The Charitable Remainder Trust

The Charitable Remainder Trust

Article posted in Charitable Remainder Trust on 17 August 1999| comments
audience: National Publication | last updated: 18 May 2011
Print
||
Rate:

Summary

Need a quick refresher on the current state of CRTs? In this week's edition of Gift Planner's Digest, returning author Michael V. Bourland, Esq. and Jeffrey N. Meyers, Esq. review the evolution, rules, and recent regulatory changes that govern the most popular of deferred gift vehicles.

by Michael V. Bourland & Jeffrey N. Myers

Used correctly, an IRC §664 charitable remainder trust (CRT) can accomplish a donor's donative goals and tax goals. (All references to "Sections" or "§" are to the Internal Revenue Code of 1986, as amended, or to Department of the Treasury Regulations "Treas. Reg.," as applicable and unless otherwise stated.)

What Is A Charitable Remainder Trust?

A CRT is an irrevocable trust. An amount of income and/or principal from the CRT is payable to noncharitable beneficiaries, usually the grantor of the CRT and the grantor's spouse. The remainder interest is irrevocably payable to charity.

The CRT pays no income tax on its income. Therefore, the CRT is not taxed on any gain it realizes upon selling appreciated property whether donated by the grantor or appreciation occurring after the donation.

The grantor of an intervivos CRT is entitled to an immediate income and gift tax deduction in the amount of the present value of the remainder interest passing to charity. The estate of the decedent who created a testamentary CRT is entitled to an estate tax deduction for the present value of the remainder interest passing to charity.

Legislative History

In 1969, Congress reacted to the abuse it perceived regarding charitable deductions resulting from gifts of remainder interests to charity. Congress believed that donors were taking income, gift, and estate tax charitable deductions based on values not ultimately passing to the charity. Prior to 1969, the tests to obtain an income, estate, or gift tax charitable deduction were liberal. A gift to a split interest trust with a remainder going to charity enabled the donor to receive an income, estate, or gift tax charitable deduction if the interest passing to charity was presently ascertainable. [Treas. Reg. §20.2055(a)] Further, as long as the ability of the trustee to invade corpus for the noncharitable beneficiary was simply subject to an ascertainable standard, the donor was entitled to the deduction. [Treas. Reg. §20.2055-2(b); Estate of Sternberger v. Commissioner, 348 U.S. 187 at 194 (1955); Rev. Rul. 54-285, 1954-2 C.B. 302] Congress amended the charitable deduction Sections (IRC §§170, 2055, and 2522) to deny charitable deductions for gifts of remainder interests in split interest trusts unless the gift of the remainder interest was made through a trust that qualified under the newly enacted Section 664. Section 664 provides the definitional scheme for a CRT.

The Code, The Regulations, And The Rulings

General rule. A donor receives no charitable income tax deduction for a gift of a remainder interest to charity. [IRC §170(f)(2)(A)] A gift of a remainder interest to charity will entitle the donor to a charitable income tax deduction if the trust is a CRT described in Section 664. [IRC §170(f)(2)(A)]

Gift/Estate. A donor receives no gift or estate tax charitable deduction for a gift of a remainder interest to charity. [IRC §§2522(c)(2); 2055(e)(2)] A gift of a remainder interest to charity will entitle the donor to an estate or gift tax charitable deduction if the trust is a CRT described in Section 664. [IRC §§2522(c)(2)(A); 2055(e)(2)(A)]

Requirements Of A CRT

A CRT is a trust that provides for a specified distribution to one or more beneficiaries, at least one of which is not a charity, for life or for a term of years (not to exceed 20 years), with an irrevocable remainder interest paid to charity. [Treas. Reg. §1.664-1(a)(1)(i)]

The following definitions will be used in this article as they are used in the regulations. [Treas. Reg. §1.664-1(a)(1)(iii)]

Annuity amount: The amount distributed to the noncharitable beneficiary of a charitable remainder annuity trust.

Unitrust amount: The amount distributed to the noncharitable beneficiary of a charitable remainder unitrust.

Recipient: The beneficiary who receives the annuity amount or unitrust amount.

CRAT Versus CRUT

CRAT. The amount paid to the recipient is set when the trust is created. It is a fixed percentage or dollar amount of the initial fair market value of the trust assets. Thus, the annuity amount paid to the recipient does not change from year to year. [IRC §664(d)(1)]

CRUT. The amount paid to the recipient is a fixed percentage of the fair market value of the trust's assets valued annually. Thus, the unitrust amount fluctuates from year to year.

Types of CRUTs

Fixed percentage (fixed percentage unitrust or flat unitrust): The recipient receives the fixed percentage of the trust assets, valued annually. [IRC §664(d)(2)]

Lesser of income or fixed percentage without makeup (NICRUT): The recipient receives the lesser of the trust's net income for that year or the fixed percentage of the trust assets valued annually. [IRC §664(d)(2) and (d)(3)]

Lessor of income or fixed percentage with makeup (NIMCRUT): The recipient receives the lesser of the trust's net income for that year or the fixed percentage, and in a year when the trust's net income exceeds the fixed percentage, such excess is used to makeup for past deficiencies in years when the net income was less than the fixed percentage. [IRC §664(d)(2) and (d)(3)]

Typically, under state trust accounting law, income excludes capital gains (i.e., capital gains are allocated to principal). However, a trust may allocate capital gains to income. Prior to recent treasury regulations (finalized December 10, 1998), the letter rulings were all over the map regarding whether the trustee could allocate capital gains to income, whether post contribution capital gains only could be allocated, and whether the makeup account had to be treated as a liability when valuing the NIMCRUT. The final treasury regulations cleared this up by stating that "post contribution" capital gains may be allocated to income. [Treas. Reg.1.664-3(a)(l)(i)(b)(5)] This applies for sales and exchanges occurring after April 18, 1997. The preamble to the final regulations states that "it is unnecessary to treat the makeup account as a liability" as originally established in several private letter rulings.

The FLIP CRUT: The final regulations also sanctioned a fourth type of CRUT called the "FLIP CRUT." A FLIP CRUT is a CRUT: 1) where the initial unitrust amount to the recipient is the lesser of income or the fixed percentage; and 2) where after a triggering event, the unitrust amount changes (i.e., flips) to the fixed percentage. Under the final regulations, the following requirements must be satisfied to use the FLIP CRUT: 1) the change (FLIP) from the NIMCRUT (NICRUT) to the fixed percentage CRUT is triggered on a specific date or by a single event whose occurrence is not discretionary with, or within the control of, the trustee or any other person; 2) the FLIP occurs at the beginning of the taxable year that immediately follows the taxable year during which the triggering event/date occurs; 3) following the flip, the CRT becomes a fixed percentage CRT (and the makeup account is forfeited). [Treas. Reg. 1.664-3(a)(l)(i)(c)]

A triggering event based on the sale of unmarketable assets or the marriage, divorce, death, or birth of a child with respect to any individual will not be considered discretionary with, or within the control of, the trustees or any other person. [Treas. Reg. 1.664-3(a)(1)(i)(d)]

Uses of the FLIP CRUT include creating a retirement account, a deferred income strea or if the CRUT is funded with unmarketable assets.

For purposes of a FLIP CRUT, unmarketable assets are assets that are not cash, cash equivalents, or other assets that can be readily sold or exchanged for cash or cash equivalents. For example, unmarketable assets include real property, closely held stocks, and an unregistered security for which there is no available exemption permitting public sale. [Treas. Reg. §664-1(a)(7)(ii)]

In regard to retirement account/deferred income stream, the donor funds the FLIP CRUT with cash or securities and picks a date certain in the future as the "triggering event." Prior to the triggering event, the trustee invests the trust assets in growth, non-income producing assets to grow the trust corpus. Upon the date certain (i.e., retirement or date donor wants the income stream to become fixed), the CRUT flips. In order to make the unitrust payment, the trustee will have to either sell sufficient assets to satisfy the payment or distribute the assets in kind to the unitrust beneficiary, who in turn can sell the assets. Ordinarily, unless there is undistributed ordinary income as outlined under Tax Consequences of a CRT, the unitrust amount would be taxed to the unitrust beneficiary at capital gains rates.

The FLIP CRUT is also useful when the assets used to fund the CRUT are unmarketable assets, and the unitrust beneficiary of the CRUT desires a payout equal to a fixed percentage of the value of the assets. The triggering event may be the sale of those unmarketable assets. During the period the trust holds the unmarketable assets, the CRUT is either a NIMCRUT or NICRUT so that the trustee is not required to distribute undivided interests in the unmarketable assets. When the unmarketable asset is sold, the CRUT flips and then the unitrust amount is a fixed percentage.

The amendments allowing a FLIP CRUT are effective for CRUTs created on or after December 10, 1998. If a CRUT is created before such effective date containing a flip provision other than the one permitted by the regulations, the CRUT may be reformed to comply with the regulations provided the trustee begins legal proceedings to reform the trust by June 8, 1999. Under IRS Notice 99-31 the deadline to file a petition for reformation and the deadline to complete a non-judicial reformation has been extended to June 30, 2000. If a CRUT is created after the effective date containing a flip provision other than one permitted by the regulations, the CRUT will continue to qualify as a CRUT only if it is reformed to comply with the regulations under the June 8, 1999, requirement. Otherwise it may be reformed, but it must be amended to omit the FLIP and use the initial method (normally a NIMCRUT). A NICRUT or NIMCRUT may be reformed to a FLIP CRUT if the trustee begins legal proceedings to reform by June 8, 1999, otherwise, if a CRUT is created before or after the effective date and it does not contain a flip provision, the CRUT cannot be reformed to add the flip provision, and if reformed, it will not qualify as a CRUT. [Treas. Reg. §1.664-3(a)(l)(i)(f)]

No Hybrids

The trust must either be a CRAT or a CRUT. The trust cannot be a combination of a CRAT and a CRUT. [Treas. Reg. §1.664-1(a)(2)]

Additional contributions cannot be made to a CRAT because the annuity amount is based on the value of the assets only valued as of creation. The governing instrument of the CRAT must prohibit additional contributions. Additional contributions can be made to a CRUT as long as the governing instrument provides a formula upon which to base the unitrust amount, which takes into account the additional contribution. [Treas. Reg. §§1.664-2(b) & 1.664-3(b)]

One other difference between the CRAT as compared to the NIMCRUT and the NICRUT (but not the fixed percentage CRUT) is that with a CRAT and the fixed percentage CRUT, the trustee may be forced to make a distribution in kind if the income of the CRAT and the fixed percentage CRUT is insufficient to satisfy the annuity amount of the CRAT or the unitrust amount of the fixed percentage CRUT. A distribution in kind is deemed to be a sale of the property so distributed causing the recipient to recognize capital gain on the property in kind distributed. [Treas. Reg. §1.664-1(d)] With CRUTs, however, if the unitrust amount is of the form based on the lesser of income or fixed percentage with or without makeup (i.e., a NICRUT or NIMCRUT), the trustee will not be forced to make a distribution in kind. Rather, the trustee can satisfy the unitrust amount based on the income earned by the CRUT. Obviously, if a non-income earning asset, such as real estate, is used to fund a CRT, it is best to choose a CRUT with the lesser of income feature (and with or without the flip feature).

Qualifying The CRT Under Section 664

The CRT must be a valid trust under applicable state law. [IRC §§664(d)(1) & 664(d)(2); Rev. Proc. 89-20, 1989-1 C.B. 841; Rev. Proc. 89-21, 1989-1 C.B. 842.] The CRT must also be irrevocable. [Treas. Reg. §1.664-1(a)(1)(i)]

Old Rule. For transfers to a CRT on or before June 18, 1997, the governing instrument had to provide that the fixed percentage be at least 5%. [IRC §§664(d)(1)(A) & 664(d)(2)(A)]

New Rule. Pursuant to The Taxpayer Relief Act of 1997 (P.L. 105-34), for transfers to a CRT after June 18, 1997, the governing instrument must now provide that the fixed percentage be at least 5% but no more than 50%. [IRC §§664(d)(1)(A) & 664(d)(2)(A)]

The governing instrument must contain language regarding proration of the unitrust amount or annuity amount in the event of a short taxable year (i.e., less than 12 months). The annuity amount or unitrust amount shall be the amount otherwise payable multiplied by a fraction, the numerator of which is the number of days in the taxable year of the trust and the denominator of which is 365 (366 if February 29th is a day included in the numerator). The governing instrument of the CRT must also include language providing that in the case of a trust taxable year within which occurs the termination of the CRAT or CRUT, the annuity amount or unitrust amount that must be distributed shall be the amount otherwise determined multiplied by a fraction, the numerator of which is the number of days in the period beginning on the first day of such taxable year and ending on the day that the CRT terminates and the denominator of which is 365 (366 if February 29th is included). [Treas. Reg. §§1.664-2(a)(1)(v)(a) & (b) & 1.664-3(a)(1)(v)(a) & (b)]

The governing instrument must require that the trustee pay to the recipient (if an undervaluation) or receive from the recipient (if an overvaluation) an amount equal to the difference between the annuity amount or unitrust amount that the trustee should have paid and the annuity amount or unitrust amount that was actually paid to the recipient. [Treas. Reg. §§1.664-2(a)(1)(iii) & 3(a)(1)(iii)]

Generally, the unitrust amount or annuity amount must be at least 5% of the trust assets (valued annually if a CRUT or valued at initial contribution if a CRAT). However, a trust may provide for a reduction in the unitrust amount or annuity amount upon the death of a recipient or the expiration of the term, as applicable, as long as the governing instrument of the CRT provides that, upon such death or expiration: 1) the distribution of the excess annuity amount or unitrust amount is made to a charity; and 2) the total of the unitrust amount or annuity amount payable after the distribution to the charity is not less than 5%. [Treas. Reg. §§1.664-2(a)(2)(ii) & 3(a)(2)(ii)]

The CRT must function exclusively as a CRT from inception. [Treas. Reg. §§1.664-2(a)(5)(i) & 3(a)(5)(i)] Therefore, the payment of the unitrust amount or annuity amount must be due for the year of the creation of the CRT. However, a CRT will not be deemed to have failed to function exclusively as a CRT merely because payment of the unitrust amount or annuity amount is made after the close of the taxable year, provided that the payment is made within a reasonable time after the close of the taxable year. [Treas. Reg. §§1.664-2(a)(1)(i)(a) & 1.664-3(a)(1)(i)(a)] With testamentary CRTs, the CRT is deemed created in the year of the decedent's death. [Treas. Reg. §1.664-1(a)(5)] In this case, the governing instrument of the CRT should also include a provision allowing the executor of the decedent's estate to defer such payment for a reasonable period of time to enable the decedent's executor to complete the administration of his or her estate. In that event, the governing instrument may include a requirement to defer the payment of the annuity amount or unitrust amount until the end of the taxable year of the CRT in which occurs the complete funding of the CRT. If such a deferment provision is provided for, the governing instrument must provide that the trustee will pay, within a reasonable time after such funding, to the recipient (in the case of an underpayment) or must receive from the recipient (in the case of an overpayment) the difference between the annuity amount or unitrust amount actually paid and the annuity amount or unitrust amount required to be paid, plus interest compounded. [Rev. Rul. 92-57, 1992-2 C.B. 123 (modifying the interest computation in Rev. Rul. 88-81, 1988-2 C.B. 127, and Rev. Rul. 82-165, 1982-1 C.B. 117); Rev. Rul. 88-81, supra (requiring such provision to be mandatory if the trustee can defer payment of the annuity amount or unitrust amount). See also Rev. Rul. 80-123, 1980-1 C.B. 205]

Terms Of Payment

The governing instrument must specify the term of the annuity amount and unitrust amount and the term may continue for a term of years not to exceed 20 years, the life or lives of a named individual or individuals, or the combination of a life or lives and a fixed term of years. [Treas. Reg. §§1.664-2(a)(5) & 1.664-3(a)(5); IRC §§664(d)(1)(A) & 664(d)(2)(A)]

The governing instrument of the CRT may provide for the acceleration of the term causing the assets to be distributed to charity. However, the possibility of acceleration is not taken into account in valuing the remainder interest. [Treas. Reg. §§1.664-2(a)(5) & 1.664-3(a)(5); IRC 664(d)(1)(A) & 664(d)(2)(A); PLR 9138024]

Short-Term CRUTs

In Notice 94-78, the Service announced its intention to challenge short-term CRUTs. [Notice 94-78, 1994-2 C.B. 555] The short-term CRUT is a technique where appreciated assets are transferred to a short-term (i.e., two years) CRUT and the unitrust amount percentage is very high (i.e., 80%). The notice provides the following example: Grantor contributes property with a value of $1,000,000 and basis of zero. The assets pay no income and the term of the trust is two years. The unitrust amount is 80% of the value of the trust assets valued annually. In year one, the unitrust amount is $800,000 (80% x $1,000,000), but such is not actually paid in year one since the trustee has a reasonable time to make the payment. At the beginning of year two, all the CRUT assets are sold for $1,000,000 and the year one's unitrust amount is distributed. The unitrust amount for year two is $160,000 (80% x ($1,000,000-$800,000)). The position of the proponents of this strategy is that the $800,000 distribution is a return of principal under the tier distribution rules.

In Notice 94-78, the Service stated that it would attack such a transaction as abusive under the following arguments: 1) substance over form in that the arrangement is a prearrangement between the grantor and the trustee and thus, such is a sale by the grantor individually; 2) an assignment of income by the grantor and thus, the gain would be attributed to the grantor; 3) the trust did not function exclusively as a CRT from its inception and thus, the CRUT will be ignored and the sale treated as one by the grantor individually; and 4) the postponement of the sale of the trust assets beyond year one is the use of the assets for the benefit of a disqualified person (i.e., self-dealing).

Under the proposed regulation, the payment of the annuity amount of a CRAT or the unitrust amount of a fixed percentage CRUT must be made by the close of the taxable year in that it is due. If such were the case in the example above, the trustee would be required to make a distribution in kind by the end of year one. The time for the payment of unitrust amount in NICRUTs and NIMCRUTs can still be extended under the proposed regulation. The proposed regulation states that such extension of time is needed with NICRUTs and NIMCRUTs since the trustee of such CRUTs may not be able to determine the unitrust amount until after the close of the year, but with fixed percentage CRUTs and CRATs, the trustee can determine the payment amount since it is a fixed amount. The proposed regulation specifically states that its concern is the accelerated CRUT described in Notice 94-78. The amendment in this proposed regulation was proposed to be effective April 18, 1997. Fixed percentage CRUTs that currently contain a provision permitting the payment of the unitrust amount after the close of the taxable year need not be reformed to comply with the proposed regulation. Instead, the trustees of such trusts must make the payment of the unitrust amount within the time permitted by the proposed regulation.

At the hearings on the proposed regulation, it was determined that requiring the payment by the close of the tax year for fixed percentage CRUTs and CRATs would be very burdensome. Therefore, the Service issued Notice 97-68 that provides for the 1997 tax year, it is not necessary to make the annual payment from the fixed percentage CRUT or the CRAT by the close of the 1997 tax year as long as the percentage is 15% or less. As far as subsequent tax years, the proposed regulation applies but it is believed that similar Notices will be issued or the rules finalized. [Notice 97-68, 1997-48I.R.B.11]

Final Regulations. For charitable remainder annuity trusts or fixed percentage unitrusts, the Annuity or unitrust amount may be paid within a reasonable time after the close of the year for which it is due if: 1) the character of such amount in the hands of the recipient is either ordinary income, capital gain, or tax-exempt income (but not corpus); and/or 2) the trust distributes property rather than cash to pay the annuity or unitrust amount and the trustee elects on the trust's return to treat any income generated by the distribution as maturing on the last day of the taxable year for which the amount is due. For pre-December 10, 1998 trusts, the distribution may be made within a reasonable time after the close of the year only if the percentage used to calculate the annuity or unitrust is 15% or less.

Recipient Of Annuity Amount And Unitrust Amount

  • Name the person or persons to be the recipient of the annuity amount or unitrust amount. If there is more than one recipient, they can be either successive or concurrent.
  • At least one of the recipients must not be a charity.
  • All individuals who are recipients must be alive at the time of the creation of the CRT.
  • The power retained by the trustee who was the grantor of CRT to sprinkle the annuity amount or unitrust amount among recipients will cause the trust to not be a CRT. In this case, the grantor would be treated as the owner of the CRT or the portion thereof. [Treas. Reg. 1.664-3(a)(3)(ii) & 1.664-2(a)(3)(ii)]
  • The grantor may retain the right to revoke by will any recipient's interest (other than charity). If done, there is no completed gift to the successive recipient. [PLR 9517020] However, the power to revoke is a retention of a power includable in the grantor's estate. In PLR 9511029, the Service ruled that the automatic termination of a successive or concurrent recipient's interest in the CRT due to divorce will not disqualify the trust as a CRT.

Current Remainderman

The governing instrument must provide that at end of the term, the entire corpus of the CRT go to charity. Such charitable interest can pass outright, or it can continue in trust for the benefit of the charity.

Old Rule. For transfers to a CRT on or before July 28, 1997, the present value of the remainder interest ultimately passing to the charitable remainderman had to equal at least 5% of the net fair market value of the property transferred to the CRT on the date of the contribution to the CRT.

New Rule. Pursuant to The Taxpayer Relief Act of 1997 (P.L. 105-34), for transfers to a CRT after July 28, 1997, the present value of the remainder interest ultimately passing to the charitable remainderman must equal at least 10% of the net fair market value of the property transferred to the CRT on the date of the contribution to the CRT. [IRC §§664(d)(1)(D) & 664(d)(2)(D)] Further, for charitable remainder annuity trusts, the CRAT must also meet the "not-so-remote-as-to-be-negligible-5%-probability" test of Rev. Rul. 77-374. That ruling provides that a charitable remainder annuity trust doesn't qualify for a charitable deduction (and by implication isn't a qualified trust) unless the possibility that the charitable transfer will not become effective is so remote as to be negligible. If there is more than a 5% probability that the noncharitable income beneficiary will survive the exhaustion of the trust assets, that probability isn't negligible. [Rev. Rul. 77-374] The tax court upheld the "5% probability test" in Moor, 43 TCM 1530 (1982). However, the court also held that the test is satisfied as long as the trust's annual earnings can be reasonably anticipated to exceed the required annual payout to the beneficiary.

The governing instrument must provide that if the named charitable remainderman is not a qualified charity under the Internal Revenue Code at the time of the distribution, then the distribution must go to an alternate charitable remainderman that is a qualified charity under the Internal Revenue Code at the time of the distribution and the governing instrument must provide the means in that the alternate charity is selected. The grantor may substitute an alternate charity as the remainderman. [Rev. Rul. 76-8, 1976-1 C.B. 179]

The governing instrument may permit the trustee of a CRT to make an early distribution of corpus to charity as long as, in the case of distributions in kind, assets distributed have adjusted bases fairly representative of the adjusted bases of all assets available. Further, the governing instrument may provide that the grantor reserves the right to terminate the trust resulting in the acceleration of the distribution to the charity. [PLR 9138024]

Private Foundation Restrictions

No other payments can be made other than: 1) the annuity amount or unitrust amount; 2) early distributions to charity; or 3) distribution to charity upon termination.

The trust must not be involved in self-dealing as precluded by IRC § 4941(d). This includes any direct or indirect: 1) sale, exchange, or leasing of property between a trust and a disqualified person; 2) lending of money or extension of credit between a trust and a disqualified person; 3) furnishing of goods, services, or facilities between a trust and a disqualified person, unless such goods, services, or facilities are made available to the general public on at least as favorable a basis as they are made to the disqualified person, [Treas. Reg. § 53.4941(d)(3)(b)(1)]; 4) payment of compensation (or payment or reimbursement of expenses) by a trust to a disqualified person, unless it is for personal services and such compensation is reasonable and necessary to carry out the exempt purpose and is not excessive; [Treas. Reg. § 53.4941(d)(3)(c)(1)] 5) transfer to, or use by or for the benefit of, a disqualified person of the income or assets of a private foundation; and 6) agreement by a private foundation to make any payment of money or other property to a government official (as defined in § 4946(c)) other than an agreement to employ such individual for any period after the termination of his/her government service if such individual is terminating his/her government service within a 90-day-period. [IRC § 4941(d)]

A disqualified person is a substantial contributor to the CRT (an individual, trust, estate, corporation, or partnership who contributes an aggregate amount in excess of $5,000 to the CRT, if his or her total contributions are more than 2% of the total contributions received), or a family member of a substantial contributor (spouse, descendants, and spouses of descendants), or persons owning more than 20% of an entity that is a substantial contributor to the CRT (includes an entity in that a disqualified person [considering the attribution rules of IRC § 4946(a)(4)] owns more than 35%).

Reimbursement to disqualified persons for travel expenses causes the CRT and the disqualified person's spouse to be potentially liable for penalty taxes for self-dealing, for making noncharitable expenditures, or possibly both. Such reimbursement of expenses will not be taxed if the expenses are reasonable and necessary to carrying out the exempt purposes of the CRT and are not excessive. [IRC § 4941(d)(2)] The Code does not explain what is "reasonable and necessary." [Treas. Reg. § 53.3941(d)-3(c)(1)] Generally, business expense deductions under Treas. Reg. § 1.162-2(1) include travel fares, meals, lodging, and expenses incident to travel. Travel expenses are not included if the trip is primarily personal in nature. [Treas. Reg. § 1.162-2(a)] The Code does cross-reference Treas. Reg. § 1.162-7 to determine what is "excessive." Under Treas. Reg. § 1.162-7, an amount spent on director's services will not be deemed "excessive" if it is only such as would be paid "for like services by like enterprises under like circumstances." [Treas. Reg. § 1.162-7 (i.e., As the organization would pay to someone independent of the CRT)]

A grant by one private foundation (a CRT in this case) to another private foundation does not constitute self-dealing within the meaning of IRC § 4941 even when one entity serves as trustee of both foundations. [Rev. Rul. 82-136 (1982-2 C.B. 300). See also Treas. Regs. Examples 53.4941(d)-2(f)(2)]

Any disqualified person who engages in an act of self-dealing is assessed an excise tax of 5% of that amount involved in the transaction for each year that the transaction is uncorrected. Additionally, a foundation manager who knows that the act is prohibited but approves it may also be subject to a tax of 2.5% of the amount involved (up to $10,000 for each such act) for each year that the transaction is uncorrected. If the transaction is not timely corrected and the 5% was initially assessed, the disqualified person is subject to being assessed an additional tax of 200% of the amount involved. Any foundation manager who does not correct the transaction may also be subject to an additional assessment of 50% of the amount involved (up to $10,000 for each such act.)

Section 4943 imposes an excise tax on the value of the "excess business holdings" of any private foundation. A private foundation created after May 26, 1969 has excess business holdings to the extent that it, together with all disqualified persons, owns in the aggregate more than 20% of the voting stock of an incorporated business enterprise (or corresponding interests in non-incorporated business enterprises). In general, where a private foundation acquires excess business holdings by gift or bequest, the foundation has five years from the date it acquires such holdings to dispose of them.

The excess business holdings provisions of Section 4943 and the "jeopardy investment" provisions of Section 4944 discussed below do not apply to a split-interest trust if either: 1) all of the income interests (and none of the remainder interests) of the trust are devoted solely to charitable purposes and all amounts in trust for which a charitable deduction was allowed have an aggregate value of not more than 60% of the aggregate fair market value of all amounts in trust; or 2) a charitable deduction was allowed for amounts payable under the terms of the trust to every remainder beneficiary, but not to any income beneficiary, as is the case with the majority of charitable remainder trusts.

Section 4947(b)(3) makes Sections 4943 and 4944 inapplicable to a split-interest trust where the charity's interest in the trust is restricted to either a relatively small income interest or a remainder interest that will not come into possession until some time in the future.

Section 4944 imposes an excise tax on a private foundation (and under some circumstances foundation managers) for investing any amount in such a manner as to jeopardize the carrying out of its exempt purposes. The imposition of an excise tax on "jeopardy" investments is intended to assure that the foundation managers adopt a "prudent person" approach toward the investment of foundation assets.

Section 4945 imposes an excise tax on each "taxable expenditure" made by a private foundation. The term "taxable expenditure" includes amounts paid or incurred by a private foundation: 1) to influence legislation; 2) to influence the outcome of a public election or carry on voter registration drives; 3) as a grant to an individual for travel, study, or other similar purposes (unless the IRS gives advance approval of the foundation's grantmaking procedures); 4) as a grant to an organization other than a "public charity" described in Section 509(a) or an "exempt operating foundation" described in Section 4940(d)(2) (unless the foundation exercises "expenditure responsibility); and 5) for any purpose other than one specified in Section 170(c)(2)(B).

Estate tax cannot be paid from a CRT. If such taxes were payable by the CRT, then the CRT would not exclusively operate as a CRT from its inception. The governing instrument must contain provisions for the payment of estate taxes from sources other than the trust itself. In PLR 8819021, the life interest of a survivor income beneficiary took effect only if the survivor beneficiary furnished funds for payment of federal estate taxes or state death taxes for which the trust was liable. [Rev. Rul. 82-128, 1982-C.B. 71] Be careful in defining death taxes. The term "death taxes" does not necessarily include estate taxes. [PLR 9225026]

The governing instrument must not permit the debts and expenses of a decedent's estate to be made from the assets of a testamentary CRT. [Treas. Reg. §1.664-1(a)(6) (Ex. 3)]

The grantor may be the trustee of a CRT even if the grantor is also a recipient. [Rev. Rul.77-285, 1977-2 C.B. 213; PLR 9504012] In this case, the grantor must be careful to avoid imposition of the grantor trust rules.

The trustee, who is also the grantor, may be entitled to reasonable compensation as trustee, as long as: 1) the compensation is not paid out of the grantor's annuity amount or unitrust amount; and 2) the compensation is reasonable and not excessive. [Rev. Rul. 74-19, 1974-1 C.B. 155; Treas. Reg. §53.4941(d)-3(c)(1)]

The legislative history of Section 664 indicates that Congress contemplated denying the charitable deduction when a grantor of a CRT, who was also trustee, transferred hard-to-value assets (i.e., all assets other than cash, cash equivalents and marketable securities) to a CRT unless an independent trustee valued the hard to value assets. [H.R. Rep. No. 413, 91st Cong., 1st Sess. 60 (1969), 1969-3 C.B. 200, 239] Thus, if the grantor is the trustee of a CRT, the governing instrument must provide that the annual valuation of the hard to value assets be prepared by an independent valuation trustee. The December 10, 1998 final regulations changed this requirement. Under the final regulations, a trust's unmarketable assets must either be valued by an independent trustee or by a qualified appraiser. [Treas. Regs. 1.664-1(a)(7)] An independent trustee is a person other than the grantor or the grantor's spouse, a noncharitable beneficiary, or a party related or subordinate to either of them. [Treas. Regs. 1.664-1(a)(7)(iii)] A co-trustee who is independent may value the trust's unmarketable assets. A qualified appraiser is defined in Treas. Regs. § 1.170A-13(c) and is more fully explained below.

The governing instrument of a CRT may permit the grantor to remove and replace the trustee and the grantor can appoint himself as trustee. [Rev. Rul. 77-285, 1977-2 C.B. 213]

A trust that is taxable as a grantor trust cannot qualify as a CRT. [IRC §664(c); Treas. Reg. §1.664-1(a)(4)] If it did, the trust's income is taxable to the grantor. It is imperative to exclude any power of the grantor to cause the CRT to be taxable as a grantor trust. See Exhibit A for pitfalls in this area. The taxable year of a CRT must be the calendar year. [IRC §645]

Tax Consequences Of A CRT

  • The distributions to the recipient of the annuity amount or unitrust amount are includable in the recipient's gross income.
  • The distribution is ordinary income to the extent of the CRT's ordinary income for that year and undistributed ordinary income from prior years. [IRC §664(b)(1); Treas. Reg. §1.664-1(d)(1)(i)(a)]
  • The distribution is treated as capital gains to the extent of the CRT's capital gains for that year and undistributed capital gains from prior years. [IRC §664(b)(2); Treas. Reg. §1.664-1(d)(1)(i)(b)]
  • The distribution is treated as other income to the extent of the CRT's other income for that year and prior years. [IRC §664(b)(3); Treas. Reg. §1.664-1(d)(1)(i)(c)]
  • After all of the above is distributed, the distribution is one of corpus. [IRC §664(b)(4); Treas. Reg. §1.664-1(d)(i)(1)(d)]

The proposed regulations included an example showing how the payout is characterized for a NIMCRUT with undistributed capital gain. The IRS received no comments on this point, and the example is included without change in the final regulations. Under the example, the NIMCRUT received $7,500 of income for 1996; all of which was tax-exempt bond interest. It had no undistributed ordinary income or capital gain except for $30,000 in undistributed capital gain of prior taxable years, and its unitrust amount for 1996 was $9,000. The amount distributable for 1996 was $7,500 and, under the four-tier system, this amount will be characterized as capital gain rather than tax-exempt income (even though it actually arose in 1996 from tax-exempt sources). This is because no tax-exempt income will be deemed distributed until all undistributed capital gain for the current year and all prior years are deemed distributed. Thus, the trust's undistributed capital gain income goes down by $7,500 and its undistributed tax-exempt income goes up by the same amount for purposes of characterizing 1997 and later distributions. [Treas. Reg. §1.664-1(d)(l)(iii)]

Making a distribution of property other than cash may satisfy the unitrust amount or annuity amount. This could happen with a CRAT or a fixed percentage CRUT where the recipient is entitled to the fixed percentage. If the annuity amount or unitrust amount is satisfied by making a distribution in kind, the distribution in kind is deemed to be a sale of the property resulting in realization of gain by the CRT. [Treas. Reg. §1.664-1(d)(5)] For example, if a donor funds a fixed percentage CRUT with closely held C stock and then the stock cannot be sold after such funding, the trustee will be obligated to distribute enough stock to the donor to meet the annual fixed percentage and the CRUT will realize the capital gain on that stock even though it was not sold; that capital gain will be passed through to the recipient under the income tax characterization rules above causing the recipient to recognize gain.

If the CRUT is a NIMCRUT version, the trustee would only be required to distribute the lesser of the annual net income or the fixed percentage. Thus, the distribution in kind would not be needed to satisfy the unitrust amount. However, the disadvantage of this approach is that the recipient of the unitrust amount would often be limited to income.

General rule: The CRT is a tax-exempt entity and thus, pays no income tax. It pays no income tax on any of its income and it recognizes no gains on sales of appreciated properties. [IRC §664(c)]

Exceptions. The courts will collapse separate transactions if, when the first step was undertaken, there was a binding commitment to undertake the later steps. [Maine Foods, Inc. v. Commissioner, 93 T.C. 181 (1989)] The courts will also collapse a series of transactions if they were so interdependent that the "legal relations created by one transaction would have been fruitless without the completion of the series."

If appreciated property is contributed to a CRUT or CRAT and if the trustee of the trust is obligated, as of the date of the contribution, to sell such property, the Service will ignore the CRUT or CRAT as the seller of the property. Instead the donor is deemed the seller and the donor will recognize the gain. [Palmer v. Commissioner, 62 T.C. 684 (1974)]

The court stated that "once the right to receive income as "ripened" for tax purposes, the taxpayer who earned or otherwise created that right, would be taxed on any gain realized from it, notwithstanding the fact that the taxpayer has transferred the right before actually receiving the income?to determine whether a right has "ripened for tax purposes, a court must consider the realities and substances of events to determine whether the receipt of income was practically certain to occur." [Ferguson v. Commissioner, 9th Circuit, Tax Ct. Dkt. Nos 21808-03, 18250-94]

This is really not an exception. If the trust is a grantor trust, it is not a CRT under Section 664. [Treas. Reg. §1.664-1(a)(4)] The drafter of the CRT must be careful not to include any provision that causes the CRT to be a grantor trust. See Exhibit A for listings of items that will and will not cause grantor trust status.

A CRT that has unrelated business taxable income in excess of $1,000 will be taxed on all of its income; not just the tainted income will be taxed; all of the income of the CRT will be taxed in the trust tax year when the trust has unrelated business taxable income. [Treas. Reg. §1.664-1(c); IRC §512(b)(12)]

Unrelated business taxable income is defined as income derived by an organization from any unrelated trade or business regularly carried on by the organization in excess of $1,000. [IRC §512(a)(1)] An unrelated trade or business that is not substantially related to the exercise of the organization's charitable functions. [IRC §513(a)]

The sale or disposition of inventory or property held primarily for sale to customers in the ordinary course of business will create unrelated business taxable income to the extent the proceeds therefrom exceeds $1,000. The sale or disposition of any other property will not create unrelated business taxable income. [IRC §512(b)(5) & (b)(12)]

Unrelated business taxable income includes any income from debt-financed property. [IRC §514(a)] A CRT has debt-financed income if the CRT acquires realty subject to a mortgage. The two exceptions are as follows:

  1. The CRT will not have unrelated business taxable income for a period of 10 years following the gift as long as it does not assume the debt. [IRC §514(c)(2)(B); Treas. Reg. §§1.514(c)-1(b)(3)]
  2. The CRT will not have unrelated business taxable income for a period of 10 years following the gift as long as: 1) the debt was placed on the property more than five years before the date of the gift; 2) the property was held by the donor for more than five years before making the gift; and 3) the CRT does not assume the debt. See, PLR 9533014 (wherein the donor remained liable on the nonrecourse debt qualifying for the exception); but see, PLR 9015049 (wherein the grantor remained personally liable on the debt causing the CRT to disqualify because it was a grantor trust).


Examples of transactions causing unrelated business taxable income in a CRT

  • Borrowing from an insurance policy in the CRT. [PLR 8745013]
  • Holding property subject to debt. [IRC §514]
  • Income from oil and gas working interests. [PLR 8834039]

Examples of transactions not causing unrelated business taxable income in a CRT

  • A third party using the assets of the CRT as collateral on a loan to the charitable remainderman. [PLR 8807082]
  • Operation of business that receives rents from real property. [PLR 9245036]
  • When the business is the donor of a CRT and the CRT sells assets of the business other than inventory and assets customarily held for the sale to customers. [PLR 9340043; PLR 9413020]

The value of the donor's federal income tax deduction is a function of: 1) the type of charitable remainderman; 2) the kind of property contributed to the CRT; and 3) whether, at the end of the noncharitable term, the assets are: a) distributed outright to the charitable remainderman; or b) held in trust for the benefit of the charitable remainderman. [IRC §170]

Remainderman Is A Public Charity

For this purpose, a public charity includes churches, educational institutions, hospitals and medical institutions, university endowment funds, governmental units, publicly supported organizations under Sections 170(c)(2) & 509(a)(2) (i.e., museums, drama companies, ballet companies, etc.), supporting organizations under Section 509(a)(3), private operating foundations, and two types of private foundations: distributing foundations and foundations that maintain a common fund.

The donor gets a federal income tax deduction for the fair market value of the remainder interest passing to charity subject to the following percentage limitations.

Gift Of Cash And Nonappreciated Property

  • Passes outright to public charity at end of noncharitable term-In the year of the gift, the donor's fair market value charitable income tax deduction is limited to 50% of his/her adjusted gross income (AGI) with a five-year carry-forward. [IRC §170(b)(1)(A); Treas. Reg. §1.170A-8(a)(2)]
  • Held in trust for the benefit of public charity at end of noncharitable term-In the year of the gift, the donor's fair market value charitable income tax deduction is limited to 30% of his/her AGI with a five-year carry-forward. [IRC §170(b)(1)(B); Treas. Reg. §1.170A-8(a)(2)]

Gift Of Appreciated Property

  • Passes outright to public charity at end of noncharitable term-In the year of the gift, the donor's fair market value charitable income tax deduction is limited to 30% of his/her AGI with a five-year carry-forward. [IRC §170(b)(1)(C)(i); Treas. Reg. §1.170A-8(a)(2)]
  • Held in trust for the benefit of public charity at end of noncharitable term-In the year of the gift, the donor's fair market value charitable income tax deduction is limited to 20% of his/her AGI with a five-year carry-forward. [IRC §170(b)(1)(D); Treas. Reg. §1.170A-8(a)(2)] IRC §170(e), which limits the charitable income tax deduction to the donor's adjusted basis in the property, does not apply. This Section applies in two situations as follows: 1) as to gifts of appreciated property to a private foundation; and 2) as to gifts for the use of a private foundation. [IRC §170(e)(B)(ii)] A gift to a CRT is not a gift to a private foundation. Under IRC §4947(a)(2), a CRT is made subject to the private foundation excise tax restrictions, but this Section does not provide the CRT is a private foundation. Thus, the gift is not to a private foundation. A gift to a CRT that continues as a trust at the end of the noncharitable term for the benefit of a public charity is not a gift for the use of a private foundation. Rather it is a gift for the use of a public charity. [Treas. Reg. §1.170A-8(a)(2)] However, if, at the end of the noncharitable term, the CRT wants to not be subject to the private foundation excise tax restrictions and private foundation reporting requirements, it will be necessary for the trustee of the CRT to file a Form 1023 to qualify the trust as a public charity. [IRC §4947(a)(1); IRC §509(a)] This is because at that time, the trust is a private foundation unless it can be shown to be otherwise.

For this purpose, private foundation is defined as all organizations other than those defined as public charities. In other words, it includes all private foundations except: 1) an operating foundation; 2) a distributing foundation; and 3) a foundation that maintains a common fund.

Charitable Income Tax Deduction

The donor gets a charitable income tax deduction in the year of the gift for the fair market value of the remainder interest passing to charity limited to 30% of his/her AGI with a five-year carry-forward. [IRC §170(b)(1)(B)] This is the deduction and applicable percentage limitation regardless of whether, at the end of the noncharitable term, the assets pass outright to the private foundation or are held in trust for the benefit of the private foundation.

On June 30, 1998, the rule allowing the donor to get a charitable income tax deduction in the year of the gift for the fair market value of the remainder interest passing to charity was limited to 20% of his AGI with a five-year carry-forward. However, the deduction was revived under the Tax and Trade Relief Extension Act of 1998 (Section 170(e)(5)(D) of the Code that created the lapse was stricken). Unlike previous relief where the deduction was extended (initially from December 31, 1994 to July 1, 1996 and then to June 30, 1998) the latest relief appears to be permanent. This is the deduction and applicable percentage limitation regardless of whether, at the end of the noncharitable term, the assets pass outright to the private foundation or are held in trust for the benefit of the private foundation.

Planning Idea - Name as the charitable remainderman the donor's family foundation. Although the donor's income tax deduction is normally lower or limited to property's basis, this can be a technique to enable the family to retain control of the assets as the officers, directors, and members of the family foundation.

An individual whose AGI exceeds $100,000 (as indexed; $126,600 in 1999 for married persons filing jointly-the "Threshold Amount") the charitable deduction for that year is reduced by the lesser of 3% of AGI in excess of the threshold amount or 80% of the total amount otherwise allowed as itemized deductions.

Qualified Appraisals

A qualified appraisal is required when the CRT holds unmarketable assets as defined in Treas. Regs. §1.664-1(a)(7)(ii). The appraisal must be prepared no earlier than 60 days prior to the date that the contribution is made and must be prepared no later than the due date of the return (with extensions) on which the deduction is claimed. [Treas. Reg. §1.170A-13(c)]

Contents of a qualified appraisal

The appraisal must be prepared, signed, and dated by a qualified appraiser as defined below. The appraisal must include the following information:

  • A description of the property in sufficient detail for a person who is not generally familiar with the type of property to ascertain that the property that was appraised is the property that was (or will be) contributed.
  • In the case of tangible property, the physical condition of the property.
  • The date (or expected date) of contribution to the donee.
  • The terms of any agreement or understanding entered into (or expected to be entered into) by or on behalf of the donor that relates to the use, sale, or other disposition of the property contributed. This includes restrictions on the donee's right to use or dispose of the donated property, all provisions that confer on anyone, other than the donee charity, the right to income from the donated property or the right to possession of the property, including voting rights to securities, a right of purchase, or a provision that earmarks the donated property for a particular use. As an added precaution, all agreements between the donor and the donee charity relating to the gift should be attached to the appraisal and incorporated into it by reference.
  • The name, address, and taxpayer identification number of the qualified appraiser and, if the qualified appraiser is a partner in a partnership, an employee of any person (whether an individual, corporation, or partnership), or an independent contractor engaged by a person other than the donor, the name, address, and taxpayer identification number of the partnership or the person who employs or engages the qualified appraiser.
  • A statement providing that the appraisal was prepared for income tax purposes.
  • The date or dates on which the property was valued.
  • The appraised fair market value of the property on the date (or expected date) of contribution.
  • The method of valuation used to determine the fair market value, such as the income approach, the market data approach, or the replacement-cost-less-depreciation approach).
  • The specific basis for the valuation, if any, such as any specific comparable sales transactions.
  • A description of the fee arrangement between the donor and the appraiser.

No part of the fee arrangement for a qualified appraisal can be based, in effect, on a percentage (or set of percentages) of the appraised value of the property.

To be a "qualified appraiser" the appraiser must sign and complete Internal Revenue Service Form 8283, Section B, "Appraisal Summary." The appraisal summary includes declarations by the appraiser that includes:

1) The individual holds himself or herself out to the public as an appraiser;

2) Because of the appraiser's qualifications as described in the appraisal, the appraiser is qualified to make appraisals of the type of property being valued.

The appraiser is not:

1) The donor or the taxpayer who claims or reports the deduction under Section 170 for the contribution of the property being appraised.

2) A party to the transaction in that the donor acquired the property being appraised (i.e., the person who sold, exchanged, or gave the property to the donor, or any person who acted as an agent for the transferor or for the donor with respect to such sale, exchange, or gift), unless the property is donated within two months of the date of acquisition and its appraised value does not exceed its acquisition price.

3) The donee of the property.

4) Any person employed by any of the foregoing persons or related to any of the foregoing persons under Section 267(b) (e.g. if the donor acquired a painting from an art dealer, neither the art dealer nor persons employed by the dealer can be qualified appraisers with respect to that painting).

5) Any person whose relationship with any of the persons listed in 1) through 4) above would cause a reasonable person to question the independence of such appraiser. For example, an appraiser who is regularly used by any person described in 1) through 3) above and who does not perform a substantial number of appraisals for other persons has a relationship with such person that is similar to that of an employee and cannot be a qualified appraiser with respect to the property contributed.

6) The appraiser understands that a false or fraudulent overstatement of the value of the property described in the qualified appraisal or appraisal summary may subject the appraiser to a civil penalty under Section 6701 for aiding and abetting an understatement of tax liability, and consequently the appraiser may have appraisals disregarded pursuant to 31 U.S.C. § 330(c).

What Is Done With The Qualified Appraisal, The Appraisal Summary, And Form 8283?

The qualified appraisal is not required to be filed with the donor's federal income tax return. It must be kept with the donor's records.

The appraisal summary is also not required to be filed with the donor's federal income tax return. It is kept with the donor's records with the appraiser's resume setting forth the appraiser's qualifications.

The original of Form 8283 must be filed with the donor's federal income tax return. The donor must keep a copy with his records.

Federal Return Filings Required For A CRT

Form 5227. Split Interest Trust Informational Return is an informational return that must be filed annually by the trustee of the CRT.

Form 1041-A. Trust Federal Income Tax Return is another informational return that must be filed by the trustee of the CRT if such trust has gross income in excess of $600.00.

Form 8282. Form 8282, Donee Information Return must be filed by the trustee of the CRT if such trust sells, exchanges, or otherwise disposes of the trust assets within two years after the date the CRT received the property.

Form 709. Federal Gift (and Generation Skipping Transfer Tax) Return must be filed on April 15th of the year following the gift.

Gift Tax Consequences

Who is the recipient of the annuity amount or unitrust amount?

Just the donor: The donor gets a charitable gift tax deduction for the value of the remainder interest passing to charity. [IRC §2522(a)]

The donor and spouse: The donor's spouse is the only other recipient of the annuity amount or unitrust amount. The donor has made a gift to his/her spouse of the value of the annuity amount or unitrust amount going to his/her spouse but such gift is shielded by the marital deduction if the spouse is the only other recipient of the unitrust amount or annuity amount. [IRC §2523(g)] The donor also gets a charitable gift tax deduction for the value of the remainder interest passing to charity. [IRC §2522(c)(2)(A)]

Spouse and others are recipients of annuity amount or unitrust amount: For example, the donor, then spouse and then children are the recipients. The donor has made a gift to his/her spouse that does not qualify for the marital deduction. [IRC §2523(g)] Further, the donor has made a gift to his/her children. However, the donor can retain the right to revoke by will his/her spouse and children's rights to the annuity amount or unitrust amount without disqualifying the trust as a CRT and if so, the gifts are incomplete. [Treas. Reg. §§1.664-2(a)(4); 1.664-3(a)(4); PLR 9517020; PLR 9326049] If done, the retention of the right to revoke by the donor results in the CRT assets being includable in the donor's estate at his/her later death. [Rev. Rul. 79-243, 1979-2 C.B. 343; IRC §2038(a)(1); PLR 9326049]

Someone other than the donor's spouse: The donor has made a gift to that person in the amount of the present value of the annuity amount or unitrust amount unless the donor retains the right to revoke by will that person's right to the annuity amount or unitrust amount. Again, such retention of the power to revoke causes the gift to be incomplete and causes the assets subject to the power to revoke to be includable in the donor's estate.

IRC Section 2702 Abuse

To circumvent the gift tax rules, previously a grantor would create a NIMCRUT first for a term of years and then for the life of a child. Ordinarily, in such a case, the interest retained by the grantor will be valued at zero pursuant to IRC Section 2702 causing the value of the grantor's gift to that other recipient to equal the entire fair market value of the property transferred to the CRT less the present value of the remainder interest passing to charity. The regulations under IRC §2702 included a broad exception for CRTs.

The Service has perceived an abuse whereby a NIMCRUT is used and funded with low income producing assets until the second recipient's interest takes effect. At that time, the trustee invests in high income producing assets and the second recipient gets the lesser of the trust's net income or the fixed percentage plus with regard to a NIMCRUT the ability to withdraw a makeup amount if the annual trust net income exceeds the fixed percentage amount, thereby transferring substantial payments to the second recipient without gift or estate tax.

Final IRC §2702 Regulations

The final regulations amend IRC §2702 regulations to limit the CRT exception to charitable remainder annuity trusts and fixed percentage charitable remainder unitrusts. In addition, an exception is provided for a secondary life interest in the donor. IRC §2702 does not apply to a CRT with two consecutive noncharitable interests where the donor has the second of the two interests. A third exception applies where the unitrust's distributions are permitted only to the donor, the donor's U.S. citizen spouse, or both.

Estate And Tax Consequences

Donor was sole recipient: The value of the CRT assets is includable in the donor's estate, but such inclusion is shielded by the estate tax charitable deduction for the value of the assets passing to charity at the donor's death.

Spouse is sole succeeding recipient of annuity amount or unitrust amount: The value of the CRT assets is includable in the donor's estate but such inclusion is shielded by: 1) the marital deduction for the value of the annuity amount or unitrust amount going to the spouse; and 2) the charitable deduction for the value of the remainder interest going to charity.

Spouse and others are succeeding recipients of annuity amount or unitrust amount: The value of the CRT assets is includable in the donor's estate. The value of the unitrust amount or annuity amount going to the recipients is not shielded by the marital deduction. The value of the remainder interest passing to charity is shielded by the charitable estate tax deduction.

Somebody other than spouse was recipient: The value of the CRT assets is not includable in the donor's estate unless the donor retained the testamentary power to revoke such recipient's interests. In that case, the donor's estate is entitled to a charitable estate tax deduction for the value of the remainder interest passing to charity.

Testamentary CRAT or CRUT

Spouse is sole recipient: The value of the CRT assets is includable in the donor's estate, but such inclusion is entirely shielded by the marital deduction and the charitable deduction. [IRC §§2055(c); 2036(a); & 2056(b)(8)]

Spouse and others are recipients: The value of the CRT assets is includable in the donor's estate. The value of the annuity amount and unitrust amount passing to the spouse and other recipient is not shielded by the marital estate tax deduction, but the value of the remainder interest passing to charity is shielded by the charitable estate tax deduction. [IRC §§2055(c); 2036(a); & 2056(b)(8)]

Somebody other than spouse is recipient: The value of the CRT assets is includable in the donor's estate, but the value of the remainder interest passing to charity is shielded by the charitable estate tax deduction. [IRC §§2036(a) & 2055(c)]

Funding CRTs

Advantages: nonrecognition of capital gains. A CRT is a tax-exempt entity and therefore, upon the sale of an asset, capital or otherwise, the CRT recognizes no gain. A donor can contribute highly appreciated property to a CRT and benefit from the appreciated value of the asset because the donor's unitrust amount from a CRUT will be greater due to such assets high value not reduced by income tax on the appreciation. The donor benefits from the appreciation and at the same time the donor avoids payment of the tax from the appreciation. The key here is to make sure that as of the date of the funding (not just creation) of the CRT that there is no legal obligation to sell such asset. The trustee must be under no legal obligation to sell the asset. If, when the trust receives the asset, the trustee is subject to an obligation to sell, the Service will ignore the gift to the CRT and treat the transaction as if the donor sold the asset. The donor then gets the worst of both worlds- payment of tax and loss of the asset. [Palmer v. Commissioner, 62 T.C. 684 (1974); Rev. Rul. 78-197, 1978-1 C.B. 83 (wherein the Service acquiesced to the position of Palmer)]

Growth of assets in a tax-exempt entity. Since a CRT is a tax-exempt entity, the value of the assets in the CRT can grow at a faster rate because gain realized on the sale of assets of the CRT is not recognized for income tax purposes in the CRT. The recipient of the unitrust amount from a CRUT gets the benefit from such growth since the fixed percentage is applied to a larger capital base.

Disadvantage: Reduction of assets ultimately passing to donor's family. The chief disadvantage of a CRT is that charity ultimately gets the assets in the CRT and not the donor's family. One way to curtail this disadvantage is to set up a non-estate taxable side fund for the donor's family with, among other options, an irrevocable life insurance trust. The death benefits paid to a properly structured irrevocable life insurance trust are excludable from the insured's estate and thus, the death benefits can be used as a non-estate taxable way to replace those assets going to charity in the CRT. The insured normally will pay the premium on the insurance policy through gifts to the irrevocable life insurance trust.

Marketable Securities

The trustee of an intervivos CRT is able to sell low basis, highly appreciated, marketable securities without gain recognition. [IRC §664(c)] The sale proceeds can then be invested to produce payments to the recipient, usually the grantor, in the form of the annuity amount or unitrust amount. In this way, the grantor benefits from the appreciation of his/her securities via the annuity amount or unitrust amount, but has no taxable recognition of the gain from the sale of the securities while the proceeds or those in that they are invested are held by the CRT.

Tax Exempt Securities

If the CRT also has realized (but unrecognized) capital gains, the recipient may still have to recognize the income therefrom upon receipt of the annuity amount or unitrust amount under the tier approach applicable to distributions to recipients. Thus, investment by the CRT in tax free securities may not be wise unless the return to the recipient after income tax at capital gains rates is greater than the return to the recipient after income tax at ordinary income tax rates if the CRT investments produce ordinary income (i.e., interest, dividends, etc.).

Real Estate

It is not a good idea to transfer a donor's personal residence to a CRT, whether unencumbered or encumbered, because the donor cannot live in the residence without committing a prohibited act of self-dealing. [Rev. Rul. 76-357, 1976-2 C.B. 285]

It is wise to use a NICRUT, a NIMCRUT, or a FLIP CRUT so the trustee will not be forced to make a distribution in kind to make the distribution to the recipient if the income of the CRT is not sufficient for the entire annual payment. If such was contributed to a CRAT or the fixed percentage CRUT, the trustee could be forced to make a distribution in kind because the trustee is required to distribute the annuity amount or unitrust amount based on the fixed percentage. A distribution of just the annual net income is not an option with the CRAT or fixed percentage CRUT.

There are problems with using encumbered real estate to fund a CRT. None of the income of a CRT is tax exempt for a year in that the CRT has unrelated business taxable income in excess of $1,000. [Treas. Reg. §1.664(c)] Debt-financed income is unrelated business income. [IRC §514(a)] Generally, if a CRT is funded with encumbered real estate, it will have unrelated business taxable income. The two exceptions are as follows:

  • The CRT will not have unrelated business taxable income for a period of 10 years following the transfer if it does not assume the debt. [IRC §514(c)(2)(B); Treas. Reg. §§1.514(c)-1(b)(3)]
  • The CRT will not have unrelated business taxable income for a period of 10 years following the gift as long as: 1) the debt was placed on the property more than five years before the date of the gift; 2) the property was held by the donor for more than five years before making the gift; and 3) the CRT does not assume the debt. See, however, PLR 9015049 (wherein the grantor remained personally liable on the debt causing the CRT to be disqualified because it was a grantor trust).

Subchapter Stock

A CRT is not a qualified subchapter S shareholder, and therefore, a donor cannot use subchapter S stock to fund a CRT. [Rev. Rul. 92-48, 1992-1 C.B. 301] Section 1361 provides that an organization that is: 1) described in Section 501(c)(3); and 2) exempt from tax under Section 501(a), can be a shareholder of an S Corporation. [IRC §1361(c)(7)[6]. From a literal reading, it appears that a CRT still cannot be a permissible shareholder of an S Corporation. A CRT is not exempt from tax under Section 501(a). Rather, a CRT is exempt from tax under Section 664(c). Further, the dividends and the capital gain on a stock sale in excess of $1,000 would be unrelated business taxable income thereby causing all the income of the CRT to be taxable for that year.

The S Corporation is a permissible donor of a CRT and may contribute its assets to a CRT, and in such a case, since the corporation is not an individual, the term of the CRT must be limited to a term of years not to exceed 20. [Treas. Reg. §1.664-2(a)(5) and 1.664-3(a)(5); PLR 9340043] However, if the CRT later sells the assets, there are several considerations.

As of the funding of the CRT, the trustee of the CRT must not have been legally bound to complete the sale. The obligation to sell must not have been entered into prior to such funding. [Palmer v. Commissioner, 62 T.C. 684 (1974)]

The type of assets to be sold is crucial in determining whether the CRT will have unrelated business taxable income. There are two main types of properties that will cause unrelated business taxable income if sold by the trustee of the CRT. The first type of asset that will generate unrelated business taxable income is property held primarily for sale to customers in the ordinary course of business (i.e., inventory). [IRC §512(b)(5); PLR 9340043] The second type of asset that will generate unrelated business taxable income is any asset that is encumbered with debt since such asset will create debt-financed income that is unrelated business taxable income. [IRC §514(a)] The sale of other assets by the CRT will not create unrelated business taxable income. For example, equipment and buildings (not inventory) will not create unrelated business taxable income. [PLR 9413020]

Regular C Corporation

Regular C Corporation stock can be used to fund a CRT. However, there are several considerations.

The CRT is treated as a private foundation for most purposes. Private foundations may not, in conjunction with other disqualified persons, own more than 35% (20% in some cases) of the voting stock of the corporation. However, the excess business holdings prohibition does not apply to CRTs if a deduction was allowed under Sections 170, 545(b)(2), 556(b)(2), 642(c), 2055, 2106(a)(2), or 2522 for amounts payable under the terms of such trust to every remainder beneficiary but not to any income beneficiary. [IRC §4947(b)(3)] Since a CRT affords a deduction under Section 170, the excess business holdings prohibition does not apply as long as a charity is not a recipient of the annuity amount or unitrust amount.

As with all sales of assets transferred to a CRT, there must be no legal obligation to sell such assets prior to the contribution of the assets to the CRT.

Prior to the contribution of stock to the CRT, it is necessary to explore the relationship between the donor and the corporation; a family member of the donor and the corporation; and, between other donor corporations and corporation whose stock is given. There are several traps within the self-dealing rules that could create a prohibited act of self-dealing. Examples of the traps include a sale, exchange, or leasing of property between a CRT and a disqualified person (unless it is without charge) [IRC § 4941(d)(1)(A) and (2)(A)]; lending of money or other extension of credit between a CRT and a disqualified person (unless no interest is charged). [IRC § 4941(d)(1)(B) and (2)(B)] If the donor of the stock continues to own after the gift to the CRT more than 35% (20% in some cases) of the voting stock of the corporation, the corporation cannot redeem the stock because this is prohibited self-dealing. However, if the offer to redeem is made on identical terms to all other shareholders who own the same class of stock, such redemption is specifically excepted from the self-dealing rules. [IRC §4941(d)(2)(f); Treas. Reg. §53.4941(d)-3(d)]

The sale of the stock itself will not create unrelated business taxable income. [IRC §512(b)(5)] Any income received as dividends from the stock will not create unrelated business taxable income. [IRC §512(b)(1)]

Options

Old position of Service. In PLR 9240017, the Service ruled that an option could be an asset used to fund a CRT and the annuity amount or unitrust amount would be based on the value of the contract right to purchase the donor's property at the purchase price provided in the option. The Service further ruled that the grantor would not recognize gain or loss on the assignment of the option to a third party.

In a situation where a donor would like to fund a CRT with an asset, but such asset cannot be used to fund the CRT, such as with subchapter S stock, the donor would fund the CRT with an option to purchase the "bad" asset.

New position of Service. In PLR 9417005, the Service withdrew PLR 9240017 without explanation. The Service stated that "no inference should be made from [the]...withdrawal as to the proper tax treatment of the transfer to a CRT of an option to purchase property."

In PLR 9501004, the Service ruled that the transfer of an option to a CRT disqualified the trust as a CRT. The Service's rationale was that: 1) the gift of an option is incomplete; and 2) an income tax charitable deduction is not allowable for the option. The result of such is that a CRT funded with an option fails to function exclusively as a CRT from its inception, disqualifying the trust as a CRT.

Other Assets Used To Fund CRTs

Qualified retirement plan benefits can be used to fund a CRT. The assets are withdrawn from the qualified plan causing income taxation. However, if the assets withdrawn are contributed to a CRT, an income tax charitable deduction will also be allowed in that year based on the value of the remainder interest passing to charity.

There would be no estate tax by naming an intervivos or testamentary CRT as the beneficiary of the plan benefits at the plan participant's death. The participant's surviving spouse would be the recipient of the annuity amount or unitrust amount with the remainder passing to charity. The participant's estate would be entitled to both a marital and charitable deduction for the value of the qualified plan benefits made payable to the CRT.

Designating a CRT as the beneficiary of retirement plan benefits will not disqualify the trust from being a CRT. [PLR 9253038; PLR 9237020]

Is a CRT a designated beneficiary of qualified plan benefits? A trust is a designated beneficiary of a qualified retirement plan if as of the later of the date on which the trust is named as a beneficiary or the participant's required beginning date (April 1st of the year following attainment of the age 70 ½), and as of all subsequent periods during which the trust is named as a beneficiary, the following requirements are met: 1) it is a valid trust under state law (or would be but for the fact that there is no corpus); 2) it is irrevocable or will, by its terms, become irrevocable upon the death of the participant; 3) the trust has only identifiable individual beneficiaries; and 4) a copy of the trust document is given to the plan administrator. A copy of the trust document must be provided to the plan administrator before his/her required beginning date and the participant must agree that if the trust document is later amended, the participant will, within a reasonable time, provide the plan administrator with a copy of the amendment. If the participant dies before required beginning date, the trustee of the trust must provide a copy of the trust document to the plan administrator by the end of the ninth month beginning after the participant's date of death. However, when a trust has multiple beneficiaries, all of the beneficiaries must qualify as designated beneficiaries. A charity is not a designated beneficiary. Thus, a CRT will not qualify as a designated beneficiary.

The effect of the CRT not qualifying as a designated beneficiary is that the distribution of the plan benefits will be accelerated to a term of either five years (if the death of the participant is before the required beginning date) or the life expectancy of the participant (if the death of the participant is after the required beginning date) causing accelerated income realization. However, since a CRT is tax exempt, such acceleration is irrelevant.

The recipient will have recognizable income as the recipient of the annuity amount or unitrust amount. The decedent's (who was the plan participant) estate tax return will reflect a charitable estate tax deduction in the amount of the value of the remainder interest passing to charity resulting in more of the estate ultimately passing to heirs.

A life insurance policy may be used to fund an intervivos CRT. [PLR 8745013] This would be advantageous if the goal of the donor is to provide income for his or her surviving spouse for such survivor's lifetime. However, several issues need to be considered.

The CRT must preclude the use of the income of the trust to pay the premiums on a life insurance policy on the life of the donor or the donor's spouse. If income is used, the trust is a grantor trust and such will disqualify the trust as a CRT. [IRC §§677(a)(3) & 664(c)] There are two ways around this rule:

  1. Be careful how you define "income" for this purpose. Income includes capital gains for federal income tax purposes. [IRC §61] However, generally, income does not include capital gains for trust accounting purposes. For example, under Texas law, unless provided otherwise in the governing instrument, capital gains are allocated to principal. Be sure to restrict the trustee from using income, as defined for federal income tax purposes, for payment of the premiums on the life of the grantor or the grantor's spouse so the Service cannot find that capital gains (i.e., income for federal income tax purposes) are used to pay the premiums. [PLR 8839008]
  2. A CRT that pays premiums on a life insurance policy will not be a grantor trust if: 1) a NIMCRUT or NICRUT is used; and 2) the amounts received on account of the insurance policy are allocated to principal. [PLR 9227017] Since the unitrust amount is limited to income and the amounts received are allocated to principal, the amounts received will be a part of the remainder payable to charity. It is suggested that for this purpose, principal, to which amounts received are allocated, be defined for trust accounting purposes to not run afoul of the issue above.


In PLR 8745013, the Service ruled that borrowing by the trustee from the cash value of an insurance policy caused unrelated business income.

A life insurance policy could be a jeopardy investment under Section 4944 if the investment in the premium by the CRT outweighs the death benefit to be received by the CRT. In Rev. Rul. 80-133, a donor-insured gave a life insurance policy to a private foundation. The donor-insured had a 10-year life expectancy. The private foundation began paying the premiums. The Service ruled that each payment by the private foundation was a jeopardizing investment because at the end of eight years, the investment by the private foundation would have been greater than the death benefit under the policy. The Service stated "an investment shall be considered to jeopardize the carrying out of the exempt purpose of a private foundation if it is determined that the foundation managers, in making such investment, have failed to exercise ordinary business care and prudence, ...in providing for the long-term and short-term financial needs of the foundation to carry out its exempt purpose. In the requisite standard of care and prudence the foundation managers may take into account the expected return of an investment and the need for diversification within the investment portfolio." [Rev. Rul. 80-133, 1980-1 C.B. 258]

In PLR 9547022, an individual sold his stock in a company to an employee stock ownership trust under an employee stock ownership plan sponsored by the firm. The individual reinvested the sale proceeds in qualified replacement property (QRP) and deferred gain under Section 1042. The individual proposed to transfer a portion of that QRP to a CRUT he established. Because no gain is realized on the transfer of the QRP to the trust, the Service ruled that the contribution to the CRUT would not cause a recapture of gain previously deferred under Section 1042.

A CRT may be funded with partnership interests and the general partner may be the trustee of the CRT. The initial funding of a CRT with partnership interests when the trustee of the CRT is the general partner of the partnership is not an act of self-dealing. [PLR 9633007] However, any other transactions must be carefully scrutinized under the self-dealing rule to ensure no violation.

The sale of the partnership, itself, will not create unrelated business taxable income. [IRC §512(b)(5)] If the partnership engages in an unrelated trade or business, the net income in excess of $1,000 from such unrelated trade or business flowing through to the CRT will be unrelated business taxable income. [IRC §§512(a) & 512(b)(12)] If the unrelated trade or business generates rents from real property, such is not unrelated business taxable income, unless such property is debt financed. [IRC §§512(b)(3) & 512(b)(4)]

The excess business holding prohibition does not apply to CRTs so long as a charity is not a recipient of the unitrust amount or annuity amount. [IRC §4947(b)(3)]

The proposed regulation stated that the Service was studying the effect of a NICRUT or NIMCRUT funded with partnership interests when the general partner in control of the partnership distributions is the trustee of the CRUT. The Service does not like the general partner of the partnership, also the trustee of a CRUT, having the discretionary power to make partnership distributions, thus, having the discretionary power to make the payment of the unitrust amount to the recipient. The final regulations do not include any mention of this issue, so it is not clear whether the Service has reached any conclusion one way or the other.

Exhibit A

Grantor Trust Avoidance

The following is a nonexclusive list of items that can cause the grantor of a trust being taxed on the income of the trust:

  1. Grantor is personally liable on a debt of property contributed to trust. Under IRC §677(a) and Treas. Reg. §1.677(a)-1(d), the CRT has been held to be a grantor trust if the grantor remains personally liable on a debt on property contributed to a CRT. [PLR 9015049]
  2. The trustee of a CRT is able to buy life insurance with the "income" of the CRT on the life of the donor or the donor's spouse. Under IRC §677(a)(3), the CRT has been held to be a grantor trust if the trustee is not precluded from using "income" of the trust to purchase life insurance on the life of the grantor or the grantor's spouse. It is crucial to define "income" for this purpose as defined for federal income tax purposes in order to prohibit the trustee from using capital gains to purchase a life insurance policy. In PLR 8839008, the Service ruled that although the trustee was prohibited from using income for trust accounting purposes, the trustee was not prohibited from using income for tax purposes. Thus, the trustee purchased a life insurance policy with corpus for trust accounting purposes and income for tax purposes. The trust was held to be a grantor trust. All CRTs, even if not funded with life insurance policies, should prohibit the trustee from using income, as defined for federal income tax purposes, to buy a policy on the life of the grantor or the grantor's spouse.


List Of Items That Have Not Caused Imposition Of Grantor Trust Rules

The following is a nonexclusive list of items that the Service has ruled will not cause a CRT to be a grantor trust.

  1. Grantor's retention of right to change charitable remainderman. [PLR 9504012; Rev. Rul. 76-8, 1976-1 C.B. 179]
  2. Grantor's retention of right to terminate all or a portion of the trust corpus accelerating distribution to charity. [PLR 9442017]
  3. Grantor's acting as trustee. [PLR 9504012]
  4. Grantor's retention of right to remove and replace trustee. [Rev. Rul. 77-285, 1977-2 C.B. 213]
  5. Grantor's retention of investment authority over trust except to the extent of valuing those assets having no readi-ly ascertainable fair market value. [PLR 9442017]
  6. Grantor or grantor's spouse as recipient of annuity amount or unitrust amount. [PLR 9504012]
  7. Grantor's contribution of property subject to a nonrecourse debt and grantor remaining liable for the nonrecourse debt. [PLR 9533014]


Exhibit B

Changes In The Tax Law

FLIP Unitrusts: The final regulations allow the CRT to provide that the CRT will convert from one of the income exception methods (NICRUT or NIMCRUT) to the fixed method for calculating the unitrust amount if the date or event triggering the conversion is outside the control of the trustee or any other person. Permissible triggering events with respect with any individual include marriage, divorce, death, or birth of a child. Also, the sale of an unmarketable asset such as real estate is a permissible triggering event. Examples of impermissible triggering events include the sale of marketable assets and a request from the unitrust recipient or the unitrust's recipient's financial advisor that the trust convert to the fixed percentage method. The conversion must take place at the beginning of the taxable year that immediately follows the taxable year in that the triggering date or event occurs. Further, any makeup amount is forfeited. The final regulations define unmarketable assets as any asset other than cash, cash equivalents, or assets that can readily be sold, exchanged for cash, or cash equivalents. For example, unmarketable assets include real property, closely held stock, and unregistered securities for which there is no available exemption permitting public sale. If a CRUT is created before such effective date containing a FLIP provision other than one permitted by the final regulations, the CRUT may be reformed to comply with the final regulations provided the trustee begins legal proceedings to reform the CRUT by June 8, 1999. If a CRUT is created after the effective date containing a provision other than one permitted by the Final Regulations, the CRUT will continue to qualify as a CRUT only if it is reformed to comply with the final regulations under the June 30, 2000 requirement, otherwise, it may be reformed, but it must be amended to omit the FLIP and use the initial method (normally a NIMCRUT). If the CRUT is created after the effective date and it does not contain a FLIP provision, the CRUT cannot be reformed to add the FLIP provision and if reformed, it will not qualify as a CRUT. Under the final regulations there is a special rule for reformation of trusts. A NIMCRUT or NICRUT may be reformed to a FLIP CRUT if the trustee begins legal proceedings to reform by June 30, 2000.

Time Limitations: For charitable remainder annuity trusts or fixed percentage unitrusts, the annuity or unitrust amount may be paid within a reasonable time after the close of the year for which it is due if: 1) the character of such amount in the hands of the recipient is either ordinary income, capital gain, or tax-exempt income (but not corpus); and/or 2) the trust distributes property rather than cash to pay the annuity or unitrust amount and the trustee elects on the trust's return to treat any income generated by the distribution as maturing on the last day of the taxable year for which the amount is due. For pre-December 10, 1998 trusts, the distribution may be made within a reasonable time after the close of the year only if the percentage used to calculate the annuity or unitrust is 15% or less.

Appraisals: A trust's unmarketable assets must be valued either by an independent trustee or by a qualified appraiser. [Treas. Regs. §1.664-1(a)(7)] An independent trustee is a person other than the grantor, or the grantor's spouse, a noncharitable beneficiary, or a party related or subordinate to either of them. [Treas. Regs. §1.664-1(a)(7)(iii). In addition, a co-trustee who is independent may value the trust's unmarketable assets. A qualified appraiser is defined is Treas. Regs. §1.170A-13(c).

IRC §2702: The final regulations amend IRC §2702 regulations to limit the CRT exception to charitable remainder annuity trusts and fixed percentage charitable remainder unitrusts. In addition, an exception is provided for a secondary life interest in the donor. IRC §2702 will not apply to a CRT with two consecutive noncharitable interests where the donor has the second of the two interests. A third exception applies where the unitrust's distributions are permitted only to the donor, the donor's U.S. citizen spouse, or both.

Capital Gain: The final regulations state that the governing instrument, if permitted under applicable local law, may allow the allocation of post contribution capital gains to trust's income. Further, the preamble to the final regulations states that it is unnecessary to treat the makeup account as a liability as originally established in several private letter rulings.

Income Tier Rules: The proposed regulations included an example showing how the payout is characterized for a NIMCRUT with undistributed capital gain. The IRS received no comments on this point, and the example is included without change in the final regulations. Under the example, the NIMCRUT received $7,500 of income for 1996, all of which was tax-exempt bond interest. It had no undistributed ordinary income or capital gain, except for $30,000 in undistributed capital gain of prior taxable years, and its unitrust amount for 1996 was $9,000. The amount distributable for 1996 was $7,500 and, under the four-tier system, this amount will be characterized as capital gain rather than tax-exempt income (even though it actually arose in 1996 from tax-exempt sources). This is because no tax-exempt income will be deemed distributed until all undistributed capital gain for the current year and all prior years are deemed distributed. Thus, the trust's undistributed capital gain income goes down by $7,500 and its undistributed tax-exempt income goes up by the same amount for purposes of characterizing 1997 and later distributions. [Treas. Reg. §1.664-1(d)(l)(iii)]

Partnership Interests: The proposed regulations stated that the Service was studying the affect of a NICRUT or NIMCRUT funded with partnership interest when the general partner in control of the partnership distributions is the trustee of the CRUT. The Service does not like the general partner of the partnership, also the trustee of a CRUT, having discretionary power to make partnership distributions, thus, having the discretionary power to make the payment of the unitrust amount. The final regulations do not include any mention of this issue, so it is not clear whether the Service has reached any conclusion one way or the other.

Add comment

Login or register to post comments

Comments

Group details

Follow

RSS

This group offers an RSS feed.
 
7520 Rates: December 26% November 2.4% October 2.2%

Already a member?

Learn, Share, Gain Insight, Connect, Advance

Join Today For Free!

Join the PGDC community and…

  • Learn through thousands of pages of content, newsletters and forums
  • Share by commenting on and rating content, answering questions in the forums, and writing
  • Gain insight into other disciplines in the field
  • Connect – Interact – Grow
  • Opt-in to Include your profile in our searchable national directory. By default, your identity is protected

…Market yourself to a growing industry