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IRS Opens Pandora's Box with Spousal Right of Election""
On March 30, 2005, Treasury and IRS published Rev. Proc. 2005-24, which is intended to provide a safe harbor procedure to avoid the disqualification of a charitable remainder trust because of the existence of a spousal right of election under state law. Following release of this guidance, Conrad Teitell, LL.B., LL.M., nationally recognized charitable giving authority and editor of "Taxwise Giving," published a comprehensive critique of the procedure and the chilling effect it will no doubt have on donors, their advisors, trustees, and charities--along with a recommendation that all interested parties contact Treasury to request it be withdrawn for further review and modification. This is no less than required reading for all advisors and nonprofits engaged in CRT planning.
PGDC Editor's Note: For background reading, see Rev. Proc. 2005-24 -- Treasury, IRS Announce Guidance on Spousal Election Rights and CRUTs
- Rev. Proc. 2005-24: IRS's drastic solution to non-existent problem
- Possible adverse applications well beyond CRUTs and CRATs
- Charities should urge withdrawal of Rev. Proc. 2005-24;
- Three-prong solution
Donors will have to jump through more hoops than a circus dog. Unless requirements (summarized and then detailed below) are met, inter vivos charitable remainder unitrusts and annuity trusts are disqualified--retroactively to the date of creation--if a spousal right of election now exists under state law, exists in the future, exists if the grantor (donor) of a CRUT or CRAT moves, marries or remarries.
Right of election. Simply stated, it is a right, in some states, that a surviving spouse has at the other spouse's death to demand and receive assets given to other individuals and charities. (More about this soon.)
--June 28, 2005 is a date that will live in matrimony--
For CRUTs and CRATs (sometimes collectively called CRTs) created on or after June 28, 2005. Disqualification can be avoided-under a safe-harbor rule-if a Spouse's waiver of a right of election is timely obtained and kept with the CRT's records. Query. Is a post-nuptial waiver of a right of election valid in all states? Tax trap: The mere existence of a right of election-even though it isn't exercised-will cause a CRT's disqualification from the date of its creation if a timely waiver hadn't been obtained.
For CRTs created before June 28, 2005. A Spouse's right of election will be disregarded by IRS and a waiver needn't be obtained for the trust to avoid disqualification. But if the spouse exercises the right of election, the CRT is disqualified from the date of its creation.
The bad things that can happen to good and generous donors even though the charities get their remainder interests (the Spouse didn't exercise a right of election). Statute of limitations' issues aside (for the first three bullet points below), if a CRT is disqualified--from the date of its creation-for failure to obtain a timely waiver:
- Income and gift tax charitable deductions will be disallowed.
- All trust income and capital gains not paid out to the income beneficiary will be taxable.
- If the Spouse has an income interest in the CRT during or following the grantor's life, the gift tax marital deduction will be disallowed.
- If the Spouse has the right to receive CRT income after the grantor's life, the estate tax marital deduction will be disallowed.
- The estate tax charitable deduction will be disallowed. And that could happen even if there is no trust beneficiary who will receive unitrust or annuity trust payments after the Grantor's death and the charity gets the trust assets (its remainder interest) on the Grantor's death. This last horrible of horribles is based upon a discussion with an IRS staffer about Letter Ruling 200414011 dealing with the 10%-minimum-remainder-interest requirement. The staffer maintained that if an inter vivos CRUT or CRAT flunked the 10% MRI requirement when it was created, there would be no estate tax charitable deduction at the Grantor's death even though all the trust assets would immediately be transferred to the charity. The staffer's reason: The CRT wasn't qualified from its creation. That's just one person's opinion, of course. But he does work for the IRS. I've mentioned this to a number of experts in the field and they couldn't believe this could happen. But whose opinion has more weight? Does your client want to make a trip to the courthouse?
Background given by IRS in Rev. Proc. 2005-24. Generally, a Testator is free by a will to dispose of property any way he or she wishes. But most state statutes protect Spouses from disinheritance. In most common law jurisdictions, the statutes are in the form of elective share provisions-often based on the elective share rules of the Uniform Probate Code (UPC), sections 2-201-2-214 (amended 1993). In
Rev. Proc. 2005-24 specifies that it applies solely to inter vivos charitable remainder annuity and unitrusts created by a spouse. The spouse who creates the CRT is called the Grantor (the Donor) and the other spouse-who has or may have a right of election-is called the Spouse.
In some states, the elective share is based solely on the probate estate (assets passing by will). In others, a Grantor's estate is defined more broadly for purposes of computing the elective share and may include assets of inter vivos CRUTS and CRATS. In states that have adopted the elective share provisions of the UPC, a Spouse has the right of election to take a percentage (generally determined by the duration of the marriage, but subject to a minimum dollar amount in some cases) of the "augmented estate" provided that certain requirements are met. UPC section 2-202. The augmented estate includes a Grantor's net probate estate, as well as specified nonprobate assets of property transferred by a Grantor to others (including to a Spouse) during life, and other specified property. UPC sections 2-202 and 2-207.
Assets of a CRAT or CRUT may be included in the augmented estate and, therefore, may be used to determine and satisfy the elective share amount. UPC section 2-209. In some states, a CRAT's or CRUT's assets may be used to satisfy the elective share only after other property in the augmented estate has first been exhausted.
IRC §664(d)(1)(B) (for CRATs) and IRC §664(d)(2)(B) (for CRUTs) provide that no amount other than the annuity payments or the unitrust payments, (other than qualified gratuitous payments described in IRC §§664(d)(1)(C) and (d)(2)(C)) may be paid to or for the use of any person other than an IRC §170(c) organization. According to Rev. Proc. 2005-24, the requirements of the just-mentioned Code sections aren't satisfied if a Spouse may exercise the right of election to receive an elective share and that share could include assets of a CRAT or CRUT. The mere existence of the right of election, whether or not exercised, and the resulting possibility that the CRAT or CRUT may be invaded for the benefit of Spouse, causes the trust to fail to qualify under IRC §664(d) for trusts created on or after June 28, 2005.
IRS feels your pain. "The Service believes that, in the interest of sound tax administration and to reduce the burden on taxpayers, [emphasis supplied] it is appropriate to provide a safe harbor procedure that, if followed, will cause the right of election to be disregarded for purposes of determining whether a CRAT or CRUT that is within the scope of this revenue procedure meets the requirements of section 664(d) continuously from the date the trust is created." Comment. Rev. Proc. 2005-24 doesn't reduce-but greatly and needlessly increases-the burden of taxpayers. A spousal exercise of a right of election against a CRAT or CRUT is a rarity.
Safe harbor--general rule. A Spouse must irrevocably waive the right of election regarding the assets of the CRAT or CRUT to ensure that no part of the trust will be used to satisfy the elective share. A waiver isn't required, however for pre-June 28, 2005 CRATs and CRUTs.
For CRATs and CRUTs created on or after June 28, 2005, a waiver of the right of election is not required if the applicable state law doesn't provide a Spouse with a right of election exercisable at the Grantor's death to receive an elective share of the Grantor's estate.
- In community property jurisdictions, elective share provisions are generally unnecessary because a Spouse typically has vested ownership in one-half of the community property. Comment. You'll want to check the law in your community property state. Also couples in community property states often have non-community property--property acquired before marriage, property acquired during marriage while the couple lived in a common law state, property acquired during marriage by gift or inheritance while living in a community property state.
- No waiver is required if, under applicable state law, a Spouse's elective share of a Grantor's estate may not include any assets of the CRAT or CRUT (other than the annuity or unitrust interest payable to a Spouse as the named recipient).
- No waiver is required if, under applicable state law, the trust's property is excluded from the base for computing the elective share because of Grantor's "receipt of adequate and full consideration for the transfer or the written consent to or joinder in the transfer by [the Spouse] and, in fact, the consideration is paid or the consent or joinder is given."
Requirements for waiver--how IRS will apply the safe harbor. A Spouse's right of election to receive an elective share of a Grantor's estate-if the share could include any assets of a CRAT or CRUT created or funded by Grantor-will be disregarded for determining whether the trust has met the requirements of IRC §664(d)(1)(B) or (d)(2)(B) continuously since its creation if all of the following requirements are satisfied:
- The Spouse must irrevocably waive the right of election to whatever extent necessary to ensure that no part of the trust (other than the annuity or unitrust interest of which the Spouse is the named recipient under the terms of the trust) may be used to satisfy the elective share.
- The waiver must be valid under applicable state law, be in writing, and be signed and dated by the Spouse.
- The Spouse is not required, however, to waive her or his right as the named recipient to receive the annuity or unitrust payment from the CRAT or CRUT.
The waiver requirement must be satisfied on or before the date that is six months after the due date (excluding extensions of time to file actually granted) of the trust's Form 5227, Split-Interest Trust Information Return, for the year in which the later (presumably, IRS means latest, because there are more than two) of the following occurs:
(1) the creation of the trust;
(2) the date of the Grantor's marriage to the Spouse;
(3) the date the Grantor first becomes domiciled or resident in a jurisdiction whose law provides a right of election that could be satisfied from assets of the trust. Query: Shouldn't it be domiciled and not domiciled or resident? What does residency have to do with this? Suppose the Grantor and Spouse are domiciled in State X (a no-right-of-election state). They have a vacation home in State Y (a right-of-election state) where they spend three months every winter. The day before they are to return to State X, their domicile, Grantor dies while Grantor and Spouse are resident in State Y. Spouse hadn't waived her right of election under State Y's laws. So what we have here is a possible State of Confusion.
(4) the effective date of applicable state law creating a right of election.
Trustee must retain a copy of the waiver. A copy of the signed waiver must be provided to the trustee of the CRAT or CRUT and the trustee must retain the copy "in the official records of the trust" so long as its contents may become material in the administration of any internal revenue law. See Reg. §1.6001-1(e). Pointer. Send the waiver to the trustee by certified mail, return receipt requested. Query: Must the trustee receive the waiver by the deadline for obtaining it?
In each of the following examples: Grantor created a CRAT that provides an annuity to Grantor for life. Upon Grantor's death, the remainder of the trust will pass to an IRC §170(c) organization. In each example (except Example 3), at the time the CRAT is created, under applicable state law Spouse has a right of election to receive an elective share of Grantor's estate and the share would include (and could be satisfied from) the trust's assets.
Example 1. Grantor creates the trust in 2007 while married to Spouse. On or before the date that is six months after the due date (excluding extensions of time to file actually granted) of the trust's Form 5227 for calendar year 2007, Spouse irrevocably waives Spouse's right of election to receive an elective share regarding the trust assets (but doesn't waive the right of election regarding Grantor's probate estate).
Example 2. An unmarried Grantor creates the trust in 2006. On May 1, 2007, Grantor marries Spouse. On or before the date that is six months after the due date (excluding extensions of time to file actually granted) of the trust's Form 5227 for calendar year 2007, Spouse irrevocably waives the right of election to receive an elective share regarding the assets in the trust (but doesn't waive the right of election regarding Grantor's probate estate).
Example 3. Grantor creates the trust in 2008 while married to Spouse. Under applicable state law on the date that Grantor creates the trust, the elective share doesn't include the assets in the trust. Effective March 1, 2009, applicable state law is amended to give Spouse the right of election to receive an elective share of the "augmented estate," which, by definition, includes the assets of the trust. On or before the date that is six months after the due date (excluding extensions of time to file actually granted) of the trust's Form 5227 for calendar year 2009, Spouse irrevocably waives the right of election to receive an elective share regarding the trust assets (but doesn't waive the right of election regarding Grantor's probate estate).
In each of Examples 1 through 3, assuming that Spouse's timely waiver of the right of election is valid under applicable state law and satisfies the other requirements of Rev. Proc. 2005-24, the existence of the right of election will be disregarded for determining whether the trust has qualified continuously since its creation as a CRAT under IRC §664(d)(1)(B). Further, in each of Examples 1, 2 and 3, the result would be the same if, instead of executing only a partial waiver, Spouse had waived the full right of election regarding all assets in Grantor's augmented estate.
Example 4. Grantor creates the trust in 2007 while married to Spouse. Under applicable state law on the date that Grantor creates the trust, the elective share includes the assets in the trust. Later in the same year, the state law is amended to provide that the augmented estate doesn't include the assets of a CRAT or CRUT and the amendment applies retroactively to include the trust created by Grantor. Accordingly, no waiver of the right of election is required regarding the trust assets for the trust to continue to qualify as a CRAT. Query: Suppose the state law is amended to do away with the right of election against CRATs and CRUTs, but not in 2007, but in 2015. A waiver of election was never obtained. Grantor dies in 2017. Is this a disqualified trust? IRS's example avoids the issue by having the law's amendment in the same year that the trust was created.
Example 5. The facts are the same as in Example 2 except that the waiver is contained in a prenuptial agreement, or is signed as required by that agreement. Unless the agreement as a whole (or only the waiver) is subsequently found to be invalid or unenforceable, the waiver will satisfy the requirements of Rev. Proc. 2005-24.
Example 6. The facts are the same as in Example 1, except that Spouse dies in 2010. In 2012, Grantor marries Spouse 2. Spouse 2 refuses to waive the right to receive an elective share regarding the trust assets. The existence of Spouse 1's right of election will be disregarded for the purpose of determining whether the trust has qualified as a CRAT under IRC §664(d)(1)(B) continuously since its creation up until Grantor's marriage to Spouse 2. However, because Spouse 2 didn't timely and irrevocably waive the right to receive an elective share regarding the trust assets, the trust doesn't qualify as a CRAT under IRC §664(d)(1)(B). Query. In which states does a Spouse-whether Spouse 1, Spouse 2, Spouse 3 (and any subsequent Spouses)-have a right of election against property transferred by the Grantor before marrying that Spouse?
Applies to CRUTs too. If, in the six examples, Grantor had created a CRUT (instead of a CRAT), the results would be the same for purposes of IRC §664(d)(2)(B).
IRS's bottom line. "The safe harbor procedure provided by this revenue procedure is not available to a CRAT or CRUT if Spouse exercises the right of election." Comment. Fair is fair.Effective date.
"This revenue procedure is effective as of March 30, 2005." What does this mean? IRS gives rules for CRTs created before June 28, 2005 and those created on or after that date. So why a March 30, 2005 effective date?
For more information. Contact Susan H. Levy, the principal author of Rev. Proc. 2005-24 at (202) 622-3090 or call Bradford R. Poston at (202) 622-3060.
IRS's solution to the possibility of a spouse's exercise of a right of election is a remedy for something that might occur once in a blue moon. Of course, tax benefits shouldn't be available if the charity's remainder interest will be reduced or eliminated by a surviving spouse or anyone else. But if that possibility is remote, generous donors shouldn't have to jump through hoops to assure the qualification of their CRTs. And that's especially so if many donors will be unaware of hoops down the road-change in state law or a move to a different state. A "protective" waiver obtained before one is required may be invalid because it's not possible to know the requirements for a valid waiver before a statute is enacted or before a donor knows the state that he or she may move to some day.
Here's my short list of potential problems:
Husband and wife retire to a warmer climate and their CRUT is disqualified. And nothing could have been done to prevent disqualification. Homer creates a CRUT on June 29, 2005. Having just read the Internal Revenue Bulletin, he gets a waiver of the right of election from his wife Mabel. It is timely, irrevocable and meets all the other requirements of Rev. Proc. 2005-24. It is an effective waiver under the law of the state in which Homer and Mabel are domiciled. He delivers it to the trustee who staples the waiver to the trust instrument with three stainless steel Swingline staples. For good measure, the trustee also adds three brass rivets.
Five years later, Homer and Mabel move to a warmer state. It also gives spouses the right of election against CRUTs and CRATs. But the new state has different requirements for a valid waiver than those of their old state. Although Homer is elderly, the first thing he does upon crossing the border into his new state is to go into the State Visitors Information Booth and ask for a waiver of election form. They've run out-this is a common request. Homer is advised to see a lawyer, and he does. But unfortunately the years have taken their toll, and Mabel is incompetent and can't sign an effective waiver. Homer is so upset that he crashes into a tree on the way to the assisted-living facility. He's killed instantly. But Mabel is fine--not a scratch. Neither Mabel nor her court-appointed guardian elect against the trust. Nevertheless, the CRUT is disqualified retroactively to the date it was created-with loss of all the attendant tax benefits.
The Grantor got the waiver, but neglected to give it to the trustee. A waiver wasn't required when Grantor created his CRUT because his state had no right of election law. But when he moved to a new state that had such a law, he got a waiver from his Spouse. But he didn't send it to the trustee in his former state. The waiver was found with his will in his safe deposit box. Is his CRUT disqualified? Yes, if you are a strict constructionist-and that, IRS is. Rev. Proc. 2005-24 requires: "Trustee To Retain Copy. A copy of the signed waiver must be provided to the trustee of the CRAT or CRUT. The trustee must retain the copy in the official records of the trust so long as the contents thereof may become material in the administration of any internal revenue law. See §1.6001-1(e) of the Income Tax Regulations." At the Grantor's death, the Spouse doesn't elect against the estate and the charity gets the entire remainder. However, according to the strict terms of the revenue procedure, the CRT isn't qualified because the Grantor missed one of the hoops.
The lawyer might be unaware. Not all lawyers who prepare CRTs are specialists. Many are likely to be unaware of Rev. Proc. 2005-24. As evidence, look at all the court proceedings to reform defectively drafted CRTs. Should the non-specialist's unawareness be visited on donors and disqualify trusts even though it is highly unlikely that a right of election will ever be exercised.
To assure that a waiver is valid. Should the Grantor and Spouse have different lawyers because their interests are potentially adverse? Additional legal fees for making a charitable gift? Not a good thing!
Are post-June 28, 2005 additions to a CRUT created before June 28, 2005 protected by the safe-harbor rule? The Spouse at Grantor's death doesn't exercise the right of election. But no waiver was obtained for post-June 28, 2005 additions to the trust. Had a new unitrust been created after June 28, 2005, a timely and properly executed waiver would have had to be obtained, and kept with the trust documents. Are the additions protected by the pre-June 28, 2005 safe-harbor?
The potential net of Rev. Proc. 2005-24 is wide. The revenue procedure (Sec. 1 Purpose and Scope) states: "In general, only inter vivos CRATs or CRUTs are within the scope of this revenue procedure." I don't want to stir up any more hornets, but if the potential right of election by a Spouse is a problem for CRATs and CRUTs, isn't it also a problem for pooled income fund gifts and remainder interests in personal residences and farms? And in some cases, perhaps also for charitable lead unitrusts and lead annuity trusts?
Why a nuclear solution to solve a non-existent problem? This issue--if it is an issue--has been kicking around at the IRS for some time. Why release a done-deal revenue procedure that has already caused great concern because of the impracticality of compliance.
SUGGESTED ACTION: IRS and Treasury should be strongly urged to withdraw the revenue procedure for further study and IRS should be asked to discuss the ramifications with people experienced in the philanthropic field.
SUGGESTED SOLUTION-three prongs:
Prong One. IRS should treat CRATs and CRUTs whenever they were or will be created, the way it treats pre-June 28, 2005 trusts in Rev. Proc. 2005-24. Thus no waiver of the right of election should ever be required. Unreasonable rules are followed if an individual has no choice whether to engage in an activity. But with charitable gifts, if it is made burdensome, many donors won't make them.
Prong Two. In the rare case that a right of election is exercised, the estate should, on the Grantor's final income tax return, be required to include as income any income tax charitable deduction taken by the Grantor when the Grantor created the trust (the tax benefit rule). If there is a statute of limitations issue, an amendment of the law could keep the statute open.
Prong Three. If the right of election is exercised, an estate tax charitable deduction should be allowed to the Grantor's estate for the value of the assets that actually go to the charitable remainder organization at the Grantor's death. Thus the deduction would be reduced by the value of the assets going to the Spouse. If at the Grantor's death, trust payments are to continue for the life of a successor recipient before the charity gets its remainder interest, the estate tax charitable deduction should be reduced to take into account the amount that went to Spouse from the CRT at the Grantor's death.
Final Advice to the Taxshorn®. Do everything you can to comply with Rev. Proc. 2005-24. Consider including the waiver as part of the charitable remainder trust document if it can be executed (following the requirements of state law) when the trust is signed by the Grantor. In any event, as soon as the waiver is obtained (and do so within the time specified in the revenue procedure) have it stapled to the trust document. If state law doesn't require witnesses or notarization, nevertheless get several witnesses and have the waiver notarized in case a state that the Grantor later moves to has those requirements. Additional executed copies should be kept with the Grantor's estate planning documents in case the staple breaks and the waiver is lost or misplaced.
If a right of election doesn't now exist, nevertheless have a generic waiver signed by the spouse. Even though the specific wording can't now be known, it might suffice and in any event, it could help in court if the IRS challenges a CRUT or CRAT at the Grantor's death.
State legislatures should be urged to change right of election laws to deny a right to elect against CRUTs, CRATs, pooled income funds, charitable remainders in personal residences and farms, and charitable lead annuity trusts and lead unitrusts.
Arguments should you end up in court with IRS for post-June 28, 2005 CRTs when the estate tax charitable deduction is at stake:
- Court cases. If the surviving spouse doesn't exercise the right to the elective share, the estate tax deduction should be allowed. The Tax Court has held that where a charitable bequest is not void-but only voidable-by reason of a decedent's children's right to a share of his estate under Louisiana law, an estate tax charitable deduction is allowable if the children do not enforce their right. Longue Vue Foundation v. Commissioner, 90 TC 150 (1988), acq. in result 1989-1 CB 1. See also: Estate of Harvey, 678 F.Supp.1268; Estate of Varick, 10 T.C. 318; Dimock, 99 F.2d 799.
- Treasury's own regulations. An estate tax charitable deduction is allowable if the charitable bequest is voidable-as opposed to void-and the charity gets the property. Example 6 of Estate Tax Reg. §20.2055-2(e)(1)(i), deals with a testator who devised real property to charity. The charitable devise could have been defeated by the exercise of the surviving spouse's statutory dower rights. The example concludes that the surviving spouse's unexercised dower rights are to be ignored, and the charitable deduction is to be allowed. A Treasury Regulation trumps an IRS Revenue Procedure.
PGDC Editor's Note: For further reading, see ACGA Asks Treasury to Withdraw Rev. Proc. 2005-24. We urge all PGDC members to contact the following parties in opposition to request a withdrawal of Rev. Proc. 2005-24:
- Mr. Eric Solomon, Acting Assistant Secretary (Tax Policy), Department of the Treasury, Eric.Solomon@DO.TREAS.GOV
- Mr. Mark W. Everson, Commissioner of the Internal Revenue Service, Mark.W.Everson@IRS.GOV
- Mr. Donald L. Korb, Chief Counsel of the Internal Revenue Service, Donald.L.Korb@IRSCOUNSEL.TREAS.GOV
- Ms. Heather Maloy, Associate Chief Counsel (Passthroughs and Special Industries), IRS, Heather.Maloy@IRSCOUNSEL.TREAS.GOV
- Ms. Catherine Hughes, Attorney, Department of Treasury, Catherine.Hughes@DO.TREAS.GOV
Copyright 2005 Conrad Teitell. Reproduced from Taxwise Giving, a monthly publication. All rights reserved. Used by permission. For information, contact Taxwise Giving and Philanthropy Tax Institute, 13 Arcadia Road, Old Greenwich, CT 06870, Toll-free (800) 243-9122, Email Conrad@taxwisegiving.com