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A Charitable Trust For Every Situation: CRUTs And CLATs

Key takeaway: There is a tax-mitigation solution available no matter your timing. If you haven’t sold your assets yet and you’ve got a big gain coming, a CRUT will likely provide the biggest returns. If you have sold your assets or already received a large amount of ordinary income this year, consider looking more closely at a CLAT.

In today’s post, we’ll pull the last few threads together to help you understand the differences between the main tax mitigation tools we offer and when/why should you use one over the other. If you haven’t sold your assets yet and you’ve got a big gain coming, a Charitable Remainder Unitrust (CRUT) will likely provide the biggest returns. If you have sold your assets or already received a large amount of ordinary income this year, consider looking more closely at a Charitable Lead Annuity Trust (CLAT).

Before we talk about the different use cases for CRUTs and CLATs, though, a quick recap of both structures:

A refresher on how Charitable Remainder Trusts work

  1. You gift appreciated assets to the trust and typically receive a charitable deduction of ~10% of the value you gifted to the trust.
  2. You can seed the trust with nearly any asset β€” public stock, private/startup equity, real estate, or crypto, for example.
  3. The trust is tax exempt so when you sell the asset, the trust does not pay taxes; this enables you to reinvest and grow the amount that you would otherwise pay in taxes.
  4. Every year, you are entitled to a distribution of a certain percent of trust assets; you pay taxes only when you receive the distributions.
  5. Celebrate β€” You successfully deferred your taxes and were able to reinvest what would have been taxes to keep those assets compounding and working for you. You’ve also lowered your effective tax rate by smoothing out your income realization over a number of years instead of realizing a massive gain β€” and taking a massive tax hit in one year.
Overview of how a Charitable Remainder Trust works

A refresher on how Charitable Lead Annuity Trusts work

  1. You gift assets or cash to the trust and get a charitable deduction up to the entire value you donated (enabling you to write off all or nearly all of your taxes).
  2. You can seed the trust with nearly any asset β€” public equities, real estate, crypto, or even cash β€” and reinvest the gains in other assets throughout the term of the trust.
  3. Every year, the trust donates a predetermined amount to a recognized charity, such as the American Cancer Society, or your own Donor Advised Fund (DAF). You are liable for the taxes on the income generated inside the trust (though we do our best to minimize this tax exposure).
  4. At the end of the trust’s term (a predetermined number of years), the trust gives its largest donation to charity and you or your beneficiary receive the majority of the trust assets back.
  5. Celebrate β€” You successfully deferred your taxes and were able to reinvest what would have been taxes to keep those assets compounding and working for you!
Overview of how a Charitable Lead Annuity Trust works

What are the key differences between CRUTs and CLATs?

Use Cases

  • CRUT: Best suited for individuals with highly appreciated assets who are aiming to mitigate their tax exposure BEFORE a major liquidity event.
  • CLAT: Best suited for individuals who are looking to mitigate tax exposure AFTER a major liquidity event, such as selling start-up equity or crypto portfolio, receiving a cash bonus, or just making a high salary.

Distribution Schedule:

  • CRUT: You are entitled to a distribution of a set percentage of trust assets every year the trust operates, while the charitable beneficiary receives whatever is left in the trust at the end of the term.
  • CLAT: Distributes a set amount to a charitable beneficiary every year and you receive whatever is left in the trust at the end of the term.

Charitable Deduction

  • CRUT: You typically receive a charitable deduction equal to ~10% of the value you gift to the trust.
  • CLAT: You can receive a charitable deduction up to 100% of the value of assets you gift to the trust.

Tax Exempt Status

  • CRUT: Gains inside the CRUT are tax exempt (outside of a few edge cases).
  • CLAT: The trust is not tax exempt and you are taxed on gains inside the trust (though we work with you to minimize those taxes).

When should I use each type of trust?

The biggest question for most customers is when they should use each strategy. The answer, in most cases, depends on one main factor: Is your big win still in the future, or is it in the past? ****

CRUTs: A good fit for highly appreciated assets you haven’t sold yet

Simply put, if you have a large unrealized capital gain and haven’t sold your assets yet, you can place those assets into a CRUT to defer and reduce your taxes. This is true for a simple reason: A CRUT is a tax-exempt account much like an IRA. It allows you to delay the taxes you owe on your capital gains β€” an incredible tool to turbocharge your returns β€” but it’s the CRUT itself that is tax exempt β€” not you β€” so that tax benefit applies only if the assets are already in the CRUT when you sell them. Otherwise, you’re the one receiving the gains, and you’re the one who will be taxed.

CLATs: Well suited for ordinary income and already realized income

If it’s too late for a CRUT β€” say you made a large amount of money this year because you didn’t know about the available strategies when you sold your crypto, or you exercised some highly appreciated options, received RSUs, or are just paying a high tax rate on your regular income, you can put those assets into a CLAT, potentially eliminate your tax bill by taking a large deduction now, and reinvesting what you would have paid in taxes.

Common CRUT use cases: Highly appreciated assets with unrealized gains

Startup equity. If you hold company stock β€” whether you received common shares or you’ve already exercised your options β€” you can move your shares into a CRUT before you sell them. In the case of an IPO, SPAC, or direct listing, that’s simple: You can work with us to finalize your trust beforehand (free of cost) and transfer your assets whenever you’re ready. If there’s a chance your company is going to be acquired in a private transaction, though, time is of the essence: If you sell your shares as part of that deal before moving them into a trust, it is too late to use a CRUT (but you could use a CLAT).

Crypto. If you’re holding crypto that’s gone to the moon and you haven’t sold yet, you can move those assets into a CRUT, make the sale, and pay no taxes today. This gives you more capital to reinvest in the market and compound at a faster rate.

Public company stock or call/put options. This one’s a lot like startup equity, but you’re more in control of the timing. Get your Tesla, Amazon, or Google shares β€” or any other stock that has appreciated significantly since you bought it β€” into a CRUT, and then you can sell, diversify your portfolio, and defer the (often massive) tax bill you would have otherwise received.

Common CLAT use cases: Ordinary income, assets already sold, and unexercised options

The common thread when it comes to CLATs is that they can save you a huge headache if you are already paying a lot in taxes.

Ordinary income. Ordinary income comes in many forms. A big bonus from your employer is ordinary income. So is the income you receive from selling an NFT you create. Your salary, of course, qualifies too. If you received a windfall this year and don’t want to deal with the resulting tax bill, you can put your income into a CLAT and write off as much as 100% of those taxes.

The key benefit of a CRUT is that you can defer taxes on income you earn inside the trust.  However, that move doesn’t work for ordinary income, because there’s no way to realize the income inside the trust β€” if you get paid for your work, that income comes to you and a CRUT cannot reduce your taxes on this income.

Assets you’ve already sold. Another form of income that doesn’t qualify for a CRUT is income that you’ve already realized β€” that is, income from the sale of an asset that happened in the past. Common scenarios we’ve seen are:

  • Equity: Your company is acquired in a surprise deal or before you have a chance to move your assets into a trust
  • Crypto / NFTs: Crypto moves fast and with a recent bull run people have been taking gains opportunistically without much forward planning

Unexercised options. When you exercise appreciated options you have to pay ordinary income tax rates on the difference between your strike price you were issued the options at and the current fair market value. Clients use CLATs to write-off that ordinary income from their exercise.

RSUs: When you receive RSUs from your company, they count as ordinary income, and clients use CLATs to avoid the potential ordinary tax rate of up to 50%.

Conclusion

Fortunately, there’s a solution available no matter your timing: If you haven’t sold your assets yet and you’ve got a big gain coming, a CRUT will likely provide the biggest returns. If you have sold your assets or already received a large amount of ordinary income this year, consider looking more closely at a CLAT.

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About Valur:

At Valur we built a platform to give everyone access to the tax and wealth building tools of the ultra-rich like Mark Zuckerberg and Phil Knight. We make it simple and seamless for our customers to take advantage of these hard to access tax advantaged structures so you can build your wealth more efficiently at less than half the cost of competitors. From picking the best strategy to taking care of all the setup and ongoing overhead, we make it easy and have helped create more than $500m in wealth for our customers. Schedule a time to chat with our team and learn more about how we can help you!