AICPA Suggests Changes to CRAT, CRUT Safe Harbor Guidance

AICPA Suggests Changes to CRAT, CRUT Safe Harbor Guidance

News story posted in Revenue Procedures on 13 June 2005| comments
audience: National Publication | last updated: 18 May 2011
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Thomas Purcell III of the American Institute of Certified Public Accountants has joined the chorus in recommending either changing or withdrawing guidance on spousal election rights and charitable remainder trusts, warning that the guidance is not only confusing but also creates traps for taxpayers and practitioners.
Full Text:

June 8, 2005

The Honorable Mark W. Everson
Commissioner
Internal Revenue Service
Courier's Desk
1111 Constitution Avenue, NW
Washington, DC 20044

RE: Rev. Proc. 2005-24 Regarding Guidance on Spousal Election Rights and Charitable Remainder Trusts under IRC section 664

Dear Commissioner Everson:

Enclosed are comments from the American Institute of Certified Public Accountants (AICPA) regarding Rev. Proc. 2005-24. Rev. Proc. 2005-24 provides guidance on spousal election rights and charitable remainder trusts under Internal Revenue Code (IRC) section 664. This Rev. Proc. requires in certain circumstances the grantor's spouse to waive his or her right to claim a portion of the charitable remainder trust as part of the spouse's statutory share of the grantor's estate (hereinafter referred to as "waiver").

The American Institute of Certified Public Accountants is the national, professional association of CPAs, with approximately 350,000 members, including CPAs in business and industry, public practice, government, and education; student affiliates; and international associates. Our members advise clients on federal, state, and international tax matters, and prepare income and other tax returns for millions of Americans. Our members provide services to individuals, not-for-profit organizations, small and medium-sized businesses, as well as America's largest businesses.

We are writing to express our concerns about Rev. Proc 2005-24, 2005 I.R.B. 1, released on March 30, 2005. As currently worded, Rev. Proc. 2005-24 creates many traps for the unwary and has the potential to disqualify every inter vivos charitable remainder trust, created on or after June 28, 2005. Even experts who devote a significant part of their practice to this area have difficulty understanding whether a waiver is necessary. In addition, taxpayers who create a valid trust may not realize the need to consult subsequently with an adviser as their circumstances change.

The potential traps for the unwary created by Rev. Proc. 2005-24 include:

  • Practitioners will need to consider whether a post-nuptial agreement is effective to waive a spouse's rights under applicable local law.
  • Even if a post-nuptial agreement is possible, applicable local law may require certain procedures to be followed to be effective (i.e., separate counsel to represent the husband and the wife, full disclosure of assets, and possibly other burdensome requirements).
  • The trustee may fail to retain a copy of the waiver, even if one is executed at the time trust is created.
  • Practitioners in community property jurisdictions may not know whether and under what circumstances a waiver is required.
  • Practitioners may be unaware that a waiver is needed at the time a trust is created.
  • Practitioners may not know that the applicable state statute has changed and has consequently created the need for a waiver.
  • Practitioners may not realize that the grantor has moved to a different state, creating a need for a waiver.
  • The spouse may be unable to execute a waiver (i.e., because the spouse is incompetent upon a subsequent state law change, because the spouse moves to a different state, or because the spouse is either incompetent or deceased at the time it is discovered that a waiver was previously required (even if the IRS would be willing to grant 9100 relief to extend the time to qualify for the safe harbor)).

The consequences of failing to have an effective waiver can be disastrous. But the penalty is really imposed on those estates for which the spouse does not actually exercise his or her right of election, rather than on those rare estates in which the election is exercised. The following example illustrates such a disaster.

EXAMPLE: Assume the following: Grantor and the grantor's spouse are the only noncharitable beneficiaries of a trust that would otherwise qualify as a charitable remainder trust. The spouse's right of election under applicable state law would include the trust in the augmented estate, and the spouse did not sign a waiver. In this situation, the issue of the effect of the lack of waiver on the qualification of the trust as a charitable remainder trust will probably not arise until the death of the grantor.

According to Rev. Proc. 2005-24, the lack of the waiver will disqualify the trust as a charitable remainder trust back to the date it was created. Because the grantor was a recipient of the annuity or unitrust amount, some or all of the value of the trust will be includible in the grantor's gross estate for federal estate tax purposes. If the spouse does not exercise his or her right of election, the includible value of the trust will be subject to estate tax with no marital or charitable deduction available. This will happen even though no assets other than the annuity or unitrust amounts will ever be paid from the trust to noncharitable beneficiaries.

If, however, the spouse exercises his or her right of election, the portion of the trust passing to the spouse will qualify for the estate tax marital deduction and the portion of the trust now passing outright to charity upon the grantor's death will qualify for the estate tax charitable deduction. As a result, none of the value of the trust will be subject to estate taxes even though a noncharitable beneficiary received something from the trust other than the annuity or unitrust amounts.

In such a situation, the substantial estate tax penalty will apply only to those estates where the spouse did not exercise the right of election and no assets were taken out of the charitable remainder trust. Those estates have done nothing wrong. In fact, good planning in the face of the Rev. Proc. would be to advise clients to in fact elect against the estate, thereby disadvantaging the charity.

Furthermore, the issue purportedly present with charitable remainder trusts would also be present in other inter vivos split- interest transfers, including pooled income funds (query whether a contribution to a pooled income fund by a grantor without a spousal waiver in a state with an augmented estate will disqualify the entire pooled income fund).

Rev. Proc. 2005-24 provides that, with respect to all charitable remainder trusts created prior to June 28, 2005, the spousal right of election will be disregarded if the spouse does not exercise the right of election. We believe that this safe harbor should be clarified to provide that the spousal right of election will be disregarded unless the spouse exercises the election and is entitled to a portion of the trust assets as a result. If the trust is merely used to determine the amount that the spouse is entitled to receive from the decedent spouse's estate and that share is satisfied from other assets, the integrity of the charitable remainder trust is not compromised.

The safe harbor applicable to pre-June 28, 2005 trusts could be expanded to include all trusts so that regardless of when the trust is created, the IRS will disregard the spouse's right of election provided the spouse's right of election is not exercised to claim a portion of the trust. With the safe harbor expanded in this fashion, if the surviving spouse does not elect against the trust (which will be the situation in almost all cases), the income, gift, and estate tax charitable deductions will be, and will have been, properly allowable.

If, in the rare instance, the surviving spouse actually elects against the will and is entitled to a share of the charitable remainder trust under applicable local law, then the charitable remainder trust can be disqualified at that time. In such a situation, the income and estate tax consequences will not vary much from what they would have been if a waiver was required in accordance with Rev. Proc. 2004-25. For purposes of the income tax charitable deduction, if the waiver would have been needed subsequent to the creation of the trust because of a change in state law, a move, or a remarriage, the original income tax deduction for the value of the charitable interest was properly taken. If the waiver would have been needed at the creation of trust, it may be possible to recoup the erroneously claimed income tax deduction on the decedent's final income tax return. If so, then the grantor's income tax consequences are similar whether or not a waiver is required.

For estate tax purposes, if the trust has noncharitable beneficiaries other than the grantor and the grantor's spouse, the estate tax charitable deduction for the value of the remainder interest would be disallowed. If the grantor, or the grantor and the grantor's spouse, are the only noncharitable beneficiaries, the portion of the trust passing to the spouse as part of the spouse's statutory share would qualify for the estate tax marital deduction and the portion of the trust passing outright to charity upon the death of the grantor would qualify for the estate tax charitable deduction. Thus, the estate tax consequences are identical whether or not a waiver is required.

The only missing piece is the income tax on the trust. The revenue procedure purports to disqualify the charitable remainder trust retroactively depending on the event that triggered the need for a waiver. As a practical matter, the issue will not surface until the death of the grantor. At that time, the IRS could seek the tax on the trust income for the open years. Unless the grantor dies shortly after the trust was created, however, and the originally-contributed assets were sold by the trust, the trust may have little taxable income for those open years. A trust that does not qualify as a charitable remainder trust would be a grantor trust since the grantor has retained the annuity or unitrust interest for life. As such the grantor would be taxed on all the current income earned by the trust. The noncharitable beneficiaries thus may be better off than if the distributions were treated as made from the undistributed income held in the section 664(b) classes.

RECOMMENDATIONS:

1. We urge that the safe harbor applicable to pre-June 28, 2005 trusts be clarified to provide that the spouse's right of election will be ignored unless the surviving spouse exercises that right and the trust's assets are actually utilized in satisfying the spouse's right.

2. We urge that this clarified safe harbor be expanded to apply to all charitable remainder trusts regardless of when they are created.

3. If the scope of the clarified safe harbor is not expanded to cover charitable remainder trusts created on or after June 28, 2005, then we urge that either Rev. Proc. 2005-24 be withdrawn or its effective date be postponed either until such time as the IRS and the Treasury Department can consult with practitioners to determine a more administrable procedure or for a period of at least two years so that the states will have time to solve the problem legislatively, not only with respect to charitable remainder trusts but with respect to other types of inter vivos split-interest gifts that pose the same problem.

We welcome the opportunity to discuss our comments further with you or others at the IRS and Treasury Department. Please contact me at (402) 280-2062, or tpurcell@creighton.edu; Roby Sawyers, Chair of the AICPA Trust, Estate, and Gift Tax Technical Resource Panel, at (919) 515-4443, or roby_sawyers@ncsu.edu; Russell Sanders, Chair of the CRT Task Force, at (410) 454-5979 or rtsanders@LMUS.leggmason.com; or Eileen Sherr, AICPA Technical Manager at (202) 434-9256, or esherr@aicpa.org.

Sincerely,

Thomas J. Purcell, III
Chair, AICPA
Tax Executive Committee

cc:

Eric Solomon, Acting Assistant Secretary (Tax Policy) and Deputy Assistant Secretary -- Regulatory Affairs, Treasury Department, Room 3104 MT (fax 202-622-0605)

Donald L. Korb, Chief Counsel, IRS, Room 3026 IR (fax 202-622-4277)

Heather C. Maloy, Associate Chief Counsel -- Passthroughs & Special Industries, IRS, Room 5300 IR (fax 202-622-4524)

Catherine V. Hughes, Attorney Adviser, Tax Legislative Counsel, Treasury Department, Room 4212 MT (fax 202-622-9260)

Susan Hurwitz Levy, Attorney, IRS Branch 4 (CC:PSI:B04), Room 5430 IR (fax 202-622-4451)

Bradford R. Poston, Attorney, IRS, Branch 2 (CC:PSI:BR02), Room 5013 IR (fax 202-622-4524)


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