Expecting an IPO windfall?

Charitable remainder trusts (CRTs) for low-basis IPO shares

 

If your shares cost you little and are about to become salable, a sale in California's top brackets surrenders roughly 37 percent of the gain: 20 percent federal capital gains tax, 3.8 percent net investment income tax, and 13.3 percent California tax.

 

A charitable remainder trust (CRT) lets you diversify without that tax at the sale. You transfer the shares to an irrevocable trust. The trust is exempt from income tax, so it can sell the shares and reinvest the full proceeds. It pays you every year, for life or for a term of up to 20 years, in one of two forms: a fixed percentage of its value, measured each year (a unitrust, or CRUT), or a fixed dollar amount (an annuity trust, or CRAT). You pay tax on the deferred gain gradually, as those payments carry it out. When the payments end, what remains goes to the charities you name. Funding the trust also produces an income tax deduction for the value of charity's future share.

 

Four objections usually come up before anyone looks at the numbers. This page answers them in the order people raise them, and includes a calculator that shows which trust designs qualify at your age.

 

 

Doesn't most of the money end up with charity?

 

Charity receives whatever remains when the trust ends, and the transfer is irrevocable. The question is whether you still come out ahead of what you would otherwise do with the shares.

 

My study in the Journal of Financial Planning counted every dollar that reached charity as a dollar the family lost. The trust still came out ahead in many scenarios. Where it did, your own wealth exceeded the alternative, so the tax savings paid for the charity's share, not your family.

 

Three conditions drive that result:

• Low basis. Shares that cost you little carry the most gain to defer. Basis above roughly one-quarter of value usually weakens the case.

• A long horizon. The tax you did not pay stays invested for as long as the trust pays you. In the study, seven additional years of life expectancy raised the probability of beating the hardest alternative from 28.2 percent to 96.4 percent.

• A high-tax state. California taxes capital gain as ordinary income, at rates up to 13.3 percent, so deferral is worth more here than in a state without an income tax.

 

The alternative matters as much as the conditions. For the study's baseline couple, the same trust came out ahead 66.4 percent of the time against selling and reinvesting, 57.8 percent against holding the stock until death, and 28.2 percent against holding it while drawing on it.

 

Horizon is the condition a young owner has the most of. When all three hold, a CRUT can come out ahead of each of those alternatives after counting what goes to charity. When they fail, the charity's share is a real cost, and only a charitable objective justifies it.

 

 

Wouldn't an exchange fund do the same thing?

 

Both remove the single-stock risk without a taxable sale by you. What each asks you to give up is different.

 

An exchange fund keeps the wealth yours. You contribute shares to a partnership and receive an interest in a pooled portfolio. The sponsor runs that portfolio under its own mandate, and part of it sits in assets such as private real estate because the tax structure calls for them. Funds customarily expect you to stay about seven years, and they pay you nothing in the meantime. Your gain carries into the fund interest. Hold it until death and the basis adjustment at death can erase that gain; spend the money during your life and you meet the gain again.

 

A CRUT gives up the remainder and keeps the portfolio in your hands. The trust can sell the shares the day after funding and reinvest the full proceeds. You can serve as trustee, and the trustee chooses the investments, subject to the duties every trustee owes. The trust pays you from the first year, and funding produces a charitable deduction. The gain reaches you gradually, as the payments carry it out.

 

Over a horizon of decades, control of the portfolio grows in value. The allocation that fits you at 35 will not fit you at 60. In a CRUT you can change it; inside an exchange fund, the sponsor decides until you leave.

 

An exchange fund is the better answer when you want diversification and nothing else: no income from the position, no interest in charity, the largest possible inheritance, and a plan to hold the investment until death.

 

The two do not exclude each other. One position can be divided, lot by lot, among a fund, a trust and an outright sale.

 

The full comparison, including the donor-advised fund, is in Saving Capital Gains Tax on SpaceX Stock.

 

 

Aren't we too young for a charitable remainder trust?

 

Not if the trust runs for a term of years. A CRUT can pay you for any fixed period up to 20 years, and your age plays no part in whether it qualifies.

 

Age matters only when the payments last for a life. The charity's share, valued when you fund the trust, must be at least 10 percent of what you contribute. The younger the life that measures the trust, the longer the expected payments and the smaller that share.

 

That makes the deciding question: whose life?

 

The life that sets the trust's length does not have to belong to everyone who benefits from it. Both spouses can fund the trust while one of you serves as the measuring life and receives the payments, and those payments support your household. The difference in qualification is large. At the 5 percent minimum payout, a CRUT measured by one life qualifies from about age 28. Measured by both spouses' lives, it needs both of you at about 39 or 40, depending on the month's rate.

 

A CRAT pays a fixed dollar amount instead of a percentage of the trust. Whether it qualifies at a young age depends on the month's §7520 rate. A fixed payment also loses value for decades: at 2.5 percent inflation, it buys less than a third as much after 50 years.

 

 

CRT Age Check Calculator

 

Enter your age and your spouse's. The calculator uses the current §7520 rate, which updates automatically each month from the IRS publication, and shows what qualifies today: a 20-year term, each spouse's life alone, both lives together, and the longer of a life or 20 years. It answers whether a design qualifies, not whether it pays off for you.