No Inclusion CLAT

No Inclusion CLAT

News story posted in Letter Rulings on 9 June 1998| comments
audience: National Publication | last updated: 18 May 2011
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Summary

The Service has ruled privately that a donor created a valid non-grantor CLAT. The assets of the CLAT would not be includable in the gross estate of the donor notwithstanding the fact that a separate committee of the donor's private foundation selected the charities to receive the payments from the CLAT.

Ltr. Rul. 9823005

PGDC Summary:

A donor intends to create a Charitable Lead Annuity Trust ("CLAT"), income to charity and remainder to children and grandchildren. The Service holds that the trust will be a valid CLAT, the gift is complete under Sec.s 2501 and 2511, no portion of the CLAT will be includible in the gross estate of the donor, and the CLAT will NOT be treated as a grantor trust for income tax purposes (Sec.s 671-677).

Facts:

A donor proposes to create an irrevocable trust to run for a term of 20 years or, if later, until the date of death of the survivor of husband and wife. Income is payable to Charity X. Remainder is to pass per stirpes to children and more remote lineal descendants. The donor has attempted to structure the CLAT in a fashion so that there is a completed gift for gift tax purposes, the assets of the CLAT are not includible in the estate of the donor, and the CLAT is not a grantor trust for income tax purposes.

Further, and of particular interest, the donor is president and a member of the board of directors of Charity X, and apparently would like to continue in this status. All monies payable to Charity X from the CLAT and given individually by the donor will be segregated and held in a separate fund, to be administered by a committee (on which donor will not sit). [In particular, see underlined language below.]

Holding:

The gift to the CLAT is complete for gift tax purposes and none of the assets of the trust will be includible in the gross estate of the donor under Sec. 2038 or any other section of the Code. The CLAT is not a grantor trust for income tax purposes.

Points to Ponder:

The IRS has been issuing interesting rulings on CLTs and the concepts that underlie a donor's right to advise with respect to the ultimate distribution of charitable funds. Here, more flexibility has been granted than in two rulings issued during the past two weeks (PLRs 9822018 and 9821030). Note also that it is Branch 7 of Passthroughs and Special Industries (Branch 7) which has begun issuing these rulings, as opposed to Branch 4 in the earlier 2 rulings.

Full Text:

Date: February 12, 1998
Refer Reply To: CC:DOM:P&SI:7-PLR-109973-97
Re: * * *
LEGEND:

Taxpayer = * * *
X = * * *

Dear * * *

This is in response to your * * * letter, in which you request rulings concerning the federal income, gift, and estate tax consequences of the creation of a proposed charitable lead annuity trust.

Taxpayer proposes to create an irrevocable trust, intended to qualify as a charitable lead annuity trust. The trust will continue for a period of 20 years from the date of the trust agreement or, if later, until the date of death of the survivor of the Taxpayer and the Taxpayer's wife. While the trust exists, it is required to distribute a fixed annual annuity to X, the charitable beneficiary of the trust. When the trust terminates, all remaining trust assets must be allocated and distributed to the Taxpayer's then living children and to the then living issue of any child of the Taxpayer who is then deceased, by right of representation. However, any share allocated to a grandchild or more remote issue of the Taxpayer who is living at the time of allocation but has not yet attained the age of 30 must be held in a separate trust for such person.

The trustee is an individual unrelated to Taxpayer and Taxpayer's spouse. Taxpayer has no authority to remove a trustee but can appoint a successor trustee. Neither Taxpayer nor Taxpayer's spouse may serve as trustee. The trust agreement contains the following relevant provisions:

Article 1.2 provides that no additions to the trust other than the initial contribution may be made to the trust at any time.

Article 2.1 provides that the Grantor will have no reversionary interest in either the principal or the income from any trust established under the agreement. Article 2.2 provides that the agreement and the trusts created under it are irrevocable, and neither the Grantor nor any other person will have any power to revoke, modify or amend the agreement or any trust created under it in any respect.

Article 4.1(01) provides that the Trustee shall pay to X, a certain sum in equal semiannual installments payable on the last day of June and December of each such taxable year.

Article 4.1(02) provides that notwithstanding anything in the agreement to the contrary, while the trust exists, no income or principal will be distributed (other than for good and valuable consideration) to or for the benefit of any person or entity other than an organization described in each of sections 170(c), 2055(a) and 2522(a). If X fails to qualify as an organization described under any of said sections when any annual annuity is to be distributed to such organization, the Trustee shall distribute such annual annuity to one or more organizations described in each of said sections. The selection of such one or more organizations, and the share of such annual annuity which any such organization shall receive, shall be in the Trustee's sole and absolute discretion.

Article 4.1(03) provides that each payment of the annual annuity shall be made first from income. To the extent the income of the trust is not sufficient, from principal. The income of the trust distributed in satisfaction of the annual annuity shall consist of the same proportion of each class of income of the trust as the total of each class of income bears to the total of all classes of income of the trust for such taxable year. Any income of the trust for any taxable year in excess of the annual annuity for such year is to be added to the principal of the trust estate.

Article 7.1 provides that notwithstanding anything within the agreement to the contrary, nothing within the agreement is to be construed or interpreted in a manner that, during the Grantor's lifetime, will cause the trust income to be considered the Grantor's income for federal income tax purposes or that, on Grantor's death, will cause any of the trust assets to be included in the Grantor's gross estate for federal estate tax purposes.

Article 7.1(01) provides that neither the Grantor nor any other person, including the Trustee, will have the power to dispose of the beneficial enjoyment of the principal of a trust or the income therefrom, except as specifically provided in the agreement.

Article 7.1(02) provides that neither the Grantor nor any other person may purchase, exchange, or otherwise deal with or dispose of any part of the principal of a trust under the agreement or any income from the trust for less than adequate consideration in money or money's worth.

Article 7.1(03) provides that neither the principal nor the income of a trust under the agreement will be loaned to the Grantor or the Grantor's spouse, directly or indirectly, without adequate interest or adequate security.

Article 7.1(04) provides that no part of the income of a trust may be: (a) distributed to the Grantor or the Grantor's spouse; (b) held or accumulated for future distribution to the Grantor or the Grantor's spouse; or, (c) applied to the payment of premiums on policies of insurance on the life of the Grantor or the Grantor's spouse.

Article 8.8 provides that if at any time while the Grantor is living the office of trustee of any trust under the agreement is vacant, and no successor trustee has been appointed as provided in the agreement, the Grantor will appoint an individual(s) (other than the Grantor or the Grantor's spouse), bank or trust company, or any combination thereof, as the successor trustee of such trust.

Article 8.9 prohibits the Trustee from any act of self- dealing (as defined in section 4941(d)), prohibits the Trustee from making any taxable expenditures as provided in section 4945(d), prohibits the Trustee from making, acquiring, or retaining any investments which jeopardize the charitable purpose of the Lead Trust as defined in section 4944, and prohibits the Trustee from retaining any excess business holdings within the meaning of section 4943. The Trustee will make distributions in such time and manner so as not to subject the trust to tax under section 4942.

Taxpayer is president of X and serves as a member of the board of directors of X. Prior to establishing the trust, the by-laws of X will be amended to provide that any funds received from the Taxpayer or the trust will be segregated and held in a separate fund. The separate fund will be administered and distributed by a separate fund committee consisting of one or more members of the board of directors, other than Taxpayer. The members of the board of directors serving on such separate fund committee will be selected by the board of directors, other than the Taxpayer. Taxpayer will have no right to vote or otherwise participate in any decisions relating to the composition of the separate fund committee, the administration of the separate fund, or the use or distribution of any of the principal of or income from such fund. In addition, Taxpayer will have no right to participate in any decision relating to amendments to the governing instruments of the organization which would alter the changes described above or otherwise affect the separate fund or the separate fund committee. [emphasis added by PGDC.]

You have asked that we rule as follows:

(1) The trust will qualify as a charitable lead trust; the funding of which will result in a completed gift for federal estate tax purposes under sections 2501 and 2511 and will entitle the Taxpayer to a gift tax charitable deduction under section 2522, based on the actuarial value of the guaranteed annuity payable from the trust.

(2) No portion of the principal of trust will be included in the Taxpayer's gross estate for federal estate tax purposes under sections 2035, 2036, or 2038, at the Taxpayer's death.

(3) The trust will not be treated as a "grantor trust" for income tax purposes under sections 671-677, and no portion of the income of the trust will be taxable to the Taxpayer.

LAW AND ANALYSIS

Section 2501 imposes a tax on the transfer of property by gift by any individual. Section 25.2511-1(a) of the Gift Tax Regulations provides that the gift tax applies to every kind of transfer by way of gift, whether direct or indirect, and whether the property is real or personal, tangible or intangible.

Section 25.2511-2(a) provides that the gift tax is not imposed upon the receipt of the property by the donee, nor is it necessarily determined by the measure of enrichment resulting to the donee at the time of the transfer. The tax is a primary and personal liability of the donor, is an excise upon the act of making the transfer, is measured by the value of the property passing from the donor, and attaches at the time the property passes, regardless of the fact that the identity of the donee may not then be known or ascertainable.

Under section 25.2511-2(b), a gift is complete and subject to the gift tax when the donor has so parted with dominion and control over the property transferred as to leave in the donor no power to change its disposition, whether for the donor's own benefit or for the benefit of another.

Section 25.2511-2(c) provides that a gift is incomplete to the extent that a reserved power gives the donor the power to name new beneficiaries or to change the interests of the beneficiaries.

Under section 25.2511-2(e), a donor is considered to have a power if it is exercisable by the donor in conjunction with any person not having a substantial adverse interest in the disposition of the transferred property, such as a trustee. Section 2522(a) provides that, in computing the taxable gift each year, there is allowed a deduction for: 1) all gifts to or for the use of federal or other government entities for exclusively public purposes, 2) all gifts to or for the use of a corporation or trust operated exclusively for religious, charitable, scientific, literary, or educational purposes, or 3) certain transfers to fraternal or veterans organizations.

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

Section 25.2522(c)-3(c)(2)(vi) provides that the term "guaranteed annuity interest" means an irrevocable right, pursuant to the instrument of transfer, to receive a guaranteed annuity. A guaranteed annuity is an arrangement under which a determinable amount is paid periodically (but not less often than annually) 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. An amount is determinable if the exact amount which must be paid under the conditions specified in the instrument of transfer can be ascertained as of the date of the gift.

Section 25.2522(c)-3(c)(2)(vi)(e) contains a further requirement for a guaranteed annuity interest in trust if the present value on the date of gift of all the income interests for a charitable purpose exceeds 60 percent of the aggregate fair market value of all amounts in the trust. Under these circumstances, the charitable interest will not be considered a guaranteed annuity interest unless the governing instrument prohibits both the acquisition and the retention of assets which would give rise to a tax under section 4944 if the trustee had acquired the assets.

Under section 25.2522(c)-3(c)(2)(vi) the amount of the deduction for a guaranteed annuity interest in trust is limited to the fair market value of the guaranteed annuity interest as determined under section 25.2522(c)-3(d)(2)(iv). Under section 25.2522(c)-3(d)(1), the fair market value of an annuity is its present value, and, under section 25.2522(c)-3(d)(2)(iv), the present value of a guaranteed annuity interest in trust is to be determined under section 25.2512-5.

In the present case, for purposes of section 25.2511-2(b), the Taxpayer will retain no power over the property he contributes to the trust. The Taxpayer retains no interest or reversion in the trust and no right to alter, amend, or revoke the trust. Neither the Taxpayer nor the Taxpayer's spouse can serve as trustee of the trust. In addition, the Taxpayer holds no general power of appointment over the property of the trust. Further, although the Taxpayer is president and a member of the board of directors of X, the by-laws of X will be revised so that any funds received from the trust will be segregated and held in a separate fund. This separate fund will be administered and distributed by a separate fund committee and the Taxpayer will have no power over the separate fund or the separate fund committee. Accordingly, we conclude that, provided the by-laws of X are amended prior to the funding of trust, the funding of trust will result in a completed gift for federal gift tax purposes under sections 2501 and 2511.

The annuity payable under the proposed terms of the trust satisfies the requirements of section 25.2522(c)-3(c)(2)(vi) and, therefore, will be a guaranteed annuity for purposes of section 2522(c)(2)(B).

Accordingly, based on the facts submitted and the representations made, the trust will qualify as a charitable lead trust, the funding of which will result in a completed gift for federal estate tax purposes under sections 2501 and 2511 and will entitle the Taxpayer to a gift tax charitable deduction under section 2522, based on the actuarial value of the guaranteed annuity payable to charity from the trust.

ESTATE TAX ISSUES

Section 2033 provides for the inclusion in the gross estate of any property in which the decedent had an interest at the time of his death.

Section 2035(d) provides that only transfers of property that would have been included under sections 2036, 2037, 2038, or 2042 are includible in the gross estate if these transfers are made within three years of death. 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 the 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 over which the decedent has retained any incidents of ownership.

In the present case, the Taxpayer proposes to create an irrevocable charitable lead annuity trust. A fixed amount will be distributed annually from each trust to qualified charitable organizations during the trust term. Thereafter, the corpus and remaining income will be divided among the Taxpayer's then-living issue by right of representation. The Taxpayer retains no interest or reversion in the trust and no right to alter, amend, or revoke the trust. The Taxpayer cannot serve as trustee of the trust. In addition, the Taxpayer holds no general power of appointment over the property in the trust.

Accordingly, based on the facts submitted and the representations made, no portion of the principal of the trust will be included in the Taxpayer's gross estate for federal estate tax purposes under sections 2035, 2036, or 2038, at the Taxpayer's death.

GRANTOR TRUST ISSUES

Section 671 provides that when the grantor or another person is treated as the owner of any portion of a trust, there shall then be included in computing the taxable income and credits of the grantor or other person those items of income, deductions, and credits against tax of the trust that are attributable to that portion of the trust to the extent that such items would be taken into account under Chapter 1 of the Internal Revenue Code in computing taxable income or credits against the tax of an individual. Generally, a grantor is treated as the owner of a portion of a trust in which the grantor has certain powers or interests described in sections 673 through 677.

Section 673 provides that the grantor of a trust is treated as the owner of any portion of the trust in which the grantor has a reversionary interest in either the principal or income therefrom, if, as of the inception of that portion of the trust, the value of such interest is greater than five percent of the value of such portion.

Section 674(a) provides that the grantor of a trust is treated as the owner of any portion of the trust in respect of which the beneficial enjoyment of the principal or income of that portion is subject to a power of disposition, exercisable by the grantor or a nonadverse party, or both, without the approval or consent of any adverse party. Section 674(b) provides certain exceptions to this general rule.

Section 674(b)(4) provides that section 674(a) does not apply to a power to determine the beneficial enjoyment of the corpus or the income therefrom if the corpus or income is irrevocably payable for a purpose specified in section 170(c) (relating to definition of charitable contributions). Section 1.674(a)-1(b)(1)(iii) of the Income Tax Regulations provides that in general terms the grantor is treated as the owner of a portion of a trust if the grantor or a nonadverse party or both has a power to dispose of the beneficial enjoyment of the corpus or income unless the power is a power to choose between charitable beneficiaries or to affect the manner of their enjoyment of a beneficial interest.

Section 675(1) provides that the grantor of a trust is treated as the owner of any portion of a trust in respect of which a power exercisable by the grantor or nonadverse party, or both, enables the grantor to borrow the trust principal or income directly or indirectly, without adequate interest or without adequate security, except where a trustee (other than the grantor) is authorized under a general lending power to make loans to any person without regard to interest or security.

Section 675(2) provides that the grantor is treated as the owner of any portion of a trust in respect of which a power exercisable by the grantor or a nonadverse party, or both, enables the grantor to borrow the trust principal or income directly or indirectly, without adequate interest or without adequate security, except where a trustee (other than the grantor) is authorized under a general lending power to make loans to any person without regard to interest or security.

Section 675(4) provides that the grantor is treated as the owner of any portion of a trust in respect of which a power of administration is exercisable in a nonfiduciary capacity by any person without the approval or consent of any person in a fiduciary capacity. For purposes of section 675(4), the term "power of administration" includes a power to reacquire the trust corpus by substituting other property of equivalent value.

Section 1.675-1(b)(4) provides that if a power is not exercisable by a person as trustee, the determination of whether the power is exercisable in a fiduciary or nonfiduciary capacity depends on all the terms of the trust and the circumstances surrounding its creation and administration

Section 676(a) provides that the grantor is treated as the owner of any portion of the trust, whether or not he is treated as such owner under any other provision of subpart E, where at any time the power to revest in the grantor title to such portion is exercisable by the grantor or a nonadverse party, or both.

Section 677(a) provides that a grantor is treated as the owner of any portion of a trust whose income without the consent or approval of any adverse party is, or, in the discretion of the grantor or a nonadverse party, or both, may be (1) distributed to the grantor or the grantor's spouse; (2) held or accumulated for future distribution to the grantor or the grantor's spouse; or, (3) applied to the payment of premiums on policies of insurance on the life of the grantor or the grantor's spouse.

In this case, the trustee's ability to change the charitable beneficiary of the annual annuity if X fails to qualify as an organization described in each of sections 170(c), 2055(a) and 2522(a) when any annual annuity is to be distributed to such organization is a power that comes within the exception of section 674(b)(4).

Accordingly, based on the facts submitted and the representations made, we conclude that the Taxpayer will not be treated as the owner of any portion of the trust for income tax purposes under sections 671-674 and sections 676-677. Additionally, our examination of the trust agreement revealed none of the circumstances that would cause administrative controls to be considered exercisable primarily for the benefit of the grantor under section 675. Thus, the circumstances attendant on the operation of the trust will determine whether the Taxpayer will be treated as the owner of any portion of the trust under section 675. This is a question of fact, the determination of which must be deferred until the federal income tax returns of the parties involved have been examined by the appropriate District Director's office.

Except as specifically set forth above, no opinion is expressed or implied regarding the federal tax consequences of this transaction under the cited provisions or any other provision of the Code.

This 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.

Sincerely yours,

Mary A. Berman
Assistant to the Chief, Branch 7
Office of the Assistant Chief Counsel
(Passthroughs and Special Industries)

Enclosures:
Copy of this letter
Copy for section 6110 purposes

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