Retirement and Charitable Remainder Trusts

I got a call from a potential client yesterday. Looking towards retirement he said "tax optimization" is his goal and he seems to believe that setting up a charitable remainder trust (CRT) is the way to achieve that. Unfortunately, he caught me off guard with some terminology from some online stuff he had been reading so I probably won't be gaining him as a client.

Also unfortunately, for him, based on his readings on the Internet he strongly believes that the distributions a donor receives from a charitable remainder trust are tax free. There are exceptions but having them apply is rare. In general, distributions from a CRT are taxable to the recipient. Technically, the nature of the income earned by the trust determines the taxability of the distribution. First, all the ordinary income (taxable at ordinary rates) is deemed to comprise the distribution, then any capital gains and finally any tax exempt income.

Example 1: Suppose a CRT starts with $100,000 of assets and earns a total of $9,000 during the year composed of $4,000 of ordinary income, $3,000 of long term capital gains and $2,000 of tax exempt interest. Let's assume the distributions are $5,000 per year. The ordinary income is deemed to be distributed first, then the long term capital gains, then the exempt interest. So our donor/taxpayer has $4,000 of ordinary income, $1,000 of long term capital gains and $0 of tax exempt interest.

Example 2: The CRT starts with $100,000 of assets and somehow manages to earn $5,000 of tax exempt interest. Now the $5,000 distribution is tax exempt to the recipient.

A problem is, in today's economy, it's somewhere between difficult and impossible to earn 5% or more on an investment in state and local bonds (the securities that generate tax exempt interest income) without taking extraordinary risks. On top of that, the trustee will be attempting to maximize the remainder interest (for the benefit of the charity) which is not conducive to investments in low interest bonds. Remember, the CRT isn't paying income taxes so the trustee has zero incentive to make investments that generate tax exempt income.

I regret not making a better impression on my caller for two reasons. First, I'm almost certainly not getting him as a client. Second, he's liable to make an irreversible decision based on his misinformation, something that would be avoided if he had me as his CPA.

Takeaway for me: Be ready for anything, particularly jargon created for use in sales pitches.

Takeaway for you: Don't believe everything you read on the Internet, especially about finances and taxes.

Caveat: The rules regarding charitable remainder trusts are way more complex and arcane than covered in this post. Don't even think about creating one for your favorite charitable organization until you've consulted with a tax professional, ONE WHO DOESN"T CARE WHETHER YOU CREATE A CRT OR NOT.

If you have questions about charitable remainder trusts or retirement planning or anything else related to income taxes, email me at bill@hollandbrowncpa.com. I promise I know more about this stuff than yesterday's caller probably believes.

Virginia's Sales Tax Holiday

Below is an email from the Virginia Department of Taxation describing the upcoming Virginia sales tax holiday.

Save on qualifying items during Virginia’s 3-day sales tax holiday Aug. 7-9

Virginia shoppers get a break from local and state sales tax on qualifying back-to-school, emergency preparedness and energy efficient items during the state’s sales tax holiday, Friday, Aug. 7 through Sunday, Aug. 9, 2015.

New legislation enacted by the 2015 General Assembly combined Virginia’s three existing sales tax holidays into one, three-day holiday in August. Previously, the August sales tax holiday only applied to qualifying back-to-school items. For detailed information on the combined holiday, refer to the department's Combined Sales Tax Holiday Guidelines and Rules.

Overview of Exempt Items include:

·         Qualifying school supplies - $20 or less per item

·         Qualifying clothing and footwear - $100 or less per item  

·         Portable generators - $1,000 or less per item

·         Gas-powered chainsaws - $350 or less per item

·         Chainsaw accessories - $60 or less per item

·         Other specified hurricane and emergency preparedness items - $60 or less per item 

·         Energy Star labeled dishwashers, clothes washers, air conditioners, ceiling fans,  light bulbs, dehumidifiers, and refrigerators - $2,500 or less per item purchased for noncommercial home or personal use

·         WaterSense labeled bathroom sink faucets, faucet accessories such as aerators and shower heads, toilets, urinals, and landscape irrigation controllers - $2,500 or less per item purchased for noncommercial home or personal use

Notable additions to the list of qualifying items from previous years include certain computer supplies priced at $20 or less per item, such as computer storage media and printer paper, and all light bulbs affixed with the Energy Star label.

For additional information on the sales tax holiday, including detailed lists of qualifying items, visit the department’s Sales Tax Holiday web page.

Note that although used to be a back-to-school tax holiday qualified items now include many related to emergency preparedness and energy efficiency.

If you have questions about this or any other tax issue, please contact me at bill@hollandbrowncpa.com