HOW TO
COORDINATE CHARITABLE CONTRIBUTION PLANNING OPPORTUNITIES WITH BUSINESS
SUCCESSION PLANNING
CHARITABLE
REMAINDER TRUST
by Michael V. Bourland
Bourland, Wall &
Wenzel,
A Professional
Corporation
City Center Tower II
(817) 877-1088
(817) 429-3945 (metro)
(817) 877-1636
(facsimile)
mbourland@bwwlaw.com (Email)
jmyers@bwwlaw.com (Email)
Presented to
Eleventh Annual Advanced
ALI-ABA Course of Study
ESTATE PLANNING FOR THE
FAMILY BUSINESS OWNER
Thursday – Saturday
©
100110
BIOGRAPHICAL INFORMATION
MICHAEL V. BOURLAND
EDUCATION
B.A.,
J.D.,
LL.M. in Taxation,
PROFESSIONAL ACTIVITIES
Founding Shareholder - Bourland, Wall &Wenzel, P.C.
Board Certified (Estate Planning and Probate Law) –
Fellow,
Former Member, Real Estate, Probate and Trust Law Council
(State Bar of
ACADEMIC APPOINTMENT AND HONORS
Guest Lecturer in Estate Planning at
The Center for American and International Law
University of
JEFFREY N. MYERS
EDUCATION
B.A.,
J.D.,
LL.M.,
PROFESSIONAL ACTIVITIES, ACADEMIC APPOINTMENT AND HONORS
Shareholder - Bourland, Wall &Wenzel, P.C.
Board
Certified (Estate Planning and Probate Law) –
Adjunct Instructor 1998-1999 –
Guest Lecturer in Estate Planning at
Notre Dame Tax and Estate Planning Institute
State Bar of Texas – Advanced Estate Planning & Probate
TABLE OF CONTENTS
INTRODUCTION............................................................................................................................. 1
I. WHAT
IS A CHARITABLE REMAINDER TRUST (CRT), IN GENERAL.............. 1
II. TAX
ADVANTAGES OF A CHARITABLE REMAINDER TRUST......................... 1
A. CRT
Is Income Tax Exempt........................................................................... 1
B. Estate,
Gift and Income Tax Deduction............................................................ 1
III. LEGISLATIVE
HISTORY........................................................................................ 1
THE CODE, THE
REGULATIONS AND THE RULINGS................................................................ 1
I. GENERAL
RULES APPLICABLE TO DEDUCTIONS OF GIFTS TO CRTS........... 1
A. Income.......................................................................................................... 1
1. GENERAL
RULE............................................................................. 1
2. EXCEPTION.................................................................................... 1
B. Gift/Estate..................................................................................................... 2
1. GENERAL
RULE............................................................................. 2
2. EXCEPTION.................................................................................... 2
II. CITES
- INCOME TAXATION OF SECTION 664 CHARITABLE REMAINDER TRUSTS 2
A. Distributions
to Recipients of Annuity Amount or Unitrust Amount.................... 2
B. Distributions
to Charities................................................................................. 2
C. Taxation
of CRT............................................................................................ 2
III. CITES
- DEFINITIONS OF CHARITABLE REMAINDER ANNUITY TRUSTS/CHARITABLE REMAINDER
UNITRUSTS..................................................................................... 2
A. General
Rules Applicable to Both.................................................................... 2
B. Charitable
Remainder Annuity Trusts (“CRAT”).............................................. 2
C. Charitable
Remainder Unitrusts (“CRUT”)...................................................... 2
IV. CITES
- CALCULATION OF FAIR MARKET VALUE OF REMAINDER INTEREST 2
V. CITES
- EXCISE TAX/PRIVATE FOUNDATION RULES....................................... 2
VI. CITES
- FILING OF RETURNS................................................................................ 2
VII. CITES
- RULINGS - APPROVED FORMS............................................................... 2
A. Charitable
Remainder Annuity Trusts.............................................................. 2
1. INTER
VIVOS.................................................................................. 2
2. TESTAMENTARY........................................................................... 3
B. Charitable
Remainder Unitrusts....................................................................... 3
1. INTER
VIVOS.................................................................................. 3
2. TESTAMENTARY........................................................................... 3
REQUIREMENTS OF A
CHARITABLE REMAINDER TRUST...................................................... 4
I. IN
GENERAL........................................................................................................... 4
A. Definitions..................................................................................................... 4
II. CHARITABLE
REMAINDER ANNUITY TRUST (“CRAT”) VS. CHARITABLE REMAINDER UNITRUST (“CRUT”).............................................................................................. 4
A. CRAT........................................................................................................... 4
B. CRUT........................................................................................................... 4
1. FOUR
TYPES OF CRUTS................................................................ 4
C. No
Hybrids.................................................................................................... 6
D. Comparison
of CRATs and CRUTs................................................................ 6
1. ADDITIONAL
CONTRIBUTIONS.................................................. 6
2. DISTRIBUTIONS
IN KIND............................................................. 6
III. QUALIFYING
THE CRT UNDER SECTION 664..................................................... 6
A. Valid
Trust and Irrevocable Trust.................................................................... 6
B. The
Annuity Amount and Unitrust Amount...................................................... 7
1. THE
AMOUNT................................................................................ 7
2. SHORT
TAXABLE YEARS............................................................. 7
3. INCORRECT
PAYMENTS............................................................... 7
4. REDUCTION
OF ANNUITY AMOUNT OR UNITRUST AMOUNT 7
5. BEGINNING
DATE FOR PAYMENT OF ANNUITY AMOUNT OR UNITRUST AMOUNT......................................................................................... 7
C. Term
of Payment of Annuity Amount and Unitrust Amount.............................. 8
1. THE
TERM....................................................................................... 8
2. ACCELERATION
OF TERM........................................................... 8
3. SHORT
TERM CRTS....................................................................... 8
D. Recipient
of Annuity Amount and Unitrust Amount......................................... 10
1. NAMED
RECIPIENTS................................................................... 10
2. AT
LEAST ONE NOT A CHARITY............................................... 10
3. ALL
INDIVIDUALS MUST BE LIVING........................................ 10
4. POWER
TO SPRINKLE RETAINED BY TRUSTEE WHO WAS GRANTOR 10
5. POWER
TO REVOKE BY WILL................................................... 10
6. AUTOMATIC
TERMINATION OF SUCCESSIVE OR CONCURRENT RECIPIENT INTEREST IN THE EVENT OF
DIVORCE.................................... 11
E. Charitable
Remainderman............................................................................. 11
1. IRREVOCABLE
CHARITABLE REMAINDERMAN.................... 11
2. PRESENT
VALUE OF CHARITABLE REMAINDER INTEREST. 11
3. CONCURRENT/SUCCESSIVE
REMAINDERMEN....................... 12
4. ALTERNATE
CHARITABLE REMAINDERMAN......................... 12
5. SUBSTITUTION
OF ALTERNATE CHARITY BY GRANTOR..... 12
6. EARLY
DISTRIBUTION OF CORPUS.......................................... 12
7. OTHER
PAYMENTS...................................................................... 12
F. Private
Foundation Restrictions...................................................................... 12
G. Taxes,
Debts and Expenses........................................................................... 14
1. DEATH
TAXES.............................................................................. 14
2. DEBTS
AND EXPENSES OF DECEDENT-TESTAMENTARY CRTS 14
H. Trustee........................................................................................................ 14
1. GRANTOR
AS TRUSTEE.............................................................. 14
2. CHARITABLE
REMAINDERMAN AS TRUSTEE......................... 15
3. GRANTOR'S
RIGHT TO REMOVE AND REPLACE TRUSTEE... 15
I. Avoidance
of Grantor Trust Imposition........................................................... 15
J. Taxable
Year............................................................................................... 15
TAX CONSEQUENCES OF A
CRT................................................................................................ 16
I. INCOME
TAX CONSEQUENCES.......................................................................... 16
A. Income........................................................................................................ 16
1. INCOME
TO RECIPIENT OF ANNUITY AMOUNT OR UNITRUST AMOUNT 16
2. DISTRIBUTIONS
TO CHARITY................................................... 17
3. TAXATION
OF CRT...................................................................... 17
B. Donor's
Income Tax Deduction..................................................................... 19
1. REMAINDERMAN
IS A PUBLIC CHARITY................................ 19
2. REMAINDERMAN
IS A PRIVATE FOUNDATION...................... 20
3. FURTHER
LIMITS APPLICABLE TO HIGH INCOME TAXPAYERS 21
4. SUBSTANTIATION
OF THE CHARITABLE GIFT....................... 21
5. FEDERAL
RETURN FILINGS REQUIRED FOR A CRT............... 24
II. GIFT
TAX CONSEQUENCES................................................................................ 24
A. Who
is the Recipient of the Annuity Amount or Unitrust Amount..................... 24
1. JUST
THE DONOR........................................................................ 24
2. THE
DONOR AND HIS SPOUSE.................................................. 24
3. SOMEBODY
OTHER THAN THE DONOR'S SPOUSE................ 25
III. ESTATE
TAX CONSEQUENCES........................................................................... 25
A. Inter
Vivos CRATs and CRUTs.................................................................... 25
1. DONOR
WAS RECIPIENT OF ANNUITY AMOUNT OR UNITRUST AMOUNT 25
B. Testamentary
CRAT or CRUT..................................................................... 26
1. SPOUSE
IS SOLE RECIPIENT....................................................... 26
2. SPOUSE
AND OTHERS ARE RECIPIENTS.................................. 26
3. SOMEBODY
OTHER THAN SPOUSE IS RECIPIENT.................. 26
FUNDING OF CRTs....................................................................................................................... 26
I. INTRODUCTION................................................................................................... 26
A. Primary
Advantage 1 of a CRT..................................................................... 26
B. Primary
Advantage 2 of a CRT..................................................................... 27
C. Primary
Disadvantage of a CRT.................................................................... 27
II. MARKETABLE
SECURITIES................................................................................ 27
A. Low
Basis Highly Appreciated Marketable Securities..................................... 27
III. TAX
EXEMPT SECURITIES.................................................................................. 27
IV. REAL
ESTATE....................................................................................................... 27
A. Unencumbered
Real Estate........................................................................... 27
1. PERSONAL
RESIDENCE.............................................................. 27
2. NON-PERSONAL
RESIDENCE REAL ESTATE........................... 27
B. Encumbered
Real Estate............................................................................... 27
1. UNRELATED
BUSINESS TAXABLE INCOME............................ 28
V. SUBCHAPTER
S STOCK....................................................................................... 28
A. Contribution
of the Stock............................................................................... 28
B. Contribution
of the Assets of S Corporation by the S Corporation..................... 28
1. LEGALLY
BINDING OBLIGATION.............................................. 28
2. UNRELATED
BUSINESS TAXABLE INCOME............................ 28
VI. REGULAR
C CORPORATION.............................................................................. 29
A. Excess
Business Holdings............................................................................. 29
B. Legally
Binding Obligation............................................................................. 29
C. Self-Dealing................................................................................................. 29
D. Unrelated
Business Taxable Income.............................................................. 29
VII. LIMITED
LIABILITY COMPANY......................................................................... 29
VIII. OPTIONS............................................................................................................... 30
A. Old
Position of Service - PLR 9240017.......................................................... 30
1. USE
OF OPTION TO FUND CRT.................................................. 30
B. New
Position of Service................................................................................ 30
1. PLR
9417005................................................................................... 30
2. PLR
9501004................................................................................... 30
IX. OTHER
ASSETS USED TO FUND CRTS.............................................................. 30
A. Qualified
Retirement Plan Benefits................................................................ 30
1. WITHDRAWING
THE PLAN ASSETS AND THEN USING ASSETS TO FUND CRT....................................................................................................... 30
2. NAMING
THE CRT AS A BENEFICIARY OF THE PLAN BENEFITS AT PLAN PARTICIPANT'S DEATH.............................................................. 30
B. Life
Insurance.............................................................................................. 31
1. PAYMENT
OF PREMIUMS BY THE CRT.................................... 31
2. UNRELATED
BUSINESS INCOME............................................... 32
3. JEOPARDY
INVESTMENT........................................................... 32
C. Qualified
Replacement Property.................................................................... 32
D. Partnership
Interests Controlled by Trustee.................................................... 32
1. SELF
DEALING............................................................................. 32
2. UNRELATED
BUSINESS TAXABLE INCOME............................ 32
3. EXCESS
BUSINESS HOLDINGS................................................... 33
4. NO
(DEFINITE) WORD YET......................................................... 33
ATTACHMENT 1 - GRANTOR
TRUST AVOIDANCE................................................................. 34
ATTACHMENT 2 - FORMS........................................................................................................... 35
The authors gratefully acknowledge Jennifer Last
Used correctly, an IRC §664 charitable remainder trust (“CRT”) can accomplish a donor's donative goals and tax goals. (All references to “sections” or “§” are to the Internal Revenue Code of 1986, as amended, or to Department of the Treasury Regulations “Treas. Reg.,” as applicable and unless otherwise stated.)
A CRT is an irrevocable trust. An amount of income and/or principal from the CRT is payable to noncharitable beneficiaries, usually the grantor of the CRT and the grantor's spouse. The remainder interest is irrevocably payable to charity.
The CRT pays no income tax on its income. Therefore, the CRT is not taxed on any gain it realizes upon selling appreciated property whether donated by the grantor or appreciation occurring after donation.
The grantor of an inter vivos CRT is entitled to an immediate income and gift tax deduction in the amount of the present value of the remainder interest passing to charity. The estate of the decedent who created a testamentary CRT is entitled to an estate tax deduction for the present value of the remainder interest passing to charity.
In
1969, Congress reacted to the abuse it perceived regarding charitable
deductions resulting from gifts of remainder interests to charity. Congress believed that donors were taking
income, gift and estate tax charitable deductions based on values not
ultimately passing to the charity. Prior
to 1969, the tests to obtain an income, estate or gift tax charitable deduction
were liberal. A gift to a split interest
trust with a remainder going to charity enabled the donor to receive an income,
estate or gift tax charitable deduction if the interest passing to charity was
presently ascertainable. Treas. Reg.
§20.2055(a). Further, as long as the
ability of the Trustee to invade corpus for the noncharitable beneficiary was
simply subject to an ascertainable standard, the donor was entitled to the
deduction. Treas. Reg. §20.2055-2(b); Estate
of Sternberger v. Commissioner, 348
A donor receives no charitable income tax deduction for a gift of a remainder interest to charity. IRC §170(f)(2)(A).
A gift of a remainder interest to charity will entitle the donor to a charitable income tax deduction if the trust is a CRT described in Section 664. IRC §170(f)(2)(A).
A donor receives no gift or estate tax charitable deduction for a gift of a remainder interest to charity - IRC §§2522(c)(2); 2055(e)(2).
A gift of a remainder interest to charity will entitle the donor to an estate or gift tax charitable deduction if the trust is a CRT described in Section 664. IRC §§2522(c)(2)(A); 2055(e)(2)(A).
§ IRC §664(b)
§ Treas. Reg. §1.664-1(d)
§ Treas. Reg. §1.664-1(e)
§ IRC §664(c)
§ Treas. Reg. §1.664-1(c)
§ Treas. Reg. §1.664-1(a)
§ IRC §664(d)(1)
§ Treas. Reg. §1.664-2
§ IRC §664(d)(2) & (d)(3)
§ Treas. Reg. §1.664-3
§ Treas. Reg. §1.664-4
§ Treas. Reg. §1.664-1(b)
§ IRC §6034
§ Treas. Reg. §1.6012-3(a)(6)
(Updated forms
released for comment in IRS Notice 2000.
The comments were to be received by
a. One Life - Section 4 of Rev. Proc. 89-21, 1989-1 C.B. 842
b. Two Lives
(1) CONSECUTIVE INTERESTS - Section 4 of Rev. Proc. 90-32, 1990-1 C.B. 546
(2) CONCURRENT AND CONSECUTIVE INTERESTS - Section 5 of Rev. Proc. 90-32
c. Term of Years - no approved form
a. One Life - Section 6 of Rev. Proc. 90-32
b. Two Lives
(1) CONSECUTIVE INTERESTS - Section 7 of Rev. Proc. 90-32
(2) CONCURRENT AND CONSECUTIVE INTERESTS - Section 8 of Rev. Proc. 90-32
c. Term of Years - no approved form
a. Fixed Percentage Amount
(1) ONE LIFE - no approved form
(2) TWO LIVES
(a) Consecutive Interests - Section 4 of Rev. Proc. 90-30, 1990-1 C.B. 534
(b) Concurrent and Consecutive Interests - Section 5 of Rev. Proc. 90-30
(3) TERM OF YEARS - no approved form
b. Net Income With Make-Up
(1) ONE LIFE - Section 4 of Rev. Proc. 90-31, 1990-1 C.B. 539
(2) TWO LIVES
(a) Consecutive Interests - Section 5 of Rev. Proc. 90-31
(b) Concurrent and Consecutive Interests - Section 6 of Rev. Proc. 90-31
(3) TERM OF YEARS - no approved form
c. Lesser of Income or Fixed Percentage Without Make-Up - no approved form
a. Fixed Percentage Amount
(1) ONE LIFE - Section 6 of Rev. Proc. 90-30
(2) TWO LIVES
(a) Consecutive Interests - Sec. 7 of Rev. Proc. 90-30
(b) Concurrent and Consecutive Interests - Section 8 of Rev. Proc 90-30
(3) TERM OF YEARS - no approved form
b. Net Income With Make-Up
(1) ONE LIFE - Section 7 of Rev. Proc. 90-31
(2) TWO LIVES -
(a) Consecutive Interests - Section 8 of Rev. Proc. 90-31
(b) Concurrent and Consecutive Interests - Sec. 9 of Rev. Proc. 90-31
(3) TERM OF YEARS - no approved form
c. Lesser of Income or Fixed Percentage Without Make-Up - no approved form
A CRT is a trust which provides for a specified distribution to one or more beneficiaries, at least one of which is not a charity, for life or for a term of years (not to exceed 20 years), with an irrevocable remainder interest paid to charity. Treas. Reg. §1.664-1(a)(1)(i).
The following definitions will be used in this outline as they are used in the regulations. Treas. Reg. §1.664 - 1(a)(1)(iii).
1. “ANNUITY AMOUNT” - the amount distributed to the noncharitable beneficiary of a charitable remainder annuity trust.
2. “UNITRUST AMOUNT” - the amount distributed to the noncharitable beneficiary of a charitable remainder unitrust.
3. “RECIPIENT” - the beneficiary who receives the Annuity Amount or Unitrust Amount.
The amount paid to the Recipient is set when the trust is created. It is a fixed percentage or dollar amount of the initial fair market value of the trust assets. Thus, the Annuity Amount paid to the Recipient does not change from year to year. IRC §664(d)(1).
The amount paid to the Recipient is a fixed percentage of the fair market value of the trust's assets valued annually. Thus, the Unitrust Amount fluctuates from year to year.
a. Fixed Percentage (“Fixed Percentage Unitrust” or “Flat Unitrust”)
The Recipient receives the fixed percentage of the trust assets, valued annually. IRC §664(d)(2).
b. Lesser of Income or Fixed Percentage Without Make-Up (“NICRUT”)
The Recipient receives the lesser of the trust's net income for that year or the fixed percentage of the trust assets valued annually. IRC §664(d)(2) and (d)(3).
c. Lessor of Income or Fixed Percentage With Make-Up (“NIMCRUT”)
The Recipient receives the lesser of the trust's net income for that year or the fixed percentage and in a year when the trust's net income exceeds the fixed percentage, such excess is used to make-up for past deficiencies in years when the net income was less than the fixed percentage. IRC §664(d)(2) and (d)(3).
(1) DEFINITION OF INCOME
Typically, under state trust accounting law, income
excludes capital gains (i.e. capital gains are allocated to principle).
d. The FLIP CRUT
The Regulations also sanctioned a fourth type of CRUT called the “FLIP CRUT.” A FLIP CRUT is a CRUT 1) where the initial Unitrust Amount to the Recipient is the lesser of income or the fixed percentage and 2) where after a triggering event, the Unitrust Amount changes (i.e. flips) to the fixed percentage. Under the Final Regulations, the following requirements must be satisfied to use the FLIP CRUT: 1) the change (FLIP) from the NIMCRUT (NICRUT) to the fixed percentage CRUT is triggered on a specific date or by a single event whose occurrence is not discretionary with, or within the control of, the trustee or any other person; 2) the FLIP occurs at the beginning of the taxable year that immediately follows the taxable year during which the triggering event/date occurs; 3) following the flip, the CRT becomes a fixed percentage CRT (and any makeup account is forfeited). Treas. Reg. 1.664-3(a)(l)(i)(c).
(1) TRIGGERING EVENT
A triggering event based on the sale of unmarketable assets or the marriage, divorce, death or birth of a child with respect to any individual will not be considered discretionary with, or within the control of, the trustees or any other person. Treas. Reg. 1.664-3(a)(1)(i)(d).
(2) UNMARKETABLE ASSETS
For purposes of a FLIP CRUT, unmarketable assets are assets that are not cash, cash equivalents or other assets that can be readily sold or exchanged for cash or cash equivalents. For example, unmarketable assets include real property, closely-held stocks, and an unregistered security for which there is no available exemption permitting public sale. Treas. Reg. §664-1(a)(7)(ii).
(3) USES
Uses of the FLIP CRUT include creating a retirement account or a deferred income stream or if the CRUT is funded with unmarketable assets.
(i) Retirement account/deferred income stream. In this instance the donor funds the FLIP CRUT with cash or securities and picks a date certain in the future as the “triggering event.” Prior to the triggering event, the Trustee invests the trust assets in growth, non-income producing assets to grow the trust corpus. Upon the date certain (i.e., retirement or date donor wants the payment stream to become fixed), the CRUT flips. The Trustee can maintain its investment strategy (i.e., growth). In order to make the unitrust payment the Trustee will either sell sufficient assets to satisfy the payment or distribute the assets in kind to the unitrust beneficiary who in turn can sell the assets. Ordinarily, unless there is undistributed ordinary income as outlined under Tax Consequences of a CRT, I.A.1, infra, the unitrust amount would be taxed to the unitrust beneficiary at capital gains rates.
(ii) Unmarketable Assets. The FLIP CRUT is also useful when the assets used to fund the CRUT are unmarketable assets and the unitrust beneficiary of the CRUT desires a payout equal to a fixed percentage of the value of the assets. The triggering event may be the sale of those unmarketable assets. During the period the trust holds the unmarketable assets, the CRUT is either a NIMCRUT or NICRUT so that the Trustee is not required to distribute undivided interests in the unmarketable assets. When the unmarketable asset is sold, the CRUT flips and then the unitrust amount is a fixed percentage.
The amendments allowing a
FLIP CRUT are effective for CRUTs created on or after
The trust must either be a CRAT or a CRUT. The trust cannot be a combination of a CRAT and a CRUT. Treas. Reg. §1.664-1(a)(2).
Additional contributions cannot be made to a CRAT because the Annuity Amount is based on the value of the assets only valued as of creation. The governing instrument of the CRAT must prohibit additional contributions. Additional contributions can be made to a CRUT as long as the governing instrument provides a formula upon which to base the Unitrust Amount, which takes into account the additional contribution. Treas. Reg. §§1.664-2(b) & 1.664-3(b).
One other difference between the CRAT as compared to the NIMCRUT and the NICRUT (but not the fixed percentage CRUT) is that with a CRAT and the fixed percentage CRUT, the trustee may be forced to make a distribution in kind if the income of the CRAT or CRUT is insufficient to satisfy the Annuity Amount of the CRAT or the Unitrust Amount of the fixed percentage CRUT. A distribution in kind is deemed to be a sale of the property so distributed causing the Recipient to recognize capital gain on the property in kind distributed to him. Treas. Reg. §1.664-1(d)(Ex. 5). With CRUTs, however, if the Unitrust Amount is of the form based on the lesser of income or fixed percentage with or without make-up (i.e. a NICRUT or NIMCRUT), the trustee will not be forced to make a distribution in kind. Rather, the trustee can satisfy the Unitrust Amount based on the income earned by the CRUT. Obviously, if a non-income earning asset, such as real estate, is used to fund a CRT, it is best to choose a CRUT with the lesser of income feature (and with or without the flip feature).
3. CRUT DIVISION – PLR 200109006
A couple established a CRUT under section 664(d)(2). The couple later divorced and as part of the
divorce proceeding stipulated that the CRUT would be divided into two separate
CRUTs. Each new CRUT would have the same
provisions as the old CRUT with the exception of being a single beneficiary
trust. The Service determined that the
new trusts would qualify as CRUTs under section 664(d)(2).
The CRT must be a valid trust under applicable state law. IRC §§664(d)(1) & 664(d)(2); Rev. Proc. 89-20, 1989-1 C.B. 841; Rev. Proc. 89-21, 1989-1 C.B. 842. The CRT must also be irrevocable. Treas. Reg. §1.664-1(a)(1)(i).
IRC §§664(d)(1)(A) & 664(d)(2)(A)
a. Old Rule
For transfers to a CRT on
or before
b. New Rule
Pursuant to The Taxpayer Relief Act of 1997 (P.L. 105-34), for transfers to a CRT after June 18, 1997, the governing instrument must now provide that the fixed percentage be at least 5 percent but no more than 50 percent. IRC §§664(d)(1)(A) & 664(d)(2)(A).
The governing instrument must contain language regarding proration of the Unitrust Amount or Annuity Amount in the event of a short taxable year (i.e. less than 12 months). The Annuity Amount or Unitrust Amount shall be the amount otherwise payable multiplied by a fraction, the numerator of which is the number of days in the taxable year of the trust and the denominator of which is 365 (366 if February 29 is a day included in the numerator). The governing instrument of the CRT must also include language providing that in the case of a trust taxable year within which occurs the termination of the CRAT or CRUT, the Annuity Amount or Unitrust Amount which must be distributed shall be the amount otherwise determined multiplied by a fraction, the numerator of which is the number of days in the period beginning on the first day of such taxable year and ending on the day that the CRT terminates and the denominator of which is 365 (366 if February 29 is a day included in the numerator). Treas. Reg. §§1.664-2(a)(1)(v)(a) & (b) & 1.664-3(a)(1)(v)(a) & (b).
The governing instrument must require that the trustee pay to the Recipient (if an undervaluation) or receive from the Recipient (if an overvaluation) an amount equal to the difference between the Annuity Amount or Unitrust Amount which the trustee should have paid and the Annuity Amount or Unitrust Amount which was actually paid to the Recipient. Treas. Reg. §§1.664-2(a)(1)(iii) & 3(a)(1)(iii).
Generally, the Unitrust Amount or Annuity Amount must be at least 5% of the trust assets (valued annually if a CRUT or valued at initial contribution if a CRAT). However, a trust may provide for a reduction in the Unitrust Amount or Annuity Amount upon the death of a Recipient or the expiration of the term, as applicable, as long as the governing instrument of the CRT provides that, upon such death or expiration, (i) the distribution of the excess Annuity Amount or Unitrust Amount is made to a charity and (2) the total of the Unitrust Amount or Annuity Amount payable after the distribution to the charity is not less than five percent. Treas. Reg. §§1.664-2(a)(2)(ii) & 3(a)(2)(ii).
The CRT must function exclusively as a CRT from
inception. Treas. Reg.
§§1.664-2(a)(5)(i) & 3(a)(5)(i).
Therefore, the payment of the Unitrust Amount or Annuity Amount must be
due for the year of the creation of the CRT.
However, a CRT will not be deemed to have failed to function exclusively
as a CRT merely because payment of the Unitrust Amount or Annuity Amount is
made after the close of the taxable year, provided that the payment is made
within a reasonable time after the close of the taxable year. Treas. Reg. §§1.664-2(a)(1)(i)(a) &
1.664-3(a)(1)(i)(a). With testamentary
CRTs, the CRT is deemed created in the year of the decedent's death. Treas. Reg. §1.664-1(a)(5). In this case, the governing instrument of the
CRT should also include a provision allowing the executor of the
decedent's estate to defer such payment for a reasonable period of time to
enable the decedent's executor to complete the administration of his or her
estate.
The governing instrument must specify the term of the Annuity Amount and Unitrust Amount and the term may continue for a term of years not to exceed twenty years, the life or lives of a named individual or individuals, or the combination of a life or lives and a fixed term of years. Treas Reg. §§1.664-2(a)(5) & 1.664-3(a)(5); IRC §§664(d)(1)(A) & 664(d)(2)(A).
The governing instrument of the CRT may provide for the acceleration of the term causing the assets to be distributed to charity. However, the possibility of acceleration is not taken into account in valuing the remainder interest. Treas. Reg. §§1.664-2(a)(5) & 1.664-3(a)(5);IRC 664(d)(1)(A) & 664(d)(2)(A); PLR 9138024.
In Notice 94-78, the Service announced its intention to challenge short term CRUTs. Notice 94-78, 1994-2 C.B. 555.
a. Explanation - The short term CRUT is a technique where appreciated assets are transferred to a short term (i.e. 2 years) CRUT and the Unitrust Amount percentage is very high (i.e. 80%). The Notice provides the following example: Grantor contributes property with a value of $1,000,000 and basis of zero. The assets pay no income and the term of the trust is two years. The Unitrust Amount is 80% of the value of the trust assets valued annually. In year one, the Unitrust Amount is $800,000 (80% x $1,000,000) but such is not actually paid in year one since the trustee has a reasonable time to make the payment. At the beginning of year 2, all the CRUT assets are sold for $1,000,000 and the year one's Unitrust Amount is distributed. The Unitrust Amount for year two is $160,000 (80% x ($1,000,000 - $800,000)).
b. Proponent's Position - The position of the proponents of this strategy is that the $800,000 distribution is a return of principal under the tier distribution rules.
c. Service's Challenges in Notice 94-78 - In Notice 94-78, the Service stated that it will attack such transaction as abusive under the following arguments: 1) substance over form in that the arrangement is a prearrangement between the grantor and the trustee and thus, such is a sale by the grantor individually; 2) an assignment of income by the grantor and thus, the gain would be attributed to the grantor; 3) the trust did not function exclusively as a CRT from its inception and thus, the CRUT will be ignored and the sale treated as one by the grantor individually and 4) the postponement of the sale of the trust assets beyond year one is the use of the assets for the benefit of a disqualified person (i.e. self-dealing).
d. Proposed
Regulation's Cure to Short Term Trusts - Under the Proposed Regulation, the
payment of the Annuity Amount of a CRAT or the Unitrust Amount of a fixed
percentage CRUT must be made by the close of the taxable year in which it is
due. If such were the case in the
example above, the trustee would be required to make a distribution in kind by
the end of year one. The time for the
payment of Unitrust Amount in NICRUTs and NIMCRUTs can still be extended under
the Proposed Regulation. The Proposed
Regulation states that such extension of time is needed with NICRUTs and
NIMCRUTs since the trustee of such CRUTs may not be able to determine the
Unitrust Amount until after the close of the year but with fixed percentage
CRUTs and CRATs, the trustee can determine the payment amount since it is a
fixed amount. The Proposed Regulation
specifically states that its concern is the accelerated CRUT described in Notice
94-78. The amendment in this Proposed
Regulation is proposed to be effective
(1) EXCEPTION
At the hearings on the Proposed Regulation, it was determined that requiring the payment by the close of the tax year for fixed percentage CRUTs and CRATs would be very burdensome. Therefore, the Service issued Notice 97-68 which provides that for the 1997 tax year, it is not necessary to make the annual payment from the fixed percentage CRUT or the CRAT by the close of the 1997 tax year as long as the percentage is 15% or less. As far as subsequent tax years, the Proposed Regulation applies but it is believed that similar Notices will be issued or the rules finalized. Notice 97-68, 1997-48I.R.B.11.
e. Final Regulations - For charitable remainder annuity trusts or fixed percentage unitrusts, the Annuity or Unitrust Amount may be paid within a reasonable time after the close of the year for which it is due if (i) the character of such amount in the hands of the recipient is either ordinary income, capital gain, or tax-exempt income (but not corpus) and/or (ii) the trust distributes property rather than cash to pay the Annuity or Unitrust Amount and the trustee elects on the trust's return to treat any income generated by the distribution as maturing on the last day of the taxable year for which the amount is due. For pre-December 10, 1998, trusts, the distribution may be made within a reasonable time after the close of the year only if the percentage used to calculate the Annuity or Unitrust Amounts is 15% or less.
f. Son of
Accelerated CRT – The IRS has issued new regulations (1.643(a)-8) that
modify the application of the rules governing the character of some
distributions from charitable remainder trusts.
These regulations are intended to combat the latest tax avoidance scheme
involving charitable remainder trusts.
Under the new scheme, a donor typically contributes highly appreciated
assets to a charitable remainder trust that has a relatively short term and a
relatively high payout rate. Rather than
sell the assets to obtain the cash needed to pay the annuity or unitrust amount
to the noncharitable beneficiary, the trustee borrows money or enters into a
forward sale of the assets. Because the
borrowing or forward sale doesn't result in current income to the trust,
parties attempt to characterize the distribution of cash to the noncharitable
beneficiary as a tax-free return of corpus under section 664(b)(4). Although the scheme literally complies with the
rules for charitable remainder trusts, the IRS says, its results are
inconsistent with the intent behind those provisions. Moreover, it says, the scheme is no less
abusive than the accelerated charitable remainder trust schemes that Congress
prohibited in 1997. To combat these
abusive transactions, the regulations provide that a trust shall be treated as
having sold, in the year for which the distribution is due, a pro rata portion
of its assets, to the extent that a distribution of the annuity or unitrust
amount (1) isn't characterized in the hands of the recipient as income under
section 664(b)(1), (2), or (3), and (2) was made from an amount received by the
trust that was neither (a) a return of basis in any asset sold by the trust nor
(b) attributable to a contribution of cash to the trust for which a deduction
was allowed under section 170, 2055, 2106, or 2522. Any transaction that has the purpose or
effect of circumventing that rule, the Service says, will be disregarded. The regulations apply to distributions made
by charitable remainder trusts after
IRC §§664(d)(1)(A) & 664(d)(2)(A); Treas. Reg. §§1.664-2(a)(3) & 1.664-3(a)(3)
Name the person or persons to be the Recipient of the Annuity Amount or Unitrust Amount. If there is more than one Recipient, they can be either successive or concurrent. While the Service has discontinued issuing rulings on the qualification of CRUTs for one or two measuring lives, the Service chose to rule in this case because the trust provides for unitrust payments for five measuring lives and is not covered by section 4.01(38) of Rev.Proc. 2001-3. The Service ruled the trust satisfied the requirements of section 664(d)(2)(A) and (D) and provided a factor for determining the present worth of the remainder interest. PLR 200150019
At least one of the Recipients must not be a charity.
All individuals who are Recipients must be alive at the time of the creation of the CRT.
The power retained by the trustee who was the grantor of CRT to sprinkle the Annuity Amount or Unitrust Amount among Recipients will cause the trust to not be a CRT. In this case, the grantor would be treated as the owner of the CRT or the portion thereof. Treas. Reg. 1.664-3(a)(3)(ii) & 1.664-2(a)(3)(ii).
The Grantor may retain right to revoke by will any Recipient's interest (other than charity). If done, there is no completed gift to the successive Recipient. PLR 9517020. However, the power to revoke is a retention of a power includable in the grantor's estate.
In PLR 9511029, the Service ruled that the automatic termination of a successive or concurrent Recipient's interest in the CRT due to divorce, will not disqualify the trust as a CRT.
7. TRUST AS RECIPIENT
In Revenue Ruling 2002-20 the Service
amplified and superceded a previous ruling allowing a CRUT to pay the annuity
or unitrust amount to a trust for an individual. Here, the factual circumstances are clarified
when an individual creates a
8. ASSIGNMENT
OF INTEREST - PLR 200124010 – Assignment of
Trust Principal Won't Affect CRUT Status
An individual set up a CRUT that required an
independent third party trustee to pay the individual the unitrust amount
during his lifetime and then pay his estate a prorated amount and upon his
death to three charities. The individual
wanted to shut down the CRUT early and proposed assigning the principal to the
three charitable remainder beneficiaries.
The Service ruled that the assignment wouldn't adversely affect the
trust's qualification provided that the charities are organizations described
in section 170(c). However, consider PLR
200127023 where it was determined that instead of distributing the assets to
charity, the trustee would distribute the actuarial value of the unitrust
amount to the unitrust beneficiary and the remainder to charity. In this instance the Service ruled that the unitrust
beneficiary will be treated as disposing of his interest in the trust in
exchange for money and property and will realize income from the sale. Good news is that it will not be an act of
self-dealing; however, the uniform basis rules will be disregarded and the
individual must recognize the entire amount realized from the disposition. Then again, in PLR 200152018, the Service
approved the transfer by the unitrust beneficiary of his entire unitrust
interest to the charity in exchange for a charitable gift annuity. Additionally, the Service stated that the
individual was entitled to an income tax charitable deduction (subject to the
30% limitation).
IRC §§1664(d)(1)(C) & 664(d)(2)(C); Treas. Reg. §§1.664-2(a)(6) & 1.664-3(a)(6)
The governing instrument must provide that at end of the term, the entire corpus of the CRT go to charity. Such charitable interest can pass outright or it can continue in trust for the benefit of the charity.
a. Old Rule
For transfers to a CRT on
or before
b. New Rule
Pursuant to The Taxpayer Relief Act of 1997 (P.L. 105-34), for transfers to a CRT after July 28, 1997, the present value of the remainder interest ultimately passing to the charitable remainderman must equal at least 10 percent of the net fair market value of the property transferred to the CRT on the date of the contribution to the CRT. IRC §§664(d)(1)(D) & 664(d)(2)(D). Further, for charitable remainder annuity trusts, the CRAT must also meet the “not-so-remote-as-to-be-negligible-5%-probability” test of Rev. Rul. 77-374. That ruling provides that a charitable remainder annuity trust doesn't qualify for a charitable deduction (and by implication isn't a qualified trust) unless the possibility that the charitable transfer will not become effective is so remote as to be negligible. If there is more than a 5% probability that the noncharitable income beneficiary will survive the exhaustion of the trust assets, that probability isn't negligible. Rev. Rul. 77-374. The Tax Court upheld the “5% probability test” in Moor, 43 TCM 1530 (1982). However, the court also held that the test is satisfied as long as the trust's annual earnings can be reasonably anticipated to exceed the required annual payout to the beneficiary.
The governing instrument may provide for more than one charitable remainderman. If so, they can be concurrent or successive charitable remaindermen.
The governing instrument must provide that if the named charitable remainderman is not a qualified charity under the Internal Revenue Code at the time of the distribution, then the distribution must go to an alternate charitable remainderman that is a qualified charity under the Internal Revenue Code at the time of the distribution and the governing instrument must provide the means in which the alternate charity is selected.
The grantor may substitute an alternate charity as the remainderman. Rev. Rul. 76-8, 1976-1 C.B. 179; PLR 200034019.
Treas. Reg. §§1.664-2(a)(4) & 1.664-3(a)(4)
The governing instrument may permit the trustee of a CRT to make an early distribution of corpus to charity as long as, in the case of distributions in kind, assets distributed have adjusted bases fairly representative of the adjusted bases of all assets available. PLR 200034010. Further, the governing instrument may provide that the grantor reserves the right to terminate the trust resulting in the acceleration of the distribution to the charity. PLR 9138024.
Treas. Reg. §§1.664-2(a)(4) & 1.664-3(a)(4)
No other payments can be made other than (1) the Annuity Amount or Unitrust Amount, (2) early distributions to charity or (3) distribution to charity upon termination.
1. SELF-DEALING
Trust must not be involved in self-dealing as precluded by IRC § 4941(d). Includes any direct or indirect: a) sale or exchange or leasing of property between a trust and a disqualified person; b) lending of money or extension of credit between a trust and a disqualified person; c) furnishing of goods, services, or facilities between a trust and a disqualified person, unless such goods, services or facilities are made available to the general public on at least as favorable a basis as they are made to the disqualified person, Treas. Reg. § 53.4941(d)(3)(b)(1); d) payment of compensation (or payment or reimbursement of expenses) by a trust to a disqualified person, unless it is for personal services and such compensation is reasonable and necessary to carry out the exempt purpose and is not excessive, Treas. Reg. § 53.4941(d)(3)(c)(1); e) transfer to, or use by or for the benefit of, a disqualified person of the income or assets of a private foundation; and, f) agreement by a private foundation to make any payment of money or other property to a government official [as defined in § 4946(c)] other than an agreement to employ such individual for any period after the termination of his government service if such individual is terminating his government service within a 90 day period. IRC § 4941(d).
A disqualified person is a substantial contributor to the CRT (an individual, trust, estate, corporation or partnership who or which contributes an aggregate amount in excess of $5,000 to the CRT, if his or her total contributions are more than 2% of the total contributions received), or a family member of a substantial contributor (spouse, descendants and spouses of descendants), or persons owning more than 20% of an entity which is a substantial contributor to the CRT (includes an entity in which a disqualified person [considering the attribution rules of I.R.C. § 4946(a)(4)] owns more than 35%).
Reimbursement for Expenses: Reimbursement to disqualified persons for travel expenses cause the CRT, the disqualified person and the Trustee to be potentially liable for penalty taxes for self-dealing, for making non-charitable expenditures, or possibly both. Such reimbursement of expenses will not be taxed if the expenses are reasonable and necessary to carrying out the exempt purposes of the CRT and are not excessive. I.R.C. § 4941(d)(2). The Code does not explain what is “reasonable and necessary.” Treas. Reg. § 53.3941(d)-3(c)(1). Generally, business expense deductions under Treas. Reg. § 1.162-2(1) include travel fares, meals and lodging and expenses incident to travel. Travel expenses are not included if the trip is primarily personal in nature. Treas. Reg. § 1.162-2(a). The Code does cross-reference Treas. Reg. § 1.162-7 to determine what is “excessive.” Under Treas. Reg. § 1.162-7, an amount spent on director's services will not be deemed “excessive” if it is only such as would be paid “for like services by like enterprises under like circumstances.” Treas. Reg. § 1.162-7 (i.e. As the organization would pay to someone independent of the CRT).
A grant by one private foundation (a CRT in this case) to another private foundation does not constitute self-dealing within the meaning of I.R.C. § 4941 even when one entity serves as Trustee of both foundations. Rev. Rul. 82-136 (1982-2 C.B. 300). See also Treas. Regs. Examples 53.4941(d)-2(f)(2).
Excise Tax on Acts of Self-Dealing: Any disqualified person who engages in an act of self-dealing is assessed an excise tax of 5% of that amount involved in the transaction for each year that the transaction is uncorrected. Additionally, a foundation manager who knows the act is prohibited but approves it may also be subject to a tax of 2.5% of the amount involved (up to $10,000 for each such act) for each year that the transaction is uncorrected. If the transaction is not timely corrected and the 5% was initially assessed, the disqualified person is subject to being assessed an additional tax of 200% of the amount involved. Any foundation manager who does not correct the transaction may also be subject to an additional assessment of 50% of the amount involved (up to $10,000 for each such act.)
2. EXCESS
BUSINESS HOLDINGS
Section 4943 imposes an excise
tax on the value of the “excess business holdings” of any private foundation. A
private foundation created after
However, the excess business holdings provisions of Section
4943 and the “jeopardy investment” provisions of
Section 4944 discussed below do not apply to any
qualified CRT that has no charitable recipient of the Annuity Amount or
Unitrust Amount IRC §4947(b)(3)(B). If the governing instrument permits payment
of the Annuity Amount or Unitrust Amount to a charity and no additional
charitable deduction was taken resulting therefrom, the CRT is still excluded
from such prohibitions. Treas. Reg.
§53.4947-1(c)(2)(ii) (Ex. 2). Or, the
CRT is excluded from such prohibitions if the Trustee is prohibited from
engaging in such prohibitions during any time the Annuity Amount or Unitrust
Amount is made to a charitable recipient.
Rev. Rul. 72-395, 1972-2 C.B. 340.
3. JEOPARDY
INVESTMENTS
Section 4944 imposes an excise
tax on a private foundation (and under some circumstances foundation managers)
for investing any amount in such a manner as to jeopardize the carrying out of
its exempt purposes. The imposition of
an excise tax on “jeopardy” investments is intended to assure that the
foundation managers adopt a “prudent person” approach toward the investment of
foundation assets.
4. TAXABLE
EXPENDITURES
Section 4945 imposes an excise
tax on each “taxable expenditure” made by a private foundation. The term
“taxable expenditure” includes amounts paid or incurred by a private
foundation: (1) to influence legislation; (2) to influence the outcome of a
public election or carry on voter registration drives; (3) as a grant to an
individual for travel, study or other similar purposes (unless the IRS gives
advance approval of the foundation's grant‑making procedures); (4) as a
grant to an organization other than a “public charity” described in Section 509(a) or an “exempt operating foundation” described in
Section 4940(d)(2) (unless the foundation exercises
“expenditure responsibility”); and (5) for any purpose other than one specified
in Section 170(c)(2)(B).
5. RESTRICTIONS
ON INVESTMENTS
The governing instrument must not include a provision restricting the Trustee from investing the CRT assets in a manner which could result in annual realization of income or gain from the sale of CRT assets. Treas. Reg. §1.664-1(a)(3).
Estate tax cannot be paid from a CRT. If such taxes were payable by the CRT, then the CRT would not exclusively operate as a CRT from its inception. The governing instrument must contain provisions for the payment of estate taxes from sources other than the trust itself. In PLR 8819021, the life interest of a survivor income beneficiary took effect only if the survivor beneficiary furnished funds for payment of federal estate taxes or state death taxes for which the trust was liable. Rev. Rul. 82-128, 1982-C.B. 71. Be careful in defining death taxes. The term “death taxes” does not necessarily include estate taxes. PLR 9225026.
The governing instrument must not permit the debts and expenses of a decedent's estate to be made from the assets of a testamentary CRT. Treas. Reg. §1.664-1(a)(6) (Ex. 3).
The grantor may be the trustee of a CRT even if the grantor is also a Recipient. Rev. Rul.77-285, 1977-2 C.B. 213, PLR 9504012, PLR 200029031. In this case, the grantor must be careful to avoid imposition of the grantor trust rules.
a. Compensation to Grantor as Trustee
-The trustee, who is also the grantor, may be entitled to reasonable
compensation as trustee as long as 1) the compensation is not paid out of the
grantor's Annuity Amount or Unitrust Amount and 2) the compensation is reasonable
and not excessive. Rev. Rul. 74-19, 1974‑1
C.B. 155; Treas. Reg.
§53.4941(d)-3(c)(1). In PLR 200135047
the Service addressed compensation for trustees of a private foundation, but the core issue of self-dealing is worth
addressing. The trustees of the trust
were required under state law to perform various duties such as physical
custody and management of trust assets, accurate recordkeeping, personnel
matters, investment decisions, and grantmaking.
The trust intended to provide the trustees compensation and
reimbursement of expenses for the performance of these services. The Service concluded that the trustees were
disqualified persons under section 4946 (i.e., foundation managers) and that
compensation would be self-dealing unless an exception applied. The Service ruled that because the
compensation is for “personal services”, is reported to be “reasonable and not
excessive” and is necessary to carry out the trust's exempt purpose, the
compensation satisfies an exception to the self-dealing rules. PLR 200135047
b. Independent Valuation Trustee - The legislative history of section 664 indicates that Congress contemplated denying the charitable deduction when a grantor of a CRT, who was also Trustee, transferred hard-to-value assets (i.e. all assets other than cash, cash equivalents and marketable securities) to a CRT unless an independent trustee valued the hard to value assets. H.R. Rep. No. 413, 91st Cong., 1st Sess. 60 (1969), 1969-3 C.B. 200, 239. Thus, if the grantor is the trustee of a CRT, the governing instrument must provide that the annual valuation of the hard to value assets be prepared by an independent valuation trustee. The December 10, 1998, Regulations changed this requirement. Under the Regulations, a trust's unmarketable assets must either be valued by an independent trustee or by a qualified appraiser. Treas. Regs. 1.664-1(a)(7). An independent trustee is a person other than the grantor, or the grantor's spouse, a noncharitable beneficiary or a party related or subordinate to either of them. Treas. Regs. 1.664-1(a)(7)(iii). A co-trustee who is independent may value the trust's unmarketable assets. A qualified appraiser is defined in Treas. Regs. Section 1.170A-13(c) and is more fully explained below at Donor's Income Tax Deduction, I.B.4(a)(3).
The charitable remainderman may serve as trustee. It is necessary to check applicable state law
to ensure the charity has trustee powers.
Under
The governing instrument of a CRT may permit the grantor to remove and replace the trustee and the grantor can appoint himself as trustee. Rev. Rul. 77-285, 1977-2 C.B. 213.
A trust that is taxable as a grantor trust cannot qualify as a CRT. IRC §664(c); Treas. Reg. §1.664-1(a)(4). If it did, the trust's income is taxable to the grantor. It is imperative to exclude any power of the grantor to cause the CRT to be taxable as a grantor trust. See Attachment 1 for pitfalls in this area.
The taxable year of a CRT must be the calendar year. IRC §645.
The distributions to the Recipient of the Annuity Amount or Unitrust Amount are includable in the Recipient's gross income.
a. Characterization Rules
(1) FIRST - ORDINARY INCOME
The distribution is ordinary income to the extent of the CRT's ordinary income for that year and undistributed ordinary income from prior years. IRC §664(b)(1); Treas. Reg. §1.664-1(d)(1)(i)(a).
(2) SECOND - CAPITAL GAINS
The distribution is treated as capital gains to the extent of the CRT's capital gains for that year and undistributed capital gains from prior years. IRC §664(b)(2); Treas. Reg. §1.664-1(d)(1)(i)(b).
(3) THIRD - OTHER INCOME (includes tax exempt income)
The distribution is treated as other income to the extent of the CRT's other income for that year and prior years. IRC §664(b)(3); Treas. Reg. §1.664-1(d)(1)(i)(c).
(4) FOURTH - CORPUS
After all of the above is distributed, the distribution is one of corpus. IRC §664(b)(4); Treas. Reg. §1.664-1(d)(i)(1)(d).
b. Example
Illustrating Four-Tier System
The NIMCRUT received $7,500 of income for 1996, all of which was tax-exempt bond interest. It had no undistributed ordinary income or capital gain, except for $30,000 in undistributed capital gain of prior taxable years, and its unitrust amount for 1996 was $9,000. The amount distributable for 1996 was $7,500 and, under the four-tier system, this amount will be characterized as capital gain rather than tax-exempt income (even though it actually arose in 1996 from tax-exempt sources). This is because no tax-exempt income will be deemed distributed until all undistributed capital gain for the current year and all prior years is deemed distributed. Thus, the trust's undistributed capital gain income goes down by $7,500 and its undistributed tax-exempt income goes up by the same amount for purposes of characterizing 1997 and later distributions. Treas. Reg. §1.664-1(d)(l)(iii).
c. Distribution In Kind
The Unitrust Amount or Annuity Amount may be satisfied by making a distribution of property other than cash. This could happen with a CRAT or a fixed percentage CRUT where the Recipient is entitled to the fixed percentage. If the Annuity Amount or Unitrust Amount is satisfied by making a distribution in kind, the distribution in kind is deemed to be a sale of the property resulting in realization of gain by the CRT. Treas. Reg. §1.664-1(d)(5). For example, if a donor funds a fixed percentage CRUT with closely held C stock and then the stock cannot be sold after such funding, the trustee will be obligated to distribute enough stock to the donor to meet the annual fixed percentage and the CRUT will realize the capital gain on that stock even though it was not sold; that capital gain will be passed through to the Recipient under the income tax characterization rules above in I.A.1.a. causing the Recipient to recognize gain.
(1) CURE ONE - NIMCRUT
If the CRUT is a NIMCRUT version, the trustee would only be required to distribute the lesser of the annual net income or the fixed percentage. Thus, the distribution in kind would not be needed to satisfy the Unitrust Amount. However, the disadvantage of this approach is that the Recipient of the Unitrust Amount would often be limited to income. (Be attentive to the definition of income. See above at Requirements, Part II, B.1.c.).
(2) CURE TWO - The FLIP CRUT
The Final Regulations permit the use of a FLIP CRUT. (See above Requirements, Part II B.1.d.) A FLIP CRUT is a CRUT, funded with unmarketable assets, that initially provides for a Unitrust Amount equal to lesser of income (with or without make-up) or the fixed percentage and upon the sale of the unmarketable assets, flips to a fixed percentage Unitrust Amount.
a. Distributions of Annuity Amount or Unitrust Amount to Charitable Recipient
The characterization order of the distribution is 1) ordinary income, 2) capital gains, 3) other income, and 4) corpus. Treas. Reg. §1.664-1(e)(1).
b. Early Distributions to Charity of Items Other than Annuity Amount or Unitrust Amount.
The characterization order of the distribution is 1) corpus, 2) other income, 3) capital gains, and 4) ordinary income. Treas. Reg. §1.664-1(e)(1).
a. General Rule
The CRT is a tax exempt entity and thus, pays no income tax. It pays no income tax on any of its income and it recognizes no gains on sales of appreciated properties. IRC §664(c).
b. Exceptions
(1) STEP TRANSACTION
a. The Binding Commitment
The courts will collapse separate transactions if, when the first step was undertaken, there was a binding commitment to undertake the later steps. Maine Foods, Inc. v. Commissioner, 93 T.C. 181 (1989).
b. Interdependent
Series of Transactions
The courts will collapse a series of transactions if they were so
interdependent that the “legal relations created by one transaction would have
been fruitless without the completion of the series”
c. Pre-Arranged
Series of Transactions
If appreciated property is contributed to a CRUT or CRAT and if the trustee of the trust is obligated, as of the date of the contribution, to sell such property, the Service will ignore the CRUT or CRAT as the seller of the property. Instead the donor is deemed the seller and the donor will recognize the gain. Palmer v. Commissioner, 62 T.C. 684 (1974).
d. Anticipatory Assignment of Income
The court stated that “once
the right to receive income has “ripened” for tax purposes, the taxpayer who
earned or otherwise created that right, will be taxed on any gain realized from
it, notwithstanding the fact that the taxpayer has transferred the right before
actually receiving the income…to determine whether a right has “ripened for tax
purposes, a court must consider the realities and substances of events to
determine whether the receipt of income was practically certain to occur.”
(2) GRANTOR TRUST TAXATION
This is really not an exception. If the trust is a grantor trust, it is not a CRT under Section 664. Treas. Reg. §1.664-1(a)(4). The drafter of the CRT must be careful not to include any provision which causes the CRT to be a grantor trust. See Attachment 1 for listings of items that will and will not cause grantor trust status.
(3) CRT HAS UNRELATED BUSINESS TAXABLE INCOME
A CRT which has unrelated business taxable income in excess of $1,000 will be taxed on all of its income; not just the tainted income will be taxed; all of the income of the CRT will be taxed in the trust tax year when the trust has unrelated business taxable income. Treas. Reg. §1.664-1(c); IRC §512(b)(12).
a. Unrelated Business Taxable Income Defined
Unrelated Business Taxable Income is defined as income derived by an organization from any unrelated trade or business regularly carried on by the organization in excess of $1,000. IRC §512(a)(1). An unrelated trade or business is one in which the conduct of the business is not substantially related to the exercise of the organization's charitable functions. IRC §513(a).
i) The
The sale or disposition of inventory or property held primarily for sale to customers in the ordinary course of business will create unrelated business taxable income to the extent the proceeds therefrom exceed $1,000. The sale or disposition of any other property will not create unrelated business taxable income. IRC §512(b)(5) & (b)(12).
b. CRT Has Debt Financed Income
Unrelated business taxable income includes any income from debt financed property. IRC §514(a). A CRT has debt financed income if the CRT acquires realty subject to a mortgage. The two exceptions are as follows:
i) Testamentary CRTs
The CRT will not have unrelated business taxable income for a period of ten years following the gift as long as it does not assume the debt. IRC §514(c)(2)(B); Treas. Reg. §§1.514(c)-1(b)(3).
ii) Inter vivos CRTs
The CRT will not have unrelated business taxable income for a
period of ten years following the gift as long as (i) the debt was placed
on the property more than five years before the date of the gift; (ii) the
property was held by the donor for more than five years before making the gift;
and (iii) the CRT does not assume the debt.
c. Examples of Transactions Causing Unrelated Business Taxable Income in a CRT
i) Borrowing from an insurance policy in the CRT - PLR 8745013
ii) Holding property subject to debt - IRC §514
iii) Income from oil and gas working interests - PLR 8834039
d. Examples of Transactions Not Causing Unrelated Business Taxable Income in a CRT
i) A third party using the assets of the CRT as collateral on a loan to the charitable remainderman - PLR 8807082
ii) Operation of business which receives rents from real property - PLR 9245036
iii) When the business is the donor of a CRT and the CRT sells assets of the business other than inventory and assets customarily held for the sale to customers - PLR 9340043; PLR 9413020
The value of the donor's federal income tax deduction is a function of 1) the type of charitable remainderman, 2) the kind of property contributed to the CRT, and 3) whether, at the end of the non-charitable term, the assets are a) distributed outright to the charitable remainderman or b) held in trust for the benefit of the charitable remainderman. IRC §170.
a. Public Charity Defined for This Purpose - IRC §170(b)(1)(A)(i)-(vi) & (viii).
For this purpose, a public charity includes churches, educational institutions, hospitals and medical institutions, university endowment funds, governmental units, publicly supported organizations under sections 170(c)(2) & 509(a)(2) (i.e. museums, drama companies, ballet companies, etc.), supporting organizations under section 509(a)(3), private operating foundations and two types of private foundations - distributing foundations and foundations that maintain a common fund.
b. Charitable Income Tax Deduction - Fair Market Value of Remainder Interest Subject to Applicable Percentage Limitation
The donor gets a federal income tax deduction for the fair market value of the remainder interest passing to charity subject to the following percentage limitations;
1. GIFT OF CASH AND NONAPPRECIATED PROPERTY
(a) Passes Outright to Public Charity At End of Non-Charitable Term - In year of gift, the donor's fair market value charitable income tax deduction is limited to 50% of his Adjusted Gross Income (“AGI”) with a five year carry-forward. IRC §170(b)(1)(A); Treas. Reg. §1.170A-8(a)(2).
(b) Held in Trust For the Benefit of Public Charity At End of Non-Charitable Term - In year of gift, the donor's fair market value charitable income tax deduction is limited to 30% of his AGI with a five year carry-forward. IRC §170(b)(1)(B); Treas. Reg. §1.170A-8(a)(2).
2. GIFT OF APPRECIATED PROPERTY
(a) Passes Outright to Public Charity At End of Non-Charitable Term - In year of gift, the donor's fair market value charitable income tax deduction is limited to 30% of his AGI with a five year carry-forward. IRC §170(b)(1)(C)(i); Treas. Reg. §1.170A-8(a)(2).
(b) Held
in Trust For the Benefit of Public Charity At End of Non-Charitable Term -
In year of gift, the donor's fair market value charitable income tax deduction
is limited to 20% of his AGI with a five year carry-forward. IRC §170(b)(1)(D); Treas. Reg.
§1.170A-8(a)(2). IRC §170(e), which
limits the charitable income tax deduction to the donor's adjusted basis in the
property, does not apply. This section applies in two situations as
follows: 1) as to gifts of appreciated property to a private foundation and 2) as to gifts for the use of a private foundation. IRC §170(e)(B)(ii). A gift to a CRT is not a gift to a private
foundation. Under IRC §4947(a)(2), a CRT
is made subject to the private foundation excise tax restrictions but this
section does not provide the CRT is a private foundation. Thus, the gift is not to a private foundation.
A gift to a CRT which continues as a trust at the end of the
non-charitable term for the benefit of a public charity is not a gift for the
use of a private foundation. Rather it
is a gift for the use of a public charity. See,
Treas. Reg. §1.170A-8(a)(2). However,
if, at the end of the non-charitable term, the CRT wants to not be subject to
the private foundation excise tax restrictions and private foundation reporting
requirements, it will be necessary for the trustee of the CRT to file a Form
1023 to qualify the trust as a public charity.
IRC §4947(a)(1); IRC §509(a).
This is because at that time, the trust is a private foundation unless
it can be shown to be otherwise.
a. Private Foundation Defined For This Purpose - IRC §170(b)(1)(A)(i)-(vi) & (viii).
For this purpose, private foundation is defined as all organizations other than those defined as public charities for this purpose. In other words, it includes all private foundations except 1) an operating foundation, 2) a distributing foundation and 3) a foundation that maintains a common fund.
b. Charitable Income Tax Deduction
(1) GIFT OF CASH AND NONAPPRECIATED PROPERTY
The donor gets a charitable income tax deduction in the year of the gift for the fair market value of the remainder interest passing to charity limited to 30% of his AGI with a five year carry-forward. IRC §170(b)(1)(B). This is the deduction and applicable percentage limitation regardless of whether, at the end of the non-charitable term, the assets pass outright to the private foundation or are held in trust for the benefit of the private foundation.
(2) GIFT OF LONG-TERM APPRECIATED PUBLICLY TRADED SECURITIES
On June 30, 1998, the rule lapsed which allowed the
donor to get a charitable income tax deduction in the year of the gift for the
fair market value of the remainder interest passing to charity limited to 20%
of his AGI with a five year carry-forward.
However, the deduction was revived under the Tax and Trade Relief Extension
Act of 1998 (Section 170(e)(5)(D) of the Code which created the lapse was
stricken). Unlike previous relief where
the deduction was extended (initially from
(3) GIFT OF ALL OTHER APPRECIATED PROPERTY
The donor's charitable income tax deduction is based on the donor's adjusted basis in the property contributed limited to 20% of his AGI with a five year carry-forward. IRC §170(e)(1)(B)(ii). This is the deduction and applicable percentage limitation regardless of whether, at the end of the non-charitable term, the assets pass outright to the private foundation or are held in trust for the benefit of the private foundation.
c. Planning Idea - Name as the charitable remainderman the donor's family foundation. Although the donor's income tax deduction is normally lower or limited to property's basis, this can be a technique to enable the family to retain control of the assets as the officers, directors and members of the family foundation.
- IRC §68
An individual whose AGI exceeds $100,000 (as indexed; $126,600 in 1999 for married persons filing jointly - the “Threshold Amount”) the charitable deduction for that year is reduced by the lesser of 3% of AGI in excess of the Threshold Amount or 80% of the total amount otherwise allowed as itemized deductions.
a. Qualified Appraisal
(1) WHEN MUST THE APPRAISAL BE DONE?
The qualified appraisal is required when the CRT holds unmarketable assets as defined in Treasury Regulation §1.664-1(a)(7)(ii). Unmarketable assets are assets that are not cash, cash equivalents, or other assets that can be readily sold or exchanged for cash or cash equivalents. For example, unmarketable assets include real property, closely-held stock, and an unregistered security for which there is no available exemption permitting public sale. The appraisal must be prepared no earlier than 60 days prior to the date that the contribution is made and must be prepared no later than the due date of the return (with extensions) on which the deduction is claimed. Treas. Reg. §1.170A-13(c).
(2) THE CONTENTS OF A QUALIFIED APPRAISAL - Treas. Reg. §1.170A-13(c)
(a) The appraisal must be prepared, signed, and dated by a qualified appraiser as defined below.
(b) The appraisal must include the following information:
§ A description of the property in sufficient detail for a person who is not generally familiar with the type of property to ascertain that the property that was appraised is the property that was (or will be) contributed;
§ In the case of tangible property, the physical condition of the property;
§ The date (or expected date) of contribution to the donee;
§ The terms of any agreement or understanding entered into (or expected to be entered into) by or on behalf of the donor which relates to the use, sale or other disposition of the property contributed. This includes restrictions on the donee's right to use or dispose of the donated property, all provisions which confer on anyone, other than the donee charity, the right to income from the donated property or the right to possession of the property, including voting rights to securities, a right of purchase, or a provision which earmarks the donated property for a particular use. As an added precaution, all agreement between the donor and the donee charity relating to the gift should be attached to the appraisal and incorporated into it by reference;
§ The name, address, and taxpayer identification number of the qualified appraiser and, if the qualified appraiser is a partner in a partnership, an employee of any person (whether an individual, corporation, or partnership), or an independent contractor engaged by a person other than the donor, the name, address and taxpayer identification number of the partnership or the person who employs or engages the qualified appraiser;
§ The qualifications of the qualified appraiser;
§ A statement providing that the appraisal was prepared for income tax purposes;
§ The date or dates on which the property was valued;
§ The appraised fair market value of the property on the date (or expected date) of contribution;
§ The method of valuation used to determine the fair market value, such as the income approach, the market data approach, or the replacement-cost-less-depreciation approach);
§ The specific basis for the valuation, if any, such as any specific comparable sales transactions;
§ A description of the fee arrangement between the donor and the appraiser.
(3) THE QUALIFIED APPRAISER - Treas. Reg. §1.170A-13(c)
(a) An appraiser who signs the appraisal summary upon its presentation to him by the donor. In this regard, no part of the fee arrangement for a qualified appraisal can be based, in effect, on a percentage (or set of percentages) of the appraised value of the property.
(b) To be a “qualified appraiser” the appraiser must sign and complete Internal Revenue Service Form 8283, Section B, denoted “Appraisal Summary.” The Appraisal Summary includes declarations by the appraiser that:
i) The individual holds himself or herself out to the public as an appraiser;
ii) Because of the appraiser's qualifications as described in the appraisal, the appraiser is qualified to make appraisals of the type of property being valued.
iii) The appraiser is not:
§ The donor or the taxpayer who claims or reports the deduction under §170 for the contribution of the property being appraised;
§ A party to the transaction in which the donor acquired the property being appraised (i.e. the person who sold, exchanged or gave the property to the donor, or any person who acted as an agent for the transferor or for the donor with respect to such sale, exchange or gift), unless the property is donated within two months of the date of acquisition and its appraised value does not exceed its acquisition price;
§ The donee of the property;
§ Any person employed by any of the foregoing persons or related to any of the foregoing persons under Section 267(b) (e.g. if the donor acquired a painting from an art dealer, neither the art dealer nor persons employed by the dealer can be qualified appraisers with respect to that painting);
§ Any person whose relationship with any of the persons listed in (1) through (4) above would cause a reasonable person to question the independence of such appraiser. For example, an appraiser who is regularly used by any person described in (1) through (3) above and who does not perform a substantial number of appraisals for other persons has a relationship with such person that is similar to that of an employee and cannot be a qualified appraiser with respect to the property contributed.
iv) The appraiser understands that a false or fraudulent overstatement of the value of the property described in the qualified appraisal or appraisal summary may subject the appraiser to a civil penalty under section 6701 for aiding and abetting an understatement of tax liability, and consequently the appraiser may have appraisals disregarded pursuant to 31 U.S.C. Section 330(c).
(4) WHAT IS DONE WITH THE QUALIFIED APPRAISAL, THE APPRAISAL SUMMARY, AND FORM 8283?
(a) Qualified Appraisal
The Qualified Appraisal is not required to be filed with the donor's federal income tax return. It must be kept with the donor's records.
(b) Appraisal Summary
The Appraisal Summary is required to be filed with the donor's federal income tax return.
(c) Form 8283
The original of Form 8283 must be filed with the donor's federal income tax return. The donor must keep a copy with his records.
a. Form 5227
Form 5227, Split Interest Trust Informational Return, is an informational return that must be filed annually by the trustee of the CRT.
b. Form 1041-A
Form 1041-A, Trust Federal Income Tax Return, is another informational return that must be filed by the trustee of the CRT if such trust has gross income in excess of $600.00.
c. Form 8282
Form 8282, Donee Information Return, must be filed by the trustee of the CRT if such trust sells, exchanges, or otherwise disposes of the trust assets within two years after the date the CRT received the property.
d. Form 709
Form 709, Federal Gift (and Generation Skipping Transfer Tax) Return, must be filed on April 15th of the year following the gift.
The donor gets a charitable gift tax deduction for the value of the remainder interest passing to charity. IRC §2522(a).
a. Spouse is only other Recipient of Annuity Amount or Unitrust Amount
The donor has made a gift to his spouse of the value of Annuity Amount or Unitrust Amount going to his spouse but such gift is shielded by the marital deduction if the spouse is the only other Recipient of the Unitrust Amount or Annuity Amount. IRC §2523(g). The donor also gets a charitable gift tax deduction for the value of the remainder interest passing to charity. IRC §2522(c)(2)(A).
b. Spouse and Others are Recipients of Annuity Amount or Unitrust Amount
For example, the donor, then his spouse and then their children are the Recipients. The donor has made a gift to his spouse which does not qualify for the marital deduction. IRC §2523(g). Further, the donor has made a gift to his children. However, the donor can retain the right to revoke by will his spouse's and children's rights to the Annuity Amount or Unitrust Amount without disqualifying the trust as a CRT and if so, the gifts are incomplete. Treas. Reg. §§1.664-2(a)(4); 1.664-3(a)(4); PLR 9517020; PLR 9326049. If done, the retention of the right to revoke by the donor results in the CRT assets being includable in the donor's estate at his later death. Rev. Rul. 79-243, 1979-2 C.B. 343; IRC §2038(a)(1); PLR 9326049.
The donor has made a gift to that person in the amount of the present value of the Annuity Amount or Unitrust Amount unless the donor retains the right to revoke by will that person's right to the Annuity Amount or Unitrust Amount. Again, such retention of the power to revoke causes the gift to be incomplete but causes the assets subject to the power to revoke to be includable in the donor's estate.
(a) IRC
Section 2702 Abuse
To circumvent the gift tax rules, previously a grantor would create a NIMCRUT first for a term of years for himself and then for the life of a child. Ordinarily, in such a case, the interest retained by the grantor will be valued at zero pursuant to IRC section 2702 causing the value of the grantor's gift to that other Recipient to equal the entire fair market value of the property transferred to the CRT less the present value of the remainder interest passing to charity. The Regulations under IRC §2702 included a broad exception for CRTs.
The Service has perceived an abuse whereby a NIMCRUT is used and funded with low income producing assets until the second Recipient's interest takes effect. At that time, the trustee invests in high income producing assets and the second Recipient gets the lesser of the trust's net income or the fixed percentage plus with regard to a NIMCRUT the ability to withdraw a make-up amount if the annual trust net income exceeds the fixed percentage amount thereby transferring substantial payments to the second Recipient without gift or estate tax.
(b) Final IRC §2702 Regulations
The Final Regulations amend Code Sec. 2702
regulations to limit the CRT exception to charitable remainder annuity trusts
and fixed percentage charitable remainder unitrusts. In addition, an exception is provided for a
secondary life interest in the donor.
Code Sec. 2702 will not apply to a CRT with two consecutive
noncharitable interests, where the donor has the second of the two
interests. A third exception applies
where the unitrust's distributions are permitted only to the donor, the donor's
IRC §§2036(a); 2055(e)
a. Donor was Sole Recipient
The value of the CRT assets is includable in the donor's estate but such inclusion is shielded by the estate tax charitable deduction for the value of the assets passing to charity at the donor's death.
b. Spouse is Sole Succeeding Recipient of Annuity Amount or Unitrust Amount
The value of the CRT assets is includable in the donor's estate but such inclusion is shielded by (1) the marital deduction for the value of the Annuity Amount or Unitrust Amount going to the spouse and (2) the charitable deduction for the value of the remainder interest going to charity.
c. Spouse and Others Are Succeeding Recipients of Annuity Amount or Unitrust Amount
The value of the CRT assets is includable in the donor's estate. The value of the Unitrust Amount or Annuity Amount going to the Recipients is not shielded by the marital deduction. The value of the remainder interest passing to charity is shielded by the charitable estate tax deduction.
2. DONOR WAS NOT A RECIPIENT OF ANNUITY AMOUNT OR UNITRUST AMOUNT
a. Somebody Other Than Spouse Was Recipient
The value of the CRT assets is not includable in donor's estate unless the donor retained the testamentary power to revoke such Recipient's interests. In that case, the donor's estate is entitled to a charitable estate tax deduction for the value of the remainder interest passing to charity.
IRC §§2055(c); 2036(a); & 2056(b)(8)
The value of the CRT assets is includable in the donor's estate but such inclusion is entirely shielded by the marital deduction and the charitable deduction.
IRC §§2055(c); 2036(a); & 2056(b)(8)
The value of the CRT assets is includable in the donor's estate. The value of the Annuity Amount and Unitrust Amount passing to the spouse and other recipient is not shielded by the marital estate tax deduction but the value of the remainder interest passing to charity is shielded by the charitable estate tax deduction.
IRC §§2036(a) & 2055(c)
The value of the CRT assets is includable in the donor's estate but the value of the remainder interest passing to charity is shielded by the charitable estate tax deduction.
Nonrecognition of Capital Gains
A CRT is a tax exempt entity and therefore, upon the sale of an asset, capital or otherwise, the CRT recognizes no gain. A donor can contribute highly appreciated property to a CRT and benefit from the appreciated value of the asset because the donor's Unitrust Amount from a CRUT will be greater due to such assets high value not reduced by income tax on the appreciation. The donor benefits from the appreciation and at the same time the donor avoids payment of the tax from the appreciation. The key here is to make sure that as of the date of the funding (not just creation) of the CRT that there is no legal obligation to sell such asset. The trustee must be under no legal obligation to sell the asset. If, when the trust receives the asset, the trustee is subject to an obligation to sell, the Service will ignore the gift to the CRT and treat the transaction as if the donor sold the asset. The donor then gets the worst of both worlds -- payment of tax and loss of the asset. Palmer v. Commissioner, 62 T.C. 684 (1974); Rev. Rul. 78-197, 1978-1 C.B. 83 (wherein the Service acquiesced to the position of Palmer).
Growth of Assets in a Tax Exempt Entity
Since a CRT is a tax exempt entity, the value of the assets in the CRT can grow at a faster rate because gain realized on the sale of assets of the CRT is not recognized for income tax purposes in the CRT. The Recipient of the Unitrust Amount from a CRUT gets the benefit from such growth since the fixed percentage is applied to a larger capital base.
Reduction of Assets Ultimately Passing to Donor's Family
The chief disadvantage of a CRT is that charity ultimately gets the assets in the CRT and not the donor's family. One way to curtail this disadvantage is to set up a non-estate taxable side fund for the donor's family with, among other options, an irrevocable life insurance trust. The death benefits paid to a properly structured irrevocable life insurance trust are excludable from the insured's estate and thus, the death benefits can be used as a non-estate taxable way to replace those assets going to charity in the CRT. The insured normally will pay the premium on the insurance policy through gifts to the irrevocable life insurance trust.
The trustee of an inter vivos CRT is able to sell low basis, highly appreciated marketable securities without gain recognition. IRC §664(c). The sale proceeds can then be invested to produce payments to the Recipient, usually the grantor, in the form of the Annuity Amount or Unitrust Amount. In this way, the grantor benefits from the appreciation of his securities via his Annuity Amount or Unitrust Amount but has no taxable recognition of the gain from the sale of the securities while the proceeds or that in which they are invested are held by the CRT.
If the CRT also has realized (but unrecognized) capital gains, the Recipient may still have to recognize the income therefrom upon receipt of the Annuity Amount or Unitrust Amount under the tier approach applicable to distributions to Recipients. Thus, investment by the CRT in tax free securities may not be wise unless the return to the Recipient after income tax at capital gains rates is greater than the return to the Recipient after income tax at ordinary income tax rates if the CRT investments produce ordinary income (i.e. interest, dividends, etc...).
It is not a good idea to transfer a donor's personal residence to a CRT, whether unencumbered or encumbered, because the donor cannot live in the residence without committing a prohibited act of self-dealing. Rev. Rul. 76-357, 1976-2 C.B. 285.
It is wise to use a NICRUT, a NIMCRUT or a FLIP CRUT so the trustee will not be forced to make a distribution in kind to make the distribution to the Recipient if the income of the CRT is not sufficient for the entire annual payment. If such was contributed to a CRAT or the fixed percentage CRUT, the trustee could be forced to make a distribution in kind because the trustee is required to distribute the Annuity Amount or Unitrust Amount based on the fixed percentage. A distribution of just the annual net income is not an option with the CRAT or fixed percentage CRUT.
There are problems with using encumbered real estate to fund a CRT.
None of the income of a CRT is tax exempt for a year in which the
CRT has unrelated business taxable income in excess of $1,000. Treas. Reg. §1.664(c). Debt financed income is unrelated business
income. IRC §514(a). Generally, if a CRT is funded with encumbered
real estate, it will have unrelated business taxable income.
a. Testamentary CRTs - The CRT will not have unrelated business taxable income for a period of ten years following the transfer if it does not assume the debt. IRC §514(c)(2)(B); Treas. Reg. §§1.514(c)-1(b)(3).
b. Inter
vivos CRTs - The CRT will not have unrelated business taxable income for a
period of ten years following the gift as long as (i) the debt was placed
on the property more than five years before the date of the gift; (ii) the
property was held by the donor for more than five years before making the gift;
and (iii) the CRT does not assume the debt.
A CRT is not a qualified
subchapter S shareholder and therefore, a donor cannot use subchapter S stock
to fund a CRT. Rev. Rul. 92-48, 1992-1
C.B. 301. Section 1361 which deals with
permissible shareholders of an S corporation has been amended to take effect on
The S corporation is a permissible donor of a CRT and may contribute its assets to a CRT. PLR 9340043. However, a trust will not qualify as a CRUT where the S corporation is the unitrust beneficiary for a term of years followed by an individual for the lifetime of the individual. PLR 200203034. Where the corporation is the beneficiary, the term of the CRT must be limited to a term of years not to exceed twenty. Treas. Reg. §1.664-2(a)(5) and 1.664-3(a)(5). PLR 9340043. If the CRT later sells the assets, there are several considerations.
As of the funding of the CRT, the trustee of the CRT must not have been legally bound to complete the sale. The obligation to sell must not have been entered into prior to such funding. Palmer v. Commissioner, 62 T.C. 684 (1974).
The type of assets to be sold is crucial in determining whether the CRT will have unrelated business taxable income. There are two main types of properties that will cause unrelated business taxable income if sold by the trustee of the CRT. The first type of asset that will generate unrelated business taxable income is property held primarily for sale to customers in the ordinary course of business (i.e. inventory). IRC §512(b)(5); PLR 9340043. The second type of asset that will generate unrelated business taxable income is any asset which is encumbered with debt since such asset will create debt financed income which is unrelated business taxable income. IRC §514(a). The sale of other assets by the CRT will not create unrelated business taxable income. For example, equipment and buildings (as long as not inventory) will not create unrelated business taxable income. PLR 9413020.
Regular C Corporation stock can be used to fund a CRT. However, there are several considerations.
The CRT is treated as a private foundation for most
purposes. Under Section 4943 private
foundations may not, considering the attribution rules with other disqualified
persons, own more than 35% (20% in some cases) of the voting stock of the
corporation. However, with respect to
the CRT the excess business holdings prohibition does not apply where a
deduction was allowed under sections 170, 545(b)(2), 556(b)(2), 642(c), 2055,
2106(a)(2), or 2522 for amounts payable under the terms of such trust to every
remainder beneficiary but not to any income beneficiary. IRC §4947(b)(2). Since a CRT affords a deduction under section
170, the excess business holdings prohibition does not apply as long as a
charity is not a Recipient of the Annuity Amount or Unitrust Amount.
As with all sales of assets transferred to a CRT, there must be no legal obligation to sell such assets prior to the contribution of the assets to the CRT. Supra, Palmer.
Prior to the contribution of stock to the CRT it is necessary to explore the relationship between the donor and the corporation; a family member of the donor and the corporation; and, between other donor corporations and corporation whose stock is gifted. There are several traps within the self-dealing rules which could create a prohibited act of self-dealing. Examples of the traps include a sale or exchange or leasing of property between a CRT and a disqualified person (unless it is without charge) IRC § 4941(d)(1)(A) and (2)(A); lending of money or other extension of credit between a CRT and a disqualified person (unless no interest is charged) IRC § 4941(d)(1)(B) and (2)(B). If the donor of the stock continues to own, considering attribution, after the gift to the CRT more than 35% (20% in some cases) of the voting stock of the corporation, the corporation cannot redeem the stock because this is prohibited self-dealing. However, if the offer to redeem is made on identical terms to all other shareholders who own the same class of stock, such redemption is specifically excepted from the self-dealing rules. IRC §4941(d)(2)(f); Treas. Reg. §53.4941(d)-3(d).
The sale of the stock itself will not create unrelated business taxable income. IRC §512(b)(5). Any income received as dividends from the stock will not create unrelated business taxable income. IRC §512(b)(1).
In PLR 200043047, the Service ruled that a charitable remainder unitrust could participate in a limited liability company. Under this ruling, two individuals created fifteen charitable remainder unitrusts. Each unitrust was for the benefit of a particular child or grandchild. The family also established an LLC to coordinate family investments. The fifteen 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, this percentage is expected to decline. The LLC will be a disqualified person with respect to each unitrust. Additionally, the LLC elected to be treated as a partnership for tax purposes. The IRS ruled that (1) the CRT's participation in an LLC fund (including deposits and withdrawals) will not be a (sale or exchange) between the LLC and the CRUT pursuant to the self-dealing rules of IRC § 4941(d)(1)(a); (2) the CRUT's participation in an LLC fund (including deposits and withdrawals) will not be a “transfer to, or use by or for the benefit of, a disqualified person of the income or assets of a private foundation” pursuant to the self-dealing rules of IRC § 4941(d)(1)(E); and (3) the CRUT's reimbursement to the LLC of investment expenses incurred because of the CRUT's participation in an LLC fund will not be self-dealing given that these payments will be for personal services, reasonable and necessary for the carrying out of the CRUT's exempt purpose, as long as the amounts are not excessive.
In PLR 9240017, the Service ruled that an option could be an asset used to fund a CRT and the Annuity Amount or Unitrust Amount would be based on the value of the contract right to purchase the donor's property at the purchase price provided in the option. The Service further ruled that the grantor would not recognize gain or loss on the assignment of the option to a third party.
In a situation where a donor would like to fund a CRT with an asset but such asset cannot be used to fund the CRT, such as with subchapter S stock, the donor would fund the CRT with an option to purchase the “bad” asset.
In PLR 9417005, the Service withdrew PLR 9240017 without explanation. The Service stated that “no inference should be made from [the]...withdrawal as to the proper tax treatment of the transfer to a CRT of an option to purchase property.”
In PLR 9501004, the Service ruled that the transfer of an option to a CRT disqualified the trust as a CRT. The Service's rationale was that 1) the gift of an option is incomplete; and 2) an income tax charitable deduction is not allowable for the option. The result of such is that a CRT funded with an option fails to function exclusively as a CRT from its inception disqualifying the trust as a CRT.
Qualified Retirement Plan benefits can be used to fund a CRT.
The assets are withdrawn from the qualified plan causing income taxation. However, if the assets withdrawn are contributed to a CRT, an income tax charitable deduction will also be allowed in that year based on the value of the remainder interest passing to charity.
There would be no estate tax by naming an intervivos or testamentary CRT as the beneficiary of the plan benefits at the plan participant's death. The participant's surviving spouse would be the Recipient of the Annuity Amount or Unitrust Amount with the remainder passing to charity. The participant's estate would be entitled to both a marital and charitable deduction for the value of the qualified plan benefits made payable to the CRT.
a. Qualification of Trust as a CRT
Designating a CRT as the beneficiary of retirement plan benefits will not disqualify the trust from being a CRT. PLR 9253038; PLR 9237020.
b. Is a CRT a Designated Beneficiary of Qualified Plan Benefits?
A trust is a designated beneficiary of a qualified retirement plan if as of the later of the date on which the trust is named as a beneficiary or the participant's required beginning date (April 1 of the year following attainment of the age 70 ½) and as of all subsequent periods during which the trust is named as a beneficiary, the following requirements are met: (1) it is a valid trust under state law (or would be but for the fact that there is no corpus), (2) it is irrevocable or will, by its terms, become irrevocable upon the death of the participant, (3) the trust has only identifiable individual beneficiaries and (4) a copy of the trust document is given to the plan administrator. A copy of the trust document must be provided to the plan administrator before his required beginning date and the participant must agree that if the trust document is later amended, the participant will, within a reasonable time, provide the plan administrator with a copy of the amendment. If the participant dies before required beginning date, the trustee of the trust must provide a copy of the trust document to the plan administrator by the end of the ninth month beginning after the participant's date of death. Prop. Reg. §1.401(a)(9)-1, Q&A D-5. However, when a trust has multiple beneficiaries, all of the beneficiaries must qualify as designated beneficiaries. Prop. Reg. §1.401(a)(9)-1, Q&A E-5 & H-2(b). A charity is not a designated beneficiary. Prop. Reg. §1.401(a)(9)-1, Q&A D-2, D-5 & D-6. Thus, a CRT will not qualify as a designated beneficiary.
(1) EFFECT
The effect of the CRT not qualifying as a designated beneficiary is that the distribution of the plan benefits will be accelerated to a term of either five years (if the death of the participant is before the required beginning date) or the life expectancy of the participant (if the death of the participant is after the required beginning date) causing accelerated income realization. However, since a CRT is tax exempt, such acceleration is irrelevant.
c. Income Tax Consequences
(1) TO RECIPIENT OF ANNUITY AMOUNT OR UNITRUST AMOUNT
The Recipient will have recognizable income as the Recipient of the Annuity Amount or Unitrust Amount.
(2) PLAN PARTICIPANT'S ESTATE TAX RETURN
The decedent's (who was the plan participant) estate tax return will reflect a charitable estate tax deduction in the amount of the value of the remainder interest passing to charity resulting in more of the estate ultimately passing to heirs.
A life insurance policy may be used to fund an intervivos CRT. PLR 8745013. This would be advantageous if the goal of the donor is to provide income for his or her surviving spouse for such survivor's lifetime. However, several issues need to be considered.
The CRT must preclude the use of the income of the trust to pay the premiums on a life insurance policy on the life of the donor or the donor's spouse. If income is used, the trust is a grantor trust and such will disqualify the trust as a CRT. IRC §§677(a)(3) & 664(c). There are two ways around this rule:
a. Use CRT Principal to Pay Premiums
Be careful how you define “income” for this purpose. Income includes capital gains for federal
income tax purposes. IRC §61. However,
generally, income does not include capital gains for trust accounting
purposes. For example, under
b. Allocate Amounts Received to Principal in a CRUT - Lesser of Income Form
A CRT that pays premiums on a life insurance policy will not be a
grantor trust if (i) a NIMCRUT or NICRUT is used, and (ii) the
amounts received on account of the insurance policy are allocated to
principal. PLR 9227017. Since the Unitrust Amount is limited to
income and the amounts received are allocated to principal, the amounts
received will be a part of the remainder payable to charity.
In PLR 8745013, the Service ruled that borrowing by the trustee from the cash value of an insurance policy caused unrelated business income.
A life insurance policy could be a jeopardy investment under Section 4944 if the investment in the premium by the CRT outweighs the death benefit to be received by the CRT. In Rev. Rul. 80-133, a donor-insured donated a life insurance policy to a private foundation. The donor-insured had a ten year life expectancy. The private foundation began paying the premiums. The Service ruled that each payment by the private foundation was a jeopardizing investment because at the end of 8 years, the investment by the private foundation would have been greater than the death benefit under the policy. The Service stated “an investment shall be considered to jeopardize the carrying out of the exempt purpose of a private foundation if it is determined that the foundation managers, in making such investment, have failed to exercise ordinary business care and prudence,...in providing for the long-term and short-term financial needs of the foundation to carry out its exempt purpose. In the requisite standard of care and prudence the foundation managers may take into account the expected return of an investment and the need for diversification within the investment portfolio. Rev. Rul. 80-133, 1980-1 C.B. 258.
In PLR 9547022, an individual sold his stock in a company to an employee stock ownership trust under an employee stock ownership plan sponsored by that firm. The individual reinvested the sale proceeds in qualified replacement property (“QRP”) and deferred gain under Section 1042. The individual proposed to transfer a portion of that QRP to a CRUT he established. Because no gain is realized on the transfer of the QRP to the trust, the Service ruled that the contribution to the CRUT will not cause a recapture of gain previously deferred under Section 1042.
A CRT may be funded with partnership interests and the general partner may be the trustee of the CRT.
The initial funding of a CRT with partnership interests when the Trustee of the CRT is the general partner of the partnership is not an act of self dealing. PLR 9633007. However, any other transactions must be carefully scrutinized under the self-dealing rule to ensure no violation.
The sale of the partnership, itself, will not create unrelated business taxable income. IRC §512(b)(5). If the partnership engages in an unrelated trade or business, the net income in excess of $1,000 from such unrelated trade or business flowing through to the CRT will be unrelated business taxable income. IRC §§512(a) & 512(b)(12). If the unrelated trade or business generates rents from real property, such is not unrelated business taxable income, unless such property is debt financed. IRC §§512(b)(3) & 512(b)(4).
The excess business holding prohibition does not apply to CRTs so long as a charity is not a Recipient of the Unitrust Amount or Annuity Amount. IRC §4947(b)(3).
The Proposed Regulation stated that the Service was studying the effect of a NICRUT or NIMCRUT funded with partnership interests when the general partner in control of the partnership distributions is the trustee of the CRUT. The Service does not like the general partner of the partnership, also the trustee of a CRUT, having the discretionary power to make partnership distributions thus, having the discretionary power to make the payment of the Unitrust Amount to the Recipient. The Final Regulations do not include any mention of this issue, so it is not clear whether the Service has reached any conclusion one way or the other on this issue. However, in PLR 200043047 the Service did approve numerous family CRTs investment in a limited liability company (to be treated as a partnership for tax purposes). There was no mention whether or not the CRTs were NIMCRUTs or NICRUTs.
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I. Grantor Trust Avoidance
A. Non-Exclusive Listing of Items Which Can Cause the Imposition of the Grantor Trust Rules
The following is a nonexclusive list of items which can cause the grantor of a trust being taxed on the income of the trust:
1. Grantor Is Personally Liable on a Debt of Property Contributed to Trust.
Under IRC §677(a) and Treas. Reg. §1.677(a)-1(d), the CRT has been held to be a grantor trust if the grantor remains personally liable on a debt on property contributed to a CRT. PLR 9015049.
2. The Trustee of a CRT is Able to Buy Life Insurance with the “Income” of the CRT on the Life of the Donor or the Donor's Spouse
Under IRC §677(a)(3), the CRT has been held to be a grantor trust if the trustee is not precluded from using “income” of the trust to purchase life insurance on the life of the grantor or the grantor's spouse. It is crucial to define “income” for this purpose as defined for federal income tax purposes in order to prohibit the trustee from using capital gains to purchase a life insurance policy. In PLR 8839008, the Service ruled that although the trustee was prohibited from using income for trust accounting purposes, the trustee was not prohibited from using income for tax purposes. Thus, the trustee, purchased a life insurance policy with corpus for trust accounting purposes and income for tax purposes. The trust was held to be a grantor trust. All CRTs, even if not funded with life insurance policies, should prohibit the trustee from using income, as defined for federal income tax purposes, to buy a policy on the life of the grantor or the grantor's spouse.
B. List of Items that Have Not Caused Imposition of Grantor Trust Rules
The following is a nonexclusive list of items which the Service has ruled will not cause a CRT to be a grantor trust.
1. Grantor's retention of right to change charitable remainderman - PLR 9504012; Rev. Rul. 76-8, 1976-1 C.B. 179
2. Grantor's retention of right to terminate all or a portion of the trust corpus accelerating distribution to charity - PLR 9442017
3. Grantor's acting as trustee - PLR 9504012
4. Grantor's
retention of right to remove and replace trustee -
5. Grantor's retention of investment authority over trust except to the extent of valuing those assets having no readily ascertainable fair market value - PLR 9442017
6. Grantor or grantor's spouse as Recipient of Annuity Amount or Unitrust Amount - PLR 9504012
(NOT PROVIDED IN THIS OUTLINE)
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