ACTEC Urges Withdrawal of Charitable Remainder Trust Guidance

ACTEC Urges Withdrawal of Charitable Remainder Trust Guidance

News story posted in Revenue Procedures on 9 January 2006| comments
audience: National Publication | last updated: 18 May 2011
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Summary

Judith McCue of the American College of Trust and Estate Counsel, Los Angeles, has submitted comments on recent guidance (Rev. Proc. 2005-24) requiring spousal election waivers for charitable remainder trusts, identifying several problems and recommending a conceptual framework for addressing the IRS's underlying concerns.
Full Text:

The Honorable Mark W. Everson
Commissioner
Internal Revenue Service
Courier's Desk
111 Constitution Avenue, N.W.
Washington, D.C. 20044

Re: Revenue Procedure 2005-24

Dear Commissioner Everson:

I am pleased to submit the comments of the American College of Trust and Estate Counsel ("ACTEC") with respect to Revenue Procedure 2005-24, 2005-16 I.R.B. 909, effective March 30, 2005 ("Rev. Proc. 200524"). ACTEC is a non-profit professional association comprised of approximately 2,600 lawyers who are selected on the basis of professional reputation and ability in the fields of trusts and estates and on the basis of having made substantial contributions to those fields through lecturing, writing, teaching, and bar leadership activities.

The purpose of this letter is not only to express ACTEC's reservations with respect to Rev. Proc. 2005-24 but also to propose a conceptual framework for addressing both the concerns of the Internal Revenue Service (the "Service") as embodied in Rev. Proc. 2005-24 and the concerns of estate planning lawyers and trustees of charitable remainder trusts ("CRTs").1


SUMMARY OF REV. PROC. 2005-24

According to SECTION L, PURPOSE AND SCOPE, Rev. Proc. 2005-24 applies to any CRT created by a grantor, if under applicable state law, the grantor's surviving spouse has a right of election exercisable on the grantor's death to receive an elective, statutory share of the grantor's estate, and such share could be satisfied in whole or in part from assets of the CRT in violation of Internal Revenue Code (the "Code") § 664(d)(1)(B) or § 664(d)(2)(B).2 Rev. Proc. 2005-24 provides a safe harbor under which a right of election will be disregarded for purposes of determining whether a CRT meets the requirements of Code § 664(d)(1)(B) or § 664(d)(2)(B), whichever is applicable, continuously since its creation3 if the grantor's spouse irrevocably waives the right of election in the manner prescribed.4

To take advantage of the safe harbor provided by Rev. Proc. 2005-24, three requirements must be met. First, the grantor's spouse must execute a written, irrevocable waiver of any right to elect against assets held in a CRT for the CRT to be considered to function exclusively as a CRT from its inception. Such waiver must be valid under applicable state law and must be dated and signed by the grantor's spouse. Second, the waiver must be executed on or before the "due date." For this purpose the due date is six (6) months after the due date (excluding extensions of time to file actually granted) of the CRT's tax return5 for the year in which the later of the following occurs: (1) the creation of the CRT; (2) the date of the grantor's marriage; (3) the date the grantor becomes domiciled or resident in a state whose law provides a right of election that could be satisfied from CRT assets; or (4) the effective date of a change in applicable state law creating a right of election. Third, the grantor must provide the trustee of the CRT with a copy of the signed waiver. The trustee must retain the copy of the waiver with the official records of the CRT.


PROBLEMS WITH THE "SAFE HARBOR" WAIVER

Set forth below is a list of problems identified by ACTEC6 associated with the safe harbor waiver approach adopted by Rev. Proc. 2005-24:

The Donor's Perspective. For a donor, Rev. Proc. 2005-24 presents the following problems:

  • The donor will be forced to incur additional expense and inconvenience in order to determine (with counsel) whether a spousal waiver is necessary and, if so, to prepare and obtain the spousal waiver. The spouse may also seek separate counsel at the donor's expense.
  • The donor will be forced to incur additional expense and inconvenience to revisit (with counsel) the spousal waiver requirement (and possibly notifying the trustee of the CRT) upon the donor's remarriage or change of domicile, and even of monitoring the probate law of the state of the donor's existing domicile for potentially relevant changes.
  • The donor may experience considerable difficulty with the current spouse (or any future spouse) in discussing and obtaining the spousal waiver. Such difficulty may also involve added expense and inconvenience to (a) review (with counsel) existing or future prenuptial/postnuptial agreements to determine the sufficiency of those documents for these purposes and/or (b) obtaining separate counsel for the spouse if required under state law to obtain a valid waiver. In our experience, many spouses are often wary when asked to sign any waiver of rights, even if there are no rights to waive or if the exercise of such rights is effectively prohibited by federal tax law (see discussion of Code § 4941 below).
  • There are potentially draconian consequences (such as loss of the donor's income, gift, and estate tax charitable deductions and loss of the CRT's tax-exempt status) if the donor fails to comply with the safe harbor spousal waiver, whether such failure is knowing or unknowing and whether presently or in the future.
  • It is impossible (notwithstanding the "safe harbor" label) to know or ensure that a trust will be a qualified CRT as of the date of its inception and on an ongoing basis, regardless of changes in circumstances. This means that a donor cannot rely on the income, gift, and estate tax status of a CRT in other tax and estate planning matters.
  • It may be necessary to provide a trustee with sensitive personal information about the donor, the donor's spouse, and/or their relationship. It may also be necessary for the donor to make representations to the trustee and to release and/or indemnify the trustee for relying on the donor's representations.

The Trustee's Perspective.

The trustee of a CRT must also be concerned with the requirements of Rev. Proc. 2005-24:

  • When a CRT is established, the trustee will incur added expense and inconvenience in order to determine (with its own counsel) whether a spousal waiver is necessary. In a case where the trustee is also the charitable remainder beneficiary of the CRT, a donor-relations problem may arise, particularly if the donor and/or the donor's counsel disagrees with the trustee and/or the trustee's counsel as to the necessity of obtaining a spousal waiver or the legal sufficiency of a particular waiver.
  • The trustee of a CRT faces the same problems as the donor in terms of added expense and inconvenience of revisiting the spousal waiver issue (with counsel) whenever the trustee has actual knowledge of the donor's remarriage or change of domicile. Given the adverse tax consequences of failing to comply with Rev. Proc. 2005-24, a trustee may have a fiduciary duty to inquire periodically concerning the marital and domicile status of the donor. (How often a trustee may be required to inquire is another problem.) Even if the trustee does inquire, the donor may fail to provide information regarding his/her marital and/or domicile status in a timely fashion. Once again, if the trustee is also the charitable remainder beneficiary of the CRT, a donor-relations problem may arise, particularly if the trustee and/or the trustee's counsel disagrees with the donor and/or the donor's counsel as to the necessity of obtaining a spousal waiver in the event of the donor's remarriage or change of domicile. Even if there is no change in the donor's marital status or domicile, the trustee of a CRT is likely to have to monitor changes in the probate law of the state in which the donor is presently domiciled for potentially relevant changes.
  • Potential difficulty and donor-relations problems may arise in discussing these issues and related personal information with the donor and/or the donor's spouse. In addition, it may be prudent for trustees to obtain (in addition to any waiver) appropriate representations, releases, and/or indemnifications, which a donor would not ordinarily have to give. These potential problems will be exacerbated if (a) the donor and/or the donor's counsel disagrees as to necessity of obtaining representations, releases, and/or indemnifications or as to the sufficiency thereof in any particular instance and/or (b) the trustee must obtain and review (with counsel, at added expense and inconvenience) existing or future prenuptial/postnuptial agreements to determine the sufficiency of these documents for purposes of Rev. Proc. 2005-24.
  • It will be impossible (notwithstanding the "safe harbor" label) for a trustee to know and ensure, especially in administering CRTs and filing tax returns, that a CRT will be a qualified CRT as of inception and on an ongoing basis, regardless of changes in circumstances.
  • A trustee will not be able to rely on the effectiveness of default reliance provisions in a CRT governing instrument or elsewhere.
  • If a CRT is retroactively disqualified because a donor violates Rev. Proc. 2005-24, how is a trustee to deal with past tax returns? Currently there is no guidance on this subject.

The Charity's Perspective.

Any charity designated as the beneficiary of a CRT must also be concerned about Rev. Proc. 2005-24:

  • A charity will have the donor-relations problems discussed above whenever it agrees to serve as trustee of a CRT.
  • The additional expense and inconvenience of compliance with Rev. Proc. 2005-24 will have the net result of discouraging donors from establishing CRTs or cause them to contribute less.
  • The added expense of having the trustee comply with the requirements of Rev. Proc. 2005-24 will be borne by charity, either indirectly as more time spent in administration (for which no fee may be charged if the charity is acting as the trustee) or directly charged against the corpus of a CRT (in the form of higher trustee fees paid to a third-party trustee).

The Service's Perspective.
  • There will be increased uncertainty in auditing tax returns and other filings, resulting in more time being required by Service personnel and greater enforcement and collection difficulties.
  • A potential loophole or "whipsaw" opportunity may exist for taxpayers. A donor may initially take advantage of the tax benefits of establishing a qualified CRT and later (after expiration of the statute of limitations) claim that the CRT was not qualified from inception.
  • What are the ramifications of Rev. Proc. 2005-24 for other splitinterest charitable gifts (e.g., pooled income funds and remainder interests in personal residences or farms) that may also be subject to spousal election rights and thus ultimately involve similar requirements and problems?
  • What are the income, gift, and estate tax ramifications of Rev. Proc. 2005-24 for all gifts, including outright gifts and non-charitable gifts, that may also be subject to spousal election rights and thus be incapable of being completed gifts (at least without a spousal waiver, or even with a waiver, if new spousal election rights could emerge upon remarriage or change of domicile)?
  • How will the Service treat CRTs that have been retroactively disqualified because of a violation of Rev. Proc. 2005-24? Will only the donor's income and gift tax consequences be considered? Will the trustee be required to file amended tax returns for prior, presumably closed, years? If so, is the problem identified in Rev. Proc. 2005-24 worth the potential damage to the statute of limitations?
SUGGESTIONS

The Service takes the view in Rev. Proc. 2005-24 that the mere existence of a spouse's right of election exercisable on the grantor's death to receive an elective share of the grantor's estate that can be satisfied in whole or in part from assets of a CRT causes the CRT not to meet the definition of and function exclusively as a CRT from inception as required by Treasury Regulations § 1.664-1 (a)(4). Taking the position that a possible future event retroactively disqualifies a CRT from inception means that no trust can ever be sure to qualify as a CRT. Laws or future court decisions might change rights in or to a CRT in ways that cannot be foreseen today. Moreover, as noted above, instances of a surviving spouse actually seeking to satisfy an elective share right from assets of a CRT are rare. Thus, ACTEC believes that the Service is justified in concluding that the likelihood of any particular spouse actually taking assets of a CRT pursuant to an elective share right is so remote as to be negligible and may be ignored as a contingency which would cause the CRT to fail to meet the definition of and function exclusively as a CRT from inception.

Meeting the definition of and functioning exclusively as a CRT from inception are the Service's own requirements. They are not embodied in Code § 664. Therefore, ACTEC believes that the Service can and should amend Treasury Regulations § 1.664- 1(a)(4). At the end of the first sentence of the text of the regulation, language should be inserted to the effect that the mere existence of a spouse's right to elect against a CRT (and perhaps other inchoate rights) will not be regarded as a violation of the rule that a CRT must meet the definition of and function exclusively as a CRT from the creation of the trust. ACTEC proposes that the following language be added at the end of the existing regulation:


A trust will not be regarded as failing to meet the definition of and function exclusively as a charitable remainder trust from the creation of the trust merely because under applicable state law the grantor's spouse possesses a right to receive an elective share of the grantor's estate that may be satisfied in whole or in part from assets of the trust.

By amending the regulation as ACTEC proposes the Service can eliminate a major part of the problem identified in Rev. Proc. 2005- 24, to wit: that the mere possibility that the grantor's spouse could satisfy an elective share right from assets of a CRT (regardless of whether or not such right is ever exercised) violates Code § 664(d)(1)(B) or § 664(d)(2)(B), whichever is applicable. Once any concern that the mere existence of a spouse's right of election causes a CRT to violate Code § 664(d)(1)(B) or § 664(d)(2)(B) is alleviated, the Service can address what ACTEC believes is the only serious problem, which is the rare case in which a spouse actually exercises such a right of election.7

ACTEC believes that any case in which a donor's spouse actually exercises a right of election can be addressed by the Service under any or all of existing Code §§ 507, 4941, and 4945, all of which deal with private foundations and all of which are applicable to CRTs pursuant to the terms of Code § 4947(a)(2). Code § 507 deals with termination of private foundation status and will be discussed last below. Code § 4941 imposes an excise tax on self- dealing by private foundations with disqualified persons. Code § 4945 imposes an excise tax on taxable expenditures made by private foundations.

Code § 4941. Code § 4941 imposes two levels of tax on any act of self-dealing. The initial tax is 5% of the amount involved with respect to the act of self-dealing for each year (or part thereof) in the taxable period.8 If an act of self-dealing is not corrected within the taxable period an additional tax of 200% of the amount involved is imposed on the disqualified person who participated in the act of self-dealing.9 Code § 4941 (d)(1)(E) defines self- dealing as any direct or indirect "transfer to, or use by or for the benefit of, a disqualified person of the income or assets of a private foundation. . ." The spouse of a grantor of a CRT trust is a disqualified person under Section 4946(d), because the spouse is a member of the family of a disqualified person. Therefore, any transfer of income or assets of a CRT to a surviving spouse, regardless of how or why made, would be an act of self-dealing subject to both the initial 5% tax and to the additional 200% tax under Code § 4941.10

As noted above, the Code § 4941 excise tax is imposed on the disqualified person, not on the private foundation itself. Therefore, the possibility that this penalty can be imposed by the Service can and should be a total disincentive for a surviving spouse to seek to satisfy any elective share right from CRT assets. To that end, it may be useful for the Service to require that the governing instrument contain language that warns any spouse of the grantor that such a claim will be considered an act of self-dealing under Code § 4941.11 In addition, the Service may want to require the trustee of a CRT to report to the Service any claim of any kind made by the grantor's spouse in an appropriate and timely manner.

Code § 4945. Code § 4945 imposes an excise tax on each taxable expenditure of a private foundation. The initial tax is 10% of the amount of the taxable expenditure, and it must be paid by the private foundation.12 If a taxable expenditure is not corrected within the taxable period, an additional tax of 100% of the amount of the taxable expenditure is imposed on the private foundation.13

"Taxable expenditure" is defined in Code § 4945(d). Several parts of the definition do not apply in the context of a surviving spouse who seeks to satisfy an elective share claim with assets of a CRT. But one part of the definition is clearly relevant. A taxable expenditure is any amount paid or incurred by a private foundation for any purpose other than one specified in Code § 170(c)(2)(B).14 Code § 170(c)(2)(B) refers to "religious, charitable, scientific, literary, or educational purposes, or to foster national or international amateur sports competition . . ., or for the prevention of cruelty to children or animals." Clearly, the enrichment of a surviving spouse does not fall within any of those purposes. Therefore, any amount paid from a CRT to a surviving spouse to satisfy an elective share right is necessarily a taxable expenditure under Code § 4945(d)(5).

As noted above, the Code § 4945 excise tax on taxable expenditures is imposed on the private foundation, not directly on the disqualified person. Moreover, the tax cannot be imposed until after a taxable expenditure has been made. So, if a CRT has already distributed funds to a surviving spouse to satisfy an elective share right, the trustee of the CRT may lack funds with which to pay the excise tax.15 Therefore, this may be a less potent remedy for the problem identified in Rev. Proc. 2005-24 than the prohibition against self-dealing under Code § 494 1. Nevertheless, it may still be useful to require that the governing instrument warn any spouse of the donor that a transfer of assets to a spouse in satisfaction of an elective share claim will be considered a taxable expenditure under Code § 4945. Once again, the Service may choose to require the trustee of a CRT to report to the Service any claim made by the grantor's spouse in an appropriate and timely manner.

Code § 507. Private foundation status can be terminated under Code § 507(a) if there have been either willful repeated acts (or failures to act) or a willful and flagrant act (or failure to act) giving rise to liability for tax under Chapter 42.16 If a private foundation is found to have acted (or failed to act) as described in the preceding sentence, a termination tax is imposed which is equal to the lesser of (1) the aggregate tax benefit resulting from the Code § 5 01 (c)(3) status of the private foundation or (2) the value of the private foundation's net assets.17 Treasury Regulations § 1.507(c) provide as follows:


(1) For purposes of section 507(a)(2)(A), the term willful repeated acts (or failures to act) means at least two acts or failures to act both of which are voluntary, conscious, and intentional.

(2) For purposes of section 507(a)(2)(A), a willful and flagrant act (or failure to act) is one which is voluntarily, consciously, and knowingly committed in violation of any provision of chapter 42 (other than section 4940 or 4948(a)) and which appears to a reasonable man to be a gross violation of any such provision.

(3) An act (or failure to act) may be treated as an act (or failure to act) by the private foundation for purposes of section 507(a)(2) even though tax is imposed upon one or more foundation managers rather than upon the foundation itself.

(4) For purposes of section 507(a)(2), the failure to correct the act or acts (or failure or failures to act) which gave rise to liability for tax under any section of chapter 42 by the close of the correction period for such section may be a willful and flagrant act (or failure to act).

(5) No motive to avoid the restrictions of the law or the incurrence of any tax is necessary to make an act (or failure to act) willful. However, a foundation's act (or failure to act) is not willful if the foundation (or foundation manager, if applicable) does not know that it is an act of self-dealing, a taxable expenditure, or other act (or failure to act) to which chapter 42 applies. Rules similar to the regulations under chapter 42 (see, for example, section 5 3.4945 -1 (a)(2)(iii) of this chapter) shall apply in determining whether a foundation or a foundation manager knows that an act (or failure to act) is an act of self-dealing, a taxable expenditure or other such act (or failure to act.)


The Treasury Regulations do not specifically address whether a spouse attempting to take or actually taking some or all of the assets of a CRT by exercising a right of election is considered a willful and flagrant act giving rise to liability under Chapter 42.18 But an attempt to claim assets of a CRT pursuant to a spouse's right of election must certainly be interpreted as a voluntary, conscious, and knowing violation of provisions of chapter 42 (viz. Code §§ 4941 and 4945).

There are at least two approaches to ensuring that an attempt to claim assets of a CRT pursuant to a spouse's right of election would allow the Service to impose the excise tax penalty under Code § 507(c). One is simply to amend the Treasury Regulations under Code § 507(c) to make it clear that a mere claim to CRT assets by a surviving spouse will be treated as a willful and flagrant act giving rise to liability under Chapter 42. If that is considered by the Service to be insufficient "notice" to a spouse, then, in addition to amending the Treasury Regulations under Code § 507(c), the Service could require that (1) the governing instrument of a CRT state that any claim by a spouse to assets of the CRT pursuant to a right of election will be regarded by the Service as a willful and flagrant act giving rise to liability under Chapter 42, thereby causing involuntary termination under Code § 507(a), and (2) the trustee of the CRT give a copy of the governing instrument to the surviving spouse of the donor upon the donor's death. Then, if the surviving spouse still makes a claim against the CRT, the Service can invoke the penalty under Code § 507(c). As the distribution of the assets would be prohibited in the governing instrument, any election to claim the CRT assets would be willful. Since the surviving spouse would refuse to return the assets once having elected to take them, the act of self-dealing would also be flagrant.

As noted above in the context of Code §§ 4941 and 4945, the Service may choose to require the trustee of a CRT to report to the Service any claim of any kind made by a surviving spouse in an appropriate and timely manner.

Since the Code § 507(c) tax is imposed on the private foundation (as opposed to being imposed on the surviving spouse personally), the burden of the tax effectively falls on the charitable remainder beneficiary or beneficiaries. Therefore, it is a matter of tax policy whether this penalty should be invoked, as opposed to the options available under Code §§ 4941 and 4945 discussed above. Nevertheless, ACTEC believes that this penalty is available to the Service to deal with the problem identified in Rev. Proc. 2005-24.

Severance. In applying any of the remedies identified above, ACTEC believes that the Service should consider treating any portion of a CRT with respect to which a surviving spouse has made an elective share claim as having been severed from the rest of the CRT. In its private letter rulings in the divorce context the Service has been liberal regarding the division of one CRT into two separate CRTs.19 There appears to be no policy reason why any portion of a CRT not subject to a surviving spouse's elective share claim should be subjected to any of the foregoing penalties.


CONCLUSION

ACTEC believes that the Service is justified in concluding that the likelihood of any particular spouse actually taking assets of a CRT pursuant to an elective share right is so remote as to be negligible and may be ignored as a contingency which would cause the CRT to fail to meet the definition of and function exclusively as a CRT from inception. Therefore, ACTEC urges the Service to insert the following language at the end of the first sentence of Treasury Regulations § 1.664-1(a)(4):


A trust will not be regarded as failing to meet the definition of and function exclusively as a charitable remainder trust from the creation of the trust merely because under applicable state law the grantor's spouse possesses a right to receive an elective share of the grantor's estate that may be satisfied in whole or in part from assets of the trust.

By amending the Treasury Regulations in this fashion, the Service will accomplish two objectives. First, it will eliminate the problem identified in Rev. Proc. 2005-24, which is that the mere existence of a spouse's elective share right causes a trust not to meet the definition of and function exclusively as a CRT from inception. Second, it will have a corollary effect of preventing a surviving spouse from arguing years later that the private foundation prohibitions (Code §§ 507, 4941, and 4945) do not apply because the particular CRT did not meet the definition of and function exclusively as a CRT from inception. If the CRT is otherwise qualified (but for the existence of an inchoate spousal election right), then the private foundation provisions will apply at the time of any actual spousal claim.

For the many reasons stated above, ACTEC does not believe that the safe harbor provided by Rev. Proc. 2005-24 is practical. Obtaining a spousal waiver that is valid under state law will cause increased expense and inconvenience for donors and CRT trustees alike. In addition, in many cases the requirement may cause friction between charities and their donors. Even from the Service's perspective, retroactive disqualification of a CRT leads to complicated statute of limitations issues and to problems in computing the tax consequences.

ACTEC believes that in the event there is an actual claim against a CRT by a surviving spouse that the trustee of the CRT should be required to report such claim to the Service in an appropriate and timely manner. Then, the portion of the CRT to which the surviving spouse's elective share claim does not apply, if any, should be treated as a separate CRT with respect to which no particular penalty or other remedy needs to be invoked.

ACTEC feels that the Service has all the tools it needs to deal with the problem identified in Rev. Proc. 2005-24 in the current statutory structure of the Code. Code §§ 507, 4941, and 4945 give the Service the authority to impose draconian penalties on the surviving spouse who actually makes an elective share claim, the trustee, or on the CRT itself. Although where any penalty should fall is a matter of tax policy, ACTEC feels that Code § 4941 is the best remedy of the three available, because the tax on self-dealing is imposed on the disqualified person -- the surviving spouse who is seeking to claim assets from the CRT. Requiring that CRT governing instruments contain additional language explicitly warning a spouse of the risk of seeking to claim a portion of a CRT in satisfaction of an elective share right should address any due process concern.

There may be concern that a surviving spouse could obtain an order from a state court that permits the distribution of assets from the CRT and that such order would prevent the Service from invoking any of the penalties described above. First, requiring the trustee of a CRT to give the Service notice in a manner considered appropriate and timely by the Service should minimize this risk. In the unlikely event it is deemed appropriate to do so, the Service could intervene in the state court action. Second and more importantly, as soon as it becomes aware that the surviving spouse has made a claim against assets of a CRT, the Service could send a notice of imposition of excise tax penalties to the surviving spouse. The Service's ability to impose excise tax penalties is in no way affected, let alone compromised or barred, by any state court action.20 Therefore, ACTEC does not believe that this should be a concern to the Service.

ACTEC hopes that the Service will withdraw Rev. Proc. 200524 and instead consider (1) amending the Treasury Regulations as discussed above, (2) adding governing instrument requirements for CRTs to warn spouses of grantors that any attempt to exercise elective share rights against a CRT will be treated as giving rise to the private foundation excise tax penalties described earlier in this letter, (3) requiring the trustee of a CRT to give appropriate and timely notice of any claim of any kind by a surviving spouse against a CRT, and/or (4) invoking the private foundation excise tax penalties discussed in this letter as and when necessary.

These comments were prepared by Robert J. Rosepink of Rosepink & Estes, P.L.L.C., Scottsdale, Arizona, Tumey Berry of Wyatt, Tarrant & Combs, L.L.P., Louisville, Kentucky, Martin Hall of Ropes & Gray, L.L.P., Boston, Massachusetts, Erik Dryburgh of Silk, Adler & Colvin, San Francisco, California, and Reynolds Cafferata of Rodriguez, Horii & Choi, L.L.P., Los Angeles, California.

We appreciate the opportunity to submit these comments and would welcome the opportunity to offer any additional assistance that might be desired, including a meeting in Washington, D.C., to discuss these issues.

Very truly yours,

Judith W. McCue
President
McDermott Will & Emery LLP
Chicago, IL

cc:
Mr. Eric Solomon
Mr. Donald L. Korb
Ms. Heather C. Maloy
Ms. Catherine V. Hughes
Ms. Susan Hurwitz Levy
Mr. Bradford Poston

CIU99 4557288-I.TO3146.0012

FOOTNOTES

1 It should be noted that ACTEC has conducted unscientific polls of many of its Fellows, all of whom must have practiced trusts and estates law for at least 10 years, and none had ever been involved a case in which a grantor's surviving spouse exercised a right of election which affected a charitable remainder trust.

2 Code § 664(d)(1)(B) defines a charitable remainder annuity trust as a trust "from which no amount other than the payments described in subparagraph (A) [the annuity amount] and other than qualified gratuitous transfers described in subparagraph (C) [the charitable remainder interest] may be paid to or for the use of any person other than an organization described in section 170(c)."

Code § 664(d)(2)(B) defines a charitable remainder unitrust as a trust "from which no amount other than the payments described in subparagraph (A) [the unitrust amount] and other than qualified gratuitous transfers described in subparagraph (C) [the charitable remainder interest] may be paid to or for the use of any person other than an organization described in section 170(c)."

3 Treasury Regulations § 1.664-1 (a)(4) provides: "In order for a trust to be a charitable remainder trust, it must meet the definition of and function exclusively as a charitable remainder trust from the creation of the trust."

4 Rev. Proc. 2005-24 applies to all CRTs created on or after June 28, 2005. For CRTs created prior to June 28, 2005, the Service will disregard the right of election, even without a waiver, if the grantor's spouse does not actually exercise a right of election.

5 Form. 5227.

6 Other organizations have identified many of the same problems. See American Council on Gift Annuities May 5, 2005, Comments to the Service concerning Rev. Proc. 2005-24; Association of the Bar of the City of New York July 15, 2005, Comments to the Service concerning Rev. Proc. 2005-24.

7 Amending the regulation as proposed above has the significant additional benefit of making it impossible for the surviving spouse to "whipsaw" the Service by retroactively claiming that the private foundation penalties discussed below cannot be invoked by the Service because a CRT did not meet the definition of and function exclusively as a CRT from its inception and, therefore, was not subject to the private foundation penalties. See discussion infra.

8 Code § 4941 (a)(1). An initial tax in the amount of 2-V2% may also be imposed on a foundation manager if the foundation manager has participated in the act of self-dealing. A trustee of a CRT is considered a foundation manager under Code § 4946(b)(1).

9 Code § 4941 (b). If an additional tax is imposed on a disqualified person and the foundation manager refuses to agree to part or all of the correction, an additional tax of 50% of the amount involved is imposed on the foundation manager.

10 There is an exception from the self-dealing prohibition for distributions of annuity or unitrust payments from a CRT to a surviving spouse under Code § 4947(a)(2)(A).

11 In Rev. Rul. 82-128, 1982-2 C.B. 71, the Service addressed state laws that allow the personal representative of a decedent's estate to recover estate taxes from trusts and other non-probate assets to the extent such assets cause estate tax. Rev. Rul. 82-128 required the governing instrument of a CRT to include language directing the donor to provide for payment of any estate tax attributable to the CRT with funds outside the CRT. If any such tax was not paid with outside funds, the governing instrument had to provide that the interest of the non-charitable beneficiary that was causing the tax was forfeited.

12 Code § 4945(a)(1). An initial tax in the amount of 2-1/2% may also be imposed on a foundation manager if the foundation manager agrees to making a taxable expenditure, unless the agreement is not willful and is due to reasonable cause. Code § 4945(a)(2).

13 Code § 4945(b)(1). If an additional tax is imposed on a disqualified person and the foundation manager refuses to agree to part or all of the correction, an additional tax of 50% of the amount involved is imposed on the foundation manager. Code § 4945(b)(2).

14 Code § 4945(d)(5).

15 Code § 4945(c)(2). This could expose the trustee to liability, although that liability is limited to $15,000.

16 Code §§ 4940 through 4948.

17 A CRT does not enjoy Code § 501(c)(3) status; hence a CRT is not exempt from federal income tax under Code § 501 (a). A CRT is exempt from federal income tax under Code § 664(c). Nevertheless, Code § 507(d)(1) defines the aggregate tax benefit as being the sum of (A) increases in income, gift, and estate tax of all substantial contributors (viz., the donor of a CRT) if deductions for contributions had been disallowed, (B) aggregate increases in income tax if the private foundation had not been exempt under Code § 501 (a) [which by definition a CRT is not], and (C) interest on the increases in tax under the prior two categories from the date on which each such increase would have been due and payable until termination of the private foundation.

18 Treasury Regulations § 53.4947-1 (e) provides that a split-interest trust is not terminated under Code § 507(a) simply because it makes a payment required under the governing instrument to a non-charitable beneficiary.

19 PLRs 200502037, 200333013. 200304025, 200301020, 200221042,200143028,200120016,200109006,200045038,and 200035014.

20 State courts often issue orders or take other actions determining interests of surviving spouses and others with respect to a decedent's estate. Such orders and actions do not affect the Service's power to impose transferee liability on a surviving spouse or others to collect federal estate tax under Code § 6901.


END OF FOOTNOTES

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