If the clients estate is over $2 Million, she probably has at least $100,000 of suitable assets to contribute to the trust while living. If everything is done on a testamentary basis, she would forfeit all of the traditional lifetime financial and tax benefits. If funded during life, she will gain valuable experience and may refine her plan in various ways. A CRT has great "up front" tax benefits, but the ongoing tax benefits are also important. If a non-qualified trust pays a unitrust amount to the heirs, the trust itself will presumably pay taxes on any income earned over the unitrust amount. Of course this would be avoided with a tax exempt qualified CRT. A CRT would probably grow more effectively, benefiting all beneficiaries. With a $2 Million exemption (possibly permanently increasing next year), federal estate taxes may or may not be an issue. State inheritance taxes may still be a significant issue. Depending on the ages of the beneficiaries, the estate could have a significant deduction for the present value of the remainder interest for a qualified CRT.

I wrote an article about what I called the "NON-CRUT" a few years ago, for the ACF newsletter. I've asked Kim Kur to try to track it down.

With multiple beneficiaries, you probably want to avoid waiting until the last beneficiary dies before distributing to charity. It makes for awkward Thanksgiving dinners, when brother looks across the table and thinks, "If my sister dies, my income doubles." Two solutions: establish a separate trust for each beneficiary, or establish one trust and say that as each beneficiary dies, a fraction of the trust (on the date of distribution) goes to the charity. The fraction is 1 over (1 + # of beneficiaries still surviving).

Does the donor have any assets in an IRA, 401(k), or similar tax-deferred account? If so, the CRUT can be named the beneficiary and there will be no shrinkage to income taxes. On the other hand, if the CRUT is named as beneficiary but is non-qualified, it will have to pay taxes on the income -- and at the trust's high tax brackets.

Kimberly Kur found it for me -- I wrote it in 2001! My, how time flies.... Thanks, Kim! Long, but here goes (footnotes deleted):

THE “INTENTIONALLY DEFECTIVE” CHARITABLE TRUST By: Mark A. Moritz

Since 1969, if we wanted an estate tax deduction for a testamentary trust with remainder to charity, we had to follow the strict rules of § 664: no distributions to non-charitable beneficiaries except for annuity or unitrust payments, and the payout rate must be at least 5%. In 1997, some new rules were added: the annuity or unitrust payout rate could be no more than 50%, and the actuarial value of the remainder interest had to be at least 10% of the initial trust value.

Now the rules have changed again. With the scheduled increases in the unified credit, we can break the old rules sometimes. In some circumstances, we can create “intentionally defective” charitable remainder trusts that do not qualify for an estate tax charitable deduction.

Why Would We Want To Do This? Consider this situation: Mrs. Concerned cares about her favorite charities, but she also cares about her daughter, Caprice. While she loves Caprice, she is realistic: Caprice has some personal problems. Mrs. Concerned believes that if Caprice were to get too much money from a trust, it could do her more harm than good. On the other hand, what if Caprice needs an expensive operation not covered by insurance or welfare? A classic 1969-vintage Qualified Charitable Remainder Trust cannot make payments to Caprice “as needed.” It must pay the annuity or unitrust amount and not a penny more or less.

What if Mrs. Concerned left her estate to a Non-qualified Charitable Remainder Trust? (The world of charitable trusts is a world of inscrutable acronyms: NICRUT, NIMCRUT, etc. Invoking author’s privilege, I hereby coin the term “Non-CRUT” to describe a trust with remainder to charity, but not qualified for the charitable deduction due to some intentional defect.) The terms of the Non-CRUT could be something like this: income and principal as needed during the daughter’s lifetime, at the discretion of the trustee, with the remainder to the Concerned Family Fund at the Arizona Community Foundation. What would happen? Mrs. Concerned’s estate would not receive a charitable estate tax deduction. Is that important? That depends on the facts.

Beginning in the year 2002, a person can leave a total estate of $1,000,000 without any estate tax. In 2004, the tax-free amount goes to $1,500,000, then $2,000,000 in 2006 and $3,500,000 in 2009. If, in the year of her death, Mrs. Concerned’s estate is less than the tax-free amount, she can get the trust provisions she actually wants, instead of the ones dictated by Congress. What if her estate is larger than the tax-free amount? Suppose, for example, that her estate is $1,500,000, and that she dies in 2002, while the tax-free amount is $1,000,000. If she were to leave her entire estate to a “normal” CRUT, with a 5% payout rate, for her 40-year-old daughter Caprice, her charitable deduction would be about $269,000, and her taxable estate would be $1,231,000, with an estate tax of $95,000. If, however, she were to leave her entire estate to a Non-CRUT, the estate tax would be about $210,000. Thus, using a non-qualified trust would cost her estate about $115,000 ($210,000 - $95,000) if she were to die before 2004. Is it worth risking $115,000 for Mrs. Concerned to have the trust provisions she wants for Caprice? Is it worth taking that risk for a couple of years, until the next scheduled increase would remove all or most of that tax? With the changes in the tax law, now Mrs. Concerned can make that choice.

Will using a Non-CRUT work to the disadvantage of charities? That depends on the terms of the Non-CRUT, which, after all, can be anything the client wants. If the trustee of the Non-CRUT makes large mandatory or discretionary distributions, then yes, the charity could receive less than it would with a Qualified CRT. However, if all payouts are discretionary, and the trustee makes few such payments, the charity could receive much more. Keep in mind, some donors might feel so strongly about providing distribution flexibility for their families, that they might choose to leave nothing to charity, rather than submit to the restrictions of a Qualified CRT. In such a case, certainly a Non-CRUT provides more ultimate benefit to charity than no CRT at all.

There is also the matter of income taxes to consider. Qualified CRT’s accumulate earnings tax-deferred, with no tax due until the non-charitable beneficiary receives payment. A Non-CRUT would be taxed on its earnings, potentially at high trust income tax rates, with annual deductions only for income actually distributed. This is a problem, certainly, but it is a problem for all complex trusts. The solution is for the trustee to manage the investment portfolio, and make discretionary distribution decisions, with one eye on the tax effects. Some people have predicted, or at least feared, that the reduction in estate taxes will cause a decrease in trusts generally, and planned gifts specifically. Such predictions and fears spring from a misunderstanding of why people establish trusts, and why people leave money to charity. Something other than tax law motivates people to leave bequests to charity. People give and leave money to charity because they care about the charity’s mission. They want to leave the world a better place. They want to cure diseases, feed the hungry, and do other good things. People establish trusts for many reasons and tax avoidance is often the least important reason. Trusts provide heirs with investment guidance, bookkeeping help, spendthrift protection and shelter from “predator creditors,” as well as meddlesome and/or avaricious spouses, relatives and “friends.”

This recent reduction in estate taxes opens up wonderful estate planning opportunities. It has given us, and our clients, new freedom. To the extent that estate taxes become irrelevant, we are free to go beyond pre-approved forms, and to draft documents that actually do what clients want, rather than what the Internal Revenue Code requires.