Income Deferral CRTs Funded with Tax Deferred Annuities

Income Deferral CRTs Funded with Tax Deferred Annuities

News story posted in Technical Advice Memoranda on 3 July 1998| comments
audience: National Publication | last updated: 18 May 2011


The IRS has issued a Technical Advice Memorandum in which it approved an arranagement whereby the trustee of a charitable remainder unitrust invested trust assets in two tax deferred annuity contracts for the purpose of controlling the timing and amount of trust income distributions.

TAM 9825001

Full Text:

A = Donor
B = Trustee
C = Independent Trustee
R = Life Insurance Company
T = Tax Planning Consultant
V = Company
X = Charitable Remainder Unitrust
m = Sales Price for Company Stock
n = Redemption Price for Company Stock
o = Investment in Each Annuity Contract


  1. Does the purchase of the deferred annuity policies from R constitute acts of self-dealing when the named annuitants are disqualified persons?
  2. Would the purchase of the annuity policies jeopardize the Trust's qualification as a charitable remainder unitrust under section 664 for federal income tax purposes?
  3. Would the annuity's withdrawal provision, described hereafter, result in income to the Trust, X, within the meaning of section 643(b).


X is a charitable remainder unitrust which was intended to qualify under section 664 of the Internal Revenue Code. X was created by A by a trust instrument dated June 25, 1990. The trust instrument provides that the Trustee shall pay to A, and upon A's death, to A's wife, a unitrust amount equal to the lesser of (1) the trust income for the year or (2) eight percent of the aggregate fair market value of the trust assets for the year. The Trust instrument includes a make-up provisions so that for any year that the unitrust payment is less than eight percent, the shortfall for prior years may be made-up in subsequent years when trust income exceeds eight percent. B is the trustee of X and is also the nephew of A.

Upon the death of the survivor of A or A's wife, the trust shall terminate and the balance of trust assets are to be distributed to designated charities.

In December, 1991, X entered into a contract to purchase two deferred annuity contracts from R, a commercial life insurance company. In one policy A is named the annuitant and in the other policy A's wife is named the annuitant. In other respects the two policies are identical. X is the owner of the policy and is beneficiary of the policies should either annuitant fail to reach the maturity date of the policies which is age 80. As a result of the endorsement of the two policies in 1997, the Trust, X, became the annuitant. Additional information relating to the policies is discussed hereafter in greater detail.


A. Self-dealing Issue:

Section 4947(a)(2) provides, in part, that in the case of a trust which is not exempt from tax under section 501(a), not all of the unexpired interests in which are devoted to one or more of the purposes described in section 170(c)(2)(B), and which has amounts in trust for which a deduction was allowed under section 170, 545(b)(2), 556(b)(2), 642(c), 2055, 2106(a)(2), or 2522, .. section 4941 (relating to taxes on self-dealing, section 4943 (relating to taxes on excess business holdings) except as provided in subsection (b)(3), section 4944 (relating to investments which jeopardize charitable purpose) except as provided in subsection (b)(3), and section 4945 (relating to taxes on taxable expenditures) shall apply as if such trust were a private foundation.

Section 4941 imposes an excise tax on acts of self-dealing between a disqualified person, as defined in Section 4946, and a private foundation.

Section 4941(d)(1) in general defines the term self-dealing, in part, to include any direct or indirect--

(E) transfer to, or use by or for the benefit of, a disqualified person of the income or assets of a private foundation.

Section 4946 defines the term disqualified person, in part, to include a person (with respect to a private foundation) who is --

(A) a substantial contributor to the foundation,

(B) a foundation manager,

Under Sections 4946(a)(2) and 507(d)(2) a substantial contributor is defined as a person who contributes over $5000 and such amount is more than 2 percent of the total contributions, or in the case of a trust, also the creator of the trust.

Section 4946(b) defines foundation manager to include an officer, director, or trustee of the foundation.

Section 53.4941(d)-2(f)(1) of the Excise Tax Regulations provides, in part, that the purchase or sale of stock or securities by a private foundation shall be an act of self-dealing if such purchase or sale is made in an attempt to manipulate the price of stock or other securities to the advantage of a disqualified person.

The Request for Technical Advise asks us to determine whether the purchase of the deferred annuity naming the donor and his wife as annuitants constitute acts of self-dealing under section 4941 of the Code.

In analyzing an issue of self-dealing under section 4941(d)(1)(E) of the Code, the Service has focused on three elements. Is a property right created? Is there a transfer of such property right to a disqualified person? Does the disqualified person receive a benefit from the receipt of such property right?

It is the view of the Service that a valid contract right constitutes an enforceable property interest. Michtom v. United States, 573 F.2d 58, 63 (Ct. Cl., 1978). Thus, the donor's rights under the annuity contract constitute a property interest.

It has been the Service view that the prohibition against transferring or using foundation assets to disqualified persons was intended to be extremely broad. The range of transactions described under 4941(d)(1)(E) would also include transactions described under sections 4941(d)(1)(A), (B), (C), (D), or (F). Here, the property interest (the annuity right in the contract) was transferred to the donor and the donor's wife who are disqualified persons under section 4946 of the Code.

The final element for consideration is whether the receipt of the right to the annuity under the contract by the Donor or his wife confers a benefit on the Donor. Certainly there is a potential benefit to the donor. If the donor and his wife reach age 80 the contract will be annuitized and the donor and his wife have the potential to receive all the payments to be made under the contract. This would leave the charitable remainder interest with nothing.

However, the annuity rights in the contracts are contingent on several factors. The donor and his wife must survive to age 80 to receive annuity payments. Further, assuming that X is the owner of the policy, the right of the named annuitants can be defeated by the policy owner's rights to a partial withdrawal from the policy or the surrender of the policy in exchange for the cash value of the policy. Additionally, the owner may defeat the benefit to the named annuitants by changing the maturity date; the date when the annuity payments are to begin. The partial withdrawals and surrender of the policy are subject to some restrictions and penalties for early surrender. A change of the maturity date does require written notice to the company. Nevertheless, the owner of the policy does have the power to preempt the annuity by taking such actions.

The Service has found an act of self-dealing under section 4941(d)(1)(E) only in the case where the disqualified person has received a current benefit. In Rev. Rul. 74-600, 1974-2 C.B. 385, the Service held that self-dealing occurred under section 4941(d)(1)(E) when paintings owned by a private foundation were allowed to be placed in the residence of a disqualified person. In Rev. Rul. 77-160, 1977-1 C.B. 351, the Service held that the dues paid to a church on behalf of a disqualified person in order to allow such person to retain his membership in the church was an act of self-dealing.

In summary, it is our position that the donor receives no present value from the contract right to receive annuity payments. We do not believe that the annuity right could be currently assigned by the donor and his wife to a third party for any significant value. The donor and his wife have recently assigned their interest in the policy as named annuitants to X. Thus, the problem is resolved for future years.

An analogy in this case may also be made to an incomplete gift for purposes of the federal gift tax. In Rev. Rul. 79-243, 1979-2 C.B. 343, the Service held that the donor made an incomplete gift to his wife of an income interest in trust by virtue of the fact that the donor retained the right to revoke the gift by will. The facts of the ruling provide that the donor created a charitable remainder trust qualifying under section 664 of the Code. The donor was to receive the unitrust amount for his life, and upon the donor's death, the wife was to receive the income interest for her life. However, the donor, in the trust instrument, reserved the right to revoke the wife's secondary interest in the unitrust amount. Authority for the Service position was based on Section 25.2511-2(c) of the Gift Tax Regulations. Part of such Regulations provide as follows:

Thus, if an estate for life is transferred but, by an exercise of a power, the estate may be terminated or cut down by the donor to one of less value, and without restriction upon the extent to which the estate may be so cut down, the transfer constitutes an incomplete gift.

To the extent that X has retained the right by contract to terminate or reduce the annuity right received by the donor and his wife, the transfer of the annuity right is not a completed transfer.

Our office has carefully considered another theory for asserting that an act of self-dealing under section 4941 has occurred with respect to the purchase of the deferred annuity contracts and the failure of the trust to withdraw income from the deferred annuity contracts. The following facts are relevant to the consideration of this additional ground for asserting an act of self-dealing:

At the time X was created by A, it was funded with 86 shares of stock of V, a business previously owned and managed by A. On March 7, 1997, A transferred an additional 7 shares of V to X. Consequently, X held 93 of 94 outstanding shares of V. In the Summer of 1991, A became aware of a third party's offer to purchase V. In September or October of 1991, the trustee of X became aware of the proposal for the purchase of V, which included payment to A for a five year period pursuant to an employment agreement and noncompetition agreement. Since A's income would be provided for a five year period without the need for income from X, A and the trustee had discussions with T, a tax planning consultant, about the possibility of investing X's assets in deferred annuities. Based on T's recommendations, the trustee believed investing in deferred annuities was a solid choice in light of other investment alternatives available and the flexibility it offered the trustee to defer trust income until A's employment agreement and noncompetition payments ceased.
Consequently, in December 1991, X entered into a contract to purchase two deferred annuity policies from R, a commercial life insurance company. On January 15, 1992, the following three events occurred more or less contemporaneously: (1) substantially all the assets of V were sold to an unrelated purchaser for m; (2) X's stock holdings in V were redeemed for n, which X deposited into its account; and (3) X wrote two identical checks for o for each of the annuities purchased. The representatives for the Trust made the following representations: (1) C, an attorney who is trusted by A and B, served as the sole trustee of X from the time after the stock sale was contributed to X until before the sale of such stock to the unrelated purchaser; and (2) soon after the annuity contracts were acquired by X, C resigned as trustee and B again became the trustee. In fact, C signed as trustee on the contract to purchase the two deferred annuity policies. Both annuity policies designated X as owner and beneficiary. As stated above, one policy named A as annuitant and one policy named A's wife as annuitant. In order to eliminate the possibility of any annuity payment being made directly to A or his wife (a potential self-dealing problem) an endorsement to each deferred annuity policy was executed, in 1997, by R and X effective as of the policy date of each annuity contract. The trustee of X signed the endorsement, which apparently represents the assignment of interest of A and his wife in the policy as annuitants to X.

We have examined the transaction with the intention of ascertaining whether B, acting in concert with A on an ongoing basis, manipulated the assets of X for the personal benefit of A, by furthering his income, retirement and tax planning goals. There was a concern that the entire transaction taken as a whole; the purchase of a deferred annuity, the failure to make withdrawals from the annuity policies, and the intention to subsequently make uniturst payments to A under the make-up provision of the Trust; could be construed as an act of self-dealing under section 4941(d)(1)(E) of the Code by virtue of the authority provided by section 53.4941(d)-2(f)(1) of the Regulations.

In as much as A, a disqualified person, is entitled to receive the income interest from the trust, it is difficult to argue that the disqualified person receives an inappropriate benefit by deferring the income interest, particularly where such deferral is permitted under section 664 of the Code. The underlying problem is that the income beneficiary interest is in itself a use for the benefit of the disqualified person of the assets of the trust. Inherently, any investment decision regarding the trust assets that increases or decreases the amount of payout of this income interest is a use for the benefit of the disqualified person (assuming the disqualified person does not object). Section 4947(a)(2)(A) provides that section 4941 will not apply to any amounts payable under the terms of the trust to the income beneficiary. The amounts of income deferred by the investment decision in this case were payable to the income beneficiary under the terms of Trust X. Accordingly, these uses must be permitted under the income exception of section 4947(a)(2)(A) unless the disqualified person controls the investment decision and uses this control to unreasonably affect the charitable remainder beneficiary's interest.

While section 53.4941(d)-1(a) of the regulations provides that it is immaterial whether the transaction results in a benefit or a detriment to the private foundation, the regulation is incompatible with section 4947(a)(2)(A) because, as discussed above, any investment decision regarding trust assets that results in an increase or decrease in the uniturst amount will inescapably constitute an attempted use for the benefit of the disqualified person. Therefore, rather than focusing on whether the deferral of income is a use of trust assets, the relevant question is whether the deferral of income is a permitted use. Since charitable remainder trusts by their intrinsic nature provide for a continuous use by the disqualified person of the entire trust corpus, we conclude that the presence of an unreasonable affect on the charitable remainder interest distinguishes a permissible use of trust assets from an impermissible use.

In addition to failing to show harm to the charitable remainder interest, the facts of this case do not clearly show control by the disqualified person. X represented that an independent attorney/trustee signed the contract to purchase the deferred annuity policies. Moreover, even if we conclude that B, as trustee, purchased the deferred annuity policies, the facts are insufficient to demonstrate that A usurped control from the trustee or that he could compel or influence the trustee to purchase the deferred annuity policies in question. Instead, the trustee merely took into consideration the particular financial needs of A before reinvesting the proceeds from the sale of the trust assets.

B. Purchase of the Annuity and Qualification under Section 664:

The purchase of the deferred annuity contracts does not adversely affect the trust's qualification as a charitable remainder unitrust under section 664 of the Code and the current regulations thereunder.

C. Trust Accounting Income Issue:

Under the terms of the annuity contracts, the Trustee, as owner of the contracts, can withdraw up to 10 percent of the cash value of each contract at the beginning of each year. The cash value equals the premiums paid, less deductions, plus accumulated interest earned. The Trustee may also surrender the contracts and receive the surrender value of each contract. The surrender value equals the cash value minus any applicable surrender charge. In the request for technical advice, it is argued that the Trust, a NIMCRUT, had income from the contracts because of the rights to receive the cash value and surrender value of the contracts.

Under section 664(d)(2)(A), the unitrust amount is generally a fixed percentage (which is not less than 5 percent) of the net fair market value of the trust's assets valued annually. Under section 664(d)(3), however, the governing instrument may instead provide that the unitrust amount is (A) the amount of the trust income if such amount is less than the amount determined by the fixed percentage of the value of the trust's assets; and (B) any amount of trust income that is in excess of the amount required to be distributed based on the fixed percentage, to the extent that the aggregate of the amounts paid in prior years was less than the aggregate of the required amounts based on the fixed percentage of the fair market value of the trust's assets.

Section 1.664-3(a)(1)(b)(1) provides that the amount of trust income for a NIMCRUT is the amount of trust income as defined in section 643(b) and the applicable regulations. Section 643(b) provides that, for section 664 purposes, among others, the terms income, when not preceded by the words taxable, distributable net, undistributed net, or gross means the amount of income of the estate or trust for the taxable year determined under the terms of the governing instrument and applicable local law. The Trust's governing instrument uses the definition of income under section 643(b) to define income. Therefore, the applicable state law defines the Trust's income.

The applicable state law, the Uniform Principal and Income Act of State, appears ambiguous on whether a trust's right to receive money is income to the trust, whether characterized as principal or income. The implication from the sections that define income and principal, however, is that a trust does not realize either until the trust actually receives possession of money or other property. See XXX Code Ann. Section XXXXX and section XXXXX (1991). Therefore, the Trust's right to receive either the cash value or the surrender value of the contracts does not create trust accounting income under section 643(b) of the Code.


  1. The purchase of the deferred annuity policies, based on the particular facts of this case as described in the preceding paragraphs, does not constitute an act of self-dealing under section 4941 of the Code.
  2. The purchase of the deferred annuity contracts does not adversely affect X's qualification as a charitable remainder trust under section 664 of the Code and the current regulations thereunder for federal income tax purposes.
  3. X's right to receive either the cash value or the surrender value of the contracts does not create trust accounting income under section 643(b) of the Code.

A copy of this technical advice memorandum is to be given to the organization. Section 6110(j)(3) of the Code provides that it may not be used or cited as precedent.

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