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Thursday, April 18, 2024
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GiftLaw Pro |
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GiftLaw Note:
Lead trusts are usually divided into two categories - grantor lead trusts with a current income tax deduction and return of the assets to the grantor and family, or non-grantor, lead trusts with the trust remainder distributed to family members. This lead trust creatively combines both concepts. Through use of the Sec. 675(4) power to substitute assets, it is a grantor trust, but it does not under Sec. 2036 require inclusion in the grantor's estate.
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This letter is in reply to a letter dated August 8, 1991, and subsequent correspondence, submitted by your authorized representative, requesting rulings concerning the establishment of a charitable lead unitrust. Specifically, the rulings requested are: (1) the Grantor will be treated as the owner of the entire trust for purposes of section 671 of the Internal Revenue Code; (2) the Trust will qualify as a charitable lead unitrust for purposes of the income tax and gift tax charitable deductions under section 170(f)(2)(B) and 2522(c)(2)(B); (3) the Grantor will be entitled to deduct, for federal income tax purposes, the value of the unitrust interest under section 170(f)(2); (4) no portion of the Trust's assets will be includible, for federal estate tax purposes, in the gross estate of the Grantor; and (5) no portion of the Trust's assets will be includible, for federal estate tax purposes, in the gross estate of the Grantor's spouse.
The Trust is intended to qualify as a charitable lead unitrust under sections 170(f)(2)(B) and 2522(c)(2)(B) of the Code. The governing instrument provides that, in each taxable year of the Trust, the trustee will pay to C a unitrust amount equal to eight percent of the net fair market value of the Trust's assets, valued as of the first day of each taxable year. If, at any time during the term of the Trust, C is not an organization described in sections 170(c), 2055(a), and 2522(a), the trustee will distribute the unitrust amount to a qualifying charitable organization selected by the trustee. The governing instrument provides that the interest of the charitable organization shall not be subject to commutation.
During the term of the Trust, the governing instrument provides that A shall have the right at any time to acquire any property held in the Trust by substituting other property of equivalent value. Such right is exercisable in a non-fiduciary capacity, without the approval or consent of any person acting in a fiduciary capacity. It has been represented that A is neither a trustee of the Trust nor an adverse party within the meaning of section 672(a) of the Code.
If A exercises the power of substitution, the governing instrument provides that A shall certify in writing that the substituted property is of equivalent value to the property for which it is substituted and the trustee may independently verify such certification of value. Any dispute regarding the value of the substituted assets may be resolved in an appropriate judicial forum.
The governing instrument provides that the Trust will terminate 10 years from the date it is created. Upon termination, the remainder interest will be transferred to the Grantor's daughter, if surviving, or to her estate, if not surviving. However, the remainder interest is subject to divestment by the Grantor's husband if he exercises a special power of appointment over the remainder. The Grantor's husband has a limited power exercisable during his lifetime to appoint any or all of the remainder among any of his surviving issue.
Since the formation of C in 1969, the Grantor and her husband have served as officers and as trustees. The Grantor's two children have also served as officers and trustees in recent years. The Grantor resigned as vice-president and as trustee of C, effective August 5, 1991. Her daughter, husband, and son now serve as president, vice-president, and treasurer, respectively.
ISSUE 1
Section 671 of the Code provides the general rule that if the grantor is treated as the owner of any portion of a trust, his taxable income and credits shall include those items of income, deduction, and credits against tax of the trust that are attributable to that portion of the trust to the extent that such items would be taken into account in computing the taxable income or credit against tax of an individual.
Section 1.671-3(b) of the Income Tax Regulations provides that if a grantor is treated as the owner of a portion of a trust, that portion may or may not include both ordinary income and other income allocable to corpus. Section 1.671-3(b)(3) provides that if the grantor is treated as an owner under section 675 of the Code because of a power over corpus, then the grantor includes both ordinary income and other income allocable to corpus in the portion he is treated as owning.
Section 675(4) of the Code provides that the grantor shall be treated as the owner of any portion of a trust in respect of which a power of administration is exercisable in a nonfiduciary capacity by any person without the approval or consent of any person in a fiduciary capacity. For purposes of section 675(4), the term "power of administration" includes a power to reacquire the trust corpus by substituting other property of an equivalent value.
Section 1.675-1(a) of the regulations provides that the grantor is treated as the owner of any portion of a trust if, under the terms of the trust instrument or circumstances attendant on its operation, administrative control is exercisable primarily for the benefit of the grantor rather than the beneficiaries of the trust. Section 1.674-1(b) provides that circumstances that cause administrative controls to be considered exercisable primarily for the benefit of the grantor include the existence of certain powers of administration exercisable in a nonfiduciary capacity by any nonadverse party without the approval or consent of any person in a fiduciary capacity. Such a power of administration includes a power to reacquire the trust corpus by substituting other property of an equivalent value.
The governing instrument gives A the power, without the consent or approval of any person in a fiduciary capacity, to acquire the Trust's assets by substituting assets of equivalent value. Thus, based on the information submitted and the representations made, we conclude that the Grantor will be treated as the owner of the entire trust under section 675 of the Code. Accordingly, all items of income, deductions, and credits against tax of the trust must be taken into account in computing the Grantor's income under section 671.
ISSUE 2
Section 170(f)(2)(B) of the Code provides that no charitable contribution deduction is allowed for the value of any interest in property (other than a remainder interest) transferred in trust unless the interest is in the form of a guaranteed annuity or the trust instrument specifies that the interest is a fixed percentage distributed yearly of the fair market value of the trust property (to be determined yearly) and the grantor is treated as the owner of the interest for purposes of applying section 671.
Section 1.170A-6(c)(2)(ii)(A) of the regulations provides that an income interest is a "unitrust interest" only if it is an irrevocable right pursuant to the governing instrument of the trust to receive payment, not less often than annually, of a fixed percentage of the net fair market value of the trust assets, determined annually.
Section 2522(a) of the Code provides generally that a gift tax charitable deduction is allowable in the case of a gift to a trust provided the gift is to be used exclusively for the purposes enumerated in section 2522(a)(2). Under section 2522(c)(2)(B) of the Code, where an interest in property (other than an interest described in section 170(f)(3)(B)) passes or has passed from a donor to a person, or for a use, described in section 2522(a) or (b), and an interest in the same property is retained by the donor or is transferred or has been transferred (for less than an adequate and full consideration in money or money's worth) from a donor to a person, or for a use, not described in section 2522(a) or (b), no deduction shall be allowed for the interest which is, or has been transferred to the person, or for the use, described in section 2522(a) or (b) unless, in the case of any interest other than a remainder interest, such interest is in the form of a guaranteed annuity or is a fixed percentage distributed yearly of the fair market value of the property (to be determined yearly).
The governing instrument specifies that the interest paid to the charitable organization is a fixed percentage distributed yearly of the fair market value of the trust property determined as of the first day of each taxable year of the trust. The terms of the governing instrument prohibit the trustee from making any unitrust payments to an organization that is not described in sections 170(c), 2055(a), and 2522(a) of the Code. Thus, a charitable organization has an irrevocable right to receive the unitrust payments.
Because the Grantor is treated as the owner of the entire trust for purposes of applying section 671 of the Code, we conclude that the Trust qualifies under section 170(f)(2)(B) as a charitable lead unitrust. In addition, because the unitrust interest comes within the meaning of section 2522(c)(2)(B), the fact that the interest is a split interest will not result in the disallowance of the gift tax charitable deduction. Therefore, a deduction under section 2522(a) will be allowed in an amount equal to the present value of the unitrust interest valued as of the date of the transfer of the property to the trust.
ISSUE 3
Section 1.170A-6(c)(3)(ii) of the regulations provides that the deduction allowed under section 170(f)(2)(B) of the Code for a charitable contribution of a unitrust interest is limited to the fair market value of the unitrust interest on the date of contribution. The fair market value of the unitrust interest is determined by subtracting the present value of all interests in the transferred property other than the unitrust interest from the fair market value of the transferred property.
Because the Trust qualifies under section 170(f)(2)(B) of the Code as a charitable lead unitrust, the Grantor will be able to deduct for federal income tax purposes the fair market value of the unitrust interest on the date of the contribution, subject to the applicable limitations of section 170.
ISSUE 4
Section 2033 of the Code provides that the value of the gross estate shall include the value of all property to the extent of the interest therein of the decedent at the time of his death.
Under section 2035(a) of the Code, except as provided in section 2035(b), the value of the gross estate shall include the value of all property to the extent of any interest therein of which the decedent has at any time made a transfer, by trust or otherwise, during the 3-year period ending on the date of the decedent's death.
Section 2035(b) of the Code provides that section 2035(a) shall not apply --
(1) to any bona fide sale for an adequate and full consideration in money or money's worth, and
(2) to any gift to a donee made during a calendar year if the decedent was not required by section 6019 (other than by reason of section 6019(2)) to file any gift tax return for such year with respect to any gifts to such donee. Paragraph (2) shall not apply to any transfer with respect to a life insurance policy.
Section 2035(d) of the Code provides in relevant part that:
(1) Except as otherwise provided in this section 2035(d), section 2035(a) shall not apply to the estate of a decedent dying after December 31, 1981.
(2) Section 2035(d)(1) and section 2035(b)(2) shall not apply to a transfer of an interest in property which is included in the value of the gross estate under section 2036, 2037, 2038, or 2042 or would have been included under any of such sections if such interest had been retained by the decedent.
Section 2036(a) of the Code provides that the value of the gross estate shall include the value of all property to the extent of any interest therein of which the decedent has at any time made a transfer (except in the case of a bona fide sale for an adequate and full consideration in money or money's worth), by trust or otherwise, under which he has retained for his life or for any period not ascertainable without reference to his death or for any period which does not in fact end before his death --
(1) the possession or enjoyment of, or the right to income from, the property, or
(2) the right, either alone or in conjunction with any person, to designate the persons who shall possess or enjoy the property or the income therefrom.
Rev. Rul. 72-552, 1972-2 C.B. 525, holds that the value of inter vivos transfers to a charitable corporation is includible in the estate of the donor under section 2036 of the Code where the donor, as president of the corporation at the time of and subsequent to the transfers, retained power over the disposition of its funds.
Section 2037(a) of the Code provides that the value of the gross estate shall include the value of all property to the extent of any interest therein of which the decedent has at any time after September 7, 1916, made a transfer (except in case of a bona fide sale for an adequate and full consideration in money or money's worth), by trust or otherwise if --
(1) possession or enjoyment of the property can, through ownership of such interest, be obtained only by surviving the decedent, and
(2) the decedent has retained a reversionary interest in the property (but in the case of a transfer made before October 8, 1949, only if such reversionary interest arose by the express terms of the instrument of transfer), and the value of such reversionary interest immediately before the death of the decedent exceeds five percent of the value of such property.
Section 2038(a)(1) of the Code provides, in the case of transfers after June 22, 1936, that the value of the gross estate shall include the value of all property to the extent of any interest therein of which the decedent has at any time made a transfer (except in case of a bona fide sale for an adequate and full consideration in money or money's worth), by trust or otherwise, where the enjoyment thereof was subject at the date of his death to any change through the exercise of a power (in whatever capacity exercisable) by the decedent alone or by the decedent in conjunction with any other person (without regard to when or from what source the decedent acquired such power) to alter, amend, revoke, or terminate, or when any such power is relinquished during the 3-year period ending on the date of the decedent's death.
Section 2041(a)(2) of the Code provides in relevant part that the value of the gross estate shall include the value of all property with respect to which the decedent has at the time of his death a general power of appointment created after October 21, 1942, or with respect to which the decedent has at any time exercised or released such a power of appointment by a disposition which is of such nature that if it were a transfer of property owned by the decedent, such property would be includible in the decedent's gross estate under sections 2035 to 2038, inclusive.
Section 2041(b)(1)(A) of the Code defines the term "general power of appointment" to mean a power which is exercisable in favor of the decedent, his estate, his creditors, or the creditors of his estate; except that a power to consume, invade or appropriate property for the benefit of the decedent which is limited by an ascertainable standard relating to the health, education, support, or maintenance of the decedent shall not be deemed a general power of appointment.
Section 2042 of the Code provides generally that the value of the gross estate shall include all amounts receivable as insurance on the life of the decedent.
The Grantor will not retain an interest in any of the property transferred to the Trust. Therefore, no part of the trust property will be includible in her estate under section 2033 of the Code.
The Grantor will not retain the right to receive any of the trust income or to designate the persons who will enjoy any of the trust income. Rev. Rul. 72-552 is distinguishable from the instant case because here the Grantor resigned as an officer and trustee of C prior to the formation of the Trust. Therefore, assuming that at no time in the future will Grantor occupy a position from which she can designate, either alone or in conjunction with any other person, the persons who shall possess any of the C's funds or enjoy any of the income therefrom, no part of the trust property will be includible in her gross estate under section 2036 of the Code.
The Grantor will not retain a reversionary interest in any of the trust property. Therefore, no part of the trust property will be includible in her estate under section 2037 of the Code.
The Grantor will not retain a power to amend or revoke any interest transferred by her in connection with the funding of the trust. Therefore, no part of the trust property will be includible in her estate under section 2038 of the Code.
The Grantor will not retain a power over the transferred property exercisable in favor of herself, her estate, her creditors or the creditors of her estate. Therefore, no part of the trust property will be includible in her estate under section 2041 of the Code.
The property transferred to the Trust by the Grantor will not include amounts receivable as insurance on her life. Therefore, no part of the trust property will be includible in her estate under section 2042 of the Code.
In view of the fact that no part of the trust property will be includible or would have been includible in the Grantor's estate under any of sections 2036, 2037, 2038, or 2042 of the Code, no part of the trust property will be includible under section 2035.
Therefore, we conclude that no part of the trust property will be includible in the Grantor's estate under any of sections 2033, 2035, 2036, 2037, 2038, 2041, or 2042 of the Code.
ISSUE 5
The Grantor's husband is the donee of a special lifetime power of appointment over the trust principal. The power of appointment is not a general power of appointment, as defined in section 2041(b)(1)(A) of the Code, because it is not exercisable in favor of the Grantor's husband, his estate, his creditors or the creditors of his estate. Therefore, the existence of the power, and the exercise or release of the power, will not cause the trust principal to be included in the estate of the Grantor's husband under section 2041.
In addition, assuming that none of the assets used to fund the trust were transferred to the Trust (either directly or indirectly) by the Grantor's husband, the provisions of sections 2033, 2036 and 2038 of the Code will not apply to the Grantor's husband.
Therefore, we conclude that no part of the trust property will be includible in the estate of the Grantor's husband under any of sections 2033, 2036, 2038, or 2041 of the Code.
Section 5.03 of Rev. Proc. 92-1, 1992-1 I.R.B. 9, provides that the estate tax rulings are based on the facts and applicable law in effect on the date of this letter. If there is a change in material fact or law (local or federal) before the death of the Grantor or the Grantor's husband, the estate tax rulings will have no force or effect. If the Grantor is in doubt whether there has been a change in material fact or law, a request for reconsideration of this ruling should be submitted.
Except as specifically ruled on above, no opinion is expressed on the federal tax consequences of the transaction under any provision of the Code.
This ruling is directed only to the taxpayer on whose behalf it was requested. Section 6110(j)(3) of the Code provides that it may not be used or cited as precedent.
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