The Hybrid Charitable Remainder Unitrust "Foundation"

This article assumes the reader has walking around knowledge of how Charitable Remainder Unitrusts and Private Foundations work.

How in the world can a Charitable Remainder Unitrust operate as a hybrid Foundation—a Unitrust Foundation? Part life income Unitrust and part grantmaking Foundation? Why would anyone want one of these?

Suppose you are working with a very fortunate Donor who is experiencing a once-in-a-blue-moon liquidity event, like the sale of a business or real estate. It’s common practice for many of you to examine a capital gains tax avoiding Unitrust side-by-side with the formation of a Private Foundation. The Unitrust is considered in order to provide a replacement source of income for the Donor’s lifetime. The Foundation of course serves as the source for giving away the windfall in the form of charitable gifts.

One jackpot winning Donor I met with was contemplating a lollapalooza-sized business sale. He estimated it would take a Unitrust gift of only 20% his sale proceeds to invest and earn enough income to meet his life income needs. He said the remaining 80% of the sale proceeds could be used to create and fund his Private Foundation to support his philanthropic grants to charitable organizations. He asked, “Should I create both a Unitrust and Private Foundation before I enter a purchase and sale contract to sell the business?”  

How would you answer this stop-and-think question? Would you be willing to consider suggesting a Unitrust that could operate in an innovatively conventional way? Would you consider recommending a so-called Unitrust Foundation?

The Unitrust Foundation is comparatively simple to operate and administer. There are fewer moving parts, it's cheaper and in some cases it’s crammed with superior income tax benefits too. Instead of having to set up and operate a Unitrust and Foundation, you only need the Unitrust.

Let’s take the example of a Donor who creates a Unitrust Foundation by funding the Unitrust with closely-held stock. The Unitrust subsequently sells the stock for cash. Since the Donor is supporting public charities, after running the calculations, you discover that the Unitrust income tax charitable deduction will be greater for the gift of long-term, highly appreciated, zero basis closely-held stock compared to the deduction for a gift to both a Unitrust and Foundation. Why? The Unitrust deduction is for the remainder value based on the full fair market of the stock, which can be deducted up to 30% of adjusted gross income. The Foundation deduction would be zero. For gifts of closely-held stock, the Foundation income tax charitable deduction is limited to cost basis, which can only be deducted up to 20% of adjusted gross income. But remember, your Donor had a zero cost basis in their stock.

Unlike Private Foundations, Unitrusts are not required to give 5% of their principal value annually to charity and Unitrusts are not subject to an annual excise tax of up to 2% on their net income. Also, unlike Private Foundations, Unitrusts can be drafted so they are not subject to the excess business holding and jeopardy investment rules either. (See See IRC §4947(b)(3)(B); Treas. Reg. § 1.664-1(b); Revenue Ruling 72-395, Section 6.07; Private Letter Rulings 9707027 and 1999952086. It’s assumed that no charitable organization is named a Unitrust income recipient.)

Under the right circumstances why not suggest that your Donor consult their attorney about creating a Unitrust Foundation. However, let’s be clear with table-pounding emphasis that the Donor must set up their Unitrust primarily to create life income, while intending to leave the remaining assets to charity after their life. The Donor’s income needs will likely change over time and outright charitable gifts from the Unitrust may increase or decrease as a result. In this regard, the Unitrust Foundation provides lasting flexibility for the Donor’s life income needs and charitable grantmaking objectives.  

By:  Dan Rice

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