Thursday, April 25, 2024
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GiftLaw Note: Under the four-tier structure of IRC Sec. 664, payments are first ordinary income, then capital gain, then other or tax free and then return of principal. In this ruling, the taxpayer desired tax-free income and planned to obtain that by funding the trust with municipal bonds. Since the trust would have no ordinary income and recognize no capital gains, the distributions would be third-tier tax-free income. While the Service did not expressly approve the plan to distribute tax-free income, it stated that this would be a qualified trust, even though it invests in tax-free bonds. Trustees should also note that state prudent investor laws can impact this investment strategy.
This is in reply to your ruling request of August 8, 1983, submitted by your authorized representative concerning the character of the aforementioned Trust and the Federal gift and income tax consequences to the Taxpayer for the year in which the Trust is funded. The specific rulings sought are:
  1. That the Trust qualifies as a charitable remainder annuity trust within the meaning of section 664 of the Internal Revenue Code;
  2. That Taxpayer is entitled to an income tax deduction in the year the Trust is funded for the fair market value of the charitable remainder interest; and
  3. That the Taxpayer in computing his taxable gifts for the calendar year in which the Trust is funded, is entitled to a gift tax deduction for the value of the charitable remainder interest.
The information submitted indicates that on * * * the Taxpayer, as settlor, created a charitable remainder annuity trust (Trust). The Taxpayer-settlor is an * * * year old male who is not in the business of trading stocks and bonds. The Trust is to be funded with municipal bonds having face value of $485,000.00. The bonds are general obligation bonds bearing 9 1/4% interest due July 1, 1996 with interest payable January 1 and July 1 of each year until the maturity date. Taxpayer will have held the bonds for less than one year at the time they are transferred to the Trust.

Pursuant to the provisions of the Trust, the Trustee shall pay to the Taxpayer during the latter's life an annuity amount of $44,862.50. The annuity amount shall be paid in equal semiannual installments from income, and, to the extent that income is not sufficient, form corpus. Any income of the Trust for a taxable year in excess of the annuity shall be added to corpus. Upon the Taxpayer's death the Trustee shall distribute all of the corpus and income, other than any amount due the Taxpayer, free of trust to X which is represented to be an organization described in sections 170(c), 170(b)(1)(A), 2055(a) and 2522(a) of the Code or to organizations that are then so described. X is not a private foundation described in section 509(a) of the Code. The subject Trust is irrevocable and unamendable.

Based on the information and documents submitted, we conclude that the provisions of the governing instrument will meet the requirements of a charitable remainder annuity trust under section 664 of the Code, provided that the Trust so created is a valid trust under applicable local law.

Accordingly, the Trust will qualify as a charitable remainder annuity trust for Federal income tax purposes, for any year in which it continues to meet the definition of, and functions exclusively as, a charitable remainder trust. For such year(s), the Trust will be exempt from taxes imposed by subtitle A of the Code unless it has any unrelated business taxable income as defined in section 512 of the Code and the regulations applicable thereto.

Annuity amounts in the hands of the recipient, will be treated as having the characteristics provided in section 664(b) of the Code and section 1.664-1(d)(1) of the Income Tax Regulations.

Section 170 of the Code provides, subject to certain limitations, a deduction for contributions and gifts to or for the use of organizations described in section 170(c), payment of which is made within the taxable year.

Section 170(f)(2)(A) of the Code provides that in the case of property transferred in trust, no deductions shall be allowed under this section for the value of a contribution of a remainder interest unless the trust is a charitable remainder annuity trust or a charitable remainder unitrust described in section 664.

Section 1.170A-1(c)(1) of the Income Tax Regulations provides that if a charitable contribution is made in property other than money, the amount of the contribution is the fair market value of the property at the time of the contribution.

Section 1.170A-6(b)(2) of the regulations provides, in part, that the fair market value of a remainder interest in a charitable remainder annuity shall be computed under section 1.664-2 of the regulations.

Section 170(e)(1) of the Code provides that the amount of any charitable contribution of property otherwise taken into account under this section shall be reduced by the amount of the gain that would not have been long-term capital gain if the property contributed had been sold by the taxpayer at its fair market value (determined at the time of the contribution).

We conclude that the transfer of the subject bonds to the Trust is deductible by the Taxpayer as a charitable contribution in that manner and to the extent provided by sections 170(b)(1) and 170(e)(1) of the Code.

Section 2501 of the Code provides for a gift tax on the transfer of property by gift. Section 2511 of the Code provides that the gift tax imposed by section 2501 shall apply whether the gift is direct or indirect, and whether the property is real or personal, tangible or intangible.

Section 2522 of the Code and the regulations thereunder provide that in computing taxable gifts for a calendar year, a charitable deduction is allowed for the present value of the remainder interest in a qualified charitable remainder annuity trust, funded during such year.

Since the Trust described complies with the provision of Code section 664, we conclude that a charitable deduction is allowable for the present value of the remainder interest passing to a charity within the meaning of section 2522(a). In this connection, section 25.2522(c)-3(d)(2)(i) of the Gift Tax Regulations provides that the fair market value of a remainder interest in a charitable remainder annuity trust is its present value as determined under section 1.664-2(c) of the Income Tax Regulations. Section 1.664-2(c) of the regulations states that, for purposes of Code section 2522, the fair market value of the remainder interest in a charitable remainder annuity trust is the net fair market value of the property placed in trust (valued as of the appropriate valuation date) less the value of the annuity. The present value of an annuity dependent on the continuation or termination of the life the Taxpayer is computed as provided in section 20.2031-10(a)(2) of the Estate Tax Regulations which refers to Table A(1) of section 20.2031-10(f). This table applies regardless of the actual yield of the property placed in the Trust.

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

A copy of this letter should be associated with your federal gift tax return, when filed.

Pursuant to the power of attorney on file in this office a copy of this letter is being furnished to your authorized representative. Very truly yours, E.L. Kennedy Chief, Specialty Tax Branch WD 84-8-06.0

Related Topics On Municipal Bonds in Charitable Trust

3.1.10  Income, Gift, Estate and GSTT:    The donor to a charitable remainder annuity trust will receive an income tax deduction equal to the present value of the remainder interest. It is calculated using the applicable federal rate for the current month or one of the prior two months, as permitted under Sec. 7520.


3.10.10  Investments of Unitrust Corpus:    One of the major decision points when creating a charitable remainder trust (CRT) is developing an investment strategy. Under the four-tier accounting rules, the type of income paid out of the trust is determined by the trust investments.


3.10.2  Four-Tier Accounting:    Unitrust payouts are one of the most important areas for the advisor to communicate to the recipient. With a charitable remainder trust, the basic payout rule is that the unitrust percentage is multiplied times the trust value and that amount is then distributed. The distribution may be monthly, quarterly, semiannually or annually.


8.2.2  CRT Payouts and Four-Tier Accounting:    Payouts from charitable remainder trusts (CRTs) are taxable to most recipients. However, the taxable amount and the tax rate of these payouts may vary greatly from year to year. Because of this uncertainty, it is very difficult to predict the exact amount of tax that a CRT beneficiary will owe each year.



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