First off I will give a short summary of the Capital Gains Elimination Trust (CGET). Then, I will provide some details about how it works and conclude with a case study as an example of how someone might use this.
The Capital Gains Elimination Trust is better known as a Charitable Remainder Trust. How this works is one would deposit highly appreciated assets into the CGET. The trust sells the assets and pays no capital gains tax. You then get to withdraw an income each year from the trust. The withdrawal can be earnings and principal.
Donors can be the trustees of the trust and decide how to invest the trust’s assets. In addition, they get an income tax deduction for their contribution to the trust that is based on the term of the trust, the size of the contribution, the distribution rate, and the assumed earnings on the trust.
At this point, the assets are now removed from their estate, they have paid no tax on the capital gains, and they have a stream of income. The IRS requires at least 10% of the present value to be projected to go to a charity of your choice.
If someone wanted the money to be left to family, they could use part of the money they would have paid taxes on and buy a life insurance policy outside of their estate. Then, their children will still receive as much or more inheritance money, free of income and estate taxes.
A CGET can be used with real estate, stocks, or any other asset with capital gains, and must be unencumbered with debt.
CGETs are subject to a maze of law and regulation. The failure of a CGET to meet all requirements can result in a trust being disqualified as a Charitable Remainder Trust, with negative income, gift, and federal estate tax consequences. The loss of charitable status would also defeat a donor’s charitable intent.
Some of these requirements involve numerical tests, several of which have long been a part of the qualifying conditions for CRTs. The Taxpayer Relief Act of 1997 (TRA 97).
5% probability test (this applies only to charitable remainder annuity trusts)
5% minimum payment test
TRA act of 1997
50% payout limitation test
10% minimum charitable benefit
TRA 97 provided several relief provisions for trusts which would meet all CRT requirements, except the 10% minimum charitable benefit requirement. The law provides that a trust may be declared void ab initio (from the beginning). Under this option, no charitable tax deduction is permitted to the donor for the transfer and any income or capital gains created by property transferred to the CRT becomes income and capital gain to the donor.
The new law also allows a donor to reform a trust, by modifying either the annual payout or the term of a CRT (or both), to allow the trust to meet the 10% minimum charitable benefit. Strict time limits have been imposed for this reformation.
Seek Professional Guidance
The laws and regulations surrounding Charitable Remainder Trusts can be complex and confusing. Individuals facing decisions concerning the tax and estate planning implications of a CGET are strongly advised to consult with an attorney.
Beth and John own $1 million of stock that cost $100,000. They realize that their portfolio needs better diversification and would like more income, but they do not want to pay the capital gains tax. They could place the stock in a trust set up by their attorney. The trust would be a tax-free entity and could sell the stock without paying the tax.
Now there is $1 million cash that can be invested. This could go into a balanced portfolio, or an annuity. It doesn’t matter. And Beth and John can make a one-time decision on how much lifetime income they’ll receive from the trust.
The IRS will let Beth and John take an income tax deduction of $417,180 when they do this, as long as at least 10% of the money that originally goes into this trust is left to charity. And since they technically no longer own the $1 million, it is out of their estate, thereby saving their heirs $460,000.
Beth and John are thrilled. They’ll end up with more income, less market risk, and a nice tax deduction. But the kids aren’t so happy. They thought that they were going to get the $1 million. However, a wealth replacement trust would take care of that.
Beth and John take part of their new income and buy a $1 million, second-to-die life insurance policy on their lives. The policy is owned by an irrevocable life insurance trust so the proceeds are removed from their estate. When the survivor dies, the children will receive $1 million tax-free, and the charity will get whatever remains in the trust.
If you ever have questions about planning for your immediate or long-term retirement goals, please feel free to call or send in the enclosed coupon.
Mark K. Lund, CRFA
Stonecreek Wealth Advisors, Inc.
10421 So. Jordan Gateway, Suite 600
So. Jordan, UT 84095
Securities offered through Sammons Securities Company, LLC
Member NASD and SIPC