A charitable remainder annuity trust (CRAT) is one form of a charitable remainder trust (CRT). A CRAT is a “split-interest” trust in which a donor contributes assets to a charitable trust and receives a partial tax deduction for the contributions.
The trust agreement provides that the trustee shall manage the trust assets and pay an annuity to the noncharitable lead beneficiary either for a term of years or the life of an individual. The annuity amount is initially calculated as a fixed percentage of the initial net fair market value of assets contributed to the trust.
Under Section 664(d)(1)(A), the percentage cannot be less than 5 percent nor more than 50 percent of the initial net FMV of the property placed into trust. The trust must make the annuity payment at least annually, and the trust term can last for someone’s lifetime or a set term not to exceed 20 years.
When the trust ends, the trustee distributes the remaining trust assets (if any) to a Section 501(c)(3) charitable organization.
The trustee must make the annuity payment even if the trust does not have sufficient current income to cover the payment amount. In many cases, the trustee must pay the annuity amount using a combination of income and principal if the trust does not generate a return on investment (ROI) sufficient to cover the annuity amount.
Example of a Charitable Remainder Annuity Trust (CRAT)
John Doe wants to form a charitable remainder trust to provide him with a current-year charitable tax deduction and a fixed income stream for a fixed number of years. John’s lawyer advises that he could set up a CRAT or a Charitable Remainder Unitrust (CRUT).
John decides to go with the CRAT. John’s lawyer creates a Charitable Remainder Annuity Trust (CRAT), which will pay John an annuity of 6% of the net FMV of trust assets for ten years. At the end of 10 years, the trust will distribute any remaining assets to a Section 501(c)(3) nonprofit organization in Miami, Florida.
John contributed $2,000,000 in cash to the trust on January 1, 2023. John’s calculated charitable contributions deduction is $1.07 million for the 2023 tax year. John reports the charitable contributions deduction on Form 1040 Schedule A (Itemized Deductions).
The trust will pay John an annual annuity of $120,000 (6% times $2,000,000). The trust must file Form 5227 (Split Interest Trust) each year and provide John with a Schedule K-1.
Assuming the trust has sufficient assets, it will pay John $1,200,000 over ten years and pay any remaining assets to the charity at the end of ten years.
Charitable Remainder Trust vs. Charitable Lead Trust
With a charitable remainder trust, the charitable beneficiary is the “remainder” beneficiary because it receives the remaining trust assets at the end of the term. In contrast, a charitable lead trust (CLT) provides the opposite arrangement.
With a CLT, the charitable beneficiary receives the current income stream each year until the trust expires. So, the charitable organization is the “lead” beneficiary. When the trust expires, the trust distributes the remaining assets to the noncharitable remainder beneficiary.
Charitable Remainder Annuity Trust vs. Charitable Remainder Unitrust
The primary difference between the CRAT and CRUT is the fluctuating payment amount. Under a CRAT arrangement, the annuity is a fixed percentage of the initial net assets, so it does not change in future years. In the example above, the annuity payment will always be $120,000 yearly, regardless of the trust’s investment performance.
In contrast, a CRUT arrangement calculates a payment amount by multiplying the payout percentage by the net fair market value of trust assets on a specified date. The selected date should be the same each year. The annual unitrust dollar amount will fluctuate as the trust net assets increase and decrease.
Additional Information
Taxpayers can find more information on charitable trust arrangements on the IRS website.