Section 2511(c) and Charitable Gift Planning

Section 2511(c) and Charitable Gift Planning

Article posted in Transfer Taxes on 20 April 2010| comments
audience: National Publication | last updated: 4 May 2013
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Summary

There has been a lot of concern recently about the effects of Internal Revenue Code §2511(c) on charitable gift planning. Although the jury is still out on certain issues in this arena, an analysis of these and related issues may be useful to readers at PGDC.

By Jonathan G. Tidd. Esq.

Section 2511(c)

Here is the tax code section causing all the hubbub -- §2511(c):

(c) Treatment of Certain Transfers in Trust. -- Notwithstanding any other provision of this section and except as provided in the regulations, a transfer in trust shall be treated as a transfer of the property by gift, unless the trust is treated as wholly owned by the donor or the donor's spouse under subpart E of part I of subchapter J of chapter 1.

This language is the result of P.L. 107-16 (2001), as amended by P.L. 107-147 (2002), and is applicable to gifts made after December 31, 2009, and before January 1, 2011. 1/

The stark language of §2511(c), taken all by itself, would appear to overthrow an enormous amount of federal gift tax law pertaining not only to charitable gift planning, but also, for example, to GRATS and ILITs. Is this what congress intended?

What Did Congress Intend in Enacting Section 2511(c)?

To say the waters here are murky is an understatement. But from the murkiness emerge certain verities (or so it appears):

1. Section 2511(c) clearly was intended to be effective only for the period the estate tax was repealed by P.L.107-16 -- i.e., 2010. 2/

2. Here's an opinion, but an opinion the author believes is nonetheless supported in the record: §2511(c) was intended to come into play only once the federal gift tax stood on its own two legs and stopped serving to backstop the estate tax (i.e., once the federal estate tax was repealed in 2010). From this perspective, the clear purpose of §2511(c) was not to overthrow a whole bunch of gift tax law -- law embedded in statute, regulations, rulings, etc.; rather it was to plug, surgically, a hole that existed in the gift tax law prior to 2010, with respect to arrangements that (a) were incomplete for gift tax purposes, but (b) were within the reach of the estate tax. The Joint Committee on Taxation backs this interpretation in JCX-12-02 (March 6, 2002). 3/

Examples of Section 2511(c)'s Reach and Non-Reach

The examples given here are the author's alone. But the author believes they are unassailable. Of course, the French nobility felt the same way about the Bastille.

Example 1: Donor creates a charitable remainder trust, the payout from which is just to the donor. Donor retains the right to change the charitable remainder beneficiary.

Prior to 2010, the gift of the remainder would be incomplete for federal gift tax purposes. 4/ Pretty clearly, as of this writing in 2010, §2511(c) makes the gift of the remainder complete for federal gift tax purposes. The donor gets to claim a federal income tax charitable deduction.. 5/

Some in the charitable gift planning community are concerned that in the situation described here, the entire property interest transferred to the trust is a completed gift for federal gift tax purposes. The author is distinctly less concerned, for reasons set forth hereinbelow.

Example 2: Party A creates a charitable remainder trust, the payout from which is to go first to Party A for life, second to Party B for life. Party A reserves the right, exercisable by will, to revoke Party B's interest in the trust. 6/

Prior to 2010, Party A would not have made a completed gift to Party B for federal gift tax purposes. Section 2511(c) clearly causes Party A to make a completed gift to Party B. 7/

Once again, some in the charitable gift planning community are concerned that §2511(c) may cause the entire property interest transferred to the trust to be a completed gift for federal gift tax purposes. That same concern extends to the situation in which the donor does not reserve the right to revoke. The author only partially shares this concern.

Example 3: Party A sets up a charitable gift annuity for Party B and reserves the inter vivos right to revoke the annuity.

Under the pre-2010 analysis, Party A has made an incomplete upfront gift to Party B. Completed gifts occur only as annuity payments are made, and these gifts qualify for the annual gift exclusion under Code §2503(b).

The author, by the way, has always believed that the donor's retained control over the annuity caused the donor to be taxable for income tax purposes on the taxable portion of each annuity payment made during the donor's life. After all, if the gift is incomplete, is not the donor in control of the taxable portion of the annuity...is not the donor deciding with each annuity payment whether the annuitant receives his or her benefit? The author understands the grantor trust rules (Code §§671 -678) do not apply to gift annuities. The author also understands, however, that the grantor trust rules are not the last word on income shifting and the like, as well as that the federal income tax and the federal gift tax are not in pari materia...although they often march to the same tune.

Under Code §2511(c), the situation here appears to be the same both before 2010 and after 2009. In other words, §2511(c) does not appear to affect the analysis of this situation. On its face, §2511(c) applies only to trust arrangements. It is conceivable, of course, that IRS regulations or other guidance will extend §2511(c)'s reach to "trust-like" arrangements including gift annuities. The author makes no predictions.

The Joint Committee on Taxation Approach to Section 2511(c)

The Joint Committee approach to §2511(c) is set forth in JCX-12-02 (March 6, 2002), as mentioned infra. The relevant discussion in JCX-12-02 is brief but salient; it lays out principally (a) one chief guiding principle, and (b) two examples.

(a) Chief Guiding principle: "Under [§2511(c)]..., certain amounts transferred in trust will be treated as transfers of property by gift, despite the fact that such transfers would be regarded as incomplete gifts or would not be treated as transferred under the law applicable to gifts made prior to 2010."

Author's note: Here we see the Joint Committee stating plainly, in the author's view, the surgical nature of §2511(c). It was congressional intent, in the author's view, for §2511(c) to be a scalpel not a bludgeon.

Rhetorical question: How, then, can one possibly maintain that the entire transfer of assets to a charitable remainder trust, the payout from which, for example, is to go to the donor for life, is a completed gift for gift tax purposes? How is the donor's retained interest a gift at all? If it is a gift, I suggest all T & E lawyers in the United States better erase their mental hard drives and ratchet up from scratch.

The author knows from experience that almost any proposition can be maintained with a straight face by a clever lawyer. But with logic as well? More to follow.

(b) Example (1): "...[I]f in 2010 an individual transfers property in trust to pay the income to one person for life, remainder to such persons and in such portions as the settlor may decide, then the entire value of the of the property will be treated as being transferred by gift under [§2511(c)], even though the transfer of the remainder interest in the trust would not be treated as a completed gift under current Treas. Reg. sec. 25.2511-2(c)."

Author's note: Let's suppose in the preceding example that the trust in question is a charitable remainder trust as defined in Code §664. JCX-12-02 appears quite clearly to stand for the propositions that (a) the remainder interest is a completed gift for gift tax purposes, and (b) the remainder interest qualifies for the gift tax charitable deduction under Code §2522. (N.B., the discussion of this situation infra is basically limited to the income tax charitable deduction. See footnotes 4 and 5.)

(c) Example (2): "...[I]f in 2010 an individual transfers property in trust

to pay the income to one person for life, and makes no transfer of the remainder interest, the entire value of the property will be treated as being transferred by gift under [§2511(c)]."

Author's note: The author -- a charitable gift planning specialist, not a T & E specialist -- confesses to never having seen such a trust. It has no analogue in the charitable gift planning arena.

IRS NOTICE 2010-19 (February 16, 2010)

In the author's opinion, if ever there was a masterpiece of tax law obfuscation, this is it. The critical language is:

Accordingly, each transfer made in 2010 to a trust that is not treated as wholly owned by the donor or the donor's spouse under [Code §§671 -678] is considered to be a transfer by gift of the entire interest in the property under section 2511(c).

Granted, what the IRS says here tracks the literal language of §2511(c). If the Service in fact takes a literal approach to this code section, it will be truly awe inspiring. Just plain amazing. And clearly contrary to congressional intent as evidenced by the Joint Committee on Taxation in JCX-12-02.

Summary

Code §2511(c) says one thing, literally. JCX-12-02, and the the history of the federal estate and gift tax laws, give rational meaning to §2511(c). The real question is, will rationality prevail?

Conclusion

If the author had the bet, he'd bet (a) IRS will withhold further guidance on §2511(c), and (b) congress sometime this year (2010) will re-enact the estate tax retroactive to January 1, 2010, making all further consideration of §2511(c) moot.

The reader, of course, may wish to bet differently.

FOOTNOTES

1. Section 2511(c) came into the Code as §511(e) of P.L. 107-16, given the name "Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA)."

As originally written, §2511(c) , looked exactly as it does as this article is being written, except that instead of saying --

a transfer in trust shall be treated as a transfer of the property by gift

§2511(c) provided --

a transfer in trust shall be treated as a taxable gift under section 2503.

The change from "taxable gift under section 2503" to "transfer of the property

by gift" came under P.L. 107-147, given the name "Job Creation and Worker

Assistance Act of 2002." JCX-12-02 pertains to this latter Act.

In this regard, JCX-12-02 states:

The provision clarifies that the effect of section 511(e) of the Act (effective for gifts made after 2009) is to treat certain transfers in trust as transfers of property by gift. The result of the clarification is that the gift tax annual exclusion and the marital and charitable deductions may apply to such transfers. Under the provision, as clarified, certain such transfers would be regarded as incomplete gifts or would not be treated as transferred under the law applicable to gifts made prior to 2010. (Emphasis added.)

To the author, it is clear congress intended a surgical strike by enacting §2511(c). One can only hope IRS sees things that way.

2. EGTRRA (§901) provides a sunset provision for §2511(c). Section 2511(c) is to operate only so long as the federal estate tax is repealed -- for all of 2010, according to plan in 2001.

To the author, this sunset provision makes clear it is wrong to apply §2511(c) literally. The only correct application of §2511(c), in the author's thinking, is that laid out by the Joint Committee on Taxation.

3. The history books make clear that the federal gift tax was enacted chiefly to backstop the federal estate tax.

The gift tax and estate tax never have been truly "unified," although "unification" was announced with passage of the 1976 Tax Reform Act.

Examples of lack of true unification include (a) the gift tax annual exclusion under section 2503(b), which has no estate tax counterpart, and (b) the differences in the gift tax and the estate tax charitable deductions.

Nonetheless, it is fair to say the main role of the gift tax prior to 2010 was to backstop the estate tax. Although, the author will admit that over the years, the IRS has used the gift tax from time to time as a "gotcha" law.

Which brings us to gifts that, before 2010, were incomplete for gift tax purposes but were within the reach of the estate tax at the donor's death.

It is these gifts, according to the Joint Committee on Taxation, that fall exclusively within the crosshairs of §2511(c).

4. See, for example, the annotations to Rev. Proc. 2005-54.

5. Even though prior to 2010 the gift of the remainder would be incomplete for federal gift tax purposes, the gift would be complete for federal income tax purposes. Id.

6. The reason, by the way, why the donor in this situation may reserve the right to revoke exercisable only by will is that an inter vivos right to revoke would cause the trust to be a grantor trust, under Code §676, which would preclude the trust from being a charitable remainder trust under Code §664. See Reg. §1.664-1(a)(4).

7. The real issue here is whether Party A's retained interest is a gift under §2511(c). If IRS says it is, the author will salute, but will chalk IRS's decision up as a great mistake.


Jonathan G. Tidd is an attorney in West Simsbury, CT, whose practice is limited to representing charitable organizations in the area of charitable gift planning. A member of the Connecticut, Illinois, Indiana and New York Bars, he works with a wide variety of educational, health care, arts, human rights and social organizations. Mr. Tidd can be reached at jgtidd@aol.com.

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