Year End Review For Charitable Gift Planners - 2000

Year End Review For Charitable Gift Planners - 2000

Article posted in Treasury on 28 February 2001| comments
audience: National Publication | last updated: 18 May 2011
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Summary

The courts and the IRS gave us a number of interesting decisions related to charitable gift planning in 2000. This article reviews some of the ones PGDC found most significant. The article also briefly describes some of the legislation proposed in 2000 that could have impacted charitable giving because we suspect that we might see some of the same or similar features in 2001 legislation.

by: Emanuel J. Kallina, II, Esquire & Jonathan D. Ackerman, Esquire

This article summarizes the proposed legislation, cases, rulings, and other items that we found to be especially relevant for charitable planning in 2000. It is hoped that a review of the past year's significant developments will give charities, donors and advisors a sense of perspective and an awareness of the risks and benefits of various techniques as they formulate their charitable planning strategies for 2001. Highlights include the following:

  • The House and Senate voted to begin phasing out the federal gift, estate and generation skipping transfer taxes and repeal them entirely in 2010; however, the President vetoed the legislation.

  • Congressional efforts persisted unsuccessfully to expand the tax incentives for charitable gifts, such as tax free rollovers from IRA accounts to a living donor's CRT, PIFs and CGA's and allowing non-itemizers to deduct 50% of their charitable donations exceeding $500/year.

  • Proposed regulations to deal with the "son-of-accelerated CRT" and the "ghoul" charitable lead trust problems were issued and debated.

  • Eight noteworthy court cases dealt with such issues as compliance with the charitable gift substantiation rules; what happens to the FETcharitable deduction for a CRT gift when the trustee fails to make required distributions; how not to deal with a covenant not to compete when a CRT trustee receives and sells a business interest; and why supporting organization wishing to avoid UBIT should not buy income producing securities on margin.

  • The IRS sought public advice on improving its prototype CRT forms, introduced a new tax return form to be completed by charities paying premiums on personal benefits contracts, and indicated it will be revising Forms 990, 990-PF, and 5227 for taxable years beginning after 12/31/99, to add questions relating to charitable split-dollar insurance arrangements.

  • Numerous IRS private rulings of interest dealt with such issues as splitting a CRT in two when the income recipients divorce; tax-free rollovers of employer securities from qualified plan accounts into CRTs; giving CLT trustees and remaindermen discretion to select which charities will receive the lead interest; and when an estate tax charitable deduction will be allowed for a bequest to a foreign charity.

Legislation

While there were no significant legislative developments for charitable planning in 2000, there were a number of proposals that could have had a tremendous impact if they had been enacted. Perhaps some of the same or similar proposals we saw in 2000 will resurface in 2001. With the new administration in place, we may see significant tax legislation in 2001, including the possible elimination of the estate tax and its related charitable deduction.

Proposed Legislation

S. 2077, the "Charitable Giving Tax Relief Act," introduced on February 22, 2000, would have allowed non-itemizers to deduct 50% of their charitable donations which exceed a cumulative total of $500 in annual donations. Identical legislation, H.R. 1310, was introduced in the House in 1999. President Clinton's fiscal 2001 budget included a similar proposal, although the administration's version would have limited the deduction to those annual cumulative contributions exceeding $1,000 for years through 2005. After that year, the floor would have dropped to $500. The President's budget explanation stated that the proposal was intended "to provide an incentive for taxpayers who use the standard deduction to make large charitable contributions."

President Clinton's budget proposal would have also repealed the special, lower contribution limits for gifts to charity of capital gain property and imposed new rules on donor advised funds. The proposal included a provision stating that if a charitable organization has, as its primary activity, the operation of one or more donor advised funds, the organization may qualify as a public charity only if: (i) there is no material restriction or condition that prevents the organization from freely and effectively employing the assets in such donor advised funds, or the income therefrom, in furtherance of its exempt purposes; (ii) distributions are made from such donor advised funds only as contributions to public charities (or private operating foundations) or governmental entities; and (iii) annual distributions from donor advised funds equal at least five percent of the net fair market value of the organization's aggregate assets held in donor advised funds (with a carry forward of excess distributions for up to five years).

H.R. 3832, the "Small Business Tax Fairness Act 2000," was passed by the House. It included a provision to reduce the top estate tax rate of 55% to 50% by 2002 and reduce all rates by 1 percentage point per year in 2003 and 2004. In addition, the bill would have repealed the 5% "bubble tax" on estates. Notably absent from H.R. 3832 were provisions allowing (i) nonitemizers to claim a charitable income tax deduction and (ii) IRA rollovers to charities, as has been previously proposed. Year 2000 also saw proposals to significantly increase the current unified credit against estate taxes, replace the unified credit with an "exclusion," and replace the current Code1 by a specific date.

H.R. 8, the "Death Tax Elimination Act of 2000," was passed by the House and Senate last summer. As anticipated, the President vetoed it in the fall. Had H.R. 8 been signed into law, it would have repealed the estate, gift, and generation?skipping taxes beginning in the year 2010. In the interim before total repeal, it would have modified existing estate, gift, generation?skipping tax rules, and would have reduced the rate and progressivity of these taxes. H.R. 8 would have also required assets at death to have a carryover basis (rather than a basis "stepped?up" to fair market value). Finally, the bill would have expanded the availability of qualified conservation easements.

The "Retirement Security and Savings Act of 2000" would have, among other things, provided an exclusion from gross income for qualified charitable distributions from individual retirement accounts to (i) charities to which deductible contributions may be made; (ii) charitable remainder trusts; and (iii) pooled income funds, or to purchase charitable gift annuities. Only the individual retirement account owner or his or her spouse or a charity would have been allowed to hold an income interest in the transferee charitable remainder trust, pooled income fund or charitable gift annuity. A transferee charitable remainder trust would have been required to populate its ordinary income tier (for four-tier tax accounting purposes) with that portion of any individual retirement account property it receives by way of a qualified charitable distribution to the extent such property would have been includible in the transferor's income had it been distributed from the IRA to the transferor. If any excess over this amount was received by the transferee CRT in a qualified charitable distribution, it would have been allocated properly to fourth tier, principal. Similar rules would have applied in determining the taxable portion of a payment from a charitable gift annuity that was purchased with a qualified charitable distribution.

Treasury Regulations

Son of Accelerated CRT Regulations

Although technically not finalized until early 2001,2 we include the "Son of the Accelerated CRT" Regulations as a year 2000 development because the Regulations were discussed extensively then. According to the Treasury, the Regulations were issued to stop certain abusive transactions involving the use of a charitable remainder trust "to convert appreciated assets into cash while avoiding tax on the gain from the disposition of the assets." Treasury noted that the taxpayer in these transactions would typically contribute highly appreciated assets to a charitable remainder trust with a relatively short term and high payout rate. According to the Treasury, the trustee would then either borrow money or enter into a contract for the sale of the assets (such as a forward sales contract) rather than sell the assets to get the cash needed to pay the annuity or unitrust amount. The Treasury noted that this borrowing or forward sale would not cause the trust to have current income, thus enabling the trustee to characterize the unitrust or annuity trust distributions as a tax-free return of corpus.

As proposed on October 18, 1999, the Regulations treated the trust as having sold a pro rata portion of its assets.3 The final Regulations changed this treatment somewhat in response to public comments. The final Regulations refined the references to the rules on the characterization of charitable remainder trust distributions in an effort to more precisely define the abuse being targeted in Regulation Section 1.643(a)-8(a). In addition, the final Regulations include an example clarifying that any charitable remainder trust borrowing to be characterized as a deemed sale of trust assets under the new Regulations will not be acquisition indebtedness that could give rise to an unrelated business income tax liability. The final Regulations also added two exceptions to the rules. Specifically, a cash distribution within a reasonable period of time after the end of the year is corpus if it is attributable either to a cash contribution for which a charitable deduction was allowed or to a return of basis in an asset contribution for which a charitable deduction was allowed and the asset was sold by the charitable remainder trust in the year that the annuity or unitrust payment was due. The Final Regulations are generally applicable to distributions made by a charitable remainder trust after October 18, 1999.

Ghoul Charitable Lead Trust Regulations

As with the charitable remainder trust regulations, we include the "ghoul" charitable lead trust Regulations as a 2000 development although these Regulations were not actually finalized until early 2001.4 These Regulations were proposed on April 5, 2000. The final Regulations provide rules for the qualification of a guaranteed annuity interest or unitrust interest for purposes of the income, estate and gift tax charitable deductions under Code Sections 170(c), 2055(e)(2) and 2522(c)(2). As finalized, the Regulations permit the measuring lives to include someone who, with respect to all of the noncharitable remainder beneficiaries, is either a lineal ancestor or a spouse of a lineal ancestor of the noncharitable remainder beneficiaries. The final Regulations provide that a trust will satisfy the requirement that all noncharitable remainder beneficiaries are lineal descendants of the individual who is the measuring life, or that individual's spouse, if there is less than a 15% probability that individuals who are not lineal descendants will receive any trust corpus, as computed on the date of transfer to the trust. The probability is calculated taking into account the interests of all individuals living at that time.

Actuarial Table Regulations

As mentioned in our 1999 year-in-review article, the Treasury issued on April 30, 1999, temporary and proposed Regulations under Code Sections 642, 664, 2031, 2512, and 7520 relating to the use of actuarial tables for valuing annuities, interests for life or terms of years, and remainder or reversionary interests. The Treasury did not receive any written comments on the proposed Regulations and, accordingly, no hearing was held. The Treasury adopted the Regulations as final, with no substantive changes, on June 12, 2000.5

Cases

We saw a number of important charitable giving cases in 2000. The cases continue to indicate that the charitable substantiation rules will be taken seriously.

Jennings v. Commissioner

In Jennings v. Commissioner, T.C. Memo. 2000-366; No. 8249-98 (Dec. 4, 2000), the Tax Court held that a donor could not deduct charitable contributions for 1994, 1995 and 1996 (including carryovers from prior years) because of his failure to substantiate the contributions and his failure to show that the recipients were qualified charities. The Court noted that the donor had the burden of proof to establish that the recipients were Code Section 170(c) organizations. The Court also held that the donor was liable for accuracy related penalties under Code Section 6662(a) for the years 1994 through 1996, rejecting the donor's argument that he was not negligent because he sought advice from an Internal Revenue Service ("IRS" or "Service") problem resolution officer. Finally, the Court ruled that no sanctions should be imposed on the IRS because donor did not show that his rights were violated.

The facts involved charitable deductions the donor claimed on his income tax return of $36,960.30 for 1994, $25,028.40 for 1995 and $32,522.32 for 1996 for amounts of cash and other items given to various organizations. The donor claimed he should be able to deduct certain articles he wrote for and that were published by an organization known as Topaz and related postage, noting that he gave the IRS the phone number for Topaz's chief executive officer so that the IRS could verify Topaz's status. No evidence of the fair market value of the articles was given. A large part of the claimed deductions for 1994 to 1996 were carryovers of charitable contributions from the years 1977 to 1993, none of which were deducted on the donor's income tax returns for those years. Further, the only specific gift identified for that period was a speaker for an organ which the donor claimed he gave to a church in 1989. The donor had no receipts for the gifts and, because none of the gifts were made by check, he had no canceled checks.

Harbison v. United States

In Harbison v. United States, 86 AFTD2d Par. 2000-5593; No. 1:98-cv-1675-BBM (Nov. 17, 2000), a United States District Court granted a summary judgment motion in favor of a decedent's granddaughters as to their right to receive an estate tax refund resulting from an estate tax charitable deduction. The Court found that a charitable deduction was allowable for the assets passing to charity upon the termination of a life estate trust created under the decedent's will given the death of the trust's income beneficiary before the first estate tax return was filed and despite the invasion of the trust for the income beneficiary's benefit prior to his death. (The IRS had denied a refund request on the basis that the decedent's will created an invalid split interest trust under Code Section 2055(e)(2).) The Court observed that Code Section 2055(e)(3)(F) provides an exception to the split interest trust requirements where the income beneficiary dies before the due date for filing the estate tax return. The Court did not agree with the government's argument that the invasions of the trust for the income beneficiary took the trust outside the exception, noting that invasions were allowed based on the legislative history to this Code Section, other cases and IRS rulings. Nor did the Court agree with the government's argument that no reformable interest existed under Code Section 2055(e)(3)(C).

Musgrave v. Commissioner

In Musgrave v. Commissioner, T.C. Memo. 2000-285 (Sept. 6, 2000), the Tax Court held that a bargain sale contract for the installment sale of real estate to a church created a completed charitable gift in the year the contract was signed, observing that "a sufficient quantity of the benefits and burdens of ownership passed to the Church so that the transaction was closed for Federal income tax purposes when the contract for deed was signed in 1994." The donors in this case had entered into a contract in November of 1994 for a bargain sale of real property in Texas to a church. The payments were to be made in monthly installments beginning in January of 1995. Under the sales contract, the donors retained legal title to the property until the price was paid in full. In the meantime, the church had the right to occupy the property and agreed to maintain it. If the church defaulted on a payment, the donors could declare the entire purchase price due immediately and enforce collection or declare the contract terminated. The donors claimed a charitable income tax deduction on their 1994 return for the difference between the value of the property ($450,000) and the purchase price ($152,500). A part of the deduction was carried over to their 1995 return. The IRS denied the deduction and carryover. The IRS asserted that the contract was merely executory in 1994 so the gift was not complete. In December of 1997, the donors had conveyed legal title to the church in exchange for a real estate lien note in the principal sum of $133,315.69 secured by the property.

Estate of Starkey v. United States

In Estate of Starkey v. United States, 86 AFTR2d Par. 2000-5161 (7th Cir. Aug. 17, 2000), the Court of Appeals for the Seventh Circuit reversed and remanded the holding of a United States District Court regarding the allowance of an estate tax charitable deduction. The Seventh Circuit agreed with the Indiana courts' interpretation of a reference in a decedent's will to "missionaries preaching the Gospel of Christ" as merely a description of the Lawndale Community Church, noting that the use of extrinsic evidence to show the decedent's intent was appropriate under Indiana law where there is a latent ambiguity. The Seventh Circuit rejected arguments that (i) the reference to missionaries should not be construed as a description of the Lawndale Community Church because it would render the will's spendthrift clause meaningless and (ii) the Indiana courts' interpretation should be rejected because the estate instituted the state court proceedings solely to decrease the estate's tax liability. The IRS had rejected a request to determine that the trust was tax exempt and had denied the estate's charitable deduction, asserting that the reference to the missionaries created a third class of unspecified beneficiaries so that the trust was a split interest trust and the amount going to the two charitable beneficiaries was not ascertainable.

Estate of Atkinson v. Commissioner

In Estate of Atkinson v. Commissioner, 115 T.C. No. 3; No. 20968-97 (July 26, 2000), the Tax Court upheld the IRS's denial of an estate tax charitable deduction because the charitable remainder annuity trust, for which the deduction was claimed, failed to make any annuity payments during the life of the donor/income beneficiary and because the trust's corpus would have to be improperly invaded to pay death taxes. The Court also noted that the reformation provisions under Code Section 2055(e)(3) were not an available remedy because they apply only to the reformation of improperly created trusts and not improperly administered trusts. The donor had created the trust during her life and funded it with stock. No payments were actually made from the charitable remainder annuity trust during the donor's lifetime and the annuity amount which was undistributed was included as an asset of her estate.

Signom v. Commissioner

In Signom v. Commissioner, T.C. Memo. 2000-175; No. 14764-98 (May 26, 2000), the Tax Court upheld the IRS's disallowance of the donors' claimed charitable deduction for their release of a property interest on property owned by a university. The Court observed that the donors failed to substantiate any charitable contribution and the Court determined that the donors received property in the exchange valued at more than the amount of the claimed charitable deduction. The Court sustained the imposition of accuracy-related penalties because the donors did not have substantial authority for their return position. Essentially, the donors, the university and a third party had engaged in a series of complex transactions, one of which involved the release of an interest that the donors had held on property owned by the university. The donors' appraiser had valued the option to buy and leasehold and the donors had deducted this amount as a charitable contribution to the university, which the IRS in turn had disallowed.

Bartels Trust v. United States

The Supreme Court denied certiorari in Bartels Trust v. United States, 85 AFTR2d Par. 2000-572, No. 98-6141 (2nd Cir. Apr. 11, 2000)6 after the Court of Appeals for the Second Circuit affirmed a District Court's holding that securities purchased on the margin by a supporting organization were debt financed property and the income from the property was subject to the tax on unrelated business income. The Second Circuit cited Elliot Knitwear Profit Sharing Plan v. Commissioner, 614 F.2d 347, 348-51 (3d Cir. 1980), stating, "under the plain language of the UBIT, the purchase of securities on margin is a purchase using borrowed funds; therefore, under section 514(c), the securities are subject to an 'acquisition indebtedness,'" causing them to be "debt-financed property" under Code Section 514(b)(1). The Second Circuit concluded that the supporting organization's purchase of securities on the margin did not fall within the "inherent" purpose exception or the "substantially related" exception to Code Section 514 because "the use of the property itself, not the income generated by the property, must be substantially related to the exempt purpose." Based on the legislative history and case law, the Second Circuit rejected the supporting organization's arguments that unfair competition is a prerequisite for the imposition of the tax on income derived from margin-financed securities and that the reference to "debt-financed property" in Code Section 514(b)(1) includes only "periodic" income.

Jorgl v. Commissioner

In Jorgl v. Commissioner; T.C. Memo. 2000-10; No. 11508-98 (Jan. 11, 2000), the Tax Court held that donors who transferred their interest in a company to a charitable remainder unitrust, which subsequently sold the company, must recognize the income from a covenant not to compete even though the trust received the proceeds. The Court concluded that the parties intended to allocate a portion of the purchase price to the covenant not to compete and that the allocation had an economic reality. The Court stated that, based on the donors' "past performance, their present ability, and the actual negotiations[, there was] a separately bargained-for agreement with a sufficient nexus to prudent business practice to conclude that their agreement had independent economic significance." The Court further held that because the donors relied on expert advice from their attorney and accountant, they were not liable for an accuracy related penalty.

Rulings and Notices

In 2000, the IRS worked on various forms related to charitable giving and continued to issue a number of reformation rulings under Code Section 2055. Also interesting were rulings related to gifts of specific kinds of assets, such as stock options and retirement plans.

Rev. Rul. 2000-43

In Rev. Rul. 2000-43, 2000-41 IRB 333, the board of directors of an accrual-basis, calendar-year S Corporation authorized a charitable contribution on December 31, 1999. The S Corporation actually made the contribution on March 1, 2000. The S Corporation elected to treat the contribution as made in the year of authorization under Code Section 170(a)(2), which allows a corporation reporting its taxable income on the accrual basis to elect to deduct a charitable contribution in the year that the board authorized the contribution as long as the contribution is made by the 15th day of the third month following the close of the taxable year.

The IRS ruled that the S Corporation must report the charitable contribution in 2000, the year the contribution was made. According to the IRS, an S Corporation may not elect under Code Section 170(a)(2) to treat a charitable contribution as made in the year of authorization because an S Corporation reports its taxable income in the same manner as an individual pursuant to Code Section 1363(b) and the election under Code Section 170(a)(2) is not available to an individual. In addition, the IRS noted that the rationale underlying Code Section 170(a)(2) is that a corporation may have difficulty in determining its charitable contribution limit under Code Section 170(b)(2) and this rationale does not apply to an S Corporation because the S Corporation is not subject to the same Code Section 170(b)(2) limit.

Notice 2000-37

In Notice 2000-37, 2000-29 IRB 118, the Service announced its intention to revise the charitable remainder annuity trust and unitrust sample forms and provisions previously published by the IRS to reflect recent changes in the law. Written comments were due by December 1, 2000, and the IRS received a number of comments.

Notice 2000-24

In Notice 2000-24, 2000-17 IRB 952, the IRS announced that Form 8870, Information Return for Transfers Associated With Certain Personal Benefits Contracts, is now available. Form 8870 needs to be filed by charities paying premiums on personal benefits contracts described in Code Section 170(f)(10). In addition to discussing Form 8870, Notice 2000-24 also provided guidance on the filing of Form 4720, Return of Certain Excise Tax on Charities and Other Persons Under Chapters 41 and 42 of the Internal Revenue Code. The Service noted that it would revise Forms 990, 990-PF, and 5227 for taxable years beginning after December 31, 1999, to add questions relating to charitable split-dollar insurance arrangements.

PLRs Involving Reformations and Other Modifications of Trusts

As it has in recent years, the IRS issued a number of private letter rulings dealing with reformations of charitable remainder trusts, indicating a somewhat more lenient policy on reformations. In PLR 200002029, the Service allowed a reformation of trust to convert it into a "flip" charitable remainder unitrust. The reformation also corrected a scrivener's error (a reference to Code Section 170(b)(1)(A)) which made it impossible for the donors to designate a particular private foundation as the charitable remainderman as they originally intended. The donors represented that they would amend their income tax returns to reflect the additional income tax and interest that is payable due to the difference in allowable deductions for a remainder interest passing to a charitable organization qualifying under Code Section 170(b)(1)(A) and a charitable organization qualifying under Code Section 170(c). PLRs 200031034 and 200022014 also involved reformations of trusts into flip charitable remainder unitrusts.

In PLR 200010035, the Service ruled, in part, that the proposed reformation of a charitable remainder annuity trust granting the trustee the authority to distribute any income in excess of the annuity amount, as well as the discretion to distribute part of the principal of the trust, to the charitable beneficiary, would not adversely effect the trust's qualification as a charitable remainder trust under Code Section 664. PLRs 200022034, 200024014 and 200027014 also dealt with reformations of charitable remainder annuity trusts.

In PLR 200013015, the IRS approved a gift tax charitable deduction for amounts passing to charity on the early termination of a qualified terminable interest property ("QTIP") marital deduction trust. A decedent had created the QTIP trust for the benefit of his surviving spouse and his estate took an estate tax marital deduction. The surviving spouse proposed to terminate the QTIP trust. She would receive outright the present value of her income interest determined under Code Section 7520 upon the termination. At that time, the balance of the QTIP trust would pass outright to the charity that her late husband had designated to receive the remainder of the trust property at her death. The IRS ruled that the early termination of the QTIP trust would constitute a Code Section 2519 disposition by the surviving spouse of her qualifying income interest in the trust. As a result, the IRS stated that she would be treated as making a gift equal to the value of the trust corpus less the present value of her income interest. The IRS also ruled that she would be entitled to a gift tax charitable deduction under Code Section 2522 for the value of the property passing to charity. The IRS observed that if the commutation did not occur and the QTIP trust continued until the surviving spouse's death, her estate would be entitled to an estate tax charitable deduction under Code Section 2055 for the value of the property passing to charity.

In PLR 200035014, the Service ruled that two net?income with makeup charitable remainder unitrusts created by the division of a net?income with makeup charitable remainder unitrust upon the divorce of the two non?charitable beneficiaries would not fail to qualify under Code Section 664 and that the division would not cause the trusts or trustees to recognize income or gain or to lose any of the accumulated makeup account. Similarly, in PLR 200045038, the Service ruled that the division of a charitable remainder unitrust into two separate unitrusts upon the divorce of the husband and wife income beneficiaries would not cause the unitrusts to fail to qualify under Code Section 664. The unitrust was also flipping from a net income with make?up charitable remainder unitrust to a standard charitable remainder unitrust but no rulings were issued on that point.

PLRs Involving Gifts of Stock Options and Retirement Plan Assets

In PLR 200002011, the Service issued favorable rulings on gifts of deferred compensation and nonstatutory stock options.7 The donor was chairman of the board of a corporation that he had founded. During his employment with the corporation, he became entitled to certain deferred compensation, which included a death benefit payable to his estate or his designated beneficiaries upon his death. The donor also had nonstatutory stock options to purchase shares of the corporation's stock at specified option prices. No option price was less than the fair market value of the stock to which it applied on the date the option was granted. These options did not have a readily ascertainable value at the time of grant. The donor planned to designate certain charities as the beneficiaries of the deferred compensation and to transfer the options by will to one or more charitable organizations.

The Service concluded that the deferred compensation and the value of the options would be includible in the donor's gross estate under Code Sections 2033 and 2039(a) and that the donor's estate would be eligible for an estate tax charitable deduction for the amounts passing to charity. In addition, the Service noted that the proceeds from the deferred compensation that would have been items of gross income to the taxpayer, if distributed to him during life, would be income in respect of a decedent to the charities when distributed to them and would not be income in respect of a decedent to the donor's estate. Regarding the options, the Service cited Regulation Section 1.83-1(d), which provides that if substantially nonvested property has been transferred in connection with the performance of services and the person who performed the services dies while the property is still substantially nonvested, any income realized on or after such death with respect to the property under Regulation Section 1.83-1(d) is income in respect of a decedent. Even though the Service noted that Regulation Section 1.83-7 is silent on the treatment of non-arm's-length transfers of nonstatutory stock options, the Service concluded that any income realized by the charities after the donor's death by exercise of the options would be income in respect of a decedent to the charities and not to the donor's estate.

In PLR 200012076, the Service ruled, in part, that a bequest of nonqualified vested stock options to a charity would result in income in respect of a decedent to the charity at the time the options are exercised by the charity. The donor was the retired board chairman and a former board member of a corporation. The donor did not plan to transfer any of the options during his lifetime. The option term was for a period of not more than 15 years from the grant date. If the donor died prior to the end of the option exercise period, the unexercised options could be exercised by his beneficiary during the remaining period. The donor planned to name a charity as the designated beneficiary of a portion of the options. The Service noted that although Regulation Section 1.83-1(d) refers only to income that is income in respect of a decedent under Code Section 691 when a person who performed services dies before stock vests, the same treatment should be afforded to income attributable to options.

In PLR 200038050, the IRS gave a myriad of favorable rulings regarding a donor's creation of a charitable remainder unitrust with appreciated company stock distributed from his company's retirement plan. The donor had turned 55 and retired during 1999 and was scheduled to receive a single sum distribution of his entire qualified retirement plan, including company stock, in 2000. He planned to roll over part of the plan directly to his individual retirement account and contribute some or all of the stock he received from the plan to the unitrust. Among other things, the IRS ruled that (i) the donor would not recognize ordinary income on the net unrealized appreciation in the portion of the stock not rolled over to his individual retirement account; (ii) any taxable gain on a later sale of such stock would be treated as capital gain on a capital asset held for more than one year to the extent of the original net unrealized appreciation regardless of the amount of time between the date such stock is distributed from the retirement plan and the date of sale; (iii) any post distribution gain exceeding the original net unrealized appreciation would be taxed at the applicable capital gain rate based on the holding period of the stock as measured from the date of distribution to the date of sale; (iv) the donor would not have immediate taxable income, gain or loss on the contribution of the stock to the unitrust so long as the trust qualifies under Code Section 664 and there is no prearranged plan for the disposition of the stock by the unitrust;8 (v) the donor would be entitled to a charitable income tax deduction for the stock contributed to the unitust equal to the fair market value of the stock on the date of contribution less the present value of the unitrust interest, but the donor's charitable income tax deduction would be reduced by any post-distribution appreciation that is not held by the donor for more than one year after the distribution; (vi) the donor would be entitled to a charitable gift tax deduction for the present value of the remainder interest so long as the unitrust satisfies the requirements of Code Section 664 and the applicable Regulations; (vii) the basis of the non-rollover stock owned by the unitrust would be determined in accordance with Code Section 1015 and Regulation Section 1.1015-1(a) but the basis of the stock in the portion of the unitrust included in the donor's estate upon his death would be determined in accordance with Code Section 1014 and Regulation Section 1.1014-1(a); (viii) to the extent that Code Section 1015 and Regulation Section 1.1015-1(a) apply, the unitrust's holding period would include the donor's holding period; (ix) the four-tier system of Code Section 664 will apply in determining the character of unitrust distributions; and (x) the gain from a later sale of the non-rollover stock by the unitrust would not be subject to immediate direct taxation to the unitrust (as long as the unitrust has no unrelated business taxable income) or to the donor.

PLR Involving Sweepstakes Program

PLR 200012061 could open up an interesting fundraising opportunity for other charities. In this ruling, a university planned to solicit funds from the public by means of a semi-annual sweepstakes program. Tickets to participate in the sweepstakes program would be made available without cost to the public by means of a direct mailing campaign. The letter or brochure to the prospective participants would make it clear that no contribution is required to participate in the sweepstakes program or to win a prize and would state that making a contribution will not increase, or change in any respect, the participant's chances of winning a prize. Both statements would be displayed in bold typeface or larger character size than the rest of the letter or brochure. The return envelope would not be marked to indicate whether a participant has enclosed a contribution. The Service ruled that the long-standing rule that the purchase price of a raffle ticket is always equal to the value of the chance to win the prize, as set forth in Revenue Ruling 67-246,9 was not applicable because the university's sweepstakes program would not involve any purchase by the participants. Accordingly, the IRS stated that contributions made to university concurrently with its fundraising program in which sweepstakes tickets are distributed free of charge to all participants would qualify for charitable income tax deductions.

PLR Involving Participation of CRT in LLCs

In PLR 200043047, the Service ruled that a charitable remainder unitrust's participation in a family limited liability company's ("LLC") investment fund and the reimbursement of certain investment expenses would not be self dealing. The donors had created 15 charitable remainder unitrusts, each of which was to benefit a particular child or grandchild. The family established the LLC to coordinate family investments. The unitrusts planned to invest in the LLC by contributing combined assets equal to approximately 80% of the LLC's current assets. As the family members individually contribute more assets to the LLC, they expected that this percentage would decline. The LLC would be a disqualified person with respect to each unitrust from time to time. The LLC elected to be treated as a partnership for tax purposes. The LLC maintained multiple investment funds with separate governing rules and the unitrusts would participate only in funds with liberal withdrawal rights by reason of investing solely in marketable securities. The LLC would not charge its members a fee for investing in the funds but the LLC would charge each member a pro rata share of investment, legal, accounting and administrative expenses. However, the unitrusts would only be charged for the marginal increase in investment expenses caused by their participation in the fund so that the fees of a disqualified person would not be reduced because of a unitrust's participation. Other than some benefits also accruing to the unitrusts as a result of the participation in an LLC fund, neither the LLC nor any disqualified person with respect to a unitrust would get compensation or other benefits because of such participation.

PLRs Involving CLTs

In PLR 200021020, the Service approved a charitable lead annuity trust despite the fact that there were no named charitable beneficiaries. The IRS ruled that the settlor of the trust, whose trustees determine the charities to receive the annuity payment each year, was entitled to a gift tax charitable deduction for the actuarial value of the guaranteed annuity interest and the trust could, upon election, take an income tax deduction for amounts actually paid to charity. In a similar vein, PLR 200029033 allowed the remainder beneficiaries of charitable lead annuity trusts to name the lead beneficiaries. The Service ruled, in part, that the grantor who created the three charitable lead trusts would not be treated as the owner of the trusts even though the remaindermen may be given the power to designate which charity is to receive the annuity amount and that such designation right would not constitute an act of self-dealing.

In PLR 200030014, a grantor established a charitable lead unitrust with a lead interest payable to a private foundation. The foundation was established by the grantor of the trust and her spouse. Its directors are the grantor's spouse and children. The Service held, in part, that the trust qualified as a split?interest charitable lead trust within the meaning of Code Section 4947(a)(2) and that the grantor could allocate all or a portion of the grantor's generation-skipping transfer tax exemption to the charitable lead trust.

In PLR 200043039, the Service issued a number of favorable and detailed rulings on an inter vivos charitable lead unitrust, including gift and estate tax rulings, generation?skipping transfer tax rulings, and grantor trust rulings. In the PLR, a donor planned to establish a 30-year charitable lead unitrust with a 7% payout rate and a private foundation. The foundation was to be the initial charitable beneficiary of the unitrust. The donor's spouse and two unrelated individuals were to be the foundation's directors. The donor would not serve as an officer or director of the foundation. At the end of the unitrust's 30-year term, the balance of the trust would be divided into equal shares for the donor's children and each child would have a general power of appointment over the assets in his or her separate trust at age 35. If a child died before reaching age 35 (during or after the end of the 30-year term), the child's share would be distributed as the child appointed under his or her limited testamentary power of appointment. If the child does not exercise his or her limited testamentary power of appointment, the child's share would go to the child's living descendants and, if the child had no living descendants, to the donor's descendants. Neither the donor or the donor's spouse would be allowed to serve as trustee of the unitrust or any trust created under the trust instrument after the end of the 30-year term.

Among other things, the IRS ruled that the unitrust could take a charitable income tax deduction for amounts of income paid to the foundation each year except to the extent of any unrelated business taxable income or to the extent that any of the amounts so paid are nondeductible under Code Sections 508(d) or 4948(c)(4). The IRS stated that no Code Section 642(c)(1) deduction would be allowed for amounts of principal so paid except to the extent that the amount so paid was included in the unitrust's gross income and no deduction was allowed for it in a previous taxable year. The IRS ruled that the donor would not be treated as the owner of the unitrust under Code Sections 673, 674, 676 or 677, but noted that application of Code Section 675 would depend on the circumstances attendant on the operation of the unitrust. The IRS ruled that a gift tax charitable deduction would be allowed for the present value of the unitrust's lead interest valued on the date of the transfer to the unitrust. Even though the donor's spouse would be serving as an officer and director of the foundation, the IRS stated that the gift to the unitrust would be a completed gift because the donor would not be an officer or director of the foundation. In addition, the IRS ruled that the gift to the unitrust would be a completed gift to the children equal to the value of the remainder interest. The IRS ruled that the value of the unitrust would not be included in the donor's gross estate given that the unitrust would be irrevocable, the donor would retain no interest in or power over, or right to amend, alter or revoke the unitrust, the donor would have no right to receive any payment from the unitrust during life and the donor holds no general power of appointment over the unitrust's assets. The IRS noted that this assumed that there would be no express or implied understanding between the donor and the foundation's officers and directors as to distribution of the payments made by the unitrust to the foundation.

The IRS ruled that each child would be considered the transferor for generation-skipping transfer tax purposes of any further transfers from his or her separate trust after receiving the general power of appointment at age 35. However, the IRS stated that the donor could allocate generation-skipping transfer tax exemption to the unitrust because a portion of the unitrust assets might pass to a skip person at the end of the unitrust's 30-year term, with the result that the termination of the foundation's interest would be a taxable termination for generation-skipping transfer tax purposes and subject to tax under Code Section 2601.

PLRs Involving Bequests to Foreign Charities

In PLR 200019011, the IRS allowed an estate tax charitable deduction for a bequest to a foreign charity. The decedent was a citizen and resident of the United States at her death. Her will provided that her residuary estate was to be distributed to six named organizations but, if an organization is not described in Code Section 2055(a), then no share would be set aside for that organization. One of the charities was located outside of the United States. The primary purpose of this foreign organization, which is not operated for profit, is to provide a residence for needy musicians aged sixty and over. No part of the organization's net earnings inure to the benefit of any private individual and its activities do not concern carrying on propaganda, influencing legislation, or participation in political campaigns. In its analysis, the Service relied, in part, on Revenue Ruling 74-523,10 which concluded that a gift to a foreign government or political subdivision to be used exclusively for charitable purposes qualifies for an estate tax charitable deduction.

In PLR 200024016, the IRS ruled that a bequest for the charitable purpose of rebuilding a mosque in a foreign country qualified for an estate tax charitable deduction. The IRS noted that title to all mosque facilities in the country were held by the government. The decedent's will provided for funds to be used to build the mosque under the supervision of the decedent's nephew. The new mosque was to be larger than the original deteriorated structure and would include religious, educational, medical and social facilities. The decedent's executor formed a charitable trust under Louisiana law, with the nephew as trustee, to eliminate exposure to construction liability, maximize the funds available to accomplish the decedent's religious and charitable purposes and satisfy the requirements of Louisiana law. The trust's purpose was limited to the reconstruction of the mosque. A Louisiana court authorized the executor to donate the specific bequest amount to the trust to rebuild the mosque under the nephew's supervision. The trust agreement gave a representative of the mosque the power to enforce the trust and compel an accounting from the trustee. The trust was to terminate in 15 years or sooner if the mosque was completed sooner. Any assets remaining in the trust at termination would be transferred to a qualified charity which is supportive of the Islamic religion.

PLR Involving Compromise Agreement

In PLR 200032010, an estate tax charitable deduction was allowed for amounts passing to charity pursuant to a compromise agreement entered into for a will contest. The executor and various beneficiaries of an estate entered into the compromise agreement to settle a dispute over the validity of a codicil and trust amendment executed shortly before a decedent's death. The compromise agreement provided that the codicil was valid and would be interpreted as causing a property to pass to the decedent's brother in his capacity as executor for him to designate charitable recipients. The compromise agreement declared the trust amendment invalid so that a charity would receive its original share of the residue of the decedent's estate. However, the charity's share would be placed into an endowment account limiting the charity's usage of the share to certain charitable purposes. The compromise agreement was conditioned upon a favorable ruling by the IRS.

After reviewing the Regulations to the marital deduction provisions of Code Section 2056 and the case of Ahmanson Foundation v. U.S., 674 F2d 761 (9th Cir. 1981), which deal with the requirements for an estate tax marital deduction to be taken for property passing to a surviving spouse under a settlement agreement, the IRS ruled that an estate tax charitable deduction was allowed for the property passing to the charity under the compromise agreement. The IRS outlined the requirements for a charitable deduction in such circumstances as follows: (i) the compromise agreement is negotiated and settles a bona fide dispute; (ii) the compromise results from arm's length negotiations and "is within the range of reasonable outcomes under the governing instrument and applicable state law;" and (iii) the assets received by the charity and other beneficiaries under the compromise agreement do not exceed what they would have been entitled to if their interests had been litigated.

Conclusion

The courts decided a number of cases and the IRS issued a number of rulings on charitable giving in 2000. A few of these cases and rulings have been summarized in this article. Issues involved included substantiating charitable gifts, giving with retirement assets and stock options and repairing defective charitable remainder trust instruments. Although a number of bills with a potential impact on charitable giving were proposed in 2000, no significant ones were enacted into law.


Footnotes


  1. All references to the "Code" in this article are to the Internal Revenue Code of 1986, as amended from time to time.back

  2. See T. D. 8926.back

  3. The proposed Regulations were discussed in our 1999 year-in-review article.back

  4. See T. D. 8923.back

  5. See T. D. 8886.back

  6. S. Ct. Dkt. No. 00-220.back

  7. In general, nonstatutory stock options are options not meeting the requirements for special income tax treatment under Code Sections 421 through 424.back

  8. The IRS cited Blake v. Commissioner, 697 F. 2d 473 (2d Cir. 1982).back

  9. 1967-2 CB 104.back

  10. 1974-2 CB 304.back

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