1. Which of the following are NOT allowable for the current payout benefit of a Charitable Remainder Trust?
a) Providing annual fixed payments to a friend, relative, or the donor for their life or lives
b) Providing annual fixed payments to a friend, relative, or the donor for 25 years
c) Providing annual payments of 5% of the trust assets to a friend, relative, or the donor for their life or lives
d) Providing annual payments of 45% of the trust assets to a friend, relative, or the donor for 2 years
e) Providing annual payments of 10% of the trust assets, or the total income from the trust, whichever is less, to a friend, relative, or the donor
2. Which of the following are allowable for the ongoing payout benefit of a Charitable Remainder Trust?
I. Providing payments of the lesser of the net income of the trust or 4% of trust assets
II. Providing payments of 20% of trust assets or all trust income, whichever is less, with the provision that anytime payments are less than 20% they should later be made up whenever income exceeds 20%
III. Providing payments of 60% of trust assets for two years
IV. Providing payments of the net income of the trust, not to exceed 8% of all trust assets, until the sale of a piece of real estate by the trust, after which time the trust must pay 8% of all trust assets, regardless of the net income of the trust
V. Providing a payment of 5% of all trust assets, with the payment to be divided equally between the donor and a charitable organization
VI. Providing payouts of between 5% and 10% of trust assets, with the donor retaining the right to choose the payout rate on an annual basis
a) Only II is allowed
b) Only II, IV & V are allowed
c) Only I, II, IV, & V are allowed
d) Only II, III, IV, & V are allowed
e) Only II, IV, V, & VI are allowed
3. If a trust is drafted to allow it, a donor who sets up a CRT is allowed to do all of the following except
a) Act as the trustee of the CRT and continue to manage the trust assets
b) Choose his friend, the charity, or a trust company as the CRT trustee
c) Change which charity will receive the remainder interest
d) Give all of his rights in future payments to the charity that is the remainder beneficiary, which would result in the CRT terminating and all assets being immediately delivered to the charity if the donor is the only income beneficiary
e) Modify the original rules of a Charitable Remainder Trust after it is established
4. Which of the following planning goals could NOT be accomplished using a Charitable Remainder Trust?
a) "I want to control my own investments and spend about 5% of my assets each year. After death I want it all to go to charity."
b) "I would like to use $50,000 per year from my assets. The rest, I want to go to my favorite charity."
c) "I want to retire today, but my pension doesn't start paying for 9 more years. I want to give assets to charity, but I still need $65,000 per year for the next 9 years."
d) "I want to leave my assets to charity at death. Prior to my death I think I will want 10% of the value of the assets each year, unless I or one of my family members has unexpected medical expenses, in which case I need to have access to enough of the trust principal to pay for reasonable and necessary medical expenses."
e) "I have a $1,000,000 asset from which I would like to provide an income of $50,000 per year for my nephew - assuming he submits to and passes random drug tests, and the rest, I want to go to my favorite charity."
5. A donor with $1,000,000 in developable raw land with a basis of $100,000 plans to sell the land, invest in income producing securities, spend 8% of the remaining value each year for the rest of her life, and leave the rest to charity. Which of the following is NOT a potential tax advantage of doing this through a Charitable Remainder Trust as compared with keeping the assets and giving to charity through her will?
a) The donor can receive an immediate income tax deduction for the present value of the projected remainder interest that will go to charity at death with the CRT
b) No capital gains tax will be due at the sale of the land if the property is sold by the CRT
c) The donor will not need to pay income taxes on any income earned by the CRT beyond the 8% being taken annually by the donor
d) The donor will receive a charitable estate tax deduction for the value of any property that is transferred to the charity by the CRT
e) Because the donor pays no capital gains tax, the entire $1,000,000 value can be invested to generate income rather than only the amount left over after paying taxes on the $900,000 of gain, when using a CRT
6. Abimelek has developable raw land with a basis of $100,000. He sells the land for $1,000,000 and invests in income producing securities. If the Abimelek pays capital gains tax at a 20% rate, how much will be left to invest after paying all capital gains taxes?
a) $900,000
b) $1,000,000
c) $800,000
d) $820,000
e) $860,000
7. Asher has developable raw land with a basis of $100,000. He gives the land to a Charitable Remainder Unitrust paying him 8% of all trust assets per year for life. The Charitable Remainder Trust sells the land for $1,000,000 and invests in income producing securities. If the Asher pays capital gains tax at a 20% rate, how much will be left for the Charitable Remainder Trust to invest after paying all capital gains taxes?
a) $900,000
b) $1,000,000
c) $800,000
d) $820,000
e) $860,000
8. Jael owns a historically important archeological artifact in the form of an ancient hammer and slightly used matching wooden peg that she expects to sell as a set to one of the top international museums for about $500,000. She has no basis in the property and she would like to place it in a Charitable Remainder Trust before it sells. However, it is likely that such a sale may take up to three years to complete because of the difficulties and delays involved in such transactions. During this period of time, there will be no other assets in the trust, and the artifact will generate no income. Which of the following would NOT likely be a reasonable planning approach?
a) She can place the artifact in an 8% NICRUT. Before the artifact sells, the CRUT will not need to make payments because payments are limited to 8% of trust assets or net income, whichever is lower.
b) She can place the artifact in an 8% NIMCRUT. Before the artifact sells, the CRUT will not need to make payments because payments are limited to 8% of trust assets or net income, whichever is lower. After the artifact sells, whenever trust income exceeds 8% these funds can be used to make-up the previous 8% payments that were not paid due to lack of income
c) She can place the artifact in a FlipCRUT that changes from an 8% NICRUT to an 8% CRUT upon the sale of the artifact. Before the artifact sells, the CRUT will not need to make payments because payments are limited to 8% of trust assets or net income, whichever is lower. After the artifact sells, the trust will be required to pay 8% of net assets, even in years when income was lower than 8%
d) She can place the artifact in an 8% CRUT. Before the artifact sells, the CRUT can borrow money against the artifact to make the annual payments. After the sale, the CRUT can use the proceeds to pay off the loan.
e) All of the approaches are reasonable planning approaches for this asset.
9. In what circumstances will there be a difference in payments between an 8% Net Income Charitable Remainder Unitrust (NICRUT) and an 8% Net Income Makeup Charitable Remainder Unitrust (NIMCRUT) over the course of the life of the trust?
a) If net income always exceeds 8% of trust assets
b) If net income never exceeds 8% of trust assets
c) If net income is 9% of trust assets in odd years and 7% of trust assets in even years
d) If net income is always 7% of trust assets
e) If net income is always 9% of trust assets
10. Which of the following is a potential advantage of a Charitable Gift Annuity over a Charitable Remainder Trust?
a) Donor can receive rights to a fixed amount of annual income for life
b) Donor can benefit a charity at his death, but receive a current income tax deduction
c) Donor can transfer highly appreciated property and avoid paying capital gains tax at the time of the sale of the property
d) Donor can receive income, some part of which may be tax-free return of capital.
e) The donor will receive payments regardless of his or her life span or the returns on the original money invested so long as the charity does not go bankrupt
11. Which of the following is a NOT a potential advantage of a Charitable Remainder Trust over a typical Charitable Gift Annuity?
a) The donor can choose an unlimited number of income beneficiaries
b) The donor can receive rights to income for the life of the donor and the donor's spouse
c) The donor can retain the ability to change the charitable beneficiary
d) The donor can choose income payments for a fixed number of years, rather than for life
e) The donor can require that the income payments be made to a child, but will be paid to another beneficiary if the child drops out of school before obtaining a college degree
12. A donor transfers $100,000 to a Charitable Remainder Unitrust scheduled to last for 10 years. It will pay equal shares to all 12 grandchildren of the donor for 10 years. However, if one of the children drops out of school before completing a college degree, their share will be given to the other grandchildren. The charity is projected to receive $10,000 when the trust terminates at the end of 10 years. Why is this trust disqualified such that the donor will receive no income tax deduction for the transfer?
a) This trust will violate the rule that there must be no greater than a 5% chance that the charity will receive no charitable gift at the termination of the trust
b) This trust will violate the rules for Generation Skipping Transfer Tax because of the transfers to grandchildren, thus causing disqualification of the trust
c) This trust will violate the "10% rule" where the present value of the projected amount going to charity must be at least 10% of the transfer
d) This trust violates public policy by penalizing a beneficiary for his educational/career choices
e) This trust will violate the trust distribution rules because the income beneficiaries are not irrevocably determined at the beginning of the trust, but could change over time
13. A donor completes his charitable transfer when market returns and interest rates averaged 15%, after which market returns and interest rates averaged only 2%. In which of the following circumstances is the donor MOST likely to permanently stop receiving any payments during his life?
a) The donor placed $100,000 in a CRUT paying 10% of all trust assets for life to the donor
b) The donor placed $100,000 in a NICRUT paying 10% of all trust assets for life to the donor
c) The donor placed $100,000 in a NIMCRUT paying 10% of all trust assets for life to the donor
d) The donor placed $100,000 in a CRAT paying $10,000 of all trust assets for life to the donor
e) The donor placed $100,000 in a CGA from Yale University paying $10,000 for life to the donor
14. Sheerah gives $100,000 of stock (she originally paid $95,000 for it) to her Charitable Remainder Unitrust. The trustee immediately sells the stock for $100,000 and invests half in corporate bonds that pay $2,000 of annual ordinary interest income and half in municipal bonds that pay $1,000 of annual tax exempt interest income. At the end of the first year, Sheerah receives her annual payment from the unitrust. What is the smallest of the following annual payments that would result in part of her payment being tax-free return of principal?
a) $1
b) $2,001
c) $3,001
d) $7,001
e) $8,001
15. Salome gives $100,000 of stock (she originally paid $95,000 for it) to her Charitable Remainder Unitrust. The trustee immediately sells the stock for $100,000 and invests half in corporate bonds that pay $2,000 of annual ordinary interest income and half in municipal bonds that pay $1,000 of annual tax exempt interest income. At the end of the first year, Salome receives her annual payment from the unitrust. What is the smallest of the following annual payments that will result in part of her payment being tax-exempt income?
a) $1
b) $2,001
c) $3,001
d) $7,001
e) $8,001
16. Serah gives $100,000 of stock (she originally paid $95,000 for it) to her Charitable Remainder Unitrust. The trustee immediately sells the stock for $100,000 and invests half in corporate bonds that pay $2,000 of annual ordinary interest income and half in municipal bonds that pay $1,000 of annual tax exempt interest income. At the end of the first year, Serah receives her annual payment from the unitrust. What is the smallest of the following annual payments that will result in part of her payment being capital gain income?
a) $1
b) $2,001
c) $3,001
d) $7,001
e) $8,001
17. Many years ago, Drusilla purchased shares of a publicly traded company for $100,000 that today are worth $1,100,000. She places these shares into her Charitable Remainder Annuity Trust that pays her $50,000 per year for 20 years. Her trustee sells the shares and spends the proceeds to purchase a 30 year corporate bond with a face value of $1,100,000 paying exactly $50,000 per year in interest. Over the course of twenty years, if the relevant capital gains tax rate was 20%, how much capital gains tax is paid on this initial transaction and the subsequent income payments?
a) $0
b) $8,000
c) $16,000
d) $160,000
e) $200,000
18. Which of the following assets can be held by a Charitable Remainder Trust and create no accompanying tax problems?
a) A 5% share of a profitable dog-grooming business held as subchapter S corporation shares
b) A 5% share of a profitable dog-grooming business held as a general partnership
c) A 100% share of a profitable dog-grooming business held as a sole proprietorship
d) A 5% share of a profitable dog-grooming business held as shares in a standard C-corporation
e) A $150,000 building with a $50,000 mortgage rented to a dog grooming business for $1,000 per month.
19. Cozbi and Zimri, a married couple, transfer their $1,000,000 house with a $100,000 basis into a Charitable Remainder Annuity Trust paying them $50,000 at the end of each twelve month period as long as either one of them is alive. The trustee borrows $100,000 against the house to make improvements to the house in preparation for sale. Within three months of the establishment of the CRT, the house is sold for $1,200,000 and the $100,000 loan is paid off with the proceeds of the sale. After receiving two $50,000 annual payments, Cozbi and Zimri are both stabbed to death by an assailant. Assuming that the proceeds from the sale were held in a non-interest bearing savings account subsequent to the sale, how much money will be available for the charity at their death.
a) $0
b) $100,000
c) $1,000,000
d) $1,100,000
e) $1,200,000
Answers
1/ Answer: B. Explanation: Charitable Remainder Trusts cannot offer payments for a fixed period of more than 20 years, although they may pay for a life or lives that are projected to live far more than 20 years. All other payout scenarios are allowable in a Charitable Remainder Trust. Providing 10% of the trust assets, or the total income from the trust, whichever is less, is a form of Charitable Remainder Trust known as the Net Income Charitable Remainder Unitrust.
2/ Answer: B. Explanation: Answers I and III are not allowed because CRUTs must payout between 5% and 50% of all assets. Answer VI is not allowed because the payout rate must be fixed, either as a fixed dollar amount in a CRAT or a fixed percentage of trust assets in a CRUT. The only exception is that trusts may restrict that payment may not be made from principal, as in a NICRUT (Net Income Charitable Remainder Unitrust) or NIMCRUT (Net Income Makeup Charitable Remainder Unitrust). II is allowed and is referred to as a NIMCRUT. IV is allowed and is referred to as a FlipCRUT. V is allowed, so long as at least one non-charitable beneficiary remains.
3/ Answer: E. Explanation: A CRT is irrevocable and the original rules may not be changed after it is established. However, if the original rules permit it, the donor may act as trustee or select someone else to act as trustee. It is quite common for the donor to retain the right to change which charity will receive the remainder interest. If the donor retains the only rights to income, he or she can terminate the trust by giving those rights to the remainder beneficiary charity. In that case the charity would hold both the life interest and remainder interest in the trust property, making it sole owner, and the trust could be dissolved.
4/ Answer: D. Explanation: A Charitable Remainder Trust does not allow the donor, or anyone else, to invade principal beyond the fixed payment level, even if it is for a good reason such as unexpected medical expenses. All other arrangements are allowed for Charitable Remainder Trusts.
5/ Answer: D. Explanation: The donor will receive a charitable estate tax deduction for the value of any property that is transferred to the charity regardless of whether the transfer happens through a will or through a Charitable Remainder Trust. All other tax benefits are available only by use of a Charitable Remainder Trust and will not be available if the donor continues to own the property herself and makes her charitable gift through a will.
6/ Answer: D. Explanation: Capital gains tax is paid on the difference between basis and the sale price. Basis is normally what you paid for the asset, but can sometimes be adjusted upward for later expenditures on asset improvements, or downward for depreciation deductions taken in intervening years. In this case the gain (sale price - basis) is $900,000 ($1,000,000 sale price - $100,000 gain). Because the tax rate is 20%, Abimelek pays $180,000 in capital gains tax ($900,000 gain X 20% tax). After paying the $180,000 tax, he will have $820,000 left to invest.
7/ Answer: B. Explanation: Because the Charitable Remainder Trust is a tax exempt entity, it pays no taxes. As such, when the CRT sells the land, no capital gains taxes are due, leaving the trust with the entire $1,000,000 left to invest.
8/ Answer: D. Explanation: When the trust borrows money against the asset it becomes debt-financed property. The sale of debt-financed property generates unrelated business income, which is taxed at a 100% rate. Thus, the entire value of the artifact (less the payments previously made) would be lost. Thus, this is not a reasonable planning approach. All other examples are common approaches for dealing with non-income produces assets in a Charitable Remainder Trust.
9/ Answer: C. Explanation: The NIMCRUT will pay more than the NICRUT if net income is 9% of trust assets in odd years and 7% of trust assets in even years. This is because during the years when income is 7% of trust assets, the NIMCRUT will record an "IOU" for the 1% that was not paid out, and will then pay out more than 8% during the later years when returns are 9% of trust assets. If net income is always greater than 8% (for example if it is always 9%), both trusts will pay out the same 8% unitrust rate. If net income is always less than 8% (for example if it is always 7%), then the NIMCRUT will record the "IOUs" for the missed payments, but it will never have any additional net income above the 8% to pay any of these "IOUs," meaning that the payout levels will be identical to a NICRUT.
10/ Answer: E. Explanation: The first four items are potentially available with either a Charitable Gift Annuity or a Charitable Remainder Trust. The last item is available only with a Charitable Gift Annuity. If the CRT experiences investment losses or the donor lives much longer than expected, it is possible for the CRT assets to exhaust and no funds will be left for charitable payments.
11/ Answer: B. Explanation: Either a CRT or a CGA can provide an income for life to the donor and the donor's spouse. However, the typical CGA will not permit the other options listed.
12/ Answer: C. Explanation: This trust violates the "10% rule" where the present value of the projected amount going to charity must be at least 10% of the transfer. Although the charity does receive 10% of the initial value of the property, it has to wait 10 years to receive that amount. Because it has to wait 10 years to get the $10,000, this gift is worth less than the value of $10,000 received today. Thus, the present value of the charity's share is worth less than 10% of the initial gift amount. This would be true regardless of whether the §7520 rate was .01% or 10%, because any positive interest rate would make the present value of the gift portion of this trust worth less than $10,000. The rule insuring no greater than a 5% chance that the charity will receive no charitable gift at the termination of the trust applies only to CRATs, not to CRUTs. The generation skipping transfer may be relevant for those tax purposes, but not for income tax purposes. Making income payments contingent on the recipient's behavior is perfectly acceptable, as long as the trust does not encourage behavior that is illegal or against public policy.
13/ Answer: D. Explanation: The Charitable Remainder Annuity Trust (CRAT) is most likely to completely exhaust because the trust must keep paying $10,000 regardless of the poor market returns. Once the trust runs out of money, no further payments can be made. The Charitable Gift Annuity (CGA) will not exhaust because the charity is responsible for making payment, even if the original amount and all subsequent returns have been completely spent. A CRUT is less likely to completely run out of funds, because as the trust becomes smaller, the payments will also become smaller. The NICRUT and NIMCRUT do not permit payments out of principal, thus making it highly unlikely for these trusts to run out of money.
14/ Answer: E. Explanation: For income tax purposes, the trust is considered to be paying out all of its ordinary income first, then all of its capital gain income, then all of its exempt income, then all of its return of principal. (This is sometimes referred to as WIFO, worst in first out, because the income type with the typically worst tax rates is paid out first.) In this case, the trust first pays out all if its ordinary income, which is the $2,000 of ordinary income earnings from the corporate bonds. Second, it pays out all capital gain, which is the $5,000 of capital gain (difference between the original $95,000 cost of the stocks and the $100,000 sale price of the stocks). Third, it pays out all tax exempt income, which is the $1,000 of municipal bond income. Finally, it pays out return of capital. In order for the trust to pay out any return of capital the payment must be larger than the ordinary income ($2,000) + the capital gain ($5,000) + the tax exempt income ($1,000). In other words, the payment must be larger than $8,000.
15/ Answer: D. Explanation: For income tax purposes, the trust is considered to be paying out all of its ordinary income first, then all of its capital gain income, then all of its exempt income, then all of its return of principal. (This is sometimes referred to as WIFO, worst in first out, because the income type with the typically worst tax rates is paid out first.) In this case, the trust first pays out all if its ordinary income, which is the $2,000 of ordinary income earnings from the corporate bonds. Second, it pays out all capital gain, which is the $5,000 of capital gain (difference between the original $95,000 cost of the stocks and the $100,000 sale price of the stocks). Third, it pays out all tax exempt income, which is the $1,000 of municipal bond income. Finally, it pays out return of capital. In order for the trust to pay out any tax exempt income the payment must be larger than the ordinary income ($2,000) + the capital gain ($5,000). In other words, the payment must be larger than $7000. The smallest annual payment meeting this qualification listed is $7001.
16/ Answer: B. Explanation: For income tax purposes, the trust is considered to be paying out all of its ordinary income first, then all of its capital gain income, then all of its exempt income, then all of its return of principal. (This is sometimes referred to as WIFO, worst in first out, because the income type with the typically worst tax rates is paid out first.) In this case, the trust first pays out all if its ordinary income, which is the $2,000 of ordinary income earnings from the corporate bonds. Second, it pays out all capital gain, which is the $5,000 of capital gain (difference between the original $95,000 cost of the stocks and the $100,000 sale price of the stocks). Third, it pays out all tax exempt income, which is the $1,000 of municipal bond income. Finally, it pays out return of capital. In order for the trust to pay out any capital gain income the payment must be larger than the ordinary income ($2,000). In other words, the payment must be larger than $2,000. The smallest annual payment meeting this qualification listed is $2001.
17/ Answer: A. Explanation: There are no capital gains taxes paid at any point. There is no capital gains tax paid when Drusilla transfers the property to the CRAT. Because the CRAT is a tax exempt entity, it pays no capital gains taxes when the property is sold. Each year, Drusilla receives $50,000. However, because the trust earns $50,000 of ordinary income from the corporate bond, all of this income is considered to be ordinary income. None of the payments are considered capital gain, and thus no capital gains tax is ever paid.
18/ Answer: D. Explanation: Charitable Remainder Trusts are not permitted to hold subchapter S corporation shares. If the CRT owns a business as a sole proprietor or a general partner it is treated as if it is directly managing the company itself. This direct management ownership would cause the net income from the business to be treated as unrelated business taxable income, which generates a 100% excise tax. Similarly, rent from debt-financed property is considered to be unrelated business taxable income. Shares owned as a C-corporation are considered to be a passive investment and any dividends or capital gains will not generate unrelated business taxable income so long as the shares are not debt-financed. Therefore, the C-corporation shares are the only assets that can be held by the CRT and create no accompanying tax problems.
19/ Answer: A. Explanation: Because the trustee took out a mortgage on the property, it became debt-financed property. Income from debt-financed property, including capital gain income, is unrelated business taxable income in a CRT and is taxed at a 100% excise tax. Thus the entire $1,000,000 of capital gain will be taken in taxes. This leaves only the $100,000 of original basis, which was paid out in the two $50,000 annual payments. Because no other interest was earned during this time, there is nothing left for the charity. Similarly, had the couple survived beyond two years, there would have been no funds left to make any additional annuity payments.