CRT Business Exit Strategy

The Two CRT Forms — CRAT and CRUT

A Charitable Remainder Annuity Trust (CRAT) pays a fixed dollar amount each year. A Charitable Remainder Unitrust (CRUT) pays a fixed percentage of the trust's annually-revalued assets each year. The choice between them affects payment volatility, contribution flexibility, and the donor's economic exposure to trust performance.

Charitable Remainder Annuity Trust (CRAT).

• Annual payment is a fixed dollar amount specified at trust creation (must be at least 5% of the initial trust value under IRC § 664(d)(1)).
• Payment is constant year-to-year regardless of trust performance.
• Additional contributions to the trust after creation are not allowed.
• If trust assets are exhausted before the term ends, payments stop. This "exhaustion risk" is meaningful for CRATs holding volatile assets.
• Best for donors who want predictable income and are comfortable with single-contribution structure.

Charitable Remainder Unitrust (CRUT).

• Annual payment is a fixed percentage of the trust's value, revalued annually (must be at least 5% of the trust value each year under IRC § 664(d)(2)).
• Payment varies year-to-year with trust performance — higher in strong years, lower in weak years.
• Additional contributions to the trust are permitted after creation.
• Trust assets cannot be exhausted while the term continues because payments scale down as the trust shrinks.
• Best for donors who want inflation protection (rising payments as trust grows), flexibility for additional contributions, and don't mind some payment variability.

Variations within the CRUT category:

• Standard CRUT. Pays the fixed percentage each year regardless of actual trust income.
• Net-Income CRUT (NICRUT). Pays the lesser of the fixed percentage or actual trust net income. Useful for trusts holding low-yielding appreciating assets.
• Net-Income with Makeup CRUT (NIMCRUT). Same as NICRUT but with a "makeup" provision — if actual income is less than the fixed percentage in early years, the shortfall can be made up in later years when income exceeds the percentage. Common for trusts intended to defer income.
• Flip CRUT. Starts as a NICRUT or NIMCRUT during a "triggering event" period (typically while the trust holds illiquid property), then "flips" to a standard CRUT after a specified event (typically the sale of the contributed property). Common for trusts funded with closely-held business stock that will be sold and then converted to marketable securities.

For business-sale planning, the Flip CRUT is the most common structure: contribute closely-held stock as a NIMCRUT during the holding period, sell the stock through the CRT after contribution, then flip to standard CRUT when the CRT becomes a portfolio of marketable securities producing reliable income.

CRT Qualification Requirements

To qualify as a CRT under IRC § 664, the trust must (1) pay at least 5% but not more than 50% of the initial value (CRAT) or annual revaluation (CRUT) each year, (2) have a term not exceeding 20 years (for term-of-years CRTs) or for the life of one or more individuals living at creation, (3) have a remainder interest worth at least 10% of the contribution at creation, and (4) name one or more qualified charitable remainder beneficiaries.

The four core requirements:

• 5%–50% payout range. The annual payment percentage must be between 5% and 50% of the trust value. Lower payouts (closer to 5%) preserve more remainder value for charity; higher payouts (closer to 50%) provide more income to the donor but reduce charitable remainder.
• Term limit. The trust must terminate within 20 years (term-of-years) or on the death of one or more individuals living at creation (life-only). Most CRTs are structured for life of the donor (or donor and spouse), but term-of-years structures work for some planning purposes.
• 10% remainder test. The present value of the charitable remainder must be at least 10% of the contribution value, calculated using the IRS's § 7520 rate and the actuarial mortality tables. This test prevents structuring CRTs with such high payouts that virtually nothing remains for charity. The 10% test creates a payout ceiling — high-percentage CRUTs and short-life-expectancy CRATs may fail this test even within the 5%–50% range.
• Qualified charitable remainderman. The remainder must pass to a charity qualified under IRC § 170(c) — typically a public charity, but private foundations can also qualify. The donor can name a specific charity, can retain the right to change the charitable beneficiary among qualified charities, or can name a donor-advised fund as the remainderman.

The 10% test is the most-often-binding constraint in CRT design. Younger donors (longer life expectancy) and higher payout percentages both push toward failure of the 10% test. A 70-year-old donor with a 6% lifetime CRUT will typically satisfy the 10% test; a 55-year-old donor with the same structure may not. The structure has to be modeled at the design stage.

The CRT Tax Benefits

The CRT delivers three tax benefits: (1) an income tax deduction at contribution equal to the present value of the charitable remainder, (2) tax-free sale of contributed property by the CRT, and (3) tiered taxation of the annuity payments to the donor under the IRC § 664 "four-tier" system.

Benefit 1: Income tax deduction at contribution.

The donor receives a charitable contribution deduction under IRC § 170 equal to the present value of the charitable remainder interest, calculated at contribution using the § 7520 rate. The deduction is limited to 30% of the donor's AGI for the contribution year (for contributions of appreciated capital-gain property to a public charity), with a 5-year carryforward for any excess.

For a $10M contribution to a CRT with a calculated 30% remainder interest, the donor receives a $3M charitable deduction. At a 37% federal marginal rate, the deduction saves approximately $1.11M of federal income tax. Combined with state-level deductions where applicable.

Benefit 2: Tax-free sale at the CRT level.

The CRT is a tax-exempt entity under IRC § 664(c). When the CRT sells contributed appreciated property, no capital gain tax is owed at the trust level. This is the central economic engine of the CRT structure — the donor's pre-CRT basis is preserved through the contribution (the CRT inherits the donor's basis under § 1015), but the gain on sale is not realized at the trust level because the trust is tax-exempt.

The implication: a donor contributing $10M of appreciated business stock (basis $1M) to a CRT before sale realizes no immediate $9M capital gain. The CRT sells the stock for $10M, reinvests in a diversified portfolio, and begins paying the donor the annual annuity.

Benefit 3: Four-tier taxation of annuity payments.

The annuity payments to the donor are taxed under the IRC § 664(b) "four-tier" system, which characterizes each payment based on the trust's character of income:

1. Tier 1 — Ordinary income. Payments first deemed to come from ordinary income earned by the trust (interest, dividends, non-qualified annuity income).
2. Tier 2 — Capital gain. Once Tier 1 income is exhausted, payments next deemed to come from capital gains realized by the trust.
3. Tier 3 — Tax-exempt income. Once Tier 1 and Tier 2 are exhausted, payments deemed to come from tax-exempt income (municipal bond interest).
4. Tier 4 — Return of principal. Once all trust income tiers are exhausted, payments deemed to return principal (not taxable to the recipient).

The four-tier system means that the donor's annuity payments are usually taxable — frequently as ordinary income for high-payout trusts holding actively-managed portfolios, or as capital gain for trusts whose income is primarily realized gains. The structure spreads the recognition of the pre-CRT built-in capital gain over the trust's term, rather than concentrating it in the year of contribution.

Worked Example

A 65-year-old founder owns $15M of closely-held business stock with $1M basis, planning a sale within 6 months. The founder contributes $10M of the stock to a Flip CRUT before signing the buyer's binding documents and keeps $5M of stock for direct sale.

Without the CRT (direct sale of all $15M):

• $15M sale price, $1M basis → $14M long-term capital gain
• Federal tax: $14M × 23.8% (LTCG + NIIT) = $3.332M
• California tax (assume CA resident): $14M × 13.3% = $1.862M
• Total tax: $5.194M
• Net to founder: $9.806M

With the CRT (contribute $10M to CRT, sell $5M directly):

• $5M direct sale: $5M − $0.333M basis (1/3 of $1M) = $4.667M capital gain → ~$1.11M federal + $621K California = $1.73M tax → ~$3.27M net to founder
• $10M CRT contribution: CRT sells stock tax-free, reinvests in diversified portfolio
• Charitable deduction at contribution (assume 7520 rate of 5%, 6% CRUT for life of 65-year-old): approximately 35% of $10M = $3.5M deduction
• Federal tax savings from deduction: $3.5M × 37% = $1.295M (over a few years given AGI deduction limits)
• State tax savings from deduction: $3.5M × 13.3% (with limitations) = ~$465K
• CRT pays 6% of trust value annually (~$600K initial, varying with portfolio); donor expected lifetime $13M+ in cumulative annuity payments based on 65-year-old life expectancy
• Annuity payments taxed under four-tier (significant portion long-term capital gain initially)
• At death, remainder ($8M+ projected) passes to charity

Comparison:

• Direct-sale net to founder: $9.81M plus the founder's separate ability to invest the proceeds and earn future returns
• CRT-combined net: $3.27M direct + present value of charitable deduction ($1.76M) + present value of expected lifetime annuity stream ($8M+ depending on assumptions) + value to charity at death ($8M+)
• Total value created (donor + charity): meaningfully higher with CRT, but the donor's personal control over the assets is reduced

The CRT is not a unitary "better" or "worse" choice. It is a different trade — converting current capital-gain exposure into a lifetime income stream and a charitable bequest. For donors with philanthropic intent and sufficient outside liquidity to absorb the loss of control over the contributed assets, the CRT is meaningfully tax-efficient. For donors who need or want the contributed value back, the CRT is the wrong tool.

Wealth Replacement — Restoring Value to Heirs

The CRT diverts the contributed value's residual from family heirs to charity. The standard companion strategy is a Wealth Replacement Trust (an Irrevocable Life Insurance Trust, or ILIT) — funded with a portion of the CRT's annual annuity — that holds a life insurance policy paying a death benefit to the heirs roughly equal to the value diverted to charity.

The wealth replacement mechanics:

1. Establish an ILIT. An irrevocable life insurance trust with the donor's children (or grandchildren) as beneficiaries. The ILIT must be a non-grantor trust to keep the life insurance proceeds outside the donor's estate.
2. Annual gifts to ILIT. The donor uses a portion of the annual CRT annuity to make annual gifts to the ILIT. Gifts can be sheltered with the annual exclusion ($18,000 per beneficiary in 2024; $36,000 per couple) and Crummey withdrawal powers.
3. ILIT purchases life insurance. The ILIT uses the annual gifts to pay premiums on a life insurance policy on the donor's life. The death benefit is structured to roughly equal the residual value the CRT will pass to charity.
4. At donor's death. CRT terminates; remainder passes to charity. ILIT receives life insurance death benefit; ILIT distributes to children outside the donor's estate (no estate tax on the insurance proceeds).

The combined effect: the donor's family receives roughly the same value through the ILIT death benefit that they would have received through direct inheritance — but the CRT's tax benefits (no capital gain on contribution, charitable deduction, lifetime income) are also captured. The total tax efficiency of CRT + ILIT exceeds direct sale + direct inheritance in most modeling.

The wealth replacement strategy depends on the donor being insurable at reasonable rates. For donors with health issues, second-to-die policies on the donor and spouse can be more affordable than single-life policies. For donors who are uninsurable, the wealth replacement strategy may not be feasible — and the CRT analysis has to stand on its own without the ILIT companion.

Timing — Contribute Before Binding Sale

The CRT contribution must be made before the donor has a binding commitment to sell the underlying asset. Contributions after the binding commitment are recharacterized under assignment-of-income doctrine — the IRS treats the contribution as a transfer of already-realized gain to the CRT, which collapses the capital-gain deferral and produces the same tax result as direct sale.

The case law line:

• Palmer v. Commissioner, 62 T.C. 684 (1974). Contribution of stock to a tax-exempt entity immediately before a redemption that was prearranged was treated as a sale by the contributor, with the proceeds redirected to charity. The Tax Court applied the anticipatory-assignment-of-income doctrine.
• Rev. Rul. 78-197. The IRS's response to Palmer: a contribution is not anticipatory assignment of income if the charity has the right to either accept the contributed property or to require the donor to sell the property and contribute the proceeds. The IRS articulated a "no commitment" standard.
• Ferguson v. Commissioner, 174 F.3d 997 (9th Cir. 1999). Donor's contribution of stock to charity shortly before a merger closed produced assignment-of-income recharacterization because the merger was effectively certain at the time of the contribution.

The practical timing constraints:

• Before any binding commitment. CRT contribution must precede any binding letter of intent, purchase agreement, or similar document. Verbal agreements or non-binding term sheets are generally fine; signed binding documents are not.
• Real risk of non-closing. The contribution should occur at a time when there is a real, substantial risk that the sale could fall through. The donor's expectation that the sale will close is acceptable; near-certainty of closing is dangerous.
• CRT controls the sale. After contribution, the CRT trustee (not the donor) should make the sale decision. Trustees that mechanically execute the donor's pre-determined sale instructions are at higher recharacterization risk than trustees who exercise independent judgment.

The standard practice is to complete the CRT contribution at least 60–90 days before any contemplated closing, with the CRT trustee independently engaging brokers or counsel to facilitate the eventual sale. The closer to closing, the higher the recharacterization risk.

The UBIT Trap for Operating Business Interests

If a CRT receives income that is "unrelated business taxable income" (UBIT) under IRC § 512, the CRT loses its tax-exempt status for that year — meaning the entire trust is subject to a 100% excise tax on the UBIT under IRC § 664(c)(2). Active operating-business interests held by a CRT can trigger this catastrophic outcome.

UBIT issues for CRTs:

• Operating S-corp stock. S-corp income flows through as ordinary business income — characterized as UBIT for CRT purposes. A CRT holding S-corp stock that receives K-1 ordinary income produces UBIT for the trust.
• LLC interests in operating businesses. Same issue. Pass-through ordinary income from operating partnerships or LLCs is UBIT to the receiving CRT.
• Debt-financed property. Income from debt-financed property is UBIT under IRC § 514, even if the underlying property is otherwise passive (real estate held with a mortgage).
• C-corp dividends — generally fine. Dividends from C-corp stock are not UBIT (they are investment income). A CRT holding C-corp stock receives non-UBIT dividends without trust-level tax consequence.

The implications for business-sale planning:

• Contribute C-corp stock, not S-corp stock. C-corp stock contributions work well in CRTs. S-corp stock contributions create UBIT exposure during any holding period before the sale.
• If S-corp, sell promptly after contribution. Some donors structure as a Flip CRUT with the trust holding S-corp stock for a very short window (60–90 days) before sale, accepting brief UBIT exposure as the price of the CRT structure.
• Consider §1361(c)(6) qualified subchapter S trust election. A QSST election can transform a trust into a permitted S-corp shareholder, but the QSST distribution requirements often conflict with CRT structure.
• Active business income, period. Active business income — distributions from operating businesses where the trust is treated as conducting the activity — is UBIT.

The UBIT analysis must be done before any CRT contribution. The 100% excise tax under § 664(c)(2) is a catastrophic outcome that has destroyed otherwise well-designed CRT plans. Contributions of operating-business interests require specialized advice.