Publish date:

Charitable Trust Has New Wrinkle

An individual can increase his cash flow and reduce his taxes by selling covered calls on investments in a Charitable Remainder Trust.

Editor's note: Kevin Simpson is the President of Capital Wealth Planning, LLC, an investment advisory firm specializing in covered calls on an ETF portfolio. He can be reached at

By Kevin Simpson



) -- The old saying, "nothing is certain except death and taxes," appears to be more relevant than ever.

As the Obama administration winds up its first year, discussion continues on the proposed changes to the tax code. The major issues include hikes to income and capital gains tax rates for high-income earners and the cancellation of the estate tax repeal in 2010. (Congress has "permanently" eliminated estate taxes twice before.)

While the details and timing of potential tax increases will depend on many factors, individuals should prepare for these changes.

One way you can benefit yourself, your family and society-at-large with one transaction is through a Charitable Remainder Trust (CRT) that could offer greater benefits to individuals if the proposed tax rate increases are adopted.

There are many great strategies to help make a CRT better but one effective way to enhance your current cash-flow and reduce future income taxes is to sell covered calls on your investments in these sheltered trusts.

A CRT is often used when an individual is interested in making a donation to charity, and they have a concentrated position in an appreciated stock or piece of real estate.

Instead of selling the asset and donating the after-tax proceeds outright, the taxpayer gifts the stock or real estate to the trust. The trust in turn can sell the asset and purchase a diversified mix of assets to produce an income stream. The donor gets the benefit of the income stream during their lifetime (or for the term of the trust), and the charity receives the principal at the end of the trust's term.

A CRT is an irrevocable trust created and funded by a donor that provides current benefits to a noncharitable beneficiary that is typically the donor or a member of the donor's family. The noncharitable beneficiary's interest can continue for a specified term of years (up to a maximum of 20) or for the life of one or more beneficiaries.

At the termination of the trust, the remainder of the trust's principal is paid to one or more charities. The donor receives a current income deduction for a percentage of the contributions made to a CRT even though the charity will potentially not receive its interest until many years into the future.

A CRT may be established as an "Annuity Trust" or a "Unitrust Interest" as follows:GA Charitable Remainder Annuity Trust (CRAT) provides the noncharitable beneficiary with an annual annuity payment that is a fixed amount (a sum-certain annuity) but not less than 5 percent or greater than 50 percent of the initial fair market value of the trust's principal. No additional donations are permitted after the CRAT is funded.

A Charitable Remainder Unitrust (CRUT) provides the noncharitable beneficiary with a fixed percentage determined when the trust is established, which is not less than 5 percent or greater than 50 percent of the annual value of the trust's principal. Because the payout from the CRUT varies with the size of the principal, additional donations are permitted in later years.

In either type of CRT, the value of the charity's interest (determined by an actuarial calculation) must be at least 10 percent of the value of the property contributed to the CRT.

TST Recommends

Because the CRUT permits additions and a choice of the payout rate, it is generally more flexible than the CRAT. One drawback with CRTs is that the annual payout must be made. This means that CRT assets might have to be sold if the trust's income is insufficient to make the required annual payments to the beneficiary.

This leads to the discussion of asset management for CRTs. All too often, charities receive much smaller pools of assets than initially intended. Mismanagement, poor investment performance or inappropriate asset allocation can lead to the rapid degradation of a CRT's asset base.

Typically, the charity's planned giving office works so hard to be named as a recipient beneficiary of this gift. However, the payout will often be delayed many years. This sometimes neglected asset is required to continue payouts regardless of investment and market performance. Many CRTs suffered greatly in 2008 as a result of the massive declines in the stock markets. Forced distribution requirements may trigger liquidations of depressed assets, further depreciating the overall asset base.

At the end of the trust, what will be left for the charity?

One technique being adopted more frequently by many Charitable Remainder Trust administrators is to hire money managers that specialize in the practice of covered call selling. At its most basic level, "covered" means you own the stocks or exchange traded funds (ETFs) that back the options, like collateral. This conservative option strategy is suitable for income-oriented, protection-minded trustees.

A "call" is one of the two basic option contracts, the other being a "put" option. A call gives the holder the right, but not the obligation, to buy the underlying stock or ETF at a preset price (the strike price) by a specific date in the future (the expiration). The seller (or writer) of a call has to sell the stock or ETF to the holder of the option if the holder exercises the option on or before that date.

Call writers make money by collecting a premium for selling the option. Call buyers can make money if the stock covered by the option trades at a higher price than when the option was purchased. Usually, but not always, a rise in the stock price raises the call price as well.

A covered call is an option sold on stocks or ETFs that an individual already owns. It gives the buyer the right to purchase shares at a fixed (strike) price for a limited amount of time, usually for several weeks. For this right, the buyer pays a premium, providing the call writer with an instant return on a stock or ETF that he or she currently owns and one that may not be moving. The premium can also act as a partial hedge should the investment decline in price.

Think of it it as "renting the stock with an option to buy." Monthly option selling is becoming a more and more popular cash-flow management strategy within CRTs every year. Be sure to ask your financial professional about this technique if you have established or are considering a CRT.

If the "unitrust" approach is adopted rather than fixed-amount annuity payments, it is permissible to limit the payout to actual income if that income is less than the required unitrust payment for the year. These deficiencies can be "made-up" in future years when income exceeds the required payment.

Transfers to a CRT are "delayed" charitable contributions. As such, they can significantly reduce a donor's income and estate tax liability without completely divesting the donor, or possibly the donor's family members, of the current benefit of the donated property. In addition, if appreciated property, such as appreciated real estate or stock, is donated to the CRT, there is no capital gains tax due if and when those assets are sold.

Commitment to charity is one of the primary reasons an individual may consider a charitable trust - but is need not be the only reason. Charitable Remainder Trusts also offer numerous estate planning advantages by enabling donors to:

  • Be the trustee of his or her CRT.
  • Diversify a highly concentrated, appreciated asset.
  • Avoid capital gains tax on appreciated property contributed to the CRT.
  • Receive an immediate income tax deduction equal to the present value of the remainder interest.
  • taxes since the appreciated property is deductible from the donor's estate tax base.
  • Maximize overall wealth transfer to charity.

For those who are charitably inclined but also believe that charity begins at home, consider applying all or part of the annual cash distributions to the purchase of life insurance. Insurance purchased in an Irrevocable Life Insurance Trust (ILIT) can be used to replace the value of the assets contributed to a CRT for family members. The ILIT can be also be funded, at least in part, by tax savings provided by the charitable donation.

With a CRT you can avoid capital gains tax, earn more income during your life, receive a tax deduction, reduce estate taxes, leave more for your heirs, and establish a charitable legacy. A CRT also offers other benefits, such as an accumulation option, control of donated assets if you act as your own trustee, and protection of your assets from claims of creditors - all with the blessing of the US Government.

Although this may seem too good to be true, the government actually encourages the establishment of Charitable Remainder Trusts. CRTs are part of the U.S. Tax Code and reflect Congress's desire to motivate taxpayers to make charitable gifts.

With increased charitable giving by the private sector, more government dollars will be available to work in other areas of the economy. Also, trust assets generate higher taxable income because the full value of the asset contributed, undiminished by capital gains taxes, is at work. With higher taxable income, more taxes are generated over the long term than would be the case from an immediate sale with a taxable gain. So in the end, the government actually comes out ahead.