Firms Comment on Proposed CRT/UBIT Regulations

Firms Comment on Proposed CRT/UBIT Regulations

News story posted in Regulations on 17 April 2008| comments
audience: National Publication | last updated: 18 May 2011
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Summary

Although the IRS last week canceled a public hearing in Washington, D.C. on proposed regulations for the new unrelated business income tax rules applicable to charitable remainder trusts, two firms from the State of Washington have asked for transitional relief in the form being able to elect the lesser of the taxes under the old and new law in order to allow CRTs time to restructure their investments.

Full Text:

April 3, 2008

Internal Revenue Service
P.O. Box 7604, Ben Franklin Station
Washington, DC 20044

CC:PA:LPD:PR (REG-127391-07), Room 5203

Dear Sirs:

I am writing to support the comments submitted to you by Mr. Christopher W. Hesse, CPA, Director of Taxation, and member of the firm of LeMaster & Daniels, PLLC. His comments are regarding changes to be made to regulations under Section 664(c) by Section 424(a) and (b) of the Tax Relief and Health Care Act of 2006.

I am attaching Mr. Hesse's comments, for I have read them, and feel that they are very appropriate, and they set forth clearly the relief that should be given to the tax payers.

I have added to the bottom of Mr. Hesse's comments my name, address and e-mail, and join that any questions relating to this submission may be addressed to me, in care of said address, e-mail and phone number. Said address is also the address set forth on this letter.

                Sincerely,

                Leavy, Schultz, Davis &
                Fearing, P.S.
                William E. Davis
                Kennewick, Washington

WED/kf
Enclosure


March 27, 2008

Internal Revenue Service
PO Box 7604, Ben Franklin Station
Washington, DC 20044

CC:PA:LPD:PR (REG-127391-07), Room 5203

Dear Sirs:

Please find attached our comments regarding changes to be made to regulations under Section 664(c) by Section 424(a) and (b) of the Tax Relief and Health Care Act of 2006.

Please address any questions regarding this submission to me at the above address or by calling me at 509-624-8887, x. 3013.

                Sincerely,

                LeMaster & Daniels PLLC
                Christopher W. Hesse, CPA
                Director of Taxation,
                Member of the Firm

The Internal Revenue Service has issued Proposed Regulations under Section 1.664-1 regarding the effect of unrelated business taxable income on charitable remainder trusts. Per the Preamble of the proposed regulations, the Internal Revenue Service has provided notice that it will consider comments on these proposed regulations. The following are such comments.

Our comments relate to one issue: the effective date of the legislation and the related lack of time available to make a transition to prevent a draconian result for certain charitable remainder trusts. We explain more fully below.

The Committee Report for the Tax Provisions of the Tax Relief and Health Care Act of 2006 provided the following commentary with respect to the present law effect of unrelated business taxable income on charitable remainder trusts:

    Charitable remainder annuity trusts and charitable remainder unitrusts are exempt from Federal income tax for a tax year unless the trust has any unrelated business taxable income for the year. Unrelated business taxable income includes certain debt financed income. A charitable remainder trust that loses exemption from income tax for a taxable year is taxed as a regular complex trust. As such, the trust is allowed a deduction in computing taxable income for amounts required to be distributed in a taxable year, not to exceed the amount of the trust's distributable net income for the year.

The Committee Report provided the following commentary as an explanation for the change in the law provision: 

    The provision imposes a 100-percent excise tax on the unrelated business taxable income of a charitable remainder trust. This replaces the present-law rule that takes away the income tax exemption of a charitable remainder trust for any year in which the trust has any unrelated business taxable income. Consistent with present law, the tax is treated as paid from corpus. The unrelated business taxable income is considered income of the trust for purposes of determining the character of the distribution made to the beneficiary.

The change in the law became effective for tax years beginning after December 31, 2006. The Tax Relief and Health Care Act of 2006 was signed into law on December 20, 2006. Thus, charitable remainder trusts had eleven days, during the holidays, to study the effects of the legislation and contemplate changes that would reduce the effects of the legislation.

Committee Purpose:

We believe that Congress viewed the changes to Section 664 as beneficial to charitable remainder trusts that have unrelated business taxable income (UBTI). However, the effect of the legislation is devastating in at least one circumstance: trusts which contain significant UBTI.

The former provision, which denied charitable trust status when the trust had just $1.00 of UBTI, was very costly to many trusts, subjecting the trust to taxation as a complex trust. However, a charitable remainder trust was never prohibited from having unrelated business taxable income. A trust which chose to invest in assets creating income classified as unrelated business taxable income was merely subject to complex trust taxation. All of the income of the trust, less the deduction for distributions to the current beneficiary, was subject to trust taxation at no more than 35% (the top marginal rate of the trust). Between the individual current beneficiaries and the trust, the total tax would not exceed 35%.

Consider the example of a trust which chooses to invest in rental properties. Further assume that the purchase of the assets was debt financed. The income of the trust, as debt financed rental income, is made up entirely of UBTI. Under the former provision, the trust was taxed as a complex trust. As a complex trust, a deduction for distributions was claimed for the payments to the current beneficiary, who included the annuity payment as taxable income in accordance with the tier system of distributions.

Under the change in the law, 100% of the taxable income, before subtracting the distribution, has become subject to the 100% excise tax on the UBTI. In addition, the current beneficiary continues to be subject to income taxation on the annuity payment received. In effect, the trust income has become subject to an effective tax rate of up to 135%.

The effect of the law change, for certain charitable trusts, is to substantially reduce or eliminate the funds available for the remainder beneficiary, i.e., the charity. This could not have been the intent of Congress. The current beneficiary will continue to receive the annuity payment until the trust funds are depleted, unless drastic action is taken to restructure investments.

We do not believe that Congress realized that the change in the law would have the effect noted here. In the best of intentions, to provide relief from one draconian provision (denying exempt status to a charitable remainder trust that has $1.00 of UBTI), a new draconian provision has been created. Instead, Congress should have provided that the tax on the income of a charitable remainder trust is the lesser of:

  • 100% of the UBTI (as provided in current law), or
  • The tax computed as if the trust were taxed as a complex trust (as provided under the pre-December 20, 2006 Internal Revenue Code).

Transition Relief Requested:

The proposed regulations, in accordance with the law as passed, are to be effective for years beginning after December 31, 2006. Due to the lack of time between the date of passage and the effective date of the legislation, transition relief in the form of the above (lesser of the taxes under the old and new law) is in order to allow charitable remainder trusts time to restructure investments.

Questions relating to this submission may be addressed to:

Christopher W. Hesse, CPA
LeMaster Daniels
2234 NW 22nd Avenue
Camas, WA 98607-7402

chesse@lemasterdaniels,com
509-624-4315, x. 3013

LeMaster Daniels is a regional certified public accounting firm with offices throughout eastern Washington state, Boise, Idaho and Bellevue, Washington.

Questions also may be submitted to:

William E. Davis,

Attorney at Law
Leavy, Schultz, Davis & Fearing, P.S.
2415 West Falls Avenue
Kennewick, WA 99336
daviswe@tricitylaw.com
509-736-1330

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