- TAI is Trust Accounting Income (under relevant state law)
- Unitrust$ is the annual unitrust amount (here, 5% of the $1 million value)
- P/Y Short is the balance at the end of the prior year that has not been distributed (note: this always starts at zero, then it’s the balance in the prior row, last column)
- C/Y Distrib is the current year distribution to the beneficiary (note the fluctuations!)
- C/Y Short is the balance at the end of the current year of the undistributed unitrust amount
And for the Excel fanatics:
- C/Y Distrib = min (TAI, sum (Unitrust$, P/Y Short))
- C/Y Short = sum (Unitrust$, P/Y Short) – C/Y Distrib
At the close of year 6, the trust’s cumulative TAI is $330,000, of which $300,000 has been distributed to the beneficiary and $30,000 remains in the trust.
Note that there are a number of valuable features of the NICRUT and NIMCRUT. One distinctive feature is that the trust principal remains intact at all times (or increases), ensuring that when the trust period ends, the principal will pass to a charity for the purpose the settlor designated. In addition, because additional contributions may be made at any time (yielding a tax deduction for a portion of the value), the settlor has more precise tax management possibilities. The trust is confidential, and the assets are generally protected from creditors. Earnings that remain in the trust, of course, increase its value with tax-deferred compounding over time. The recipient charity can be changed at any time. Finally, administrative costs are generally lower than for a variety of other tax-reducing plans.
II. FLIP Variants
Both NICRUTs and NIMCRUTs can also have “flip” characteristics—that is, the language of the document specifies that the nature of the trust changes, with a different payout calculation, upon the occurrence of a particular event.
For example, assume that the settlor contributes a (former) family home to a CRT for the local college or university. That former residence might be vacant and not an income producing property, making it not a strong candidate for either a CRUT or CRAT. Nevertheless, the settlor might want the assurance of the cash flows of a CRUT.
Enter the flip. From the start, the CRT will be a NICRUT or NIMCRUT. The settlor will contribute the asset. Trust accounting income may be zero (or a nominal amount), entitling the beneficiary (often the settlor) to little or no income. But then the CRT sells the home.
The trust contains language such as the following:
- The “Initial Term” of the trust means the term beginning on the date the trust is created and ending on the last day of the taxable year in which the Conversion Date occurs.
- The “Conversion Date” means the date of the sale or exchange of the real property described on Schedule A which was contributed to the trust upon its creation.
- In each taxable year of the trust during the Initial Term, the Unitrust Amount shall be equal to the lesser of (a) the trust income for the taxable year and (b) 7 percent of the net fair market value of the assets of the trust.
- In each taxable year of the trust after the Initial Term, the Unitrust Amount shall be 7 percent of the net fair market value of the assets of the trust.
After the sale, the trust becomes a fairly standard CRUT, paying out 7 percent of the value of its assets to the beneficiary. In contrast, prior to that sale, the trust is a NICRUT, paying out the lesser of trust income or the 7 percent amount. That’s a “flip NICRUT” in action.
A similar example could be constructed for a flip NIMCRUT. The only difference is that the unitrust amounts prior to the Conversion Date would accumulate (similar to the accumulation in the prior NIMCRUT example in the first part, above). Those prior unpaid amounts would be taken into account for the distributions made after the Conversion Date.
Tax compliance for NICRUTs, NIMCRUTs, and the flip versions of them is similar to that for CRTs in general. Each of these trusts must file Form 5227 on a calendar-year basis and issue a Schedule K1 to the unitrust beneficiary or beneficiaries. Each accumulates income into different tranches. (See Part I of this article in the summer 2021 issue of ATT for a discussion of how those tranches fluctuate in amount during each tax year).
NICRUTs and NIMCRUTs use a few more lines on Form 5227 to reflect the calculations of trust accounting income. For the NIMCRUT, the return also tracks any amount undistributed from one year to the next.
III. Pooled Income Funds
Not every client situation warrants the creation of a full-blown independent trust, with the associated administrative costs of setting up trust accounts, finding a willing trustee, managing the trust’s investments, and the like.
Congress was sympathetic to this need and created the Pooled Income Fund. It’s similar to a charitable mutual fund where one or more donors contribute property (cash or marketable securities) to a common fund that is managed and administered by a qualified non-profit organization (often a college or university).
Instead of each donor having a separate annuity or unitrust calculation, the fund calculates a rate of return and that rate of return drives the annual distributions to the beneficiaries. After the death of each beneficiary, a share of the assets in the fund is then distributed to the charitable sponsor.
Pooled income fund deductions are computed using a valuation rate rather than the IRS discount rate. The applicable valuation rate depends on the age and investment history of the fund. The mandated valuation rate for gifts to ‘young’ funds originally funded in 2020 and 2021 is 2.2%. The valuation rate for gifts to older funds is the fund’s highest annual rate of return in the prior three years. This rate of return must be computed as described in Treas. Regs. sections 1.642-6(c)(2)–(3). (The details for that calculation are far beyond the scope of this article.)
To illustrate, assume GreenAcres University has a long-established Pooled Income Fund. Donors Smith and Jones contribute cash to the fund: Smith donates $10,000 and Jones contributes $15,000. The fund would add those contributions to the pooled fund. Assume that the fund has one prior member who has 5 shares in the fund and that, based on their relative contributions, Smith is credited with 2 shares and Jones is credited with 3 shares in the pooled fund.
If the fund has $50,000 and earns 2%, it will have income of $1,000—i.e., $100 per share. That means Smith will receive a K1 from the fund listing $200 of income, and Jones will receive a K1 from the fund listing $300 of income, while the earlier member’s K1 will list the remaining $500.
Charitable giving is widespread in the United States. Americans gave over $471 billion to charities in 2020, 5.1% more than they donated in 2019. Sixty-nine percent (69%) of that amount was donated by individuals—i.e., a total amount of $324 billion. That amount has grown in 5 of the past 6 years.
A. Interesting Statistics on Form 5227
The IRS periodically releases Statistics of Income but has not updated these releases for Form 5227 in almost a decade. Their most recent summary provided the following information on filings:
The number of Forms 5227 filed with the IRS has declined in recent years.
In Filing Year 2012, the IRS received 113,688 Forms 5227, down from 117,710 in 2011.
Charitable remainder unitrusts continued to be the most common split-interest trusts, accounting for more than three-quarters (80.3 percent) of returns filed in 2012.
Total investments reported increased 1.5 percent to $8.7 billion in 2012, with corporate stock remaining the largest investment category, accounting for 88 percent of total assets.
Trustees of split-interest trusts reported approximately $4.3 billion in charitable distributions, with charities established for public or societal benefit receiving $2.5 billion in distributions, 58 percent of the total.
The number of active pooled income funds declined rapidly in the data, likely reflecting the interest rate environment (which has not improved since the study period), as lower interest rates have an impact on the rates of returns used by these funds but can positively impact the charitable deduction claimed by the donor.
B. Other Funding Concerns
Some clients may ask about a Donor Advised Fund (DAF). While a DAF is often a public charity, which brings considerable simplicity (no separate tax return, no separate trust document is needed, etc.), that simplicity comes at a cost. DAF donors do not usually have any input on how the funds are managed by the DAF sponsor, and, more relevant to this article, DAF donors retain no interest in the DAF assets—there is no income stream for their retirements or for their surviving spouses.
Other clients may wish to have a split-interest trust survive beyond their generation to provide for members of the next generation. It’s very difficult to have a CRT qualify when there are young beneficiaries.
A Pooled Income Fund may solve some of these difficulties—a payment stream for the donor and/or family members is permitted, and there’s no 10 percent remainder requirement as there is for a CRT. Also, a donation to a Pooled Income Fund (particularly one that’s been in existence for many years) may provide a significant income tax deduction. However, such a fund usually has one charitable sponsor, so the donor won’t have the ability to pick/choose other charities to receive funds at the termination of the income interest.
C. Planning Opportunity
A flip unitrust may also help with administrative issues for CRUTs formed late in the year. For example, if a donor creates a CRUT during December, the regulations require either (a) a distribution by December 31st of a pro-rated amount for the year or (b) a complex trustee election which is deemed to generate gain.
If, instead, the document is a flip NICRUT or flip NIMCRUT and there’s no income earned in the account for December, there’s no required distribution for the month. The ‘flip’ event can be “January 1 of the year following the funding of the trust”, which automatically changes the trust from an income-only trust to a ‘regular’ unitrust. This structure avoids the need to make a short-year calculation and distribution or the need to prematurely recognize gain.