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.
For unto whomsoever much is given, of him shall be much required. —Luke 12:48
My charitable giving is not predicated upon religion or religious belief; I haven’t contributed to a church in more than a decade. However, I am not afraid to take words from the Bible, or any other religious tract, and integrate them into my life and worldview. I am not the kind of guy who needs the biggest bank account to feel validated so when fortune smiles my way I selectively contribute to causes I feel make a difference in the quality of human life around the world.
Selecting a charitable entity to contribute to is a process for me. I donate to only a few causes with donation tending to be $1,000 or more per donation. My giving is also lumpy. I go for extended periods without any charitable work and then give large amounts at one time. Taxes are not a part of my consideration process, but I do take the deductions allowed. Some of my charitable giving is not deductible on Schedule A. Some charitable work is considered a promotional expense for my business which allows me to kill two birds with one stone: helping a charity and getting a deduction before it ever gets to my personal tax return.
Luck of the Draw
From the first human to live to today I have outlived the vast majority of people. I am 52 and live in a Western country where food, water, sanitation and medical care allows most people to live to a ripe old age. Large populations of Asia and Africa still have life expectancy similar to a century ago in the United States or European nations. I have already outlived most of them. Mortality rates have decreased drastically and the quality of life for many, including me, is an outlier of human history.
According to the U.S. Centers for Disease Control and Prevention, in 2011, 94,281 people out of 100,000 born alive were still alive at age 50. Nearly 6% cashed it in. Looks like I am a winner again. Lucky I was born in the right place at the right time. The same CDC table shows 84,368 out of 100,000 still alive at age 65. It seems another 10% die between my age and what is considered retirement age. One in ten! I might need to reconsider my attitude toward working one more year.
Life expediencies for most of human history has been lower than 50 years of age. Even in our modern world a large number of people do not survive to “normal” retirement age. Outside North America, Western Europe, Japan, Australia, and a few pockets of longevity, a majority of populations die before living to my age. It is this luck of the draw, this gratitude I feel each day I wake which motivates me to improve the human condition wherever I can.
Non-profit organizations file Form 990 with the IRS. You can review a candidate for your charitable money here before you send money. My policy is always research the organization before supporting. I look for a few key points. I want to see most of the money going to the charitable cause they claim they support. Large percentages going to fundraising or to executive salaries are a bad sign.
The choices are endless. There are over 1.5 million non-profit organizations in the U.S. alone. Research takes time so I have a limited number of charities I support and keep supporting. Here is my list.
- Doctors Without Borders: The next time you think all doctors are overpaid with a bad bedside manner, think of the doctors working in this organization. They travel to dangerous parts of the world and provide medical care to people with serious needs at no cost. I can’t imagine what these doctors go through to help their patients. Talk about house calls! I have supported Doctors Without Borders for over a decade. I am not sure I would even want to live in the conditions they work in so they are on my short-list of organizations to fund.
- Special Olympics: In the past I have supported Wisconsin Special Olympics Wisconsin Special Olympics provides sporting opportunities for over 10,000 athletes each year. Once again, this is work I do not think I could handle. Working with these remarkable people would bring me to tears. When I see these outstanding individuals reach for the stars I am humbled. Anyone who can personally help the disadvantaged do something I know I am not man enough to do myself deserves kudos. Just writing about this makes me emotional. Even now I fight tears knowing I am not good enough to help these people who really need support. Regardless their disadvantage, they never quit. They have more fight, more spirit than most people with no disadvantages. We can learn a lot from these outstanding men, women, and young people.
- Bethesda: This is the closest I get to donating to a religious organization. Twenty-five years ago when I still attended church services, a man from Bethesda came to my church and shared some of the work they did. They provide a home setting for severely mentally challenged people. What stuck with me was one story. He explained how they broke down the process to tying a shoe into 87 steps. They would patiently work with some of their clients for years teaching them just one more step in the process to tying a shoe. Their patience moved me emotionally. My personality has no room for that kind of patience. The cost to run such homes is expensive. People with special needs frequently have no money for that need. Bethesda is possible because people like you and me support their work. I take my hat off to all the patient men and women who help these people day in and day out. If there is a heaven, these are the people who will populate it. There is no room for people like me there.
- CommunityFest: This is one local event I periodically support. Every few years I donate a slug of money supporting this local event over the 4th of July holiday. Prizes, games, music, fireworks, and great family fun are all free for families in our local community, paid for by local businesses. From a tax viewpoint, the donation is really a business promotional expense and deductible by the company. Technically not a charitable donation, it shows how individuals and businesses can support local programs to improve our local communities.
- Children’s Hospital: I never donated directly to Children’s Hospital, but I have supported Children’s Hospital through the Vic Ferrari Golf Event and similar programs. The Vic Ferrari Band is a client. They are awesome performers and do more than jam tunes; they make a difference. Vic supports several local charities through special events. The Vic guys deserve a humble bow; they are valuable members of our community. If you never saw these guys perform you need to fix that.
- Other Charitable Work: To a lesser extent I have contributed to charities in a wide variety of fields. In a limited fashion I have supported the arts (Wisconsin Writers Association) and other charities through special events.
I have a few additional rules when supporting charities. I never support a cause whose sole purpose is to raise awareness. It might be an unfair rule, but my resources are limited and I want the bulk of my money to support disadvantaged people with few options for a better life available. You can see I strongly support the down and out. The truth is I support organizations that help people I am unable to help myself. The patience, love, and kindness these people show every day in such challenging situations is more than I can bear to think about for any period of time without tears coming to my eyes. What they do every day without real recognition is beyond my comprehension. I support them because they are better people than I will ever be. I hope you will support them too.
List your favorite charities in the comments below.