ACGA Suggests Solutions to Potentially Abusive CRT Transaction

ACGA Suggests Solutions to Potentially Abusive CRT Transaction

News story posted in Charitable Remainder Trust on 13 January 2009| comments
audience: National Publication | last updated: 18 May 2011
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Summary

Writing on behalf of the American Council on Gift Annuities, Conrad Teitell has drafted a letter to the Treasury and the IRS to suggest solutions in response to Notice 2008-99 in which the IRS and Treasury announced their interest in a type of transaction involving the sale of interests in a charitable remainder trust that might result in inappropriate tax avoidance by the trust

Background:

For background regarding this Notice, see the PGDC's prior reporting entitled, "Service Issues Trick or Treat Notice Regarding CRT Transaction."

See also Conrad Teitell's reporting from the December 2008 edition of Taxwise Giving entitled, "CRT Capital Gain Avoidance on IRS Radar" attached as a PDF file at the bottom of this page.

Full Text:

January 12, 2009

People of the Treasury and the Internal Revenue Service:

Comments submitted by the American Council on Gift Annuities (ACGA) (formerly the Committee on Gift Annuities). ACGA, formed in 1927, is an IRC §501(c)(3) organization described in IRC §170(b)(1)(A)(vi). ACGA’s board of directors and its legal counsel are all unpaid volunteers. ACGA is sponsored by over 1200 social welfare charities, health organizations, environmental organizations, colleges, universities, religious organizations and other charities. The Mission of ACGA is to “actively promote responsible philanthropy through actuarially sound charitable gift annuity rate recommendations, quality training opportunities and the advocacy of appropriate consumer protection.” American Council on Gift Annuities, 233 McCrea Street, Suite 400, Indianapolis, IN 46225. Phone: (317) 269-6271; Fax: (317) 269-6276; E-mail: acga@acga-web.org.

Prepared by: ACGA’s pro bono legal counsel, Conrad Teitell, Cummings & Lockwood, Six Landmark Square, Stamford, CT 06901. Phone: (203) 351-4164; Fax: (203) 708-3840; E-mail: cteitell@cl-law.com.

We support the Treasury’s and the Internal Revenue Service’s efforts to curb any abuses involving the tax treatment of charitable contributions. In fact, the charities initially alerted the Internal Revenue Service about the abusive so-called accelerated charitable remainder trust.

Clearly, Congress didn’t intend to allow the capital gains avoidance described in Notice 2008-99. And that avoidance should be curbed. Any corrective regulation or legislation should, however, also deal fairly with and not thwart proper transactions.

In these difficult economic times, some life-income recipients of charitable remainder trusts and the charitable remainder organizations wish to terminate those trusts early — the charities need funds now (instead of in the future when the trust term ends) and the life-income recipients need immediate funds (instead of piecemeal over the balance of the trust term). Improper capital gain avoidance is not on their radar.

The abuse under the facts detailed in Notice 2008-99 should be curbed by at a minimum reducing the life-income recipient’s basis in his interest to zero. However, the following two examples show how it would be unfair and not in furtherance of good tax policy to reduce in all cases the basis in the life-income recipient’s interest to zero on a sale to a third party of the respective interests of the life-income recipient and the charitable remainder organization.

The examples are followed by a suggested solution to the abuse outlined in Notice 2008-99. It is fair to the Treasury, the IRS, the life-income recipient, and the charitable remainder organization.

Example 1. Five years ago, a donor transferred securities valued at $1 million to fund a charitable remainder unitrust. The securities were not appreciated and had a $1 million basis and the CRUT took over the donor’s basis. The CRUT retained the assets used to fund the trust. The donor, who is the life-income recipient, and the charitable remainder organization now terminate the CRUT by selling their respective interests to a third party for $1 million, the current fair market value.

The life-income recipient’s interest is now valued at 60% of the fair market value of the CRUT’s assets and the charity’s remainder interest is now valued at 40% of the CRUT’s assets. So the life-income recipient receives $600,000 and the charity receives $400,000. It would be unfair for the life-income recipient’s basis to be deemed to be zero. In this case, he hasn’t through the CRUT stepped up the basis of the assets used to fund the trust. Thus the basis of his share of the trust assets sold to the third party should be $600,000. The same rule should apply if the CRUT sold the assets originally used to fund the trust and purchased other assets and at the time the trust is terminated those new assets are also valued at $1 million (with the life-income recipient’s then interest being valued at $600,000).

Example 2. Donor funded his charitable remainder unitrust with appreciated assets that had a basis of $800,000 and a $1 million fair market value and the trust took over the donor’s basis. The funding assets were sold by the CRUT and the proceeds reinvested in new assets having a $1 million fair market value. Five years after the CRUT was created, the life-income recipient and the charitable remainder organization sell their respective interests to a third party for $1 million. At that time, the life-income recipient’s interest is worth 60% of the value of the CRUT’s assets and he receives $600,000. It would be unfair (not intended by Congress) for him to have no capital gain — nor would it be fair for him to have a zero basis and a $600,000 capital gain. To thicken the plot, suppose the donor as the CRUT life-income recipient was taxed on some or all of the capital gain when it was deemed distributed to him and taxable under the capital gains category of Reg. Sec. 1.664-1. This should be taken into account in determining the life-income recipient’s basis on the termination of the CRUT.

Suggested solution — fair to the Treasury, the IRS, the life-income recipient and the charitable remainder organization on a sale by the life-income recipient and the charity of the trust assets to a third party. The life-income recipient’s basis is his pro rata share of the charitable remainder unitrust’s or annuity trust’s basis reduced by his pro rata share of any undistributed amounts then in the capital gains category of Reg. Sec. 1.664-1. Hereinafter, this suggested solution is called the “adjusted uniform basis rule.”

ACGA requests that when the situation described in Notice 2008-99 is addressed, that you also issue guidance on the following related situations involving early termination of charitable remainder unitrusts and annuity trusts so that donors, charities and their advisers can plan without having to seek costly private letter rulings. This would also reduce the workload of the Service’s overburdened staff. (The safe-harbor charitable remainder and charitable lead unitrust and annuity trust specimen agreements that have been issued by the Service are examples of how published guidance has benefitted donors, charities, their advisers and the Service.)

  • The adjusted uniform basis rule should apply not only when a charitable remainder trust is terminated by the parties’ sale of their respective interests to a third party, but also to a termination of the trust with the assets being divided pro rata between the life-income recipient and the charitable remainder organization. It is not wise public policy to require the life-income recipient and the charitable remainder organization to go through the exercise and expense of finding and then selling the trust assets to a third party. If the adjusted uniform basis rule is adopted for a termination by a sale to a third party, it should also apply to a pro rata distribution of the assets between the parties. Since capital gain won’t be improperly avoided under the adjusted uniform basis rule, that rule should also be made applicable in the latter situation by guidance in the form of a revenue ruling, revenue procedure, regulations or otherwise.
  • Apart from the capital gain treatment on the early termination of a charitable remainder trust is the issue of the valuation of the life-income recipient’s interest on the termination of a net-income-with-makeup charitable remainder trust (NIM-CRUT). In Letter Rulings 200725044 and 200833014 the Service ruled that on early termination of a NIMCRUT, “one” reasonable method of calculating the actuarial value of the income interest upon early termination is to use the lower of the stated percentage distribution rate of the NIMCRUT or the section 7520 rate in effect for the month of termination. This special rule has never been applied, it should be noted, in computing the charitable deduction on the creation of a NIMCRUT.

    We believe it is important that the computation of the value of the life-income recipient’s and the charitable remainder organization’s interests on both the creation and early termination of a NIMCRUT accurately reflect the respective values of those interests. The cited letter rulings specify “one” method of calculating the value of the NIMCRUT’s income interest on early termination. Another way to determine the value of a NIMCRUT’s life-income recipient’s interest on early termination would be to have a qualified appraisal on what a reasonable buyer would pay a reasonable seller both having knowledge of relevant facts and neither being under compulsion to buy or sell. If this additional approach were to be adopted, guidance should be given on the qualification of the appraiser and other appraisal requirements.
  • The IRS has suspended issuing letter rulings on the early termination of charitable remainder unitrusts and annuity trusts. Most recently in Rev. Proc. 2009-3 under Section 5. Areas under study in which rulings or determination letters will not be issued until the Service resolves the issue through the publication of a revenue ruling, revenue procedure, regulations or otherwise, it is stated:

.09 Section 664. — Charitable Remainder Trusts. — Whether the termination of a charitable remainder trust before the end of the trust term as defined in the trust’s governing instrument, in a transaction in which the trust beneficiaries receive their actuarial shares of the value of the trust assets, causes the trust to have ceased to qualify as a charitable remainder trust within the meaning of §664.

This pronouncement can have a deep-freeze effect on the non-abusive early termination of charitable remainder trusts. And the ability to do so, as stated earlier, is important to charitable remainder organizations and life-income recipients in these troubled economic times.

We ask that the issues in Notice 2008-99 and those that we have raised in this letter be resolved promptly and that published guidance be issued — thus making letter rulings necessary only in unusual cases. We ask that the published guidance cover these points:

  • The adjusted uniform basis rule be allowed for sales of the respective interests to a third party and also be allowed for a pro rata distribution of the assets between the life-income recipient and the charitable remainder organization.
  • An early termination of a charitable remainder unitrust or annuity trust by either a sale to a third party or a pro rata distribution of the assets between the life-income recipient and the charitable remainder organization must be authorized under the law of the state governing the trust. If state law requirements have been met, a letter ruling is not required if the life-income recipient furnishes an affidavit that he is unaware of any medical condition that would shorten life expectancy and also furnishes an affidavit from his physician that he has examined the life-income recipient and he has a normal life expectancy.
  • Specify the approved (but not exclusive) methods of valuing the life interest and the remainder interest on the termination of a net-income-with-make-up and a net-income-with-no-make-up charitable remainder unitrust.
  • If a charitable remainder unitrust or annuity trust is terminated following the Treasury’s and the IRS’s guidance, none of the self-dealing rules will apply to any of the parties to the trust and its trustees and the charitable remainder trust will not be subject to termination tax.
  • Appropriate forms for reporting the details of an early termination should be issued so that the Service has notice.
Conclusion. The American Council on Gift Annuities appreciates this opportunity to express our views on Notice 2008-99. Please let us know if you wish additional information or amplification. We ask that any guidance issued by the Treasury and the IRS not be final, but in proposed form so that the American Council on Gift Annuities and other interested parties may make their views known. Thank you.
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Notice 2008-99 -- Explanation.pdf74.29 KB

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