The Income Control Unitrust

The Income Control Unitrust

Article posted in Charitable Remainder Trust on 28 August 2014| comments
audience: National Publication, David Wheeler Newman | last updated: 28 August 2014
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Summary

David Wheeler Newman explores the NIMCRUT and its extraordinary possibilities. His case study makes a compelling statement that Charitable Remainder Trusts are alive and well and will continue to be.

By: David Wheeler Newman

Introduction

The net-income with make-up charitable remainder unitrust (NIMCRUT) continues to be an important vehicle to coordinate philanthropic objectives with financial and estate planning objectives.  Design considerations should focus on planning and drafting NIMCRUTs to achieve these dual objectives while building into these long-term irrevocable trusts as much flexibility for investment and administration as the rules will allow. 

CASE STUDY

Our examination of provisions for a NIMCRUT to be used for this purpose will be in the context of the following case study.

Leo is the principal shareholder of his company, Ajax, owning all of the shares other than a small number of shares owned by key employees.  He has been approached by a large public company in the same industry that would like to purchase Ajax.  Their offer equates to $10 million for Leo's shares, in which he has an adjusted basis for tax purposes of $1 million.  The offer comes at a good time for Leo who, at age 62, is thinking about retirement.  The purchaser would like to retain Leo in his current position as President of Ajax for a period of three years following the sale at his current salary of $400,000 per year, and it is willing to pay him as a consultant on an as-needed basis for two years thereafter at the rate of $300,000 per year.  Leo and his wife, Carina, are currently living comfortably on the pre-tax equivalent of $300,000 per year.

One of his advisors suggests that Leo and Carina may want to contribute a portion of their Ajax shares to a 9.5% NIMCRUT providing income for the joint lives of Leo (age 62) and Carina (age 60), with the remainder upon termination of the trust to a public charity to be named later by Leo and Carina.  The planner explains that, assuming a value of $5 million for the shares contributed to the NIMCRUT, Leo and Carina will be entitled to a charitable income tax deduction of $508,000, resulting in potential tax savings at their current maximum federal income tax rate of over $200,000.

Better than the initial tax savings is the fact that the before-tax proceeds of the sale of the stock will work to produce compounded investment returns rather than the after-tax proceeds:

Assets in CRT $5,000,000
6% Return $300,000 per year
   
Assets Sold Outside CRT $5,000,000
Capital Gains Tax (State and Fed) at 26% ($1,170,000)
Available for Investment $3,830,000
   
6% Return $230,000
   
After Tax Return Required to Produce $300,000 7.8%
Before Tax Return Required 13%

The planner points out that Leo and Carina are unlikely to need distributions from the NIMCRUT for the next five years during which he will remain employed by Ajax.  Going out on a limb, he illustrates an average 6% return over five years to show what the assets in the NIMCRUT would be at the end of five years:

Beginning Assets $5,000,000
End of Year One $5,300,000
End of Year Two $5,618,000
End of Year Three $5,955,000
End of Year Four $6,312,000
End of Year Five $6,691,000

If the CRT assets continue to yield an average of 6% per year, Leo and Carina could begin to take distributions of about $400,000 per year beginning in year six, without depleting the increased corpus of the trust and maintaining a charitable legacy of over $6.7 million. See table in Appendix 1.

Now that we have set the stage with this outline of a plan, let's examine the technical issues the planner and other advisors (including the attorney drafting the CRT and related documents) will need to navigate to make it all happen.

The Importance of Fiduciary Accounting Income

A NIMCRUT provides for distributions each year during its term to a non-charitable beneficiary, in an amount determined by formula, with the remainder of whatever is left in the trust at the end of its term distributed to the charitable organization named in the trust document as remainder beneficiary remainder.   The formula for the amount to be distributed each year is the lesser of the unitrust amount (a fixed percentage of trust assets, valued annually) or the net income of the trust.  Net income for this purpose is not the taxable income of the trust, nor is it income determined under the financial accounting rules.  Net income for this purpose is defined in Internal Revenue Code (IRC) § 643(b), and the regulations thereunder, as fiduciary accounting income determined under the terms of the governing instrument and applicable local law.  The “local law” in question is, in most states, the principal and income act, as well as cases interpreting that act. 

Like financial accounting and tax accounting, fiduciary accounting is a system of rules used to calculate income.  There are, however, important distinctions.  First, the fiduciary accounting system distinguishes between the income and remainder beneficiaries of a trust, and provides rules, or at least guidelines, for allocating receipts and disbursements between the income of the trust and the principal held for the eventual benefit of the remainder beneficiary.  Second, unlike the relatively rigid systems of financial and tax accounting, the fiduciary accounting system allows the drafter remarkable flexibility in writing accounting rules unique to the trust:  the principal and income acts of most states provide what amounts to a set of default rules -- direction to trustees on allocation of receipts and disbursements in the absence of contrary provisions in the trust document.

  • A fundamental principle of NIMCRUT design is to take full advantage of the opportunity to write your own accounting rules into the trust document, to achieve the donor’s planning objectives and to build flexibility into investment and administration of the trust.
  • One must keep in mind that trust accounting provisions written into the trust document that fundamentally depart from concepts of state principal and income law will not be respected for tax purposes.  Treas. Regs. § 1.643(b)-1.

The Revised Uniform Principal and Income Act

The National Conference of Commissioners on Uniform Laws approved a Revised Uniform Principal and Income Act (“RUPIA”) in the Summer of 1997, which has now been adopted, with some variations, in most states.

Trustee Reallocation Power

The most important change made by RUPIA is the power granted (in section 104) to trustees to “... adjust between principal and income to the extent the trustee considers necessary if the trustee invests and manages trust assets as a prudent investor...”  The purpose of this provision is to allow trustees to invest for a total return, a portion of which may come from capital appreciation of trust assets rather than traditional income items such as interest and dividends.  This provision is a significant departure from the 1962 version of the Uniform Act, since for the first time a fiduciary is allowed to allocate trust principal to the income beneficiary (or to reallocate a portion of the trust income to principal), even if no provision exists in the trust document allowing the fiduciary to do so.  What this means in practice is that a trustee could allocate to the income of a net-income unitrust all or a portion of a realized capital gain, even though capital gains are allocated to principal under the normal rules, if the trustee determines that the allocation is necessary to balance the interests of the beneficiaries in the trust.

This provision of RUPIA grew out of the Uniform Management of Institutional Funds Act which in 1972 first introduced the concept of investing for total return, rather than simply to generate current income, in the case of institutional endowments, and the Uniform Prudent Investor Act in 1995 which applies modern portfolio theory to private trusts.  Taken together, this progression of uniform legislation recognizes the importance to all beneficiaries -- income and remainder -- of the trustee investing for total return, and at the same time that the traditional concepts of “principal” and “income” may not accommodate total return investing in a way that will be fair to all beneficiaries.

However, the power to reallocate is not unlimited.  RUPIA lists situations in which the trustee is prohibited or restricted from exercising the power.  A significant limitation, which in some situations can constitute a trap for the unwary, prohibits the trustee from exercising the reallocation power if the trustee is a beneficiary of the trust.  This limitation will not only prevent reallocation where the trustee is the grantor and income beneficiary of the trust (and there are thousands of these trusts in existence), but also where the trustee is the charity which is the remainder beneficiary of the trust.  In other  words, unless a power to reallocate is specifically written into the trust RUPIA empowers only independent trustees to exercise the power. 

  • NIMCRUTs can avoid this problem by writing the reallocation power into the accounting provisions of the trust instrument, and making it clear that the power may be exercised by a trustee even if the trustee is also a beneficiary of the trust.

The importance for net-income unitrusts of the power to allocate between income and principal  is illustrated by a situation in which the only receipts for the year are from the realization of capital gains.  If the only device available to the trustee is an “on-off switch” in the trust instrument, which says that all capital gains shall be allocated to income, the portion of the realized gain characterized as income may be more than would be needed to balance the interests of the income and remainder beneficiaries of the trust.  In fact, the interest of the remainder beneficiary has clearly suffered, since the principal of the trust is not protected against inflation.  With the power to allocate, preferably in the document but at least now supplied (to an independent trustee) by statute, the realized capital gain may be apportioned between income and principal, to provide adequately for the income beneficiary while providing growth of principal to protect both the income and remainder beneficiaries from future erosion of purchasing power.

Mutual Fund Distributions

RUPIA distinguishes between different types of distributions from mutual funds.  The general rule is that distributions from any type of entity, including a mutual fund, are income.  Excluded from this general rule are long-term capital gain distributions, which are principal.  But mutual funds often distribute both long-term and short-term capital gains, and short-term capital gains dividends remain subject to the general rule -- they are allocated to income.  This is an important change from the previous uniform act, under which all capital gain distributions are principal.  This treatment of mutual fund distributions is important, since use of these investment vehicles by CRT trustees has grown as a means to achieve  asset diversification and lower-cost professional asset management.

Receipts from Entities

RUPIA provides detailed default rules for fiduciary accounting characterization of receipts from entities.  For this purpose, an entity includes a corporation, partnership, limited liability company, mutual fund, real estate investment trust (REIT) and common trust fund.  The general rule (RUPIA § 401(b)) is simple enough:  except as otherwise provided, money received from an entity is allocated to income. 

Example:  A net-income unitrust holds an interest in a partnership.  Assume that the partnership conducts a variety of investment activities, generating interest, dividends, short-term capital gain and long term capital gain.  For tax accounting purposes, the partnership is merely a conduit, with tax characteristics of its income flowing through to its partners, whether or not that income is distributed.  If a charitable remainder trust is a partner, the income of the partnership -- whether distributed or not -- fills up the appropriate tier under the four-tier system for characterizing CRT distributions, with ordinary income flowing into tier 1, capital gain into tier 2 and tax-exempt income into tier 3.   For fiduciary accounting purposes, the trust will account for partnership income only when a distribution is received.

RUPIA contains important exceptions to this general rule: 

  • First, a partnership distribution of property other than money is allocated to principal under the default rule.  This provision could create planning opportunities or another trap for the unwary.  Assume, for example, a  NIMCRUT with a deficiency account of 100 holds an interest in a partnership about to distribute to the trust property with a value of 100.  If the partnership distributes cash, the distribution will be treated as income by the trustee who will distribute it to the income beneficiary.  On the other hand, if the partnership instead distributes property other than cash -- even publicly-traded securities -- the distribution is characterized as principal and no distribution is made to the income beneficiary.
  • Second, distributions from entities in partial liquidation of the entity are allocated to principal.  Distributions (of cash and property combined) which total more than 20% of an entity’s gross assets are deemed by RUPIA to be in partial liquidation of the entity.

Zero Coupon Bonds

Unlike regular bonds which are issued at face value and pay interest periodically to holders, zero coupon bonds pay no interest at all -- they are issued at a discount from face value and the holder realizes the equivalent of interest in the form of accrued bond discount when the bond is sold or matures and is redeemed for the full face value.  Since the accrued bond discount is the investor’s equivalent of interest, it is treated as interest for income tax purposes.  This leads some planners to assume that accrued bond discount, when realized by the trust, is treated also treated as income for fiduciary accounting purposes.  However, the default treatment under RUPIA is exactly the opposite -- realized bond discount is treated as principal.

Zero coupons bonds have been a popular income timing device for NIMCRUTs, with which deferred income can be accrued at a predictable rate for future distribution when the bonds are sold or redeemed.  To give the trustee the flexibility to pursue this investment strategy, it has always been advisable for the drafter to include a specific provision in the trust document’s accounting rules allocating realized bond discount to income.  This is even more the case now that RUPIA provides a contrary default result.

The Importance of Trust Language

The revised Act, like its predecessor, provides a set of default rules to guide the trustee in the absence of specific provisions in the trust instrument.  The primary themes of RUPIA include both increasing and focusing of these default rules.  Since RUPIA now covers a broader array of categories of trust receipts and disbursements, it is more important than ever for the drafter of net-income unitrusts to place the desired accounting rules into the text of the document, at least to the extent that the desired result is different from RUPIA’s default rules.  The drafter may be lulled into reliance on the power granted to trustees by RUPIA to allocate receipts between principal and income, but must remember that RUPIA extends this power only to trustees which are not also beneficiaries of the trust.  In the world of CRTs, where it is very common for the income or remainder beneficiary to also serve as trustee, the flexibility arising from this provision of RUPIA may prove illusory.  But like the default rules for characterizing receipts and disbursements, this restriction may also be overridden by a specific provision in the trust instrument authorizing the trustee to allocate between principal and income in the manner provided in RUPIA, even if the trustee is also a beneficiary of the trust.  Such a provision should be seriously considered for all new net-income unitrusts.

The Income Control Unitrust

A popular financial planning objective accomplished with a NIMCRUT is to defer distributions of cash to the income beneficiary until he or she requires the cash.  Until that time, interest, dividends, capital gains and other investment returns can be held for reinvestment in the tax-exempt environment of the CRT.  In some ways, the NIMCRUT resembles a retirement plan, yet the NIMCRUT is not subject to minimum distribution, mandatory coverage or other rules that often limit the attractiveness of qualified retirement plans.

  • To effectively achieve this objective, it is necessary to have a means by which fiduciary accounting income can be controlled, since the NIMCRUT will not be required to make distributions unless and until it realizes receipts allocated to income under the fiduciary accounting system. 
  • The choice of investments by the trustee provides the means by which fiduciary accounting income may be controlled.  Although other investment vehicles have been tried by trustees over the years, the planning community has settled on two as the most effective -- variable annuity contracts issued by insurance companies and interests in investment partnerships

IRS No-Ruling Area

In April, 1997 the IRS issued Revenue Procedure 97-23 to expand the areas in which rulings will not be issued to include the following:

“Whether a trust that will calculate the unitrust amount under §664(d)(3) qualifies as a §664 charitable remainder trust when a grantor, a trustee, a beneficiary, or a person related or subordinate to a grantor, trustee or a beneficiary can control the timing of the trust’s receipt of trust income from a partnership or a deferred annuity contract to take advantage of the difference between trust income under §643(b) and income for federal income tax purposes for the benefit of the unitrust recipient.”

The Revenue Procedure explained that the Service and Treasury will study whether creating or using net-income unitrusts to control the timing of the trust’s receipt of trust income causes the trust to fail to function exclusively as a charitable reminder unitrust -- a pre-requisite for qualification as a CRT.  In the years since issuance of Rev. Proc 97-23, nothing further has been heard of the study that was to be conducted, leading cynics to suggest that the IRS never intended to conduct a study, but instead accomplished its objective by creating uncertainty in the minds of donors and their advisors considering the use of LLC or partnership interests, or variable annuity contracts, as devices to time the receipt of fiduciary accounting income by a NIMCRUT.  While planners were encouraged by the Technical Advice Memorandum discussed below, at least in the case of variable annuities, the issue remains on the annual list of areas in which the IRS will not issue rulings  -- but in the meantime hundreds if not thousands of income control unitrusts have been created that make use of these devices to time fiduciary accounting income.

Variable Annuity Contract

One device that is frequently used to time the income of a NIMCRUT is a deferred annuity contract purchased by the trustee from an insurance company.  The CRT will not realize fiduciary accounting income until, and only to the extent that, the trustee elects for the trust to receive a withdrawal from the annuity contract.  Variable annuity contracts are not only a reliable device for timing the realization of income, they typically allow for investment within the contract in a variety of portfolios with different investment objectives.  However, after years of experience with this device, planners have recognized some limitations with use of annuity contracts to time the income of NIMCRUTs:

  • All withdrawals from an annuity contract are ordinary income, filling tier one of the CRT and therefore characterizing all distributions from the NIMCRUT as ordinary income until tier 1 is exhausted.  This can have the deleterious effect of converting qualified dividends and long-term capital gain, taxable at a maximum federal rate of 20% into ordinary income taxable at a maximum federal rate of 39.6% -- reverse alchemy in the world of tax planning -- in situations where most of the investment return within the annuity contract results from dividends and realized capital appreciation rather than interest or other ordinary income.
  • The insurance company issuing the annuity contract may also limit the types of investments that may be purchased within the annuity contract.  As investors and their advisors have become more sophisticated, they increasingly seek alternatives to publicly traded stocks and bonds, such as real estate, hedge funds and private equity opportunities which are typically not offered by the insurance companies offering these annuities.

Following Revenue Procedure 97-23, discussed above, there was considerable anxiety in the advisor community that investment of NIMCRUT assets in a variable annuity contract might disqualify the trust.  These advisors were also concerned, based on internal IRS training materials, that this type of investment might constitute self-dealing.  Both issues were raised in Technical Advice Memorandum 9825001, involving a classic retirement NIMCRUT invested in variable annuities.  These issues were apparently raised in an examination of the tax returns of either the donor or the trust, and technical advice from the IRS National Office was requested.  The TAM analyzes the self-dealing issue at length before concluding that this type of investment, even if done for the purpose of creating a device to time the realization of fiduciary income, does not constitute self-dealing.  It deals with the qualification issue more summarily, merely concluding:

“The purchase of the deferred annuity contracts does not adversely affect the trust’s qualification as a charitable remainder unitrust under section 664 of the Code and the current regulations thereunder.”

Planners who had been hesitant to recommend income control NIMCRUTs after the release of Revenue Procedure 97-23 were once again encouraged to do so after the apparent change of thinking within the IRS just six months later, in the context of a real-life fact pattern raised in the TAM.

Limited Liability Companies and Partnerships

The other widely used NIMCRUT investment used as a device to control the timing of fiduciary accounting income is a partnership interest or a member interest in a limited liability company (LLC) which is treated as a partnership for tax purposes.  In the simplest variation, the trustee of the trust forms a partnership or LLC with the donor.  NIMCRUT assets are contributed to the partnership or LLC, which then buys, sells and holds investments.  The underlying concept, now codified in RUPIA, is that the NIMCRUT will not have fiduciary accounting income except, and only to the extent that, the trust receives distributions from the partnership or LLC.  In some ways, the partnership or LLC is a more flexible income-timing device than the variable annuity contract:

  • The partnership is a conduit for tax purposes, with taxable income flowing through to partners under IRC §701-702, whether or not distributed.  The important point is that the income retains its character when passing through the conduit, so that qualified dividends and long-term capital gains realized by the partnership retain their tax character in the NIMCRUT. Unlike a NIMCRUT which invests in a variable annuity, a NIMCRUT which invests in a partnership interest is able to distribute qualified dividends and long-term capital gains.  An LLC enjoys the same advantage
  • The partnership or LLC also allows more investment flexibility than the annuity contract, since there is no insurance company or other third party setting guidelines or restrictions on allowable investments.  The partnership or LLC is free to invest in private equity, hedge funds, real estate or other investments that might not be allowable in a variable annuity, limited only by the prudent investor rules.

Notwithstanding this greater flexibility, the use of a partnership as a NIMCRUT income-timing device raises other issues that planners must consider, including:

  • The deferral of income which is a key element of income control NIMCRUT planning will necessarily be incomplete.  For example, if the LLC is between the trust, with a 99% interest, and the donor, with a 1% interest, only 99% of the income of the trust will be deferred.  Moreover, since distributions from the LLC are contrary to the objective of deferral, the individual holding the 1% interest may be in the position of recognizing taxable income without receiving from the LLC a distribution of funds which could be used to pay the tax on that income.
  • Some planners have recommended a limited partnership for as the investment vehicle for deferral of NIMCRUT planning.  However, the same valuation adjustments that have resulted in discounting of limited partnership interests could have a negative impact in the case of NIMCRUT planning:  the trustee (or qualified appraiser if the trustee is the income beneficiary) might be forced to discount the value of the limited partnership interest when calculating the unitrust amount, thus slowing the growth of the deficit account from which distributions may be made in the future.  The spread of such valuation adjustments as an accepted principle of tax planning has led some NIMCRUT planners to instead focus on either general partnerships or member-managed LLCs which would result in smaller discounts.

Single Member Limited Liability Companies

As noted above, one problem with the partnership is that the deferral of taxable income is incomplete -- there is “leakage” of phantom income to the extent of the percentage interest held by a taxable person or entity.  One alternative which eliminates this problem is a single member LLCs.  with some obvious attractions:

  • The deferral of income is complete, since all LLC income flows though the conduit to the NIMCRUT as the sole member (Single member LLCs are disregarded for tax purposes).
  • Unlike a partnership, no separate tax return is required for the single member LLC, since its existence is ignored for tax purposes.

One area of concern, which has restrained many planners from recommending a single-member LLC as an income-timing device for an income control unitrust, is that this type of entity is ignored for federal income tax purposes.  Even though the entity may have a separate existence under state law, for example, to protect the CRT from liability, the concern is that the IRS might disregard its existence, making deferral impossible since income recognized by the LLC would be deemed recognized by the NIMCRUT.

Investment Flexibility

Planners and draftspersons of charitable remainder unitrusts should give as much thought to the administrative provisions of the trust as to the unitrust percentage and definition of fiduciary accounting income.  One of the areas in which the trustees frequently find themselves frustrated by language in the trust document is the lack of flexibility regarding certain categories of investments.

Private Foundation Prohibitions:  Problems With Boilerplate

It is very common for the governing instruments of charitable remainder trusts to repeat all of the prohibitions to which private foundations are subject.  This is unfortunate, since some, but not all of the private foundation restrictions apply to charitable remainder trusts.  Code section 4947 applies section 4941 (self-dealing) and 4945 (taxable expenditures) to charitable remainder trusts, but specifically provides that section 4944 (investments which jeopardize charitable purpose) and -- more importantly -- section 4943, excess business holdings, do not apply to charitable remainder trusts.  The Code does not restrict a charitable remainder trust from owning 100% of stock in a company carrying on a business, even though this investment would clearly be prohibited for a private foundation.  Boilerplate in the trust document should not deprive the trustee of this investment flexibility.

Uniform Prudent Investor Act (1994)

While the Internal Revenue Code does not prohibit a concentration of CRT assets in, for example, a single business, the trustee is nevertheless subject to the general requirement under the Prudent Investor Act to diversify investments of the trust.  If the planner anticipates that the CRT may concentrate its assets in a single investment, the trust document should specifically relieve the trustee from the duty to diversify that would otherwise apply.  This language needs to be in the trust document for an income control unitrust to be able to retain the annuity contract, partnership, or LLC interest that functions as the income timing device.

Illustration

Returning to our case study of Leo and Carina, assume that they implement the plan proposed by the advisor.  Leo transfers half of his Ajax shares into a newly created limited liability company and becomes its sole member and manager.  He then transfers a 99% interest in the LLC to a 9.5% NIMCRUT for the joint lives of himself and Carina.  Following this transfer, the LLC enters into an agreement to sell its Ajax shares for $5,000,000, and          Leo agrees to sell the shares he retained for $5,000,000.  The LLC recognizes a capital gain of $4,500,000 from the sale of its shares, one percent of which, $45,000, passes through to Leo via the one percent LLC member interest he retained.  This capital gain will be added to the $4,500,000 he recognizes from the Ajax shares he sold personally.  The remaining gain recognized by the LLC passes through to the NIMCRUT, which is tax exempt.  This gain will be held in Tier Two (long-term capital gains) of the trust for purposes of characterizing future distributions.  The LLC reinvests the proceeds from sale of its shares in a diversified portfolio structured to generate total return emphasizing dividends and capital gains, both of which will be taxed more favorably to Leo and Carina when distributed by the NIMCRUT, rather than interest income which would be less favorably taxed. 

The NIMCRUT will not be required to make distributions unless and until it receives a distribution from the LLC.  Appendix 1 illustrates the results if Leo and Carina stick to the plan and begin taking distributions of $400,000 annually, beginning in year 6.  The distributions from the LLC are treated as income of the NIMCRUT for fiduciary accounting purposes.  Note that because the distribution is less than the unitrust amount, the deficit account available for future distributions continues to grow.

But what if plans change over time, as they have a way of doing?  Assume that in year 10, in addition to the $400,000 they use to live on, they would like to take an extra $1,000,000 to give to their daughter to help her capitalize her tech start-up.  There is certainly enough in the “IOU” deficit account – over $3.8 million.  But the total distribution from the LLC to the NIMCRUT of $1,400,000 is more than twenty percent of the value of LLC assets of $6.7 million, and would therefore be characterized as a partial liquidation under the RUPIA 20% rule described above, allocable to fiduciary accounting principal of the NIMCRUT, not income.  Leo and Carina are going to need to limit the total distribution to $1,300,000, which is less than twenty percent of the LLC asset value at the beginning of year 10 based on the assumptions in Appendix 1, and give their daughter only $900,000 for the new company.  Appendix 2 illustrates the impact of this extra distribution.  Starting in year 11, the 9.5% unitrust amount will be less, because the assets held in the trust (via the LLC), are smaller, but there is plenty of deficit in the IOU account resulting from the net income limitation to sustain the $400,000 normal annual distribution without violating the RUPIA 20% rule.  However, the eventual gift to charity is reduced – possibly by as much as $2 million, or even more depending on how long Leo and Carina live to enjoy their Income Control Unitrust.

Of course, this illustration has been simplified to make it easier to follow.  Even if the investment portfolio averages a 6% total return over the term of the NIMCRUT, it almost certainly will not earn 6% each and every year.  No tax compliance or other administrative costs are taken into account.  Plus, to make the math easier, the appendices assume that the NIMCRUT owns 100% of the LLC, not 99% as in the actual plan.  Remember that the 1% “leakage” results in Leo and Carina recognizing 1% of the taxable income recognized by the LLC (and receiving 1% of the cash distributed by the LLC).  Finally, keep in mind that care must be taken in the drafting of the LLC and NIMCRUT documents in order achieve the desired results – this is not a plan to be implemented with off-the-shelf templates.

 

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