TAM 9610005

TAM 9610005

Story posted in Technical Advice Memoranda on 26 September 1999
audience: PGDC Network | last updated: 15 June 2011
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Section 2055 -- Estate Tax Charitable Deduction UIL Number(s) 2055.12-10

Full Text:

Date: November 9, 1995

Control No: TR-32-205-95

Taxpayer's Name: * * *

LEGEND:
Decedent = * * *
A = * * *
B = * * *
Charity = * * *
State = * * *

Dear * * *

ISSUES

1. Were A's and B's disclaimers of the right to principal qualified disclaimers in view of the fact that A and B acquired a right through the reformation proceeding to receive a unitrust payment which, if income was insufficient, would be paid from

principal?

2. Would a charitable deduction have been allowed under section 2055(a) for the charitable interest at the time of Decedent's death but for section 2055(e)(2)?

3. Does Article IV Paragraph 4.1(a) of Decedent's trust agreement preclude a charitable deduction?

FACTS

[1] Decedent died in 1993, survived by A and B. Decedent executed a revocable trust in 1992 that became irrevocable on Decedent's death. On Decedent's death, the trust was divided into two separate trusts, one for the benefit of A and one for the benefit of B. During their respective lifetimes, each beneficiary was entitled to receive the entire net income from his or her trust. In addition, each beneficiary was entitled to receive principal distributions pursuant to the second sentence of section 3.1 of Article III of the trust as follows:

Furthermore, if, in the opinion of the Trustee, the income herein provided, together with receipts of either beneficiary from all sources known to the Trustee, shall be insufficient for the support and maintenance of the beneficiary, or in the event of an emergency such as illness or financial distress, the trustee may use such part of the principal as she shall deem appropriate to make up such deficiency or meet such emergency.

[2] On the death of A or B, that beneficiary's trust was to pass to Charity. Charity is an organization described in section 501(c)(3).

[3] On September 3, 1993, A and B each executed and delivered to the personal representative and trustee, a disclaimer disclaiming his or her rights to receive distributions of principal from the trust pursuant to the second sentence of section 3.1 of Article III of Trust. On October 7, 1993, the disclaimers were filed with the county probate court. The filing of the disclaimers was within nine months of the date of death of Decedent.

[4] On December 2, 1993, the trustee filed a petition for reformation of the trust agreement with the probate court. On December 7, 1993, the trustee filed an amended petition for reformation of the trust agreement with the county probate court. The commencement of the reformation proceeding preceded the filing of the federal estate tax return which was timely filed (with extensions) on April 7, 1994.

[5] Waivers and consents to the reformation were filed by A and B on December 10, 1993, by Charity on December 16, 1993, and by the Attorney General on December 22, 1993.

[6] On January 25, 1995, the probate court issued an order reforming the trusts to conform to the requirements of section 664 for charitable remainder unitrusts. As reformed, each trust will pay to its noncharitable beneficiary (A or B), a unitrust amount equal to seven and 4/10 (7.4%) percent of the net fair market value of the assets of each trust valued as of the first day of each taxable year of the trust. The unitrust amount shall be paid in monthly installments from income and, to the extent that income is not sufficient, from principal. Any income of the trust for a taxable year in excess of the unitrust amount shall be added to principal. No additional contributions may be made to the trust after the initial contribution. The initial contribution, however, shall be deemed to consist of all property passing to the trust by reason of Decedent's death.

[7] Upon the death of either A or B, the trustee shall distribute all of the then principal and income of that decedent's trust (other than any amount due A or B) to Charity. If Charity is not an organization described in sections 170(c), 2055(a), and 2522(a) at the time when any principal or income of the trust is to be distributed to it, then the trustee shall distribute such principal or income to one or more organizations described in sections 170(c), 2055(a), and 2522(a) as the trustee shall select in its sole discretion.

[8] The trustee shall have the power, acting alone, to amend the trust in any manner required for the sole purpose of ensuring that the trust qualifies and continues to qualify as a charitable remainder unitrust within the meaning of section 664(d)(2). Finally, pursuant to the court's order, any provisions of the trust agreement which are inconsistent with changes to qualify the trust as a charitable remainder unitrust shall be revoked.

LAW AND RATIONALE

[9] Section 2055(a) provides that for purposes of the federal estate tax, the value of the taxable estate shall be determined by deducting from the gross estate the amount of all bequests, legacies, devises, or transfers for public, charitable and religious uses.

[10] Section 2055(e)(2) 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 in the same property passes or has passed from the decedent to a person, or for a use, not described in section 2055(a), no deduction shall be allowed under section 2055(a) unless, in the case of a charitable remainder interest, such interest is in a trust which is a charitable remainder annuity trust or a charitable remainder unitrust (described in section 664) or a pooled income fund (described in section 642(c)).

[11] Section 2055(e)(3)(A) provides that a deduction shall be allowed under section 2055(a) in respect of any qualified reformation.

[12] Under section 2055(e)(3)(B), the term "qualified reformation" means a change of a governing instrument by reformation, amendment, construction or otherwise which changes a reformable interest into a qualified interest, if certain conditions are met. First any difference between the actuarial value of the qualified interest and the actuarial value of the reformable interest cannot exceed 5 percent of the actuarial value of the reformable interest. Further, in the case of a charitable remainder interest, the nonremainder interest before and after the qualified reformation must terminate at the same time. Finally, the change must be effective as of the date of the decedent's death.

[13] Under section 2055(e)(3)(c)(i), the term "reformable interest" means any interest for which a deduction would be allowable under section 2055(a) at the time of the decedent's death but for section 2055(e)(2).

[14] 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 either expressed in specific dollar amounts or a fixed percentage of the fair market value of the property.

[15] Section 2055(e)(3)(C)(iii) provides that section 2055(e)(3)(C)(ii) does not apply to any interest if a judicial proceeding is commenced to change the interest into a qualified interest not later than the 90th day after, the last date (including extensions) for filing the estate tax return (if a return is required).

[16] Section 2518(a) provides that if a person makes a qualified disclaimer with respect to any interest in property, then the estate, gift and generation-skipping tax provisions will apply with respect to the interest as if the interest had never been transferred to the disclaimant.

[17] Section 2518(b) defines the term "qualified disclaimer" as an irrevocable and unqualified refusal by a person to accept an interest in property but only if --

(1) the refusal is in writing

(2) the writing is received by the transferor of the interest, his legal representatives, or the holder the legal title to the property to which the interest relates not later than the date which is 9 months after the later of the date on which the transfer creating the interest in such person is made,

(3) the disclaimant has not accepted the interest or any of its benefits, and

(4) as a result of the refusal, the interest passes without any direction on the part of the disclaimant and passes either to the spouse of the decedent, or to a person other than the disclaimant.

[18] Section 25.2518-3(a)(1) of the Gift Tax Regulations provides that if certain requirements are met, the disclaimer of all or an undivided portion of any separate interest in property may be a qualified disclaimer EVEN IF THE DISCLAIMANT HAS ANOTHER INTEREST IN THE SAME PROPERTY. In general, each interest in property that even if the disclaimant has another interest is separately created by the transferor is treated as a separate interest in property. A disclaimant is treated as making a qualified disclaimer of a separate interest in property if the disclaimer relates to a severable property and the disclaimant makes a disclaimer that would be a qualified disclaimer if the property were the only property in which the disclaimant had an interest. Severable property is property that can be divided into separate parts each of which, after severance, maintains a complete and independent existence.

[19] In Example (11) of section 25.2518-3(d), W is to receive the trust income for life, but the trustee has the power to invade the trust corpus for the support or maintenance of D during W's life. Upon W's death, the trust will terminate, and the trust-property will be distributed to D. D makes a timely disclaimer of the right to corpus during W's lifetime but does not disclaim the remainder interest. Example 11 concludes that D's disclaimer is a qualified disclaimer assuming the remaining requirements of section 2518 are met.

[20] In the present situation, the terms of Decedent's trust agreement gave A and B all the income for life from his or her trust. In addition, the trustee had the power to invade trust corpus for the benefit of A and B in accordance with section 3.1 of Article III of the trust agreement. The income interest and the interest in the corpus were two separate interests in property created under the terms of the trust agreement.

[21] Both A and B disclaimed his or her right to receive any distributions of corpus pursuant to section 3.1 of Article III. The disclaimers were in writing and were delivered to the appropriate parties within 9 months after Decedent's date of death. A and B had not accepted any interest or benefits in the disclaimed interests. Thus, the disclaimers have met the first three requirements of section 2518(b) to be qualified disclaimers. The last requirement, section 2518(b)(4), is that the disclaimed interest passes without any direction on the part of the disclaimant to a person other than the disclaimant.

[22] After the disclaimers were executed, A and B are treated under applicable local law as if they predeceased Decedent. Thus, as of the date of Decedent's death, A and B had only a right to all the income from his or her trust. Even though the remainder interest in each trust would pass to Charity, no estate tax charitable deduction would be available for those interests unless the trusts qualified as charitable remainder trusts under section 664. Thus, the estate's personal representative sought a court order to reform the trusts to meet the statutory requirements of section 664.

[23] To qualify as a charitable remainder trust under section 664, the payments to the noncharitable beneficiary cannot be based on the income of the trust. Rather, the annual payments to the noncharitable beneficiary must generally be either a fixed amount or a fixed percentage of the annual fair market value of the trust assets. The annuity or unitrust payments will include some amounts of principal if the trust's income is insufficient to produce the required payout. However, the structure of the noncharitable payments is not intended as a method by which the trust corpus can be invaded to benefit noncharitable beneficiaries. Rather, the structure is intended to protect the value of the charitable remainder interest by removing any incentive to favor the income beneficiary over the charitable remainderman through investing in high-income, high-risk assets. The fact that some corpus may be paid to the noncharitable beneficiaries is a required part of mechanics of section 664.

[24] In this situation, the disclaimers of A and B meet the requirements of section 2518(b)(4) that the disclaimed interest passes without any direction on the part of the disclaimant to a person other than the disclaimant. This situation is analogous to Example (11) of section 25.2518-3(d), in which D made a qualified disclaimer of the right to corpus during the trust term even though D will receive all the trust corpus upon the termination of the trust. In addition, the possibility that some principal may be paid to A or B as part of the unitrust payment results from the mechanical application of the provisions of section 664 that were specifically designed to protect the interests of the charitable remainderman, and not for the benefit of the noncharitable beneficiaries.

[25] Thus, the disclaimers executed by A and B were qualified disclaimers under section 2518. As a result of the qualified disclaimers, A and B had only an income interest for life in his or her trust under the terms of the trust agreement. The value of the charitable interest in each trust is ascertainable and would have qualified for a charitable deduction under section 2055(a) but for section 2055(e)(2). Accordingly, the charitable interests in the trusts are reformable interests under section 2055(e)(3)(C).

[26] In the present situation, the judicial proceeding to reform the trusts was commenced before the timely filing of the estate tax return. Therefore, the requirement that the noncharitable interest be expressed in specific dollar amounts or a fixed percentage of the fair market value of the property is not applicable.

[27] The reformation changed the reformable interests into a qualified interests. The actuarial value of the charitable remainder interest in A's trust before the reformation is $0.73347 and the actuarial value of the charitable remainder interest after reformation will be $.73066. The actuarial value of the charitable remainder interest in B's trust before the reformation is $0.66353 and the actuarial value of the charitable remainder interest after reformation will be $0.66024. Therefore, with respect to each trust, 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. In addition, A's interest and B's interest in their separate trusts before and after the reformation will terminate at the same time. Further, it is represented that the reformation will be effective as of the date of Decedent's death. Consequently, the requirements under section 2055(e)(3)(B) are satisfied and the reformation will be a qualified reformation.

[28] The reformed charitable remainder trusts as submitted 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. Thus, we conclude that the trusts meet the requirements of a charitable remainder unitrust as described under section 664. Therefore, the present value of the remainder interest in each trust will be allowed as an estate tax deduction under section 2055(a).

[29] Finally, the language in Paragraph 4.1(a) of Article IV, providing for termination of the trusts and distribution of the remaining assets to the income beneficiaries if the trust principal falls below a certain amount will not, in this case, control the allowance (or disallowance) of a charitable deduction. Paragraph 4 of the court's order reforming the trust states "[t]hat any provisions of the trust agreement which are inconsistent with the foregoing changes shall be revoked." Paragraph 4.1(a) of Article IV of Decedent's is clearly inconsistent with the reformation of the trusts to be qualified charitable remainder trusts under section 664, and in light of paragraph 4 of the court's order, would be revoked by the reformation.

CONCLUSIONS

1. A's and B's disclaimers of the right to receive principal pursuant to the trustee's invasion power are qualified disclaimers of their interests with respect to that invasion power. The interest that each acquired, after the disclaimer, through the reformation proceeding, to receive a unitrust payment which, if income was insufficient, would be paid from principal, is a separate interest and will not disqualify the otherwise qualified disclaimer.

2. A's and B's qualified disclaimers of the right to principal relate back to the date of Decedent's death. Accordingly, at the time

of Decedent's death a charitable deduction would have been allowed under section 2055(a) for the charitable remainder interests but for section 2055(e)(2).

3. Article IV Paragraph 4.1(a) of Decedent's trust agreement does not preclude a charitable deduction as it was in effect revoked by Paragraph 4 of the court's order reforming the trusts.

A's and B's disclaimers of the right to principal pursuant to the trustee's invasion power are qualified disclaimers under section 2518(b) and A and B will be treated as having predeceased Decedent for purposes of that power. In addition, the court ordered reformation reformed the reformable interests in A's and B's trusts into qualified interests under section 2055(e)(3)(B). Accordingly, a charitable deduction under section 2055(a) is allowable for the present value of the remainder interests passing to charity, as provided in the reformed trusts.

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

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