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Legal Memorandum: Rules for Federal Income Taxation of a CRT

Issue: What are the rules regarding federal income taxation of a Charitable Remainder Trust?

Area of Law: Estate Planning & Probate, Tax Law
Keywords: Charitable remainder trust (CRT); Federal income taxation rules
Jurisdiction: Federal
Cited Cases: None
Cited Statutes: IRC §§ 4941, 4943-4945; IRC Regulation 1.1664-1(a) and -1(c); IRC § 664(b)
Date: 11/01/2008

A Charitable Remainder Trust (CRT) is treated as a private foundation under IRC §§ 4941 and 4943-4945.  It is also exempt from all income taxes, unless it has unrelated business income (UBI).

Before January 1, 2007, if the CRT had any UBI, the trust is taxed on all of its income as a complex trust and is allowed deductions as a complex trust, including a deduction for distributions to the income beneficiaries (IRC Regulation 1.1664-1(a) and -1(c).

As of January 1, 2007, CRTs with UBI may retain their tax-exempt status but a 100 percent excise tax on their UBI is imposed.

Example:  The CRT’s trustee invests $100,000 in a hedge fund that results in $10,000 of unrelated business income tax (UBIT).  Investment advisor fees are $1,000 and administrative costs are $200.  The CRT must pay $8,800 in excise tax ($10,000 minus $1,000 advisor fees and $200 administrative costs= $8,800).

Distributions from CRTs are includible in the gross income of the recipient for the year in which the annuity or unitrust amount is required to be distributed under the terms of the trust’s governing instrument.  They are taxed to the income beneficiaries under the special four-tier system provided in IRC § 664(b).

Under this system, amounts distributed by CRTs are treated as having the following characteristics in the hands of a beneficiary to whom the payments are made:

(1)        ordinary income to the extent of the trust’s ordinary income for […]

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