Nongrantor CLT Can Deduct Amounts Paid to Charity

Nongrantor CLT Can Deduct Amounts Paid to Charity

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

The IRS has ruled privately that a charitable lead annuity trust will be entitled to an income tax deduction for amounts paid to charity and will not be a grantor trust for income tax purposes.

Ltr. Rul. 9822025

PGDC Summary:

The charitable lead annuity trust will be entitled to an income tax deduction for amounts paid to charity and will not be a grantor trust for income tax purposes.

Facts:

The donor will create a CLAT for a term expiring on 12/31/2013, the income interest being payable to a charitable entity which may be a private foundation. If the charitable recipients are not designated by the 15th day before the end of each year by the trustees, the annuity amount will be distributed to certain named qualified charities. Neither the donor nor his spouse can act as trustee. The trust instrument permits a change of situs in the trustees' discretion.

Holding:

(1) No portion of the CLAT's income will be taxable to the donor under the grantor trust rules; (2) the CLAT will be entitled to a charitable income tax deduction under Code Section 642(c) for amounts of gross income paid to charity; and (3) a gift tax charitable deduction is permitted to the donor for the present value of the lead interest to charity.

Points to Ponder:

What reason might the trustees desire to change the situs of a CLAT? Is the income interest to be paid to the donor's private foundation? The charitable gift tax deduction is permitted even though the charitable recipients may change?

Full Text:

February 23, 1998

Refer Reply to: CC:DOM:P&SI:4/PLR-119489-97

Dear * * *

This is in response to your letter dated October 14, 1997, in which you request rulings relating to the establishment and operation of a charitable lead annuity trust for federal gift and income tax purposes.

The taxpayer proposes to create a charitable lead annuity trust to which he will transfer cash and other assets in the amount of approximately $2,000,000. Trustee A and Trustee B are the initial trustees.

Article Second (A) of the trust instrument provides that for a period of time dating from the execution of the indenture through December 31, 2013, the trustees will annually distribute an annuity of a specified dollar amount (the "annuity amount") to "qualified charities", defined as organizations which are described in sections 170(c) and 2522(a), selected by the trustees. If the recipients have not been selected by the fifteenth day before the end of each year, then the annuity amount will be distributed to certain named qualified charitable organizations. For each taxable year, said annuity shall be paid from current income, and to the extent current income shall be insufficient, from accumulated income, and to the extent accumulated income shall be insufficient, from principal (including capital gains). Any income not so distributed may be added currently to principal in the Trustees' sole discretion. The annuity amount is $130,000. The annuity cannot be commuted or prepaid prior to the termination date.

Article Second (B) of the instrument provides that on the termination date, the remaining trust assets will be distributed in equal shares to the taxpayer's children, their heirs, executors and administrators.

Article Third of the instrument provides for trustee succession. The Article sets out the names of successor trustees and provides that a majority of the trustees may act, that any trustee may resign, that a trustee may appoint his successor, that a majority of the trustees may appoint a co-trustee, that a corporate trustee may be replaced by action of the individual co-trustees. Neither the taxpayer nor his spouse may serve as a trustee.

Article Fourth (C) of the instrument allows the trust situs to be changed from State X to any other state if the trustees determine that the trust can be managed more advantageously in some state other than State X, or the state where such trust is presently being administered. Article Fifth of the trust instrument provides that the trust must terminate within twenty-one years after the death of the last to die of all of taxpayer's descendants living at the time of the execution of the trust. Article Sixth of the instrument provides that it is irrevocable and that taxpayer will have no rights or powers to alter, amend or terminate the trust or designate its income beneficiaries.

Article Seventh provides that the trust will be executed under and governed by the laws of State X. Article First (X) of the instrument prohibits the trustee from engaging in any act of self dealing as defined in section 4941(d), from causing the trust to have excess business holding as defined in section 4943(c), from causing an investment to be acquired or retained in a manner that subjects the trust to tax under section 4944, and from making any taxable expenditure as defined in section 4945(d).

Specifically, you have asked us to rule as follows:

1. That the annuity interest in the trust will be a guaranteed annuity interest within the meaning of section 2522(c)(2)(B)of the Internal Revenue Code and section 25.2522(c)-3(c)(2)(vi) of the Gift Tax Regulations and that a gift tax deduction will be allowed to the taxpayer pursuant to section 2522 equal to the value of the guaranteed annuity.

2. That the trust will be allowed a deduction under section 642(c) in each taxable year in an amount equal to the annuity amount paid from gross income during such taxable year in accordance with the trust's terms.

3. That no portion of the trust's income will be taxable to taxpayer under sections 671-678. Section 2501 imposes a tax on the transfer of property by gift by an individual. Section 2522(a) provides that, in computing the taxable gifts 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 interest, 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)(a) 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)(b) provides that "a charitable interest is a guaranteed annuity interest only if it is a guaranteed annuity interest in every respect." 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.

Section 671 provides that if the grantor or another person is treated as the owner of any portion of the trust, there shall be included in computing the taxable income and credits of the grantor or other person those items of income, deductions and credits against the tax of the trust which are attributable to that portion of the trust to the extent that such items would be taken into account in computing the taxable income or credits against the tax of an individual.

Section 673 through 678 specify circumstances under which the grantor or other person will be treated as the owner of a trust.

Section 642(c) provides the general rule that in computing its taxable income, a trust is allowed a deduction for any amount of gross income, which pursuant to the terms of its governing instrument, is paid during the taxable year for a purpose specified in section 170(c)(determined without regard to section 170(c)(2)(A)). Section 642(c)(4) provides that the deduction allowed for a trust is subject to section 681 (relating to unrelated business income).

Section 681(a) provides that no charitable deduction is allowable to a trust under section 642(c) for any amounts allocable to the trust's "unrelated business income" for the taxable year. The term "unrelated business income" means an amount under section 512, if the trust were exempt from tax under section 501(a) by reason of section 501(c)(3), that would be computed as its unrelated business taxable income under section 512.

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 section 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 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.

Issue 1

From the date of the execution of the trust instrument until the termination date, a fixed amount of the charitable annuity will be distributed no less frequently than annually to organizations described in sections 170(c) and 2522(a). Accordingly, the annuity interest meets the definition of a guaranteed annuity interest described in sections 2522(e)(2)(B) and 25.2522(c)-3(c)(2)(vi). Based on the representations made and provided that charitable lead annuity trust is established and administered as set forth above and provided that the trust will be a valid trust under applicable local law, we conclude that the annuity interest provided for in the trust instrument is a guaranteed annuity interest within the meaning of section 2522(c)(2)(B). A federal gift tax charitable deduction for the value of the charitable interest will be allowable to the taxpayer under section 2522(a). The amount of the charitable deduction will be determined under section 25.2522(c)-3(d)(2)(v).

Issue 2

Except to the extent that the trust has unrelated business income under section 681(a), and except to the extent that contributions are nondeductible under sections 508(d) or 4948(c)(4), the trust will be allowed deductions in accordance with section 642(c)(1) for amounts of gross income paid to charitable beneficiaries described in section 170(c) during the taxable year, or by the close of the following taxable year, if the trustee makes an election under section 1.642(c)-1(b). Because the deduction under section 642(c)(1) is limited to amounts of gross income, no deduction will be allowed for a distribution of principal except to the extent that the amount distributed has been included in the gross income of the trust and provided no deduction was allowed for any previous taxable year for the amount distributed.

Issue 3

After examining the trust document, we conclude that the trust does not contain any of the provisions or powers that would cause the grantor or any other person to be treated as the owner of any portion of the trust under sections 673, 674, 676, 677 or 678.

In addition, the trust agreement does not contain powers that cause administrative control to be exercisable primarily for the benefit of a grantor under section 675. Whether the grantor will be treated as owner of the trust under section 675 will depend on the actual operation of the trust. This is a question of fact, the determination of which must necessarily be deferred until the District Director's office (with which the returns are filed) examines the federal income tax returns of the relevant parties. Thus, the trust is not a grantor trust under section 675 (unless the District Director's office determines otherwise).

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 any other provisions of the Code.

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

Sincerely yours,

Assistant Chief Counsel
(Passthroughs & Special Industries)

By: George L. Masnik
Chief, Branch 4
Enclosure
Copy for section 6110 purposes

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