Gift to Charitable Lead Trust Complete for Gift Tax Purposes

Gift to Charitable Lead Trust Complete for Gift Tax Purposes

News story posted in Letter Rulings on 1 June 1998| comments
audience: National Publication | last updated: 18 May 2011
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Summary

In a ruling similar to Ltr. Rul. 9821030 (reported by the PGDC on May 26, 1998), the Service has ruled in Ltr. Rul. 9822018 that a donor's gift to a charitable lead unitrust will be completed for gift tax purposes and not includible in the donor's estate. In addition, the CLT will be entitled to a deduction for amounts paid to charity.

Ltr. Rul. 9822018

PGDC Summary:

A donor's gift to a charitable lead unitrust will be complete for gift tax purposes and not includible in the donor's estate. In addition, the CLT will be entitled to a deduction for amounts paid to charity.

Facts:

The donor will create a CLUT for a term of 20 years, the income interest being payable to a charitable entity, which is presumably a private family foundation. The donor has resigned as an officer and director of the Foundation, but the donor's wife and children still continue on as officers and directors. The donor represents "that [he] will not participate in or influence the future selection of beneficiaries to receive distributions from Foundation."

Holdings:

(1) The IRS will not honor the "ordering" payout in the trust document, where distributions to charity are determined under the 4-tier accounting system of Sec. 664; (2) the gift is complete and the CLT will be entitled to the set-aside deduction under Sec. 642(c); and (3) "assuming there is no understanding, express or implied between Grantor and the officers and directors of Foundation regarding the disposition of the amounts received by Trust, we conclude that the corpus of Trust will not be includible in the gross estate of Grantor at Grantor's death."

Points to Ponder:

What would be the estate tax result under Sec. 2036(a) of the Code, if the donor created a Donor Advised Fund (DAF) and merely "suggested" who could be the charitable recipients? Would the CLT assets be excludible from the donor's gross estate if he dies during the CLT term?

Full Text:

Date: February 18, 1998

Refer Reply to: CC:DOM:P&SI:4/PLR-113952-97

LEGEND:

Grantor = * * *
Trust = * * *
Foundation = * * *
Stock = * * *
Spouse = * * *
Daughters = * * *
Grandchildren = * * *
X = * * *

Dear * * *

This is in response to your authorized representative's July 15, 1997 letter, on your behalf, requesting certain rulings concerning the income and gift tax consequences of the creation of Trust, a charitable lead unitrust trust. Specifically, you have requested the following rulings:

1. Trust is a charitable lead unitrust that satisfies the requirements of section 2522 of the Internal Revenue Code and that a gift tax charitable deduction will be allowed for the present value of the charitable interest in Trust.

2. Grantor's gift to Trust will not be incomplete for purposes of section 25.2511-2(c) of the Gift Tax Regulations due to the fact that Grantor's Spouse and Daughters will serve as officers and trustees of Foundation and Grantor's Daughters will be trustees of Trust.

3. Grantor has not retained any interests in or powers over Trust that are described in section 2035 through 2038 and therefore Trust will not be includible in the gross estate of Grantor.

4. Trust will be allowed a deduction under section 642(c) for amounts of gross income paid to Foundation or other charitable beneficiaries described in section 170(c) during the taxable year, or by the close of the following year pursuant to an election under section 1.642(c)-1(b).

Grantor proposes to establish a trust, Trust, by transferring assets to the trustees, Grantor's Daughters. The term of Trust is 20 years. During each year of Trust's term, the trustee is required to pay a unitrust amount equal to X percent of the net fair market value of the trust principal, valued as of the first day of each taxable year of Trust to Foundation.

Grantor's spouse, Spouse, is an officer and trustee of Foundation and Grantor's Daughters are officers and Trustees of Foundation. It is represented that Grantor was previously an officer and trustee of Foundation but that Grantor resigned as Vice-President and trustee of Foundation. Neither Grantor, nor Spouse, may be appointed as trustees of Trust. In addition, it is represented that Grantor has no plan or intention to become and will not agree to be appointed an officer or Trustee of Foundation in the future. Furthermore, Grantor represents that Grantor will not participate in or influence the future selection of beneficiaries to receive distributions from Foundation.

Article II, paragraph B, of Trust provides that at the end of the charitable term, the trustees shall distribute the remaining income, if any, and principal of the trust not required to be paid out in satisfaction of the final Unitrust Amount payment, in equal shares to Grantor's grandchildren, Grandchildren. If one or more the Grantor's grandchildren are not living at the time of such distribution, his or her share shall be distributed to his or her descendants per stirpes, or if none to his or her then living brothers and sisters, or if none, to his or her heirs at law.

Article III, paragraph A, provides that the Unitrust Amount for each taxable year shall be distributed by the last day of such year or within a reasonable time thereafter. The Unitrust Amount shall be paid first from ordinary net income (including short-term capital gain) of the trust which is not "unrelated business income" as defined in section 681, and to the extent that ordinary net income is insufficient, from fifty percent (50%) of the unrelated business income of the trust, and to the extent that all these sources are insufficient, from tax-exempt income of the trust, and finally, to the extent that all sources of income are insufficient, from trust principal. The terms "short-term capital gain" and "long-term capital gain" have the same meaning as set forth in section 1222.

Article III, paragraph C, provides that if the number of days included in the charitable term in any taxable year of the trust is fewer than 365 (366 if the taxable year includes February 29), the Unitrust Amount payable in such taxable year or years shall be prorated on a daily basis.

Article III, paragraph I, provides, that if the fair market value of the trust principal is incorrectly determined for any taxable year, then within a reasonable period after the final determination of the correct value, the trustees shall pay to the charitable beneficiary in the case of undervaluation, or shall recover from the charitable beneficiary in the case of overvaluation, an amount equal to the difference between the unitrust amount properly payable and the unitrust amount actually paid.

Under Article II, paragraph A, the unitrust amount will be paid annually to Foundation. It is represented that Foundation is a charitable organization described in section 501(c)(3). If Foundation is not a "Charitable Organization" (defined in Article VII, paragraph G, as any organization described in sections 170(c)(2), 2055(a) and 2522(a) of the Code), then the unitrust amount will be paid to such one or more organizations selected by the Trustees, each of which is a charitable organization described in sections 170(c)(2), 2055(a) and 2522(a) at the time of the payments, in such proportions among such organizations as the Trustees in their sole discretion, shall decide.

Article III, paragraph F, provides, in part, that the Trustees are prohibited from: (i) engaging in any act of self-dealing as defined in section 4941(d); (ii) retaining any excess business holdings as defined in section 4943(c) which would subject Trust to tax under section 4943; (iii) acquire or retain any investments which would subject Trust to tax under section 4944; or (iv) making any taxable expenditures as defined in section 4945(e) and to the extent required, the Trustees shall distribute property of Trust at such time or time and in such manner as not subject Trust to tax under section 4942.

Grantor has retained no right to alter or amend Trust or otherwise designate the beneficiaries of Trust or Descendant's Trust. Trustees may amend Trust for the sole purpose of ensuring that it complies with the requirements of the Internal Revenue Code and Treasury Regulations so that the gift of the unitrust amount will qualify for the charitable deduction under sections 2055 and 2522(a).

GIFT TAX RULINGS:

Section 2501(a)(1) imposes a tax on the transfer of property by gift. Section 2511(a) provides that the federal gift tax shall apply whether a transfer is in trust or otherwise, whether the gift is direct or indirect, and whether the property is real or personal, tangible or intangible.

Section 2522(a) provides that, in computing an individual's taxable gifts for the calendar year, a deduction shall be allowed for the amount of all gifts to or for the use of certain governmental entities, certain corporations organized and operated exclusively for religious, charitable, scientific, literary, or educational purposes, and certain other fraternal and veterans organizations.

Section 2522(c)(2)(B) provides that, where a transfer is made to both a charitable and a noncharitable person or entity, no deduction shall be allowed for the charitable portion of the gift unless, in the case of interests other than charitable remainder interests, such interest is in the form of a guaranteed annuity or is a fixed percentage distributed yearly of the fair market value of the property (to be determined yearly).

Section 25.2511-2(c) of the Gift Tax Regulations provides, in part, that a gift is incomplete in every instance in which a donor reserves the power to revest the beneficial title to the property in himself. A gift is also incomplete if and to the extent that a reserved power gives the donor the power to name new beneficiaries or to change the interests of the beneficiaries as between themselves.

Section 25.2511-2(f) provides that the relinquishment or termination of a power to change the beneficiaries of transferred property, occurring otherwise than by the death of the donor (the statute being confined to transfers by living donors), is regarded as the event that completes the gift and causes the tax to apply.

Section 25.2522(c)-3(c)(2)(vii) states that the term unitrust interest means the right pursuant to the instrument of transfer to receive a payment, not less often than annually, of a fixed percentage of the net fair market value, determined annually, of the property which funds the unitrust interest. In computing the net fair market value of the property which funds the unitrust interest, all assets and liabilities shall be taken into account without regard to whether particular items are taken into account in determining the income from the property. The net fair market value of the property which funds the unitrust interest may be determined on any one date during the year or by taking the average of valuations made on more than one date during the year, provided that the same valuation date or dates and valuation methods are used each year. Payments under a unitrust interest may be paid for a specified term or for the life or lives of a named individual or individuals, each of whom must be living at the date of the gift and can be ascertained at such date.

In this case, it is represented that, while Grantor was previously an officer and trustee of Foundation, Grantor resigned as Vice-President and trustee of Foundation. Based on the representation made, we conclude that the gift to Trust will be a completed gift for purposes of section 25.2511-2(c); in addition, the fact that Grantor's Spouse and Daughters will serve as officers and trustees of Foundation and Grantor's Daughters will serve as trustees of Trust will not cause Grantor's gift to Trust to be incomplete for purposes of section 25.2511-2(c).

Under the terms of the governing instrument, qualified charitable organizations are given the irrevocable right to receive annually an amount equal to X percent of the net fair market value of the assets in Trust determined annually. We conclude that the interest is a unitrust interest within the meaning of section 2522(c)(2)(B) and the regulations thereunder.

Consequently, we conclude that a gift tax charitable deduction under section 2522(a) will be allowed in an amount equal to the present value of the unitrust interest determined as of the date of the funding of Trust. The amount of the charitable deduction will be determined under section 25.2522(c)-3(d)(2)(v).

ESTATE TAX RULING:

Under section 2035(a) as amended by the Taxpayer Relief Act of 1997, if the decedent made a transfer by trust or otherwise of an interest in property, or relinquished a power with respect to property during the 3-year period ending on the date of decedent's death, and the value of such property (or an interest therein) would have been included in the decedent's gross estate under sections 2036, 2037, 2038, or 2042, if such transferred interest or relinquished power had been retained by the decedent on the date of death, then the value of the gross estate shall include the value of any property which would have been so included. Other transfers made within three years of death are not includible in the gross estate.

Sections 2036, 2037, and 2038 provide for the inclusion in the gross estate of property of which the decedent has made a transfer and in which the decedent has either retained an interest in the property or a power over the property. Section 2042 provides for the inclusion in the gross estate of the proceeds of life insurance on the decedent's life over which the decedent has possessed any incidents of ownership.

Section 2039 provides that the gross estate shall include the value of an annuity or other payment receivable by any beneficiary by reason of surviving the decedent under any contract or agreement if, under such contract or agreement, an annuity or other payment was payable to the decedent during his lifetime.

Section 2041 provides that the gross estate shall include any property with respect to which the decedent has, at the time of his death, a general power of appointment or with respect to which the decedent has at any time released or exercised such power of appointment by a disposition which, had the property been owned by the decedent, such property would be includible in the decedent's gross estate under sections 2035 through 2038, inclusive. A general power of appointment is a power which is exercisable in favor of the decedent, his estate, his creditors, or the creditors of his estate, except where the decedent's power is limited by an ascertainable standard relating to the health, education, support, or maintenance of the decedent.

Rev. Rul. 72-552, 1972-2 C.B. 525, involves a situation where prior to death, a decedent transfers property to a charitable corporation with respect to which the decedent serves as an officer with the discretionary power to select the ultimate charitable recipients of distributions from the organization. The revenue ruling concludes that, as an officer of the corporation, the decedent retained the power to determine the ultimate beneficiaries of the transferred property. Accordingly, the transferred property was includible in the decedent's gross estate under section 2036.

Section 20.2036-1 of the Estate Tax Regulations, provides that for purposes of section 2036, an interest or right is treated as having been retained or reserved by the decedent, if at the time of the transfer there was an understanding, express or implied that the interest or right would later be conferred.

In the present case, Trust will be irrevocable. A fixed percentage of the value of Trust property, determined annually, will be distributed to Foundation (or to charities described in section 170(c)(2), 2055(a) and 2522(a), if Foundation no longer so qualifies) during a 20 year period and, thereafter, the corpus will pass to Grantor's descendants, per stirpes. Grantor retains no interest or reversion in Trust and no right to alter, amend, or revoke Trust. Grantor has no right to receive an annuity or other payment from the trust during Grantor's lifetime. In addition, Grantor holds no general power of appointment over the trust property. Accordingly, assuming there is no understanding, express or implied between Grantor and the officers and directors of Foundation regarding the disposition of the amounts received by Trust, we conclude that the corpus of Trust will not be includible in the gross estate of Grantor at Grantor's death.

INCOME TAX RULING:

Section 642(c)(1) provides that in the case of an estate or trust (other than a trust meeting the specifications of sections 651 and 652), there shall be allowed as a deduction in computing its taxable income (in lieu of the deduction allowed by section 170(a), relating to deduction for charitable, etc., contributions and gifts) any amount of the gross income, without limitation, which pursuant to the terms of the governing instrument is, during the taxable year, paid for a purpose specified in section 170(c) (determined without regard to section 170(c)(2)(A)).

Section 642(c)(4) provides that in the case of a trust, the deduction allowed by section 642(c) is subject to section 681.

Section 681(a) provides that in computing the deduction allowable under section 642(c) to a trust, no amount otherwise allowable under section 642(c) as a deduction shall be allowed as a deduction with respect to income of the taxable year which is allocable to its unrelated business income for such year.

Section 1.642(c)-3(b)(2) of the Income Tax Regulations provides that, in determining whether the amounts of income paid, permanently set aside, or used for a purpose specified in sections 642(c)(1), (2), or (3) include particular items of income of an estate or trust not included in gross income, the specific provision controls if the governing instrument specifically provides as to the source out of which amounts are to be paid, permanently set aside, or used for such purpose. In the absence of specific provisions in the governing instrument, an amount to which section 642(c)(1), (2), or (3) applies is deemed to consist of the same proportion of each class of the items of income of the estate or trust as the total of each class bears to the total of all classes.

In the present case, the terms of Trust provide for a unitrust amount to be paid annually to Foundation that is represented to be described in sections 170(c)(2), 2055(a) and 2522(a). In addition, in the event that the Trust's designated charitable beneficiary ceases to exist or is no longer a "Charitable Organization" as defined in Article VII, paragraph G, of Trust, the trustees shall pay any amount which would otherwise be payable to such a charitable beneficiary to such one or more organizations selected by the Trustees, each of which is a "Charitable Organization," as defined in Trust instrument, at the time of payment, in such proportions among such organizations as the Trustees, in their sole discretion, shall decide. Accordingly, except to the extent that Trust has unrelated business income within the meaning of section 681(a), we conclude that Trust will be allowed deductions in accordance with section 642(c)(1) for amounts of gross income paid during the taxable year or by the close of the following taxable year (if the trustees so elect in accordance with section 1.642(c)-1(b)) to charitable beneficiaries described in section 170(c). Because the deduction under section 642(c)(1) is limited to amounts of gross income of the trust, a deduction will be allowed for a distribution of trust principal only to the extent that the amount distributed has been included in Trust's gross income and has not been allowed as a deduction in any prior year.

In addition, the ordering of the income distributions provided in Article III, paragraph A, of Trust will not be given effect for federal income tax purposes because the ordering provision has no economic effect on the distributions independent of tax consequences. Trust is required to pay annually a stated unitrust amount to an organization described in section 170(c), 2055(a) and 2522(a), regardless of the amount or character of income earned by Trust. Instead, income distributed to organizations described in sections 170(c), 2055(a) and 2522(a) shall consist of the same proportion of each class of items of income of Trust as the total of each class bears to the total of all classes. See section 1.642(c)- 3(b)(2).

Except as we have specifically ruled herein, we express no opinion on the federal tax consequences of the transaction under the cited provisions of the Code or under any other provisions of the Code. In particular we express no opinion as to whether or not the charitable beneficiary of Trust is described in section 170(c), 2055(a) or 2522(a).

A copy of this ruling should be attached to the federal gift tax return filed in conjunction with the gifts when made. A copy is enclosed for this purpose.

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

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

Sincerely,

By: George L. Masnik
Assistant Chief Counsel
(Passthroughs and Special Industries)
Chief, Branch 4

Enclosure
Copy for 6110 purposes

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