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Thursday, April 18, 2024
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GiftLaw Pro |
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GiftLaw Note:
In PLR 9442017, several powers were approved for inclusion in the trust. First, so long as the trustee has no discretion to allocate income among recipients, under Reg. 1.664-3(a)3(ii) there is no problem with the retention of a right to appoint a successor trustee, including one of the trust grantors.
In states that have passed the Uniform Principal and Income Act, a trustee of many trusts may be given the power to allocate capital gains to distributable income or to principal. However, effective Jan. 2, 2004, a charitable remainder unitrust under Reg. 1.664-3(a)(1)(i)(b)(3) is precluded from permitting the trustee to have a purely discretionary power to allocate capital gain. The unitrust drafter may now allocate all recognized capital gain to income, no recognized capital gain to income or a fixed fractional part of gain to income. An alternative to permit discretionary distribution of capital gain is to place the unitrust assets in a partnership or single-member LLC. When a trust payout is desired, recognized capital gains are distributed from the partnership or LLC to the unitrust, and then to the income recipients.
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This responds to a letter from your authorized representative dated November 10, 1993, as supplemented March 9 and May 24, 1994, in which he asks us on your behalf to rule on the qualification of Trust as a charitable remainder unitrust under section 664 of the Internal Revenue Code.
According to section 4.01(39) of Rev. Proc. 94-3, 1994-1 I.R.B. 79, the Service ordinarily will not rule on whether a charitable remainder trust that provides for annuity or unitrust payments for one or two measuring lives satisfies the requirements described in section 664 of the Code. In addition, according to sections 4.01(16), (44), and (46) of Rev. Proc. 94-3, the Service ordinarily will not rule on whether a transfer to a charitable remainder trust described in section 664 that provides for annuity or unitrust payments for one or two measuring lives qualifies for charitable deductions under sections 170(f)(2)(A), 2055(e)(2)(A), and 2522(c)(2)(A).
In lieu of seeking the Service's advance approval of a charitable remainder unitrust, taxpayers are directed to follow the sample provisions for charitable remainder unitrusts outlined in Rev. Proc. 90-31, 1990-1 C.B. 539 The Service will recognize as meeting all of the requirements of a charitable remainder unitrust any trust substantially following one of the sample forms of trust in Rev Proc 90-31, provided that the trust operates in a manner consistent with the terms of the instrument creating the trust and provided it is a valid trust under applicable local law For transfers to a qualifying charitable remainder unitrust, the present value of the remainder interest will be deductible under sections 170(f)(2)(A), 2055(e)(2)(A), and 2522(c)(2)(A) if the charitable beneficiary otherwise meets all of the requirements of these sections.
Taxpayers, however, have submitted a trust agreement with substantive provisions not included in, or different from, the sample provisions outlined in Rev. Proc. 90-31 or Rev. Rul 72-395, 1972-2 C.B. 340, as modified by Rev. Rul. 80-123, 1980-1 C.B. 205, and Rev. Rul. 82-128, 1982-2 C.B. 71, and clarified by Rev. Rul. 82-165, 1982-2 C.B. 117 Therefore, we will rule on whether these substantive modifications disqualify Trust as a charitable remainder unitrust under section 664 of the Code, if it is otherwise qualified.
FACTS
Taxpayers are husband and wife. They will establish Trust, to be governed by the trust agreement and the laws of State. Trust is intended to qualify as a charitable remainder unitrust for federal tax purposes.
Taxpayer A will contribute approximately a shares of Company to Trust. Taxpayers may make additional contributions to Trust.
Charity, an organization exempt from tax under section 170(c) of the Code, will act as trustee of Trust. However, Taxpayers retain the right to remove Charity as trustee, without cause, and to appoint as successor trustee any individual or entity, including themselves.
The unitrust amount to be paid to Taxpayers is limited to Trust's net income. If Trust's net income exceeds 7 percent of Trust's net fair market value, the trustee will apply the excess to any deficiencies in prior year unitrust payments resulting from the net income limitation.
The trustee will pay the unitrust amount to Taxpayers in equal shares for their joint lives, and then to the survivor for the survivor's life Trust will terminate at the survivor's death, and the trustee will pay the charitable remainder to organizations described in sections 170(c), 2055(a), and 2522(a) of the Code.
Taxpayer A, as investment manager, retains the right to direct the investment of all trust assets, except for those having no readily ascertainable market value. Taxpayer A expects to invest some of the assets of Trust in Partnership.
Taxpayer A is a general partner of Partnership. He also is a managing director and employee of Firm, a registered investment advisor that provides all investment advice and management to Partnership invests funds received from its partners. Partnership pays Firm a quarterly fee of .25 percent of the market value of Partnership and reimburses Firm for certain expenses up to .50 percent of the year-end market value of Partnership. Taxpayer A is compensated by Firm for his work in connection with the investment advice and management services Firm provides Partnership. Partnership interests are valued quarterly and may be withdrawn quarterly after 30 days notice.
In addition to ruling that the provisions of the trust agreement not contained in Rev. Proc. 90-31 or Rev. Rul. 72-395, as modified and clarified, will not disqualify Trust as a charitable remainder unitrust (Ruling Request 1), Taxpayers have asked us to rule that the investment of trust assets in Partnership at the direction of Taxpayer A or B acting as the investment manager of Trust will not disqualify Trust as a charitable remainder unitrust (Ruling Request 2).
LAW & ANALYSIS
RULING REQUEST 1
Paragraph 13 of the trust agreement allows Taxpayers to terminate the appointment of the trustee and to appoint a successor trustee, which may be one or both of Taxpayers.
Section 1.664-1(a)(4) of the Income Tax Regulations provides that, in order for a trust to be a charitable remainder trust, it must meet the definition of and function exclusively as a charitable remainder trust from the creation of the trust Solely for purposes of section 664 and the regulations thereunder, the trust will be deemed to be created at the earliest time that neither the grantor nor any other person is treated as the owner of the entire trust under subpart E, part 1, subchapter J, chapter 1, subtitle A of the Code (relating to grantors and others treated as substantial owners), but in no event prior to the time property is first transferred to the trust. For purposes of the preceding sentence, neither the grantor nor his spouse shall be treated as the owner of the trust under such subpart E merely because the grantor or his spouse is named as a recipient.
Section 1.664-3(a)(3)(ii) of the regulations provides that a trust is not a charitable remainder unitrust if any person has the power to alter the amount to be paid to any named person other than an organization described in section 170(c) of the Code if such power would cause any person to be treated as the owner of the trust, or any portion thereof, if subpart E, part 1, subchapter J, chapter 1, subtitle A were applicable to such trust.
Section 674(a) of the Code provides that the grantor shall be treated as the owner of any portion of a trust in respect of which the beneficial enjoyment of the corpus or income therefrom is subject to a power of disposition exercisable by the grantor or a nonadverse party, or both, without the approval or consent of any adverse party. Rev. Rul. 77-285, 1977-2 C.B. 213, holds that an otherwise qualifying charitable remainder trust that authorizes the grantor to remove the trustee for any reason and substitute any person, including himself, is not disqualified under section 664 of the Code as long as the trustee has no discretion to allocate the specified distribution between beneficiaries.
The trust agreement provides for the distribution to Taxpayers of a fixed unitrust amount. The trustee has no discretion to allocate this amount between Taxpayers. This provision complies with section 1.664-3(a)(3)(ii) of the regulations. Therefore, the authority of Taxpayers under paragraph 13 of the trust agreement to terminate the appointment of the trustee and to appoint a successor trustee, including one or both of themselves, does not disqualify Trust as a charitable remainder unitrust, if it is otherwise qualified.
Paragraph 14 of the trust agreement appoints first Taxpayer A, then Taxpayer B, as the investment manager of Trust and gives the investment manager authority to direct the investment of trust assets (other than assets having no readily ascertainable market value).
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 this paragraph, the term "power of administration" includes a power to control the investment of the trust funds either by directing investments or reinvestments, or by vetoing proposed investments or reinvestments, to the extent that the trust funds consist of stocks or securities of corporations in which the holdings of the grantor and the trust are significant from the viewpoint of voting control.
Section 1.675-1(b)(4) of the regulations provides that, if a power is exercisable by a person as trustee, it is presumed that the power is exercisable in a fiduciary capacity primarily in the interests of the beneficiaries. This presumption may be rebutted only by clear and convincing proof that the power is not exercisable primarily in the interests of the beneficiaries. If a power is not exercisable by a person as trustee, the determination of whether the power is exercisable in a fiduciary or a nonfiduciary capacity depends on all the terms of the trust and the circumstances surrounding its creation and administration.
The trust agreement provides that Taxpayer A for life, then Taxpayer B for life, shall serve as the investment manager of Trust, with the authority to designate others to direct trust investments or to direct the trustee to make certain investments. The investment manager may direct the investment of trust assets in specific partnerships, pooled funds, common trust funds, or mutual funds which may be managed by the investment manager. The investment manager may direct the investment of trust assets in specified publicly traded stocks and bonds. The only limit to this investment authority, other than the stipulation that it be exercised in a fiduciary capacity, is the provision in paragraph 15 of the trust agreement for an independent investment manager to determine the value and direct the investment of trust assets having no readily ascertainable fair market value. These investment provisions are very broad and could involve the investment of trust funds in stocks or securities of corporations in which the holdings of the grantor and the trust are significant from the viewpoint of voting control. Therefore, only the circumstances surrounding the administration of Trust will determine whether the investment manager holds a power of administration within the meaning of section 675(4) of the Code or whether such a power is held in a fiduciary capacity. This is a question of fact, the determination of which must be deferred until the federal income tax returns of the parties involved have been examined by the office of the appropriate District Director. Therefore, we can not determine at this time whether the authority of the investment manager under paragraph 14 of the trust agreement to direct the investment of trust assets disqualifies Trust as a charitable remainder unitrust.
Paragraph 15 of the trust agreement provides for the appointment of an independent investment manager meeting the qualifications of an "independent" trustee under section 674(c) of the Code, to value and direct the investment of assets having no readily ascertainable market value. The legislative history of section 664 of the Code (Tax Reform Act 1969) indicates that Congress--
contemplated that a charitable contribution deduction would be denied where assets which do not have an objective, ascertainable market value, such as real estate or stock in a closely held corporation, are transferred in trust, unless an independent trustee is the sole party responsible for making the annual determination of value.
H.R. Rep. No. 413 (Part 1), 91st Cong., 1st Sess. 60 (1969); reprinted 1969-3 C.B. 200, 239.
The trust agreement provides for the appointment of an independent investment manager whenever Trust holds any asset not having a readily ascertainable fair market value, such as the stock of a closely held corporation The independent investment manager has sole authority to value these assets and to determine whether, and under what terms, to dispose of these assets. The independent investment manager is required to be an "independent trustee", as that term is used in section 674(c) of the Code. These provisions do not conflict with any of the regulations under section 664 (the requirement for an independent trustee to value trust assets having no readily ascertainable market value is not specifically incorporated in the section 664 regulations). However, the provisions are very broad and could involve the investment of trust funds in stocks or securities of corporations in which the holdings of the grantor and the trust are significant from the viewpoint of voting control. Therefore, only the circumstances surrounding the administration of Trust will determine whether the independent investment manager holds a power of administration within the meaning of section 675(4) of the Code or whether such a power is held in a fiduciary capacity. This is a question of fact, the determination of which must be deferred until the federal income tax returns of the parties involved have been examined by the office of the appropriate District Director. Therefore, we can not determine at this time whether the authority of the independent investment manager under paragraph 15 of the trust agreement to direct the investment of trust assets having no readily ascertainable market value disqualifies Trust as a charitable remainder unitrust.
Paragraphs 8 and 21 of the trust agreement permit the trustee to distribute Trust assets to charitable organizations during the lines of Taxpayers only with the consent of Taxpayers or the survivor. Under section 1.664-3(a)(4) of the regulations, the governing instrument of a charitable remainder unitrust may provide that any amount other than the unitrust amount may be paid in the discretion of the trustee to an organization described in section 170(c) of the Code provided that, in the case of distributions in kind, the adjusted basis of the property distributed is fairly representative of the adjusted basis of the property available for payment on the date of payment.
The trust agreement provides for the distribution of trust assets at any time to qualified charitable organizations. If trust assets are distributed in kind, the adjusted basis of this property must be fairly representative of the adjusted basis of all trust property available for distribution at the time of distribution. These provisions comply with section 1.664-3(a)(4) of the regulations. The additional requirement that any such distribution be made only with the consent of Taxpayers is nor in conflict with these regulations. See section 3.04, Rev. Rul. 72-395, 1972-2 C.B. 340. Therefore, the authority of the trustee under paragraphs 8 and 21 of the trust instrument to make accelerated distributions to charity does not disqualify Trust as a charitable remainder unitrust, if it is otherwise qualified.
Paragraph 9 of the trust agreement allows the trustee to make a reasonable allocation to income from capital gains received by Trust on assets that produced limited or no income for the time Trust owned them.
Section 643(b) of the Code provides that, for purposes of this subpart and subparts B, C, and D, the term "income", when not preceded by the words "taxable", "distributable net", "distributed net", or "gross", means the amount of income of the estate or trust for the taxable year determined under the terms of the governing instrument and applicable local law. Items of gross income constituting extraordinary dividends or taxable stock dividends which a fiduciary, acting in good faith, determines to be allocable to corpus under the terms of the governing instrument and applicable local law shall not be considered income.
The trustee's authority to allocate receipts and expenses between income and principal is governed by the State Principal and Income Act. In general, capital gains are allocated to principal. However, this act provides an exception:
A person making an outright gift or establishing a trust may make provision in the creating instrument for the manner of ascertainment of income and principal and the apportionment of receipts and expenditures or grant discretion to the personal representative or trustee to do so and the provision, where not otherwise contrary to law, controls notwithstanding sections 30-3101 to 30-3115.
Neb. Rev. Stat. section 30-3101 (Reissue 1989). Thus, a trustee in State may allocate capital gains on unproductive assets to income if the trust agreement specifically authorizes the trustee to do so. See In Re Johnson Trust, 320 N.W. 2d 466 (Neb. 1982).
Section 674(b)(8) of the Code provides that subsection (a) shall not apply to a power, regardless of by whom held, to allocate receipts and disbursements as between corpus and income, even though expressed in broad language.
The trust agreement provides for the allocation to income of some or all of the capital gains received by Trust on the sale or other disposition of any stock, bond, or other security that provided no or limited income during the period it was owned by Trust. This provision complies with section 674(b)(8) of the Code and is permitted by State law. Therefore, the authority of the trustee under paragraph 9 of the trust instrument to make reasonable allocations between income and principal of any gains from the disposition of unproductive assets does not disqualify Trust as a charitable remainder unitrust, if it is otherwise qualified.
RULING REQUEST 2
Paragraph 14 of the trust agreement appoints first Taxpayer A, then Taxpayer B, as the investment manager of Trust and gives the investment manager authority to direct the investment of trust assets (other than assets having no readily ascertainable market value). In his capacity as investment manager for Trust, Taxpayer A anticipates directing the substantial investment of trust assets in Partnership. Partnership interests are valued and withdrawable quarterly. With the exception of securities of controlled companies, the market value of the partnership assets is computed on the basis of objective standards. Securities of controlled companies are valued in good faith by the general partners, based upon their judgment. Unless the securities of controlled companies make up a significant share of Partnership assets, these assets will not be considered assets having no readily ascertainable value.
As a trust described in section 4947(a)(2) of the Code, Trust is subject to chapter 42 of the Code, including the following sections: section 4941, relating to taxes on self dealing; section 4943, relating to taxes on excess business holdings, except as provided in subsection (b)(3); section 4944, relating to investments which jeopardize charitable purposes, except as provided in subsection (b)(3); and section 4945, relating to taxes on taxable expenditures.
If Taxpayers are allowed a deduction under section 170 of the Code with respect to transfers to Trust, then sections 4943 and 4944 are not applicable to the Trust by virtue of section 4947(b)(3).
Taxpayers represent that they will never charge or accept any fees, charges, or other benefits from Trust in respect of their services as investment manager for Trust. Accordingly, these services come within the exception provided in section 4941(d)(2)(C) of the Code, which states that the furnishing of goods, services, or facilities by a disqualified person to a private foundation shall not be an act of self-dealing if the furnishing is without charge and if the goods, services, or facilities so furnished are used exclusively for section 501(c)(3) purposes. In the event that Taxpayers do receive compensation for their services in the future, it will not constitute an act of self-dealing as long as the amount thereof is reasonable. See section 4941(d)(2)(E) of the Code and sections 53.4941(d)-3(c), Example (2), and 53.4941(d)-2(c)(4) of the Foundation and Similar Excise Tax Regulations.
Section 4945(d)(5) of the Code provides that the term "taxable expenditure" means any amount paid or incurred by a private foundation for any purpose other than one specified in section 170(c)(2)(B). Section 53.4945-6(b)(1) of the regulations provides that the following types of expenditures ordinarily will not be treated as taxable expenditures under section 4945(d)(5): (i) expenditures to acquire investments entered into for the purpose of obtaining income or funds to be used in furtherance of purposes described in section 170(c)(2)(B); and (ii) reasonable expenses with respect to these investments. Assuming that Trust will make such investments, then it should not incur any taxable expenditures under section 4945.
Section 512(b)(1) of the Code provides that dividend and interest income is excluded from the definition of "unrelated business taxable income." Assuming that the income generated by Trust's investment activity is passive in nature, then Trust, if it was subject to the unrelated trade or business provisions, would not have any unrelated business taxable income.
RULINGS
Based solely on the facts as presented in this ruling request, and viewed in light of the applicable law and regulations, we rule as follows:- Except for paragraphs 14 and 15, the provisions of the trust agreement not contained in Rev. Proc. 90-31 (paragraphs 8, 9, 13, and 21), will not disqualify Trust as a charitable remainder unitrust under section 664 of the Code, if it is otherwise qualified. Regarding paragraphs 14 and 15 of the trust agreement, if the circumstances surrounding the administration of Trust indicate that either the investment manager or the independent investment manager holds a power of administration within the meaning of section 675(4) of the Code and that such a power is held in a nonfiduciary capacity, then Taxpayers will be treated as the owner of the entire Trust and Trust will not be deemed created for purposes of section 664. Thus, Trust would not qualify as a charitable remainder unitrust under section 664.
- The investment of trust assets in Partnership at the direction of Taxpayer A or B acting as the investment manager of Trust will not disqualify Trust as a charitable remainder unitrust under section 664 of the Code. However, if the circumstances surrounding the administration of Trust indicate that the investment manager holds a power of administration within the meaning of section 675(4) of the Code and that such a power is held in a nonfiduciary capacity, then Taxpayers will be treated as the owner of the entire Trust and Trust will not be deemed created for purposes of section 664. Thus, Trust would not qualify as a charitable remainder unitrust under section 664.
No opinion is expressed or implied as to any other provisions of the trust agreement or as to the federal tax consequences of the formation and operation of Trust under any other provisions of the Code. Specifically, no opinion is expressed as to whether Trust qualifies as a charitable remainder trust under section 664.
A copy of this letter should be attached to the federal income tax return of Taxpayers for the tax year in which Trust is formed. A copy of this letter is enclosed for that purpose.
In accordance with the power of attorney on file with this office, we are sending a copy of this letter to your authorized representative.
This ruling is directed only to the taxpayer who requested it According to section 6110(j)(3) of the Code, this ruling may not be cited or used as precedent.
Sincerely,
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FRANCES D. SCHAFER
Senior Technician Reviewer, Branch 3
Office of Assistant Chief Counsel
(Passthroughs and Special Industries)
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