There is a high economic cost to terminating a charitable remainder trust (CRT) before the date specified in the trust.
There are two primary tax issues associated with terminating a CRT early: the excise tax on self-dealing and the excise tax on the termination of a private foundation (a CRT is treated like a private foundation for purposes of this tax). These issues can apparently be avoided by following procedures described in various private letter rulings (PLRs). However, a PLR is only binding on the person who requested it. Thus these PLRs provide guidance only and may not be relied upon as precedential authority.
According to the available guidance, a CRT can be terminated early if authorized under applicable state law. In addition, the parties must receive the actuarial value of their interests, determined using special valuation tables established by the IRS. In the case of a net income makeup charitable remainder unitrust, or NIMCRUT, the determination of actuarial value must be made based on an assumed payout rate equal to the lesser of the unitrust amount or the 7520 rate in effect in the month of termination. Moreover, to avoid self-dealing concerns, the remainder interest must be paid to a charity unrelated to the grantor (i.e., a charity other than the grantor’s private foundation). Finally, both the beneficiary and the beneficiary’s doctor must certify that they are aware of no physical condition that would decrease the beneficiary’s normal life expectancy.
If all of these requirements are satisfied, the grantor is treated as selling his life interest in the CRT to charity. The grantor’s amount realized is the full value of his interest. He is treated as having a zero basis in the interest. Thus the grantor’s gain realized and recognized is also the full value of the interest. The gain is treated as capital gain.
Accordingly, an individual who is interested in terminating a CRT early must be prepared for two economic losses: the distribution of the remainder interest to charity and the payment of tax on the full value of the present interest.
Posted by Joel D. Roettger, JD, LLM, EPLS