Friday, April 26, 2024
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GiftLaw Note: Several years ago, Husband and Wife created a two-life charitable remainder unitrust. The CRUT pays income to them jointly and, upon the death of either of them, then to the survivor for life. Husband and Wife are now in the process of obtaining a divorce and propose dividing their CRUT into two separate CRUTs. The terms of the newly divided CRUTs would be identical to the original trust except there would be two one-life CRUTs instead of a two-life CRUT. Further, the newly divided CRUTs would each hold 50% of the current trust principal. Taxpayers request a ruling that the division of their CRUT will not disqualify the trusts or subject them to penalties under the private foundation rules.

In general, Sec. 4947 states that charitable trusts are subject to the private foundation rules. Sec. 4941 imposes a tax on acts of self-dealing between disqualified persons and charitable trusts. Reg. 53.4947 -1(c)(2) provides that income payments from a CRUT are not subject to Sec. 4941. In this case, Husband and Wife receive a unitrust payment before and after the division. Moreover, the Service stated that there would be no increase in the unitrust payment at the expense of the charitable interest. Thus, there are no acts between the parties other than the receipt of a unitrust income stream. Therefore, the Service concluded that the division of the trust would not be an act of self-dealing. Finally, because the terms of the newly created trusts were identical to the original CRUT, the Service concluded that the newly created trusts would qualify as CRUTs under Sec. 664.

Editor's Note: From time to time Crescendo revisits "Classic" Private Letter Rulings that address topics of significance to planned giving. This letter ruling is such a "Classic" letter ruling. It offers a reminder that in the unfortunate situation of a divorce, it is possible to separate the trust into two. In this situation, it is best that the division occur through the divorce proceedings when the other assets are being divided. If the trust is not separated, it could cause estate tax complications upon the death of the first recipient. This is because there is an income stream being paid to someone who is no longer a spouse and, therefore, the marital deduction no longer applies.
This letter responds to a letter dated August 21, 2000, written on behalf of Trust, requesting the following rulings regarding a proposed division of Trust, a charitable remainder unitrust, into two separate trusts, Trust A and Trust B, each of which will also comply with the requirements under section 664 of the Internal Revenue Code:

1) The proposed division of Trust into Trust A and Trust B will not cause Trust, Trust A, or Trust B to fail to qualify as charitable remainder trusts under section 664;

2) The proposed division of Trust into Trust A and Trust B will not terminate Trust's status as a trust described in, and subject to, the private foundation provisions of section 4947(a)(2), and will not result in the imposition of an excise tax under section 507(c);

3) Trust A and Trust B will not be treated as newly created organizations. The aggregate tax benefits of Trust under section 507(d) will carry over to Trust A and Trust B in proportion to the amount of Trust's assets transferred to Trust A and Trust B, subject to any liability which Trust has under Chapter 42 of the Code to the extent not already satisfied by Trust;

4) The proposed division of Trust into Trust A and Trust B will not be an act of self-dealing under section 4941;

5) The proposed division of Trust into Trust A and Trust B will not be a taxable expenditure under section 4945; and

6) If reasonable in amount, the legal and other expenditures incurred by Trust to effect the proposed division of Trust will not be self-dealing under section 4941, or taxable expenditures under section 4945.

FACTS


On Date 1, A and B, who were then husband and wife, established Trust. Trust provides for quarterly unitrust payments to be made to A and B in equal proportions during their joint lifetimes, and after the death of either of them, wholly to the survivor during his or her lifetime. A and B each have the power, exercisable only by his or her last will or codicil, to terminate the right of the surviving settlor in the deceased settlor's one-half share in the unitrust amount. After the death of the surviving settlor, the Trust assets will be distributed to a charitable organization described in sections 170(c), 2055(a), and 2522(a). It is represented that Trust satisfies the requirements under section 664(d)(2).

A and B are in the process of obtaining a divorce and propose dividing Trust into two separate charitable remainder unitrusts -- Trust A for the benefit of A and Trust B for the benefit of B. The terms of each of Trust A and Trust B are identical to the terms of Trust, except for the following:

1) Trust A and Trust B will each hold 50 percent of the trust principal and any undistributed income of Trust;

2) A will be the sole income beneficiary and sole trustee of Trust A, with the power to appoint and remove successor trustees and to designate the charitable remainder beneficiary;

3) B will be the sole income beneficiary and sole trustee of Trust B, with the power to appoint and remove successor trustees and to designate the charitable remainder beneficiary;

4) The name of the contingent charitable beneficiary, Foundation, will be changed to reflect the organization's new name, and

5) The provisions regarding the valuation of unmarketable assets will be revised to conform with section 1.664-1(a)(7) of the Income Tax Regulations, which was promulgated after execution of Trust.

LAW AND ANALYSIS


RULINGS 2 THROUGH 6


Section 4946(a)(1)(A) defines the term "disqualified person" to include a substantial contributor to the foundation.

Section 4946(a)(1)(D) together with section 4946(d) define the term "disqualified person" to include a spouse of a substantial contributor, among others.

Section 4947(a)(2) describes trusts not exempt from federal income tax under section 501(a), not all of the unexpired interests in which are devoted to purposes in section 170(c)(2)(B), and which have amounts in trust for which a deduction was allowed under sections 170, 545(b)(2), 556(b)(2), 642(c), 2055, 2106(a)(2), or 2522, as split interest trusts, and provides that sections 507, 508(e) (to the extent applicable), 4941, 4943 (with exception), 4944 (with exception), and 4945 shall apply as if such trusts were a private foundation.

Section 507(a) provides that except as provided in section 507(b), a private foundation may terminate its private foundation status only under the specific rules set forth in section 507(a).

Section 507(b)(2) provides that in the case of transfer of assets of any private foundation to another private foundation pursuant to any liquidation, merger, redemption, recapitalization, or other adjustment, organization or reorganization, the transferee foundation shall not be treated as a newly created organization.

Section 507(c), in substance, imposes a tax equal to certain defined amounts.

Section 507(d), in substance, defines the term "aggregate tax benefit" which term is used in section 507(c) as one means to measure the section 507(c) tax.

Section 1.507-1(b)(6) provides that if a private foundation transfers all or part of its assets to one or more other private foundations pursuant to a transfer described in section 507(b)(2), such transferor foundation will not have terminated its private foundation status under section 507(a)(1).

Section 1.507-3(c)(1) provides, in part, that for purposes of section 507(b)(2), the term "other adjustment, organization or reorganization" shall include any partial liquidation or any other significant disposition of assets to one or more private foundations.

Section 1.507-3(c)(2)(ii) provides, in substance, that the term a "significant disposition of assets" means the transfer of 25 percent or more of the net assets of the foundation at the beginning of the year, which disposition may be made in a single year or in a series of related dispositions over more than one year.

Sections 1.507-3(a)(1) and (2) provide, in substance, that in the transfer of assets from one private foundation to one or more private foundations in a section 507(b)(2) transfer, each transferee private foundation shall not be treated as a newly created organization, but shall succeed to the transferor's aggregate tax benefit within the meaning of section 507(d).

Section 1.507-4(b) provides that the excise tax on termination of private foundation status under section 507(c) does not apply to a transfer of assets pursuant to section 507(b)(2).

Section 4941 imposes an excise tax on any act of self- dealing between a private foundation and any disqualified person defined under section 4946.

Section 4945 imposes an excise tax on a private foundation's making any taxable expenditure under section 4945(d).

Although split interest trusts are not section 501(c)(3) or section 4947(a)(1) private foundations that are exclusively charitable, they are subject to section 507 termination rules that are appropriate. Section 4947(a)(2) subjects split interest trusts to the provisions of section 507. Section 507(b)(2) is applicable to the division of the Trust. Since the Trust will transfer all of its net assets equally to Trust A and Trust B, under section 1.507-1(b)(6), the Trust will not have terminated its private foundation status under section 507(a)(1). Accordingly, the excise tax imposed under section 507(c) is not applicable to it.

The transfer of all of the Trust's assets, under the prevailing divorce proceedings, to Trust A and Trust B will qualify as transfers meeting the requirements of sections 1.507-3(c)(1) and (c)(2)(ii). Accordingly, under section 1.507-3(a)(1), Trust and Trust B will not be treated as newly created private foundations. Further, such trusts shall, under section 1.507-3(a)(2)(i) succeed to aggregate tax benefit of the transferor organization, the Trust, on a pro rata basis determined by fair market value of the assets.

The only interest that either A or B had in the Trust was the payment of the unitrust amount under the provisions of section 664(d)(2). They have each exchanged a one-half interest in a unitrust payment in the Trust for a full unitrust payment in a trust having fewer assets, one-half of the assets of the Trust prior to its division. Thus, they are likely to receive more or less the same unitrust payment as before. However it makes no difference for purposes of section 4941 whether either one or both is receiving more or less of a unitrust payment after the division of the Trust assets. Section 53.4947-1(c)(2) of the Foundation and Similar Excise Taxes Regulations provides, in substance, that the amounts payable under charitable remainder split-interest trusts to the income beneficiaries are not subject to section 4941 (or section 507 or section 4945). Thus, the disqualified persons are insulated from self-dealing as far as each of their income interests in the Trust are concerned based on the fact that the unitrust payment is the same before and after the division of the Trust. Since neither of the disqualified persons receive any interest in the assets of the trust principal, no self-dealing transaction has occurred within the meaning of section 4941(d).

The trust principal remains preserved for charitable interests. There has been no increase in the unitrust amount at the expense of the charitable interest. Any expenses paid pursuant to the division of the Trust, assuming such expenses are reasonable, are justified as necessary to carry out trust purpose to facilitate the smooth functioning and operation of the trusts which was likely not possible under the prevailing divorce proceedings. There are no other transactions with the income beneficiaries that affect the trust principal. Accordingly, again no self-dealing transaction has occurred.

Based on the same analysis as applied in the two preceding paragraphs, no taxable expenditure has occurred under section 4945. See also section 53.4945-6(b)(2). Further, under sections 1.507-3(a)(7) and (9), the Trust will not be required to exercise "expenditure responsibility" under sections 4945(d) and (h) with respect to the assets transferred to Trust A and Trust B. The Trust will dispose of all of its assets within the meaning of section 1.507-3(a)(7) and Trust A and Trust B will be controlled by the same persons who controlled the Trust within the meaning of section 1.507-3(a)(9).

CONCLUSIONS


After applying the relevant law to the information provided and the representations made, we conclude the following:

1. The proposed division of Trust into Trust A and Trust B will not cause Trust, Trust A, or Trust B to fail to qualify as charitable remainder trusts under section 664;

2. The proposed division of Trust into Trust A and Trust B will not terminate Trust's status as a trust described in, and subject to, the private foundation provisions imposed on split-interest trusts under section 4947(a)(2), and will not result in the imposition of an excise tax under section 507(c);

3. Trust A and Trust B will not be treated as newly created organizations. Trust A and Trust B shall succeed to the aggregate tax benefit of Trust defined by section 507(d) in proportion to the fair market value of the assets transferred to Trust A and Trust B;

4. The proposed division of Trust into Trust A and Trust B will not be an act of self-dealing under section 4941;

5. The proposed division of Trust into Trust A and Trust B will not be a taxable expenditure under section 4945; and

6. If reasonable in amount, the legal and other expenditures incurred by Trust to effect the proposed division of Trust will not be self-dealing under section 4941 nor a taxable expenditure under section 4945.

CAVEATS


Except as specifically set forth above, no opinion is expressed concerning the federal tax consequences of the facts described above under any other provision of the Code. Specifically, no opinion is expressed concerning whether Trust qualifies as a charitable remainder trust under section 664 or whether Trust A or Trust B each will qualify as a charitable remainder trust under section 664.

This ruling is directed only to the taxpayer who requested it. Section 6110(k)(3) provides that it may not be used or cited as precedent.

Under a power of attorney on file with this office, we are sending a copy of this letter to Trust.

Sincerely yours,

Mary Beth Collins
Senior Technician Reviewer, Branch 3
Office of the Associate Chief Counsel
(Passthroughs and Special Industries)

Related Topics On Divorcing Taxpayers Allowed to Split Their Two-Life CRUT

3.10.8  Unitrust Reformations:    Due to the complexity of the mandatory and optional provisions and the difficulty counsel have had in drafting charitable remainder trusts with all of the required provisions, Congress created a provision for reformation of charitable remainder trusts. The reformation provision is intended to facilitate the proper creation and operation of charitable remainder trusts. There are two main categories of trusts that may be reformed -- the "intended to comply" trust and the trust with a charitable remainder but little or no other language in compliance with the Code and Regulations.



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