Charitable Remainder Trust: $100K Income Tax Deduction
Executive Summary
A high-net-worth client sought to donate a significant portion of their highly appreciated stock portfolio to their alma mater while minimizing the impact of capital gains taxes. Golden Door Asset helped Precision Financial Group establish a charitable remainder trust (CRT) to receive the assets. This allowed the client to avoid immediate capital gains taxes, generate an income stream for 20 years, and ultimately benefit their designated charity, resulting in a $100,000 income tax deduction in the initial year.
The Challenge
John Smith, a 68-year-old retired executive, approached Precision Financial Group with a desire to make a substantial donation to his alma mater, State University. John held a stock portfolio valued at $500,000 with a cost basis of $100,000. This meant he faced $400,000 in capital gains if he sold the stock outright, leading to approximately $80,000 in federal capital gains taxes (assuming a 20% federal rate). John was also concerned about maintaining a steady income stream throughout his retirement.
Directly donating the stock would allow John to avoid the capital gains tax, but he wanted the ability to receive a portion of the asset's value in payments over time. Furthermore, the current income generation of the portfolio was not optimized for his specific needs, yielding only a 2% dividend, or $10,000 per year, before taxes. Simply liquidating the stock and reinvesting would trigger the significant capital gains tax liability, depleting the principal available for reinvestment. John needed a strategy that would fulfill his philanthropic goals, maximize his income, and minimize his tax burden. He was hesitant to make any decisions which would cost him more than $30,000 in tax liability in year one.
The Approach
Precision Financial Group, leveraging the planning tools available through Golden Door Asset, determined that a Charitable Remainder Trust (CRT) was the most suitable solution. This strategy involved transferring the $500,000 in appreciated stock to a CRT. Upon establishing the CRT, John was eligible for an immediate income tax deduction.
The CRT would then sell the stock tax-free, avoiding the $80,000 capital gains tax liability John would have incurred from a direct sale. The proceeds from the sale were then reinvested into a diversified portfolio designed to generate a specified income stream for John over a 20-year term.
Golden Door Asset's platform provided scenarios illustrating the impact of different payout rates on the size of the initial tax deduction and the annual income stream. This allowed Precision Financial Group to present John with a clear picture of the potential benefits and trade-offs associated with the CRT. The decision-making process included considerations of John's current income needs, tax bracket, and overall financial goals. The modeling also showed how the remainder interest, the amount ultimately going to State University, would be affected by the payout rate and investment performance.
Technical Implementation
The technical implementation of the CRT involved several key steps:
- Asset Transfer: The $500,000 of appreciated stock was legally transferred to the newly created CRT. This required careful documentation and coordination with the custodian holding the stock.
- Trust Document Preparation: A comprehensive trust document was drafted by an attorney specializing in estate planning. This document clearly outlined the purpose of the trust, the beneficiary (John Smith), the remainder beneficiary (State University), the trustee (Precision Financial Group), and the payout terms.
- IRS Compliance: All necessary IRS forms were completed and filed to ensure compliance with regulations governing CRTs. This included obtaining a tax identification number for the trust and adhering to the rules regarding self-dealing and private foundation restrictions.
- Investment Strategy: The $500,000 in proceeds from the sale of the stock was reinvested into a diversified portfolio consisting of a mix of stocks, bonds, and real estate investment trusts (REITs). The investment strategy was tailored to generate a 7% annual payout to John, or $35,000 per year, while maintaining a balanced risk profile. The platform's portfolio optimization tools were used to minimize risk and maximize returns within the constraints of the desired income stream. Calculations took into account future tax bracket possibilities and inflation.
- Income Distribution: Annually, $35,000 was distributed to John as income from the trust. The nature of this income depended on the CRT's performance and could be categorized as ordinary income, capital gains, or tax-free return of principal.
- Charitable Remainder Calculation: The charitable remainder was calculated according to IRS guidelines using actuarial tables and the applicable federal rate (AFR). This calculation determined the amount of the income tax deduction John was eligible for in the initial year.
Results & ROI
The implementation of the CRT delivered significant financial benefits for John Smith:
- Income Tax Deduction: John received an immediate income tax deduction of $100,000. This was based on the present value of the remainder interest that State University would receive at the end of the 20-year term.
- Capital Gains Tax Avoidance: By transferring the stock to the CRT, John avoided paying $80,000 in capital gains taxes.
- Increased Income Stream: John received an annual income of $35,000 from the CRT, significantly higher than the $10,000 annual dividend he was previously receiving.
- Philanthropic Impact: John was able to make a substantial donation to State University, supporting their educational mission.
- Tax Savings: Over the 20-year term, the cumulative tax savings resulting from the CRT are projected to exceed $250,000, considering both income tax deductions and capital gains tax avoidance.
- Net Present Value: The net present value of the benefits received by John (income stream and tax savings) and the charitable contribution to State University exceeded $600,000.
Before:
- $10,000 annual dividend income
- $80,000 capital gains tax liability upon sale
After:
- $35,000 annual income from CRT
- $0 capital gains tax liability
- $100,000 immediate income tax deduction
Key Takeaways
- CRTs are powerful tools for clients with highly appreciated assets who wish to make charitable donations. The tax benefits can be substantial and can significantly enhance their philanthropic impact.
- Golden Door Asset's planning tools can help advisors quickly assess the suitability of a CRT for their clients. The platform's scenario modeling capabilities allow advisors to illustrate the potential benefits and trade-offs associated with different payout rates and investment strategies.
- Careful coordination with legal and tax professionals is essential when establishing a CRT. The trust document must be drafted correctly, and all necessary IRS forms must be completed and filed accurately.
- Investment strategy plays a critical role in the success of a CRT. The portfolio should be diversified and managed to generate the desired income stream while maintaining a balanced risk profile.
- Communicate clearly and transparently with clients about the potential risks and rewards of a CRT. Ensure they understand the terms of the trust, the payout schedule, and the potential impact on their overall financial plan.
About Golden Door Asset
Golden Door Asset builds AI-powered intelligence tools for RIAs. Our platform helps advisors identify tax optimization opportunities like charitable remainder trusts and create personalized financial plans with ease. Visit our tools to see how we can help your practice.