	$900,000	$900,000
Total Withdrawals After Tax	$2,575,988	$1,438,727
Total Tax	$236,497	$273,663

This is not the result of smoke and mirrors; it is merely the magic of tax-free compounding. Since more money is left in the tax-exempt CRT than is left in the taxable non-CRT fund, the CRT grows faster, continuously compounding tax-free.

Furthermore, the assets contributed to the CRT are no longer part of your taxable estate when you pass away. The removal of a $1,000,000 asset from your estate could result in an estate tax savings of $500,000, depending on the total value of your taxable estate at death.

In addition to the immediate capital gains tax savings, the continuous income tax savings and the future estate tax savings, the CRT’s charitable contribution requirement provides for an immediate income tax charitable deduction of $12,321, which equals the present value of the future $100,000 gift to charity, even though the charity will not receive the gift for many years.

This additional tax savings could be used for additional investment or for any other purpose.

Finally, you may get anything from a thank you note to a testimonial dinner from the charity, depending on the size of your final gift.

If used properly, a CRT can serve as a private pension plan without the restrictions usually associated with pensions. Pension plans are subject to penalties for early withdrawal, as well as limitations on initial funding.

Pension distributions are taxed at your personal income tax rate no matter how the money was earned by the pension (you lose the benefit of long-term capital gains).

By comparison, a CRT has no age restriction; distributions can be made by a CRT immediately, regardless of age; and taxation on CRT distributions is based on how the money was earned by the CRT, not on your income tax bracket.

A CRT has no limitations or restrictions on the amount of initial funding. Finally, the investor who creates the CRT also gets a tax deduction for the present value of his future charitable gift and a reduction in estate taxes.

Remember, some of the money must ultimately go to a recognized charity — at least 10% of the original amount that funded the CRT. In addition, you must make sure that your annual withdrawals are not so large as to completely deplete the CRT before it expires, leaving nothing to charity.

Charitable Remainder Trusts are complicated plans requiring computer-generated spreadsheets and voluminous legal documents, mostly written in “revenue-eze.” They are governed by complicated tax regulations, so they must be planned and prepared by an attorney who practices in this specialized area. It all comes back to the old adage — you have to spend money to make money.

But if you are prepared to spend some, you can make a lot, and more importantly, you can keep almost all of it.