The best laid tax plans often go awry as tax laws and life circumstances change. In other cases tax plans go awry because they were improperly conceived. I have been encountering a number of NIMCRUTs that should not have been undertaken.
The NIMCRUT, otherwise known as the net income with makeup charitable remainder unitrust, is a charitable trust that requires the less of a fixed percentage of the income (minimum 5%) or the actual earnings be distributed to the donor or other non-charitable beneficiary annually. Upon the demise of the donor or non-charitable beneficiary or the expiration of a set period (not to exceed 20 years), the trust assets are distributed outright to the named charity. Taxpayers typically establish NIMCRUTs in order to provide a current income tax deduction, to convert appreciated assets to income-producing assets, and to fulfill charitable inclinations.
NIMCRUTs often hold a variety of assets. The idea is typically to invest in growth assets during the donor’s accumulation years and then sell the assets and/or invest in income assets during the donor’s retirement years or when the donor wants to receive income. This allows the trust to have little or no income during the donor’s accumulation years, resulting in little or no trust distributions during those years. When the donor begins receiving income they are able to receive the amount stated in the trust plus an additional amount to make up for the under performing years. This can allow prolonged tax-free build up, current income tax deductions and a steady stream of income when the donor desires. This timing is most often achieved by investing in zero coupon bonds, partnerships or LLCs, or even variable annuity contracts. The partnership, LLC, and variable annuity contract options allow the trustee to turn the investment income on and off at will, which allows the trustee to most effectively make distributions when most appropriate for the donor.
Remember that most NIMCRUTs are established with appreciated property, which when sold by the trust does not result in capital gain for income tax purposes. Thus, the gain is typically appreciation that occurred before the trust was established. The Regulations prohibit such gain from being allocated to trust income, regardless of whether the state allows the trustee to allocate the gain from trust principal to trust income. Consequently, even though it is simplistic, I encounter NIMCRUTs where there is almost no trust income or items that can be allocated to income and the term of the trust is set sufficiently short so that it is impossible to time the distributions in a way that benefits the donor, as would otherwise be the case.
If that is not bad enough I have encountered NIMCRUTs that invest in variable annuities, which result in ordinary income when they are paid out. In these instances the donor is giving up the option to pay a lower capital gains tax currently in exchange for tax deferral and a higher ordinary tax at a later time. This can be particularly problematic for older clients or for trusts with shorter maturities. This is even more problematic in that all of the annuity income in such situations is fully taxable, rather than it being partially taxable and partially a return of basis as when individuals own and receive annuity income. Again, while simplistic, I have encountered a number of clients is this situation.
The combination of a NIMCRUT and a variable annuity or partnership can be a powerful planning tool; however, advisors must run the numbers before making such a recommendation.