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Recently I discussed my net worth and how I went from a poor farm boy to an eight figure net worth. To keep the discussion moving I glossed over a few issues, most notably some of the vehicles I use to invest and protect my net worth from taxation. My sole mention of using trust instruments to protect net worth and save taxes caused several requests to hit my email inbox. People wanted to know more about trusts and how they can be used to super-charge net worth, provide guaranteed income, reduce taxes and protect against lawsuits stealing your hard earned money.
To which I mentally replied, “Is that all?”
A tax discussion on trusts turns into hard core tax planning quickly. Discussing all trusts is beyond the scope of a simple blog post and even beyond the scope of an entire blog. Too many variables are involved. What we can do in a single blog post is cover one trust topic enough to help you decide if it is right for you and get you to the right people to facilitate the process.
Today we will discuss an animal called the net income makeup charitable remainder unitrust, or NIMCRUT. It sounds like a derogatory name you would call someone in the heat of battle. Instead, the NIMCRUT, or even her sister the CRUT, is the perfect tool to get a massive tax break now, avoid paying capital gains on highly appreciated assets, help the charity of your choice and get a nice income stream—some of which might be tax free—for your entire life or a set number of years. Sound like fun? Then read on.
Highly appreciated assets face a large capital gains tax rate, currently topping out at 20% for federal, plus more in many states. To make matters worse, the alternative minimum tax is calculated using a 22 ½% capital gains rate.
Moving money from a long-term, highly appreciated asset to a higher income producing asset requires a serious tax haircut. The reason for the transfer of investments frequently revolves around income. The old asset has appreciated several fold, but has a low or no current income distribution. To access your net worth requires sale of a portion of or the entire asset, triggering a taxable event.
Basics of a NIMCRUT
A NIMCRUT is really a charitable remainder trust with a unique income makeup feature.
Once a NIMCRUT is established, assets are transferred into the trust. The trust sells the asset/s and since it is a charitable trust pays no tax on the gain. You personally did not sell the asset so you also pay no tax on the gain, nor is there anything to report on your personal tax return.
Because you donated to a charitable trust (a qualified nonprofit organization (the beneficiary) gets the remainder at some point in the future) you also get a tax deduction on your personal tax return. The tax deduction has to be discounted for the present value of the future gift. In the old days we used tables provided by the IRS to calculate our deduction; today we have handy online calculators linked at the end of this post.
Example: A 53 year old donating $1 million of stock to a NIMCRUT with a basis of $100,000 would avoid paying capital gains tax on $900,000, plus get a current tax deduction on Schedule A (subject to limitations) of $239,894. Any unused charitable deduction is carried forward up to five years.
The tax avoided and the additional deduction is a great start. BUT, you also get an income stream from the trust. Remember, this is not a straight forward donation to a charity. The charity gets the remainder at some point in the future. You choose how much income per year you want before the charity takes possession of the gift. The Tax Code requires at least a 5% rate with higher amounts allowed (up to 50%). A common rate is 7% and is used for our example above.
You also choose the term, either life or up to 20 years. The longer the term the lower the tax deduction on Schedule A.
CRUT or NIMCRUT
There is a difference between the two. Generally, a NIMCRUT only pays you from income, excluding capital gains. A CRUT can dip into the corpus to fund payments. The NIM part of a NIMCRUT means you can catch up, if you will, the missed portion of past payments.
Since many investments do not throw off a 7% income available for distribution, two investments rise to the surface: real estate and annuities. The rent is available to distribute to the annuitant (you).
An annuity inside the NIMCRUT can control the flow of funds. Income must be distributed up to the rate listed in the trust document. Previously missed payments are “made up” in years when the income supports the payment.
Since tax is due on all or most distributions, your personal tax situation might require more control over when you get paid and hence pay tax. The annuity inside the NIMCRUT can delay paying out; therefore, no income is available for distribution. When you need the money you can take your distribution by having the annuity pay out income to the NIMCRUT. (Special thanks to Putnam Investments for presenting the annuity strategy at a H.D. Vest Financial Services conference during the mid 1990s.)
Assessing the Benefits
Let’s add up all the benefits of a NIMCRUT before disclosing a few negatives.
First, you avoid capital gains on a highly appreciated asset. Most taxpayers will avoid 15% to 20% long-term capital gains tax with a NIMCRUT, plus state capital gains taxes. In our example, $900,000 of avoided LTCG adds to a $180,000 tax reduction at the 20% LTCG rate.
Next, you get a present value charitable deduction on Schedule A subject to normal limitations for the future charitable contribution. Our example shows a $239,894 deduction.
Assuming a 7% rate and no increases in value of the NIMCRUT investments, you will receive 140% of the original investment over 20 years. If the investments inside the NIMCRUT increase, your payment will too. Our example should generate $1.4 million over 20 years.
Normally you are the trustee so you determine the investments inside the NIMCRUT.
You control in a limited fashion when and how much you get paid. Most income from a CRUT or NIMCRUT is taxable. A portion of a CRUT might be exempt.
At the end of the term your named charity receives the remainder.
To keep the kiddos happy you can purchase a single premium term life insurance policy for the amount of the charitable gift with the tax savings from avoiding the LTCG tax. This is done with an irrevocable life insurance trust (ILIT).
If you die while the NIMCRUT is in effect the remainder goes to the charity, is added to your estate, but your estate takes an equal amount as a charitable deduction.
In sum, you avoid LTCG taxes on unrealized asset appreciation, get a deduction up front, receive income over your lifetime (single or joint) or a set number of years up to twenty, support your preferred charitable causes and give the kiddos a healthy legacy to boot.
Every strategy has pros and cons. A NIMCRUT is irrevocable. This means you can’t later change your mind. Well, you can change your mind, but there is nothing you can do about it. You must plan in advance for a NIMCRUT. The issues and process is complex and set in stone once in effect.
There are annual reporting requirements. At minimum a Form 5227 is required. Sometimes a Form 1041 or other tax forms are required. Few tax professionals are versed or experienced in preparing complex trust tax returns. You will need to find one who is.
You must have an attorney to draft the trust documents. No shortcuts here. An experienced estate attorney will smooth the process and inform you of issues pertinent to you while avoiding IRS scrutiny.
Large investments are required and large unrealized LTCG increase the tax benefits of the NIMCRUT. Realistically, anything less than $100,000 of asset value or $50,000 of unrealized gain to transfer to the NIMCRUT is inadvisable. $1 million of highly appreciated assets and greater put into a NIMCRUT yield excellent advantages to many high net worth taxpayers.
A CRUT usually allows corpus to be used to pay the annuitant, but yields fewer tax benefits. A NIMCRUT must have income from which to pay the annuitant (you). Many NIMCRUTs exclude capital gains from income in the trust documents.
The Next Step
It’s not all roses when planning a trust. Trusts are nor for everyone. They are powerful estate planning tools to carry out your wishes and serve your needs. It takes time and there are legal fees.
I intentionally left out a massive amount of information to keep to this post’s story line brief. Additional research is required even before you contact your estate attorney.
Here is an interesting article on NIMCRUTs you might find valuable.
Here is a NIMCRUT calculator. You can play with the numbers to get an idea of the tax benefits available. The same site has excellent calculators for a variety of CRUTs and CRATs as well.
You can read a bit more from the IRS on the issues discussed.
Finding a qualified attorney is an issue for many readers. Here is an article by a company that helps people set up charitable trusts. (Not an affiliate.)
Finally, if you want to read extensively before committing to a discussion with an attorney, here is a good book on the subject from Amazon.