CRT's Qualify Despite Fact Interests are Incomplete Gifts

CRT's Qualify Despite Fact Interests are Incomplete Gifts

News story posted in Letter Rulings on 8 July 1998| comments
audience: National Publication | last updated: 18 May 2011
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Summary

The Service has ruled privately that two trusts qualify as valid charitable remainder unitrusts under Code Section 664(d)(2) despite the fact that all interests in the trusts are incomplete gifts for federal gift tax purposes.

Ltr. Rul. 9827017

PGDC Summary:

The Service has ruled privately that two trusts qualify as valid charitable remainder unitrusts under Code Section 664(d)(2) despite the fact that all interests in the trusts are incomplete gifts for federal gift tax purposes.

A husband and wife each established a trust. The husband's trust provides that a unitrust amount of 11% will be paid to him semi-annually. At his death, the unitrust amount will be paid to the wife and at her death, the unitrust amount will be paid to another individual. At the death of the survivor of the three individuals, the remainder of the trust will pass to three charities. The husband is trustee of his trust and an independent trustee is appointed to value assets that do not have ascertainable values. The husband retains the power exercisable only by his will to revoke or terminate the successive interests of the wife and the other individual. The husband also reserves the power to add or substitute other charitable beneficiaries and/or to change the percentages to be received by each charity. If any charity is not qualified under Code Section 170(b)(1)(A), 170(c), 2055(a) and 2522(a), then the trustee is to distribute such charity's share to one or more charities which are so qualified.

The wife's trust is substantially similar to the husband's trust except that the wife receives the initial unitrust amount from her trust, she is the initial trustee of her trust and she retains the testamentary power to revoke the interests of her husband and the other individual beneficiary. We assume the wife also retained the power to change the charities or the percentages going to the charities under her trust (There are some apparent typographical errors in the ruling as it pertains to the provisions of the wife's trust).

The Service ruled that husband and wife made incomplete gifts via their respective trusts. The trusts qualify as charitable remainder unitrusts for purposes of Code Section 664(d)(2) with respect to transfers made to them prior to July 28, 1997. The IRS did not rule on qualification with respect to any transfers after that date (for transfers after July 28, 1997, the value of the remainder interest in a charitable remainder trust must be equal to at least 10% of the value of the assets transferred to the trust).

Points to Ponder:

If the interest of the non-spouse individual beneficiary is not revoked, then in all likelihood, the unitrust interest passing from the deceased spouse's trust to the surviving spouse at the death of the first spouse to die will not qualify for the federal estate tax marital deduction. Perhaps the plan contemplated is for the non-spouse individual beneficiary to disclaim his or her interest in the trust created by the spouse who dies first but keep his or her interest in the trust created by the spouse who dies last. This scenario would avoid gift taxes and postpone the estate taxes until both spouses are gone and would avoid estate taxes with respect to only one charitable remainder trust. How would the new 10% test for charitable remainder trusts impact this type of planning?

Full Text:

LEGEND:
Q = * * *
R = * * *
S = * * *
Trust 1 = * * *
Trust 2 = * * *
State = * * *

Dear * * *

This is in response to your authorized representative's October 4, 1997 letter in which a ruling was requested under sections 664 and 2522 of the Internal Revenue Code.

According to the facts submitted, on February 13, 1997, Q and R each established a trust (Trust 1 and Trust 2, respectively) and transferred property to the trusts. Both trusts are intended to qualify as charitable remainder unitrusts under section 664. The terms of the two trusts are substantially similar except for the order in which the unitrust beneficiaries are to receive their respective unitrust interests. Q is designated the trustee of Trust 1. However, an independent trustee is appointed to value all assets that do not have an objectively ascertainable value.

Under the terms of Paragraph 2 of Trust 1, the trust will pay a unitrust amount equal to 11 percent of the net fair market value of the trust assets valued as of the first business day of each calendar year of the trust to Q during Q's lifetime. The unitrust amount is paid-semiannually, on June 30 and December 31 of each year. Upon the death of Q, the unitrust amount will be paid to R (Q's wife), if living, until her death. Upon the death of R (or the death of Q if R predeceases Q), the unitrust amount will be paid to S, if S is then living. On the death of the last of the three unitrust recipients to die, the corpus is distributed in accordance with Paragraph 5, discussed below. Q has retained the power, exercisable only by his will, to revoke or terminate the successive interests of R and S.

Paragraph 2 also provides that any income of Trust 1 for a taxable year in excess of the unitrust amount is to be added to principal. If for any year the net fair market value of Trust 1 assets is incorrectly determined, then within a reasonable period after the value is finally determined for federal estate tax purposes, the Trustee is to pay to the Unitrust recipients (in the case of an undervaluation) or receive from the unitrust recipients (in the case of an overvaluation) an amount equal to the difference between the unitrust amount properly payable and the unitrust amount actually paid.

Paragraph 3, provides that the lifetime unitrust interest of R and S will take effect upon the death of Q only if R and S furnish the funds for payment of any federal estate taxes or state death taxes for which the Trustee may be liable upon the death of Q.

Paragraph 4 provides that, in determining the unitrust amount, the Trustee is to prorate the same on a daily basis for a short taxable year and for the taxable year ending with the surviving recipient's death.

Under Paragraph 5 of Trust 1, upon the death of the last to die of Q, R, and S, whose rights of R and S were not revoked by Q's will, the Trustee is to distribute all of the then principal and income of Trust 1 (other than any amount due any of the recipients or their estates under the provisions above) in specified percentages to three charities. Q reserves the limited right to add or substitute other charitable remaindermen and/or revoke or change the percentage of any one or more charitable beneficiaries by written instrument delivered to the Trustee or by will.

Paragraph 5 further provides that in all events, any charitable remainderman named in Paragraph 5 must be an organization described in sections 170(b)(1)(A), 170(c), 2055(a), and 2522(a) of the Internal Revenue Code. In the event that any portion of the remainder interest remains undesignated upon the death of Q, the undesignated portion is to be transferred to one or more organizations described in sections 170(b)(1)(A), 170(c), 2055(a), and 2522(a) in the sole discretion of the Trustee. If an organization is not described in sections 170(b)(1)(A), 170(c), 2055(a), and 2522(a) at the time when any principal or income of Trust 1 is to be distributed to it, then the Trustee is to distribute such principal and income to one or more organizations described in sections 170(b)(1)(A), 170(c), 2055(a), and 2522(a).

Paragraph 6 provides that if any additional contributions are made to Trust 1 after the initial contribution, the unitrust amount for the year in which the additional contribution is made is to be 11% of the sum of (1) the net fair market value of the Trust 1 assets as of the valuation date (excluding assets so added and any income from or appreciation on such assets) and (2) that proportion of the fair market value of the assets so added that was excluded under (1) that the number of days in the period that begins with the date of contribution and ends with the earlier of the last day of the taxable year or the date of death of the last surviving unitrust recipient bears to the number of days in the period that begins on the first day of such taxable year and ends with the earlier of the last day in such taxable year or the date of death of the last surviving recipient. In the case where there is no valuation date after the time of contribution, the assets so added shall be valued as of the time of contribution.

Paragraph 8 provides that the trustee shall make distributions at such time and in such manner as not to subject Trust 1 to tax under section 4942. Except for the payment of the unitrust amount to the recipients, the Trustee shall not engage in any act of self-dealing, as defined in section 4941(d), and shall not make any taxable expenditures, as defined in section 4945(d). The Trustee shall not make any investments that jeopardize the charitable purpose of Trust 1, within the meaning of section 4944 and the regulations thereunder, or retain any excess business holdings, within the meaning of section 4943(c).

Paragraph 9 provides that nothing in the Trust 1 instrument shall be construed to restrict the Trustee from investing the Trust 1 assets in a manner that could result in the annual realization of a reasonable amount of income or gain from the sale or disposition of Trust 1 assets.

Paragraph 12 provides that the taxable year of the trust shall be the calendar year.

Paragraph 13 provides that the operation of Trust 1 shall be governed by the laws of State and the Trustee is authorized to exercise the trust powers specified in those laws. The Trustee, however, is prohibited from exercising any power or discretion granted in the trust or under State trust laws that would be inconsistent with the qualification of Trust 1 under section 664(d)(2) and corresponding regulations.

Paragraph 14 provides that Trust 1 is irrevocable. The trustee, however, shall have the power, acting alone, to amend the trust in any manner for the sole purpose of ensuring that Trust 1 qualifies and continues to qualify as a charitable remainder trust within the meaning of section 664(d)(2).

The terms of Trust 2 are identical to Trust 1 except for the following. R is the initial trustee of Trust 2. Additionally, R is the initial unitrust recipient of Trust 2, followed upon R's death by Q, and upon Q's death by S. R has retained the power, exercisable only by will, to revoke or terminate the successive interests of Q and S.

Law and Analysis

Section 664 provides definitions, general rules governing the creation and administration of a charitable remainder trust, and rules governing the taxation of the trust and its beneficiaries.

Prior to amendment by the Tax Reform Act of 1997, 664(d)(2) defined a charitable remainder unitrust, generally, as a trust:

(A) from which a fixed percentage (which is not less than 5 percent) of the net fair market value of its assets, valued annually, is to be paid, not less often than annually, to one or more persons (at least one of which is not an organization described in section 170(c) and, in the case of individuals, only to an individual who is living at the time of creation of the trust) for a term of years (not in excess of 20 years) or for the life or lives of such individual or individuals,

(B) from which no amount other than the payments described in subparagraph (A) may be paid to or for the use of any person other than an organization described in section 170(c), and

(C) following the termination of the payments described in subparagraph (A), the remainder interest in the trust is to be transferred to, or for the use of, an organization described in section 170(c) or is to be retained by the trust for such a use.

The Tax Reform Act of 1997, P.L. 105-34, amended section 664(d) to add additional requirements that must be satisfied in order to qualify as a charitable remainder trust. In particular, under section 664(d)(2)(D), in order to qualify as a charitable remainder unitrust, with respect to each contribution of property to the trust, the value (determined under section 7520) of such remainder interest in such property must be at least 10 percent of the net fair market value of such property as of the date such property is contributed to the trust. This amendment is generally applicable to transfers in trust after July 28, 1997.

Section 1.664-1(a)(3) provides that a trust is not a charitable remainder trust if the provisions of the trust include a provision which restricts the Trustee from investing the trust assets in a manner which could result in the annual realization of a reasonable amount of income or gain from the sale or disposition of trust assets.

Section 1.664-2(a)(4) provides that, in general, the trust may not be subject to a power to alter, amend, or revoke for the beneficial use of a person other than an organization described in section 170(c). However, the grantor may retain the power, exercisable only by will, to revoke or terminate the interest of any recipient other than an organization described in section 170(c).

Section 1.664-1(a)(4) provides that in order for a trust to be a charitable remainder trust, it must meet the definition of and function exclusively as a charitable remainder trust from the creation of the trust.

In Rev. Rul. 79-243, 1979-2 C.B. 343, G, created and funded an inter vivos charitable remainder unitrust that meets the requirements of section 664. The trustee is to pay the unitrust amount to G for life and upon G's death to A for life. Upon A's death, the corpus of the trust is to be paid to an organization that meets the requirements of sections 170(c) and 2522(a). The trust instrument also provides that G has the power to revoke, by will, A's unitrust interest. If G revokes A's interest, the corpus will pass to the charitable organization upon G's death.

The revenue ruling holds that G made an incomplete gift to A for purposes of section 2511, since G retained the right to revoke A's interest. See section 25.2511-2(c) of the Gift Tax Regulations. G, however, has made a completed transfer to the charitable organization of the remainder interest in the unitrust. A gift tax charitable deduction is allowable under section 2522 for the value of the remainder interest (the present worth of the right to receive the trust corpus after the death of the survivor of G and A).

In the instant case, with respect to Trust 1, Q has retained the right to revoke the successive interests of R and S, and has retained the right to add or substitute charitable remainder beneficiaries, or change the interests of the remainder beneficiaries, currently designated. Similarly, with respect to Trust 2, Q has retained the right to revoke the successive interests of Q and S, and has retained the right to add or substitute charitable remainder beneficiaries currently designated. Under these circumstances, neither Q nor R has made a completed gift for gift tax purposes. See section 25.2511-2(c).

Based on our examination of the trust documents, we conclude that Trust 1 and Trust 2 meet the requirements for a charitable remainder unitrust described in section 664(d)(2) with respect to transfers to the trusts made on or before July 28, 1997. We are specifically not ruling on the qualification under section 664 of transfers made after July 28, 1997.

Actuarial Factor

The amount allowable as a deduction under section 170(a) is the present value of the remainder interest, determined as provided under section 1.664-4(a) as of the date of Q's transfer to the trust. Based on Life Table 80CNSMT, interest at 7.6 percent and an adjusted payout rate of 11 percent x .946703 or 10.414 percent, the present worth of the right to receive the remainder interest due in a charitable remainder unitrust upon the death of the last to die of three persons aged 76, 74 and 44, is $0.05167 of each $1.00 of initial trust corpus. Life Table 80CNSMT is found in section 20.2031- 7(d)(6) of the Estate Tax Regulations.

Except as we have specifically ruled herein, we express no opinion as to the consequences of this transaction under the cited provisions of the Code or under any other provisions of the Code.

In accordance with the power of attorney on file with this office, we are sending a copy of this letter to your authorized representative.

This ruling is directed only to the taxpayer who requested it. Section 6110(j)(3) of the Code provides that it may not be used or cited as precedent.

A copy of this letter should be attached to Q's (and R's) federal gift tax return when it is filed. A copy is enclosed for that purpose.

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