A flip unitrust generates net income for a period of time defined by the donor, after which the trust “flips” and begins to pay the stated payout rate. A flip unitrust can be an excellent way for you to give an asset that may take time to sell and receive substantial payments for life once the asset is sold. You might also be interested in using a flip unitrust to make a gift now that will supplement your income in the future, such as when you retire.
A charitable flip unitrust could be right for you if:
- You want to give an asset that is hard to sell (such as real estate or closely-held stock).
- You want to provide income for yourself or others, or supplement your retirement income.
- You want the possibility of income growth.
- You itemize your deductions and want to save income or capital gains taxes.
- You want to make a generous gift to GDS.
- You are considering a gift amount of $100,000 or more.
Example
Jeff Reynolds, a 58-year-old alumnus, made a wise $50,000 investment in Berkshire Hathaway stock years ago. It's now worth $1,200,000. He makes the maximum contribution to his 401(K) retirement plan each year and is interested in options for generating additional retirement income. He also would like to make a major gift to GDS.
After consulting with his advisors, Jeff chooses to fund a 5% flip unitrust with $1,200,000 in Berkshire Hathaway stock. His unitrust will flip payment methods when he turns 68, the age at which he expects to retire. In the intervening years, the trustee is free to sell the stock to reinvest in a diversified portfolio without paying any capital gains tax.
Since Jeff doesn't want to receive payments from the trust while he is still working, the trustee can focus on investing for growth and minimizing net income during the trust's pre-flip years and maximizing income during his retirement years.
Benefits
Jeff will receive an income tax charitable deduction of $403,416. He has enough income to be able to use all of his deduction over his next five tax returns. If he itemizes deductions, the gift will substantially reduce his income taxes during this period. Once Jeff turns 68, he can rely on receiving 5% of the value of his flip unitrust each year for the rest of his life.
What’s more, if the income and appreciation of the trust's investments total 7.0% annually and Jeff lives for his life expectancy, over $3,177,033 will be left in his trust to support GDS.
Separate trust
A charitable remainder unitrust with a flip provision is a tax-exempt trust governed by a trust agreement. You choose the trustee who is responsible for administering your trust and guiding the investment of its assets. Georgetown Day School may also act as trustee.
Irrevocable gift
A flip unitrust is an irrevocable arrangement. Once you transfer assets to create the trust, you cannot change your mind and get the assets back. This requirement assures that whatever value remains in your flip unitrust when it ends will be used to support GDS.
Payments made for duration of trust
A flip unitrust will make payments to individuals, such as you, or you and your spouse, for as long as the trust lasts. The amount of its payments will depend on several factors, including whether the trust has flipped.
Remaining assets to Georgetown Day School
When your flip unitrust ends, all of its remaining principal will become available to support GDS.
Determination of payment amount before and after flip
Initially, a flip unitrust makes payments each year equal to a percentage of its value, as revalued annually, or its net income, whichever is less. If the flip unitrust earns no net income during this period, for example, it makes no payments. After the unitrust flips, it makes payments equal to a percentage of its value, as revalued annually, regardless of its net income. If it earns 3% net income one year during this period, for example, but has a stated payment percentage of 5%, it will pay 5% of its value from income and realized capital gain for the year.
Designated event causes flip
You designate the event that will cause your trust to change how it determines payment amounts. The event must be an occurrence that is not within your control, or the control of the beneficiary, the trustee, or any other person. A typical triggering event may include the date you plan to retire or the sale of an unmarketable asset with which the unitrust was funded. The change in payment method takes effect on January 1 of the year following the triggering event.
You choose the payment percentage
You choose the percentage of your trust’s value that it must distribute to its income beneficiaries each year, once it flips. The trust is revalued anually. This payment percentage must be at least 5%. It may be to your advantage to choose a relatively low payment percentage so that the assets have the best chance to grow. If the value of your trust grows, so will its payments. A payment rate of 5% to 6% is typical. Payments are usually made in annual, semiannual, or quarterly installments.
Who can receive payments?
You decide who will get the payments from your flip unitrust. Usually, this will be you, or you and your spouse. You can, however, select other people to receive the payments. For example, you may wish to provide income for parents, a sibling, or children.
How long do payments last?
While most flip unitrusts last for the lives of one or two payment recipients, other terms are possible. A unitrust can last for more than two lives, for a specific length of time of up to 20 years, or for a combination of lives and years.
Tax benefits
- Tax savings from an income tax charitable deduction, if you itemize.
- Avoid capital gains tax.
- May reduce estate taxes and probate costs.
You will receive an income tax charitable deduction in the year of your gift, if you itemize. If you cannot use the entire deduction that year, you may carry forward your unused deduction for up to five additional years.
If you donate appreciated assets to fund your flip unitrust, you will not pay any capital gains tax when you make your gift. In addition, because a flip unitrust is tax-exempt, it will not pay any capital gains tax when it sells these assets. This means that your trustee will be able to reinvest the full value of the assets you donate. By removing the gift assets from your estate, you may also reduce estate taxes if your estate exceeds the estate tax credit. You may also reduce probate costs when your estate is settled.
Taxation of payments
The taxation of flip unitrust payments depends on the trust’s past distributions and investment performance. Payments are typically taxed as ordinary income. If the trust is funded with appreciated assets, a portion of the payments could be taxed at lower capital gains tax rates in some years. It is possible for a portion of the payments to be tax-free in years when there is not enough ordinary income and capital gain income to make the payments.
Add funds anytime
You can make additional gifts to your flip unitrust at any time. Additions generate an additional income tax charitable deduction that may save you income taxes if you itemize. You will also increase your future payments without the effort and expense of creating a new flip unitrust.
Assets to consider giving
The following assets make excellent sources for funding your flip unitrust:
- Cash that you currently have in a savings account, bank CD, money-market fund, or other safe but low-yielding investment.
- Securities, especially highly-appreciated securities.
- Real estate that is debt-free, closely-held stock, and other assets that may take time to sell.
Flip unitrust as retirement supplement
A flip unitrust can work nicely as a supplemental retirement plan that also supports GDS. The trustee of your flip unitrust can focus on asset growth during its pre-flip years, generating minimal or no payments to you during its early years when you don't need the income. If you set up your unitrust to flip payment methods in the year you expect to retire, then it will make payments to you equal to its full percentage amount, such as 5% or 6% of its value, starting when you need the income.
Flip unitrust as way to increase income from asset that may take time to sell
A flip unitrust also can work as a way to make a gift of an asset that may take time to sell, such as real estate or closely-held stock, and increase your income at low tax-cost. During your unitrust's pre-flip period, the trustee can focus on selling your asset at a fair price without worrying about making payments to you when there isn't enough income available to make them. The sale of your asset can trigger your unitrust to flip payment methods so that from then on your unitrust will pay you its stated percentage amount every year. Since your flip unitrust is tax-exempt, the trustee will be able to reinvest all of the proceeds from the sale of the asset.