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Sunday, April 28, 2024
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Case Studies |
In-Kind Distributions to Charity and the Reverse Four-Tier, Part 2 of 2
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Case:
Jim Thompson, a retired engineer, and his spouse Logan Thompson, a retired nurse, are currently considering funding a term-of-years charitable remainder unitrust with Americans for the Arts charity. Americans for the Arts is raising money for the construction of a new building that would house a state-of-the-art theater and museum. The Thompsons are active investors and have amassed quite a large stock portfolio over the past few years. In particular, they have investments in numerous established medical technology companies that have quadrupled in value over the past several years. They would like to use $800,000 of stocks with a cost basis of $100,000 to fund a five-year CRUT with a 15% payout. However, they believe these companies are great investments with acceptable risk and prefer that the trustee of the CRUT not sell off these stocks. Instead, the Thompsons would like their CRUT payouts to be the actual stock, an in-kind distribution, as opposed to cash payouts.
While the charity will receive the trust principal in five years, the Thompsons also want the flexibility to make discretionary distributions to Americans' for the Arts during that five year term in the event such funds are needed for construction. Since the trust assets would be the original contributed technology stock, the distributions to the American's for the Arts would be an in-kind distribution, as opposed to cash payouts.
Question:
Can the Thompsons maintain flexibility and make in-kind distributions to the charity during the five-year term? What are the tax consequences to the CRUT and the charity of such a transaction?
Solution:
First, per Reg. 1.664-3(a)(4), the governing instrument may provide that any amount (other than the unitrust amount) shall or may be paid to an organization described in Sec. 170(c). For example, the trust document may provide that a portion of trust assets may be distributed currently. Thus, the Thompsons' attorney will add the appropriate provision and thereby enable the Thompsons to make annual grants to charity. This concept was approved in PLR 9550026.
Second, with respect to the trust, no gain or loss is realized due to the discretionary in-kind distribution under Reg. 1.664-1(e)(2). However, the trustee must still determine the character of the distribution. Reg. 1.664-1(e)(1) mandates the use of a reverse four-tier accounting system. Specifically, the distribution will be considered to come first from corpus; second from other income; third from capital gains; and finally from ordinary income. Implicit in this regulation, the IRS is limiting a donor's ability to make distributions to charity from taxable tiers; thereby, potentially reducing the eventual taxable income payable to the donors. Finally, Reg. 1.664-3(a)(4) requires the adjusted basis of the property distributed to be fairly representative of the adjusted basis of the property available for payment on the date of payment.
In the end, the Thompsons are pleased to know that they will have the flexibility to make current distributions to Americans for the Arts if they so desire and that such distributions will not have adverse tax consequences to them or their CRUT.
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