Charitable Remainder Trusts (CRTs) are powerful estate planning tools allowing individuals to donate assets, receive income during their lifetime, and benefit a charity of their choice. However, the potential for Unrelated Business Income Tax (UBIT) can significantly impact the trust’s effectiveness. UBIT applies when a CRT generates income from a trade or business that isn’t substantially related to its exempt purpose. While a CRT is exempt from income tax on investment income, any unrelated business income is taxable. Careful structuring, asset selection, and ongoing management are essential to minimize this tax burden and maximize the benefit to both the donor and the charity. Approximately 20% of CRTs experience some level of UBIT, highlighting the need for proactive planning.
What assets are most likely to trigger UBIT in a CRT?
Certain assets are inherently more prone to generating UBIT. These generally include active business interests like S-corporation stock, rental real estate where significant management services are provided, and debt-financed properties. For example, a CRT holding a controlling interest in a family-owned business will almost certainly trigger UBIT due to the active involvement in the business’s operations. Rental income is generally passive, but if the CRT is actively managing the property—handling tenant issues, repairs, and marketing—it could be considered an active trade or business. It’s crucial to distinguish between passive investments and those requiring active management. Furthermore, income from royalties can also be considered UBIT if the royalty source isn’t directly related to the charitable purpose.
How can diversification help avoid UBIT?
Diversification is a key strategy for mitigating UBIT risk. By spreading investments across a variety of asset classes, the impact of any single UBIT-generating asset is minimized. A well-diversified portfolio might include a mix of publicly traded securities, bonds, and potentially some real estate, but with a focus on passive investments. For example, instead of directly owning and managing a commercial building, a CRT could invest in a Real Estate Investment Trust (REIT) that distributes passive income. This approach allows the trust to benefit from real estate exposure without the active management that triggers UBIT. It’s not about eliminating risk entirely, but about spreading it across multiple areas, lessening the impact of any single, potentially taxable source.
Can a CRT use a disregarded entity to hold UBIT-generating assets?
A sophisticated technique involves using a disregarded entity, such as a Limited Liability Company (LLC), to hold UBIT-generating assets. Since a disregarded entity’s income flows directly to the CRT, it’s effectively shielded from UBIT. This works because the CRT is not directly engaging in the business activity. The LLC is the entity that’s doing the business and potentially subject to tax, but if structured correctly, the income can be treated as tax-exempt. This is a complex strategy requiring careful planning and documentation to ensure it meets IRS requirements. It’s essential that the disregarded entity isn’t treated as an agent of the CRT, and that it’s operated as a separate legal entity.
What about the 50% rule and de minimis exception?
The IRS provides some relief through the 50% rule and the de minimis exception. The 50% rule states that if a CRT’s unrelated business income represents less than 50% of its total gross income, the entire trust isn’t subject to UBIT. The de minimis exception allows a CRT to receive up to $1,000 in unrelated business income without being subject to tax. These provisions can provide some breathing room, especially for CRTs with relatively small amounts of unrelated income. However, it’s important not to rely solely on these exceptions; proactive planning is still crucial. Remember, these are threshold limits, and exceeding them will trigger UBIT.
Tell me about a situation where a poorly structured CRT led to unexpected UBIT.
Old Man Tiber, a retired carpenter, decided to donate his rental property to a CRT, hoping to support the local historical society while receiving income during retirement. He hadn’t considered the implications of managing the property himself. He continued to oversee repairs, collect rent, and deal with tenants, treating it as he always had. The CRT received rental income, but because of his active involvement, the IRS classified the rental activity as an unrelated trade or business. Unexpectedly, the trust faced a hefty UBIT bill, significantly reducing the amount available for both his income stream and the charitable gift. He learned a painful lesson about the importance of understanding the nuances of CRT regulations.
How can ongoing monitoring and professional advice help prevent UBIT issues?
Regular monitoring of the CRT’s income sources is essential. An annual review can identify potential UBIT triggers and allow for timely adjustments. Professional advice from an estate planning attorney and a CPA specializing in non-profit taxation is invaluable. They can help assess the tax implications of various investment strategies and ensure the CRT remains compliant with IRS regulations. Staying informed about changes in tax law is also crucial. Tax laws are constantly evolving, and what was once acceptable may no longer be. A proactive approach to monitoring and professional guidance can prevent costly mistakes and maximize the benefits of the CRT.
Share a story where careful planning saved a CRT from UBIT.
Mrs. Eleanor Vance, a passionate art collector, wanted to support a local museum while providing for her grandchildren. She donated shares of a family-owned gallery to a CRT. Recognizing the potential for UBIT, her estate planning attorney recommended establishing a Limited Partnership with the CRT as the limited partner and an independent manager as the general partner. The independent manager handled the day-to-day operations of the gallery, shielding the CRT from active involvement. This structure ensured the income flowed to the CRT as passive investment income, avoiding UBIT entirely. Years later, the museum received a substantial donation, her grandchildren received a consistent income stream, and everyone benefited from careful planning.
About Steven F. Bliss Esq. at San Diego Probate Law:
Secure Your Family’s Future with San Diego’s Trusted Trust Attorney. Minimize estate taxes with stress-free Probate. We craft wills, trusts, & customized plans to ensure your wishes are met and loved ones protected.
My skills are as follows:
● Probate Law: Efficiently navigate the court process.
● Probate Law: Minimize taxes & distribute assets smoothly.
● Trust Law: Protect your legacy & loved ones with wills & trusts.
● Bankruptcy Law: Knowledgeable guidance helping clients regain financial stability.
● Compassionate & client-focused. We explain things clearly.
● Free consultation.
Map To Steve Bliss at San Diego Probate Law: https://maps.app.goo.gl/qxGS9N9iS2bqr9oo6
Address:
San Diego Probate Law3914 Murphy Canyon Rd, San Diego, CA 92123
(858) 278-2800
Key Words Related To San Diego Probate Law:
| intentionally defective grantor trust | wills and trust lawyer | intestate succession California |
| guardianship in California | will in California | California will requirements |
| legal guardianship California | asset protection trust | making a will in California |
Feel free to ask Attorney Steve Bliss about: “What is a trust?” or “How do I find all the assets of the deceased?” and even “How do I retitle accounts in the name of a trust?” Or any other related questions that you may have about Probate or my trust law practice.