Trust Reformed as CRUT to Qualify for Estate Tax Deduction

Trust Reformed as CRUT to Qualify for Estate Tax Deduction

News story posted in Letter Rulings on 7 July 1998| comments
audience: National Publication | last updated: 18 May 2011
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Summary

In private letter ruling 9827008, the IRS rules that an estate will be entitled to a charitable deduction for the present value of the remainder interest in a trust provided that the non-charitable beneficiaries of the trust validly disclaim their powers to invade corpus and provided that judicial reformation proceedings are commenced within the appropriate time frame.

SUMMARY:
In private letter ruling 9827008, the IRS rules that an estate will be entitled to a charitable deduction for the present value of the remainder interest in a trust provided that the non-charitable beneficiaries of the trust validly disclaim their powers to invade corpus and provided that judicial reformation proceedings are commenced within the appropriate time frame.

FACTS:
A decedent's will provides that the residue of her estate is to be held in trust, with the income to be paid to her niece for life. The niece has the power to invade corpus for extraordinary medical expenses. At the niece's death, the income is to be paid equally to two friends for their lives and then to the survivor of the friends. The two friends also have the power to invade corpus for extraordinary medical expenses. At the death of the survivor of the niece and the two friends, the remainder of the trust is to be divided among four charities. If any charity loses its non-profit status, such charity's share will be distributed to the other charities.

The estate cannot take a charitable estate tax deduction under Code Section 2055 for the value of the remainder interest that will pass to charity because the trust does not qualify as a charitable remainder trust under Code Section 664. The estate proposes to have the niece and the two friends disclaim their powers to invade corpus pursuant to Code Section 2518 and to reform the trust so that the niece and the two friends will receive, respectively, a unitrust amount equal to 7.4 percent of the net fair market value of the trust assets valued annually. The charities would have to be qualified under Code Sections 2055 and 170(c). The reformation would be effective as of the decedent's death.

According to the IRS, the difference between the actuarial value of the charitable interest prior to the reformation and after the reformation will not exceed 5 percent of the actuarial value of the reformable interest. The interests of the niece and two friends after the reformation will terminate at the same time that these interests would have terminated prior to the reformation.

HOLDING:
Provided that the judicial proceedings to reform the trust are commenced before the 90th day after the last date for filing the decedent's estate tax return (including extensions) and the disclaimers are qualified under Code Section 2518 and the regulations thereunder, the estate will be entitled to a charitable deduction for the present value of the remainder interest in the trust under Code Section 2055.

POINTS TO PONDER:
It appears likely that the decedent in this ruling did not contemplate creating a qualified charitable remainder trust when she signed her will. Charitable remainder interests are often created in a haphazard fashion during the estate planning process. This ruling demonstrates that it can pay to consider using the charitable trust reformation provisions in some situations where no one thought of setting up a qualified charitable trust during the original planning stage.

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Date: March 30, 1998
Refer Reply To: CC:DOM:P&SI:7:PLR-103142-98
Re: * * *
LEGEND:
Estate = * * *
Decedent = * * *
Date 1 = * * *
Date 2 = * * *
Niece = * * *
Friend 1 = * * *
Friend 2 = * * *
Charity 1 = * * *
Charity 2 = * * *
Charity 3 = * * *
Charity 4 = * * *
State = * * *
a = * * *
b = * * *

Dear * * *

Your correspondence dated * * *, requests rulings under section 2055 of the Internal Revenue Code on behalf of Estate. This letter responds to your request.

The information presented indicates that Decedent died on Date 1. Decedent's Will, dated Date 2, provided that the residue of her estate is to be held in trust for the benefit of three named individuals. Under the terms of the trust, the trustee is to pay the income to Niece for life, with a power to invade the corpus to pay Niece's "extraordinary medical expenses, including the cost of care at a nursing facility." At Niece's death, the monthly income is to be paid to Friend 1 and/or Friend 2 (in equal shares if both living), with a similar right of corpus invasion for extraordinary medical expenses. Upon the death of the last beneficiary, the trust terminates and the corpus is distributed as follows: three-sixths (3/6) to Charity 1, one-sixth to Charity 2, one-sixth (1/6) to Charity 3, and one-sixth to Charity 4. The Will provides that if any charity loses its nonprofit status, the bequest lapses and that share will be distributed to the remaining non-profit organizations.

As the trust presently exists, it does not qualify as a charitable remainder trust under section 664, and therefore, Decedent's estate may not deduct the value of the remainder interest in the trust as an estate tax charitable deduction under section 2055(e)(2). In order to qualify the trust for the estate tax charitable deduction, the estate proposes to reform the trust.

In conjunction with the proposed reformation, Niece, Friend 1, and Friend 2 will disclaim, within nine months of the Decedent's death, their rights to corpus invasion. In each taxable year of the reformed trust, the trustee is to pay Niece in monthly installments a unitrust amount equal to 7.4 percent of the net fair market value of the assets of such trust valued as of the first day of such taxable year. Upon Niece's death, the trustee is to pay Friend I and Friend 2 (in equal shares if both living) in monthly installments a unitrust amount which together equals 7.4 percent of the net fair market value of the assets of such trust valued as of the first day of such taxable year. At either Friend 1 or Friend 2's death, the unitrust amount shall be paid entirely to the survivor. At the death of the last survivor, the corpus will be distributed as follows: three-sixths to Charity 1, one-sixth to Charity 2, one- sixth to Charity 3, and one-sixth to Charity 4. If any charity loses its nonprofit status, the bequest lapses and that share will be distributed to the remaining non-profit organizations. If none of the charities are organizations described in section 170(c) and 2055(a) at the time when any principal is to be distributed to it, then the trustee will make distributions to one or more organizations described in sections 170(c) and 2055(c) as the trustee selects in its sole discretion.

Section 2055(a) provides that, for purposes of the federal estate tax, the value of the taxable estate is determined by deducting from the value of the gross estate the amount of all bequests, legacies, devises, or transfers for public, educational, scientific, literary, charitable, or religious uses.

Section 2055(e)(2)(A) provides that where an interest in property passes or has passed from the decedent to a person, or for a use, described in section 2055(a), and an interest (other than an interest that is extinguished upon the decedent's death) in the same property passes or has passed (for less than an adequate and full consideration in money or money's worth) from the decedent to a person, or for a use, not described in section 2055(a), no deduction is allowed under section 2055(a) for the interest that passes or has passed to the person, or for a use, described in section 2055(a), unless in the case of a remainder interest, the interest is in a charitable remainder annuity trust or a charitable remainder unitrust (described in section 664) or a pooled income fund (described in section 642(c)(5)).

Section 2055(e)(3)(A) provides that a deduction is allowed for any qualified reformation.

Section 2055(e)(3)(B) defines the term "qualified reformation" to mean a change of a governing instrument by reformation, amendment, construction, or otherwise that changes a reformable interest into a qualified interest, but only if (i) any difference between the actuarial value (determined as of the date of the decedent's death) of the qualified interest, and the actuarial value (as so determined) of the reformable interest does not exceed five percent of the actuarial value (as so determined) of the reformable interest, (ii) in the case of a charitable remainder interest, the nonremainder interest (before and after the qualified reformation) terminated at the same time, or, in the case of any other interest, the reformable interest and the qualified interest are for the same period, and (iii) the change is effective as of the date of the decedent's death.

Section 2055(e)(3)(C)(i) defines the term "reformable interest" to mean any interest for which a deduction would be allowable under section 2055(a) at the time of decedent's death but for 2055(e)(2).

Section 2055(e)(3)(C)(ii) provides that the term "reformable interest" does not include any interest unless, before the remainder vests in possession, all payments to persons other than an organization described in section 2055(a) are expressed either in specified dollar amounts or a fixed percentage of the fair market value of the property.

Section 2055(e)(3)(C)(iii) provides, in part, that 2055(e)(3)(C)(ii) does not apply to any interest if not later than 90 days after the last date (including extensions) for filing an estate tax return, if an estate tax return is required to be filed, a judicial proceeding is commenced to change the interest into a qualified interest.

Section 2055(e)(3)(D) defines the term "qualified interest" to mean an interest for which a deduction is allowable under section 2055(a).

Based on the information submitted and the representations made, we conclude that the charitable remainder interest is a reformable interest within the meaning of section 2055(e)(3)(C)(i) because an estate tax deduction for the value of the interest would have been allowable under section 2055(a) but for the provisions of section 2055(e).

The reformation of the trust will be effective as of the date of Decedent's death and the nonremainder interest will terminate at the same time before and after the reformation. The actuarial value of the charitable remainder interest in the original trust will be a and the actuarial value of the charitable remainder interest in the reformed trust will be b. Thus, the difference between the actuarial value of the qualified interest and the actuarial value of the reformable interest will not exceed 5 percent of the actuarial value of the reformable interest.

The reformed trust will contain the provisions set forth in Rev. Rul. 72-395, 1972-2 C.B. 340, as modified by Rev. Rul. 80- 123, 1980-1 C.B. 205, and Rev. Rul. 82-128, 1982-2 C.B. 71, and clarified by Rev. Rul. 82-165, 1982-2 C.B. 117. Consequently, the reformed trust meets the requirements of a charitable remainder unitrust as described in section 664(d)(2). Accordingly, provided that judicial proceedings to reform the original trust are commenced before the 90th day after the last date (including extensions) for filing Decedent's estate tax return, and provided also the disclaimers executed by Niece, Friend 1, and Friend 2 are qualified disclaimers within the meaning of section 2518 and the regulations thereunder, the present value of the charitable remainder interest in the reformed trust will be allowed as an estate tax deduction under section 2055(a).

Except as ruled in this letter, we express or imply no opinion concerning the federal tax consequences of this transaction under the cited provisions or under any other provision of the Code. In particular, we express or imply no opinion on whether the disclaimers are or will be qualified disclaimers within the meaning of section 2518 and the regulations thereunder.

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

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