The following article originally appeared in an issue of Planning Partners Press, a free newsletter provided courtesy of Carolina Family Estate Planning to Triangle-area financial professionals.
One possibility is the sale of the income interest. There are companies that will purchase these income interests. They will pay the grantor the present value of the income stream, giving the grantor immediate funds and the company some profits over time. The sale is taxed as a capital transaction, so there will probably be capital gains taxes on the sale. The capital gains tax rate will be at the current 15% bracket (or less), rather than whatever the future rates will be. Without the sale of the income stream, the taxpayer will pay taxes on all or some of the distributions, perhaps as capital gains, perhaps as other types of income. A spendthrift provision in the CRT could prevent the sale entirely, so an attorney should review the trust to ensure the sale doesn’t violate any trust provisions.
Roger Silk of Sterling Foundation Management points out that
CRTs are tax-deferral vehicles; they defer to the future the tax a client must pay on the donated assets. If tax rates are stable or falling, this deferral works great because the client gets to pay the tax at a lower rate. But if tax rates rise, the deferral works against the client by forcing them to take their income in the future, when tax rates are higher.
If a client does nothing and tax rates rise, they’ll almost certainly suffer a loss on the value of their CRT. They can avoid this loss entirely by selling their CRT interest today, for a lump-sum cash payment. The benefit, of course, is that the sale is considered a capital transaction, so the proceeds are taxed at capital gains rates.
The sale of a CRT income interest is not always the right thing to do, but sometimes it is. Financial advisers, attorneys and CPAs who have clients who have CRTs should take a look at whether the sale of the income interest makes sense. This review is best done as a team to consider the family, income tax, estate tax, and financial consequences of such a sale.
