Best Last Minute Tax Deduction at the End of the Year: Charitable Remainder Trust

Have Taxable Income or Gain. If you had substantial income or have a large taxable gain in 2009 or will in future years, the best end of year tax savings technique is often the Charitable Remainder Trust (CRT). This is because with a CRT, you can obtain a large tax deduction even if you wait until the end of the year. Many of the other techniques that taxpayers used in the past for end of year tax deductions have been severely limited. With the CRT, you retain some control over the asset, receive income from it, get an immediate tax deduction and postpone or avoid capital gains on the sale of the asset.

What is a CRT? A CRT is a trust which you create and to which you contribute assets such as stocks or free and clear real estate. The CRT then sells the asset and because the CRT is similar to a charity which pays no income taxes for charitable activities, the CRT does not pay any capital gains at the time of the sale of the property. Depending on how you set up the CRT, you may never pay any capital gain taxes on the sale of the asset.


Major features of the CRT:

*Planning A Must. The first step is to plan the CRT, which involves integrating your CRT into your financial, business and estate plan:
*Not Too Big and Not Too Small Deduction. You generally want to maximize the deductions you will receive in the year of the gift. The deduction is calculated based upon IRS tables which predict how much the charity will receive. If you contribute $100,000 in 2009 to the CRT and the IRS tables say the charity is predicted to receive $30,000, you receive a $30,000 deduction from your taxes in 2009. If you exceed the maximum deductable level for charitable deductions in year 2009, you can carry forward the deduction to use in future years, with certain limitations. You do not want to give too much or too little.
*Charity Minimum Ten Percent. The charity has to receive at least 10% of the total gift. If you are below 50 years of age, you may not be able to use your lifetime as the time for the payments back to you from the CRT and may have to use a maximum of 20 years before the assets go to the charity. As part of the planning, we run computer calculations of the results of different options.
*Payout Rate. You have to decide the annual rate at which the CRT will pay you. It has to be at least 5% and not more than 50% and it can be fixed or dependent upon earnings or the value of the property. The pay out rate is the rate at which you will receive income for your life or the set period of the CRT.
*Distributions Taxed. You pay taxes on the distributions if they are ordinary income or capital gains, but not return of principal or tax exempt income.
*Postpone Income Taxes. If you will have high income for the next several years, high taxes and do not want to receive any payments which would be subject to taxes, you can set the CRT up so that the CRT does not make payments to you during the high income years through the use of financial instruments such as an annuity or family limited partnerships. You can turn the cash flow spigot on or off depending upon your future cash needs. The IRS is watching for abuses.
*Appraisals. If you contribute to the CRT real estate or a hard to value asset such as an interest in a closely held business, you must have an independent appraisal and a special independent trustee involved in the process.
*You are the Trustee. You can be the trustee of the trust, but there are self dealing limitations.
*Option to Change Charity Designated. You initially name the charity, but you can retain the right to change the charity. Properly planned, your family foundation may become a beneficiary.
*Exempt from Estate Taxes. The assets in the CRT will not be part of your taxable estate and you do not use up any of your exemptions from estate taxes by use of the CRT.
*Replace the Inheritance. Since the assets go to the charity upon your passing and not to your heirs, you can decide to replace those assets with life insurance. If is possible to so design a CRT in many cases where the net tax and other financial advantages provide enough additional cash to pay for the insurance.
*Money is in the CRT. Once established, you can not change the rules of the CRT and take back the asset. You have to be able financially to not have this as an asset that you must liquidate to pay bills. However, with the deferred income CRT, you can sell assets in the CRT when you need money so that you receive all of the distributions you did not receive over the prior years.

Your Team of Advisors. There are exceptions and many details to this planning not discussed above which you do not need to know in order to accomplish your goals. The key point is that there is a way to obtain large last minute tax deductions at the end of the year. The CRT will be used more in the future as capital gains rates, income tax rates and estate tax rates increase in the coming years. If you want to plan for the coming higher taxes, we will assemble your team of advisors to use the tools permitted under the law to lessen the blow of these higher taxes on you.

Dad Died and the Bank Took Everything

Successful Contracting Company. Jimmy Jones had a successful contracting company which was worth several million dollars. Over his lifetime, he had seen the business go up and down with the economy. To put away some funds for the future, he bought an apartment building and a small shopping center. Jimmy worked until his seventies and never found the right person to take over his company. His daughter Jane is a successful CPA with her own practice but his son Jimmy Jr. drifts from job to job. Jimmy gave his children everything when they were growing up because he didn’t want his children to remember being poor as a child.

Great Banking Relationship. Jimmy has had a great relationship with his local community bank where he had his business accounts over the years. He had a line of credit and commercial loans on his apartment building and shopping center all with the same bank. He thought he saved on legal fees when he obtained or renewed his loans by not having a lawyer review the documents.

MegaBank Takes Over. On Friday the 13th of November, Jimmy had a heart attack and died. All of the loan documents for his business and his real estate have a clause in the loan documents which say that if Jimmy died, the bank could demand full payment immediately on all of his loans. Recently, his local community bank had been acquired by MegaBank which now has all of Jimmy’s loans. MegaBank has been kept out of bankruptcy by billions of dollars from the federal government. The federal regulators want MegaBank to have higher cash reserves in case of loan defaults and to get rid of all risky loans, which the regulators classify as including all commercial loans on local real estate to individual owners. Jimmy had always paid all of his loans on time and the business and real estate generated enough cash flow most months to pay all of the loans; Jimmy was an excellent credit risk. Now, because Jimmy has no successor in place to take over his construction business and manage his real estate, MegaBank feels itself insecure, is being pressured by the regulators and therefore declares due and immediately payable all of the loans that Jimmy had with the bank based upon the clause in the loan documents that the bank can demand immediate full payment if the borrower dies.

MegaBank Wins in Court. Jimmy’s daughter Jane hires an attorney to try to stop the foreclosures on the business and the real estate. Jane loses in court because the loan documents clearly allowed MegaBank to foreclose if Jimmy died. Jane pays $120,000 in legal fees out of her savings and MegaBank adds its legal fees of $150,000 to the balance due on the loans owed by Jimmy’s estate. Due to the depressed construction industry during the recession and the decrease in values for the real estate and the shortage of loan money, Jane can not get loans to stop the foreclosures. After MegaBank foreclosed, Jimmy’s construction company closed its doors and 32 people lost their jobs. The real estate was sold at fire sale prices for less than the balances on the loans. MegaBank came after Jimmy’s savings and wiped out any other money he had that did not go by right of survivorship to Gerry, Jimmy’s widow. Jimmy’s widow sells her house to have money to live on and moves in with her sister and her sister’s crude and rude husband. Jimmy’s children, who could have each inherited millions, will get no significant inheritance from their parents.

Prevention. This could have all been prevented. “Death is a default” is a standard term in commercial loan documents that can be removed through negotiations. If Jimmy had hired our firm to represent him with his commercial loans, we would have insisted that the loan commitment letter state that the loan could not be called by the bank if Jimmy died. We would have worked with Jimmy to have a business succession plan in place that we would show to the bank to convince them that they would still be paid if Jimmy died. We have always been able to obtain bank agreement that the loan could not be called in the event of the death of the principal borrower. MegaBank would not have had the right to foreclose and the Jimmy Jones family assets would have been saved and Gerry would not have had to move in with her sister and her rude husband. Many entrepreneurs do not use competent legal counsel to review the commercial loan commitment letter before their sign it. This story shows what can happen to a lifetime of work and a family if you do not obtain the proper loan terms.

How to Protect Yourself: US Goes Bankrupt: Taxes Going Up, Services Going Down; President Obama Tells the Truth

You Can’t Handle the Truth: When I was in politics for ten years as a member of the Virginia legislature, most politicians believed that the “people” couldn’t handle the truth. My experience was that people didn’t like to hear about the harsh realities that government often faces.

Obama Tells the Truth. President Obama did a public service for the country when he said the US is going bankrupt unless we raise taxes and cut spending. Now, the President didn’t say it exactly that way, but the pending health plan in the Senate recommended by the President relies upon decreasing expenditures for Medicare and Medicaid and raising taxes. New Hampshire Republican Senator Gregg claims current and proposed spending will lead to bankruptcy for the United States.

Unsustainable Budget. In our private client letter mailed in December 2008, I quoted: “Under any plausible scenario, the federal budget is on an unsustainable path”-Peter Orszag, Director, Congressional Budget Office, December, 2007. This was before the historic spending of 2009. In our Prepare for the Return of the Estate Tax, we provided the numbers which show how the government is going broke. The Obama Administration is projecting a $9 Trillion deficit in the next ten years. This is more debt than America accumulated from 1789 to 2008 combined. The Heritage Foundation says the correct number is $13 Trillion over ten years with the national debt being equal to the entire production of the country (GDP) by 2019. At some point, the federal government will no longer be able to borrow money at acceptable rates to finance spending. The projected rates of spending will force punishingly high taxes on individuals, businesses and the economy. So, what do you do if the US government goes bankrupt?

Capital Gains. The 15% federal capital gain rate expires by law at the end of 2010. Rates will go higher. Strategies include selling of stock now with capital losses to store up loses against future taxes, use of charitable trusts to postpone or avoid gains and use of tax deferred exchanges for real estate.

Income Taxes. The maximum 35% personal rate expires at the end of 2010. Rates will probably go to $39.5%. With increases in state taxes, phase out of deductions and the raising of the ceiling on withholding taxes, the effective rate could be near 60%. Business owners will increase corporate perks and take another look at deferred compensation planning. Tax payers will seek charitable planning, annuities, life insurance and tax shelters.

Estate Taxes. We predicted the $1,000,000 exemption and 55% tax rate is coming back in Prepare for the Return of the Estate Tax. There are time tested techniques to legally reduce your estate taxes to zero even if you have a large estate.

Decline of the Dollar. If the US government goes bankrupt, the value of the dollar will decline greatly and the prices you pay will increase greatly. If all of your assets are in dollars denominations, you will have to work to able to pay your bills, if you can find a job that pays enough to live on. Talk with your financial advisor about whether you should diversify a substantial amount of your portfolio into assets in currencies other than dollars, assets that will retain their buying power or other defensive moves. There is a historically wide variation of opinion among economists as to whether we will have inflation or deflation.

Health Care. It is well known and documented that the path to saving on personal health care expenses is to control your weight, exercise, get a good nights sleep, avoid fast foods, eat a Mediterranean diet, avoid harmful medicines, have a warm and loving family, avoid narcotics and excess alcohol consumption, reduce stress and feel you are making a worthwhile contribution to your community. Sounds simple enough-for the perfect person. A large number of people I know think that their health care is in their hands and that they will not be able to depend upon a government provided health care system. My personal recommendation is for you to read a book such as “Ultraprevention: The 6-week Plan that Will Make you Health for Life” by the two medical doctors who run the Canyon Ranch health spas. We will give away copies of this book to the first ten people who call Silvio at 571-633-0330 and to anyone who comes in for an appointment to plan their taxes, estate or business.

Be Ready. Call us to have a balanced plan for the coming years of more financial turmoil.