How to Prepare and File a CRUT Tax Return

A Charitable Remainder Unitrust (CRUT) is a trust that provides an income stream to a beneficiary for a set period, with the remaining assets eventually passing to a designated charity. While the trust itself is tax-exempt, the Internal Revenue Service (IRS) mandates an annual information return. This filing ensures the trust operates correctly and tracks distributions to income beneficiaries.

The trustee is responsible for this yearly filing. Failure to file without reasonable cause can lead to significant daily penalties that increase with the trust’s gross income and can jeopardize the trust’s tax-exempt status.

Information and Accounting Requirements for Form 5227

The trustee must begin by compiling all financial data for the trust’s tax year. This involves gathering a comprehensive set of records that details the trust’s financial activities. The trustee must have:

• A complete inventory of all assets held by the trust and their fair market value (FMV) as of the valuation date.
• A detailed accounting of all income generated, such as interest, dividends, and rental income.
• Documentation for any assets sold, including the cost basis, sale date, and sale price to determine capital gains or losses.
• A record of all deductible trust expenses, including trustee fees, investment management costs, and accounting fees.
• The exact amount and date of every distribution made to the income beneficiaries.

A core concept for CRUT distributions is the four-tier accounting system, a method mandated by the IRS to determine the tax character of payments. This system operates on a “worst-in, first-out” basis, meaning income with the highest tax rate must be distributed before income from a lower-taxed category.

The first tier is ordinary income, which includes items like interest and non-qualified dividends. The second tier is capital gains, with short-term gains distributed before long-term gains.

Once all ordinary income and capital gains are distributed, the third tier is other tax-exempt income, such as interest from municipal bonds. The final, fourth tier is the return of principal, also known as the trust corpus. Distributions from this tier are non-taxable to the beneficiary.

A separate consideration for the trustee is identifying any Unrelated Business Taxable Income (UBTI). This is income from a trade or business regularly carried on by the trust that is not substantially related to its charitable purpose. A common source is income from debt-financed property, such as a mortgaged rental property. If a trust has UBTI, it is subject to a 100% excise tax on that income for the year, though the trust retains its overall tax-exempt status.

Completing Form 5227 and Schedule K-1

The trustee uses Form 5227, the “Split-Interest Trust Information Return,” to report the CRUT’s annual financial activities to the IRS. The initial part of the form requires basic identifying details, including the trust’s name, its Employer Identification Number (EIN), and the trustee’s name and address.

Part I, Section A for unitrusts, is where the annual distribution calculation is reported. The trustee enters the FMV of the trust’s assets as of the valuation date and applies the payout percentage from the trust document to determine the required distribution amount.

Part II, the Schedule of Distributable Income, is where the four-tier accounting system is applied. The trustee reports all the trust’s income for the year, categorizing each item into one of the four tiers. Part III then details the actual distributions made to beneficiaries and characterizes that income according to the “worst-in, first-out” ordering rule.

The form’s balance sheet in Part V requires the trustee to report the trust’s assets, liabilities, and net assets at both the beginning and end of the tax year. This provides a snapshot of the trust’s financial health.

From the completed Form 5227, the trustee generates a Schedule K-1 for each income beneficiary. The Schedule K-1 breaks down the total distribution a beneficiary received and specifies the tax character of those funds—how much was ordinary income, capital gain, or other types of income.

Filing Procedures and Deadlines

For a CRUT on a calendar year, the filing deadline for Form 5227 is April 15th of the following year. If the trustee needs more time, an automatic extension can be obtained by filing Form 8868, “Application for Extension of Time To File an Exempt Organization Return,” before the original due date.

The return can be mailed to the address specified in the form’s instructions, which should be verified on the IRS website. Electronic filing is another option and is mandatory for trusts required to file 10 or more returns of any type in a calendar year. E-filing is done through an approved IRS e-file provider.

Trustees must also consider state-level obligations. Many states have separate registration and filing requirements for split-interest trusts. The trustee should consult a qualified tax professional or the state’s department of revenue to understand and fulfill any applicable state filing duties.

Reporting CRUT Distributions on a Personal Tax Return

When an income beneficiary receives their Schedule K-1, the focus of tax compliance shifts to them. The beneficiary must transfer the information from the Schedule K-1 to their personal income tax return, Form 1040. Each box on the Schedule K-1 corresponds to a specific line or schedule on the tax return.

For example, ordinary income from the K-1 is carried over to Schedule B (Interest and Ordinary Dividends). Any long-term capital gains are reported on Schedule D (Capital Gains and Losses), ensuring the income is taxed at the correct rate. If a portion of the distribution was tax-exempt income, this amount is noted on Form 1040 but does not increase the beneficiary’s taxable income.

Beneficiaries should retain a copy of every Schedule K-1 they receive. These documents are part of their tax records and provide the necessary documentation of the income’s source and character if the IRS has questions.