Charitable Remainder Trusts as a Diversification Exit

A 55-year-old post-IPO employee has $5 million of employer stock, basis $600,000. She wants to diversify, generate retirement income, and leave something to charity eventually. Selling triggers $1.05 million of federal and state tax, leaving $3.95 million to reinvest. An alternative: contribute the stock to a charitable remainder trust. The CRT sells the stock inside the trust (no tax at the trust level), reinvests the full $5 million in a diversified portfolio, pays her an annuity or unitrust amount for life, and distributes what remains to a named charity at her death.

The upfront charitable deduction (present value of the remainder interest, based on IRS actuarial tables) is roughly $1 million, worth $370,000 at a 37% marginal rate. The trust generates taxable income to her as distributions flow through, but the income profile can be managed over decades, and the full sale proceeds compound inside the trust.

For the right holder, the CRT is the cleanest tool to convert a concentrated position to diversified income with lifetime utility and a charitable finish.

The mechanics under IRC Section 664

IRC §664 defines the charitable remainder trust. Two standard structures:

CRAT (Charitable Remainder Annuity Trust). Pays the income beneficiary a fixed dollar amount annually (at least 5% of initial fair market value, not more than 50%). Once set, the payment never changes. No additional contributions permitted after initial funding.

CRUT (Charitable Remainder Unitrust). Pays the income beneficiary a fixed percentage of the trust’s annual fair market value (at least 5%, not more than 50%), recalculated each year. Additional contributions permitted. Several variants exist: standard CRUT, NICRUT (net income only), NIMCRUT (net income with makeup), flip CRUT (starts as NIMCRUT, flips to standard).

For concentrated-stock exit planning, the flip CRUT is often the chosen structure. It starts as a NIMCRUT (paying only actual income earned, which may be near zero while the trust holds the concentrated stock), flips to a standard CRUT at a triggering event (typically the sale of the concentrated stock), and then pays a fixed percentage of annual value from a diversified portfolio.

The immediate tax benefits

At funding, the donor receives a charitable income-tax deduction equal to the present value of the remainder interest. The remainder interest is calculated using IRS actuarial tables based on:

The §7520 rate in the month of funding (or the prior two months, donor’s choice).
The age(s) of the income beneficiary.
The payout rate of the CRT.

Higher §7520 rate, older beneficiary, lower payout rate: larger remainder interest (and larger deduction). Lower §7520 rate, younger beneficiary, higher payout rate: smaller remainder interest.

In April 2026, the §7520 rate is in the high 4% range. For a 55-year-old with a 5% unitrust payout, the remainder interest is typically 30-40% of the contribution. For the $5M example, that’s $1.5M to $2.0M of charitable deduction.

The deduction is limited to 30% of AGI for contributions of appreciated long-term capital gain property to a CRT where the charity is a public charity; 20% for private foundations. Excess carries forward five years.

The trust takes the donated stock with carryover basis. When the trust sells, the gain is realized at the trust level but the CRT is a tax-exempt entity under §664, so no tax at the trust level. The trust can reinvest the full sale proceeds.

Income taxation on distributions: the four-tier system

IRC §664(b) imposes a character-ordering rule on distributions to the income beneficiary:

Tier 1: Ordinary income. Distributions are treated as ordinary income first, to the extent the trust has current and accumulated ordinary income (interest, non-qualified dividends, short-term gains).
Tier 2: Capital gains. Once ordinary is exhausted, distributions are capital gains (long-term first, then short-term) to the extent of the trust’s current and accumulated capital gains.
Tier 3: Tax-exempt income. After capital gains, tax-exempt interest.
Tier 4: Return of principal. Only after all tiered income is exhausted.

Practical effect for the concentrated-stock case: when the trust sells the donated stock, it generates a large pool of long-term capital gain (at the trust level, untaxed). That pool sits in the Tier 2 bucket. Distributions to the beneficiary come out first as whatever current-year ordinary income exists (typically small in a diversified bond-heavy portfolio), then as long-term capital gains until the big pool is exhausted.

For the $5M example with $4.4M of embedded gain at funding, the Tier 2 pool starts at $4.4M. Annual distributions at 5% of $5M = $250K each year. Current ordinary income inside the trust might be $50K (interest). So distributions come out as $50K ordinary, $200K long-term capital gain. That happens every year until the $4.4M pool is exhausted, which at $200K per year takes 22 years.

The beneficiary pays tax on distributions as received. In a CRT, the taxation of the sale is spread over many years instead of hitting in one year.

Comparison: CRT vs direct sale vs exchange fund

Approach	Tax on sale today	Ongoing income	Lifetime flexibility	Final disposition
Direct sale	Full gain in year of sale	From reinvested after-tax proceeds	Full	Owner’s estate
Exchange fund	None for 7 years	Fund distributions (small)	Locked 7 years	Pro-rata basket, owner’s estate
CRT	None at trust level, annual spread to beneficiary	5%+ of trust value per year	Locked into trust	Charity
Hold + step-up at death	None if held to death	Dividends only	Full	Heirs (stepped-up basis)

The CRT wins on spread-over-time taxation and lifetime income but loses the principal to charity at death. For holders with strong charitable intent, this is a feature. For holders without, it is the cost.

The Rockefeller case and step-transaction risk

The IRS challenges CRTs that are funded and then immediately sold where the sale appears pre-arranged. The classic issue: if the donor has a binding agreement or “ripened” plan to sell before funding the CRT, the IRS will apply the assignment-of-income doctrine and tax the donor personally on the sale.

Rev. Rul. 78-197 set the rule: a CRT can be funded with appreciated stock where a future sale is anticipated, but the trustee must have genuine discretion over whether to sell. A letter of intent to sell, an existing contract, or a shareholder tender commitment typically fails this test.

For concentrated-stock planning before a liquidity event, this means CRTs must be funded well before the sale is pre-arranged: ideally before an S-1 is filed or a deal is signed. Inside of six months of a known transaction, the risk grows significantly.

Trust administration and costs

CRTs require a trustee. Options:

Individual trustee (friend, family, or the donor in limited cases). Cheapest but requires expertise.
Professional trustee at a bank or trust company. Fees 0.5-1.0% per year.
Charitable trustee (some charities sponsor CRTs and serve as trustee for no additional fee beyond the expectation of remainder).

The CRT files Form 5227 annually. Investment management is often separate, adding 0.5-1.0%. Total annual cost for a professionally administered CRT is typically 1% to 1.5% of assets.

Amendment is difficult. Once funded, the CRT’s terms are fixed. Payout rate, beneficiary, charity can all be difficult or impossible to change. The donor should be confident in the structure before funding.

Frequently asked

Can I serve as trustee of my own CRT? Yes, but self-trusteeship creates self-dealing risk and administrative complexity. Most donors use a professional trustee for larger CRTs.

Can I change the charity beneficiary later? If the trust document permits, yes. Some CRTs name a charitable-giving umbrella (like a donor-advised fund sponsor) and allow the donor to recommend distributions at death.

What if I die before the trust exhausts the Tier 2 gain pool? The remaining trust goes to charity. The beneficiary’s stream stops. Any undistributed gain disappears (the charity is tax-exempt).

Can I use a CRT for pre-IPO stock? Yes, but the trust needs liquid assets to pay the unitrust or annuity amount. A flip CRUT (NIMCRUT until sale event) is the standard structure for pre-IPO funding.

What is the minimum trust size? Practically, $250K to $500K is the minimum for cost efficiency. Below that, administrative costs consume too much of the payout.

Next step

Run the numbers with your specific ages, payout rate preference, and charity choice. Compare the 30-year after-tax, after-fee total to your family of direct-sale-and-reinvest, staged-selling, and exchange-fund alternatives. If lifetime income, spread-gain taxation, and charitable remainder all fit your goals, engage a trust and estates attorney to draft the CRT at least 90 days before any liquidity event is in motion.