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Friday, April 19, 2024
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GiftLaw Pro |
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GiftLaw Note:
A lead trust makes distribution of either a fixed amount or a fixed percentage to charity for a period of time, usually a term of years. After all payments have been completed, the remainder is distributed either back to the grantor or to family. This lead trust will make distribution to charities for a 10-year term, with the remainder to family. The service noted that the trust would not be a grantor trust, and since there would not be unrelated business income, all distributions to charity would qualify for a deduction on the annual trust income tax return. Furthermore, there will be a charitable gift tax deduction for the value of the income transferred to charity and it will be permissible for the children serving as trustees to select the charities.
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This is in response to your letter dated October 9, 1995, and prior submissions in which you request rulings concerning the income and gift tax consequences of the creation of a proposed charitable lead annuity trust.
You represent that the taxpayer proposes to create an irrevocable trust intended to qualify as a charitable lead annuity trust. The term of the proposed charitable lead period will be 10 years. The trustees of the trust will pay annually to various charitable beneficiaries a guaranteed annuity in an amount to be determined as of the creation date of the trust. The amount will be no less than 6 percent nor more than 8 percent of the value of the initial trust corpus. The annuity amount is to be paid first from ordinary income (including short-term capital gains) which is not unrelated business income, then in the following order 50 percent of the unrelated business income, the long-term capital gains, the balance of the unrelated business income, the tax-exempt income, any accumulated income, and the trust principal.
The trustees of the trust will be the children of the donor. The charitable beneficiaries of the trust must be organizations described in sections 170(b)(1)(A), 170(c), 2055(a), and 2522(a) of the Internal Revenue Code. The trustees are required to distribute the annuity payments to one or more organizations described in those sections as selected by the trustees. During the term of the trust, no payment may be made to any person other than organizations described in those Code sections.
The terms of the trust do not allow the trustees to engage in acts of self-dealing as defined in section 4941(d), to make any taxable expenditures as described in section 4945(d), to retain any excess business holdings as defined in section 4943, or to make distributions that would subject the trust to tax under section 4942. In addition, the terms of the trust provide that the trustees shall not acquire or retain any assets which, if acquired by the trustees, would give rise to a tax under section 4944. No additional contributions may be made to the trust after the initial contribution.
At the termination of the charitable lead period of the proposed trust, the remaining corpus and income of the trust will be distributed to the taxpayer's then-living issue per stirpes.
You request that we rule as follows:- The taxpayer will not be considered the owner of the proposed trust under sections 673 through 677.
- The payment of the annual guaranteed annuity amount to organizations described in sections 170(b)(1)(A), 170(c), 2055(a), and 2522(a) will be deductible for income tax purposes by the proposed charitable lead annuity trust to the extent that the payments are made from trust income
- A portion of the contribution by the taxpayer to the proposed charitable lead annuity trust will be eligible for a charitable gift tax deduction under section 2522(a).
- The trust property will not be includible in the gross estate of the taxpayer under sections 2033, 2035 through 2038, or 2041, if the taxpayer should die during the charitable lead term of the trust.
ISSUE 1 (TAXPAYER AS OWNER OF THE TRUST)
Section 671 provides the general rule that if the grantor is treated as the owner of any portion of a trust, the grantor's taxable income and credits shall include those items of income, deductions, 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 taxable income or credits against the tax of an individual.
Sections 673 through 677 specify the circumstances under which the grantor is treated as the owner of all or a portion of a trust.
In the present case, our examination of the trust agreement reveals none of the circumstances that would cause the grantor to be treated as the owner of any portion of the trust under sections 673, 676, or 677.
Section 674(a) provides the general rule 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 the 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. Section 674(b)(4) provides that section 674(a) shall not apply to a power to determine the beneficial enjoyment of the corpus or the income therefrom if the corpus or income is irrevocably payable for a purpose specified in section 170(c).
Section 1.674(a)-1(b) of the Income Tax Regulations provides that the grantor is treated as the owner of a portion of a trust if the grantor or a nonadverse party or both has a power to dispose of the beneficial enjoyment of the corpus or income unless the power is one described in section 1.674(a)-1(b)(1) through section 1.674(a)-1(b)(3). Pursuant to section 1.674(a)-1(b)(1)(iii), the power to choose between charitable beneficiaries or to affect the manner of their enjoyment of a beneficial interest will not cause the grantor to be treated as an owner of a portion of the trust.
In the present case, the trustees have the power to choose the charitable organizations that will receive the annual annuity payments. A power held by nonadverse parties to choose between charitable beneficiaries comes within the exception of section 674(b)(4) and thus does not cause the grantor to be treated as the owner of any portion of the trust.
Section 675 and the regulations thereunder treat the grantor as the owner of any portion of a trust if under the terms of the trust agreement or circumstances attendant on its operation, administrative control is exercised primarily for the benefit of the grantor rather than the beneficiary of the trust.
The terms of the trust, in the present case, authorize none of the circumstances that cause administrative controls to be exercised primarily for the benefit of the grantor under section 675. Thus, the circumstances attendant with the operation of the trust will determine whether taxpayer will be treated as the owner of any portion of the trust under section 675. This is a question of fact whose determination must be made by the office of the District Director that has jurisdiction over the parties.
Accordingly, we conclude that under the terms of the trust's governing instrument none of the circumstances exist that would cause the taxpayer to be treated as the owner of any portion of the trust under sections 673 through 677.
ISSUE 2 (CHARITABLE DEDUCTION FOR TRUST DISTRIBUTIONS)
Section 642(c)(1) provides that, in computing its taxable income, a trust is allowed a deduction for any amount of gross income which pursuant to the terms of the governing instrument is paid during the taxable year for a purpose specified in section 170(c) (determined without regard to section 170(c)(2)(A)). Section 642(c)(4) provides that the deduction allowed for a trust is subject to section 681 (relating to unrelated business income).
Section 681(a) provides that no charitable deduction is allowable to a trust under section 642(c) for any amounts allocable to the trust's unrelated business income for the taxable year. The term "unrelated business income" means an amount which would be computed as the trust's unrelated business income under section 512, if the trust were exempt from tax under section 501(a) by reason of section 501(c)(3).
Section 170(c) provides that, for purposes of section 170, the term "charitable contribution" means a contribution or gift to or for the use of: 1) federal or other government entities for exclusively public purposes, 2) a corporation or trust operated exclusively for religious, charitable, scientific, literary, or educational purposes, or 3) certain transfers to fraternal or veterans organizations. Section 170(c)(2)(A) restricts charitable contributions to corporations or trusts created in the United States.
In the present case, the terms of the proposed trust provide for an annual annuity to be paid first from income to organizations that qualify under section 170(c). Accordingly, except to the extent that the trust has unrelated business income within the meaning of section 681(a), the trust will be entitled to a deduction under section 642(c)(1) for the amount of the trust's gross income paid to the charitable organizations during the taxable year.
ISSUE 3 (GIFT TAX CHARITABLE DEDUCTION)
Section 2501 imposes a tax on the transfer of property by gift by an individual. Section 2522(a) provides that, in computing the taxable gift each year, there is allowed a deduction for: 1) all gifts to or for the use of federal or other government entities for exclusively public purposes, 2) all gifts to or for the use of a corporation or trust operated exclusively for religious, charitable, scientific, literary, or educational purposes, or 3) certain transfers to fraternal or veterans organizations.
Section 2522(c)(2)(B) provides that, where a transfer is made to both a charitable and noncharitable person or entity, no deduction shall be allowed for the charitable portion of the gift, in the case of any interest other than a remainder trust, unless the interest is in the form of a guaranteed annuity or is a fixed percentage distributed annually of the fair market value of the property determined on an annual basis.
Section 25.2522(c)-3(c)(2)(vi) of the Gift Tax Regulations provides that the term "guaranteed annuity interest" means an irrevocable right, pursuant to the instrument of transfer, to receive a guaranteed annuity. A guaranteed annuity is an arrangement under which a determinable amount is paid periodically (but not less often than annually) for a specified term or for the life or lives of a named individual or individuals, each of whom must be living at the date of the gift and can be ascertained at such date. An amount is determinable if the exact amount which must be paid under the conditions specified in the instrument of transfer can be ascertained as of the date of the gift.
Section 25.2522(c)-3(c)(2)(vi)(e) contains a further requirement for a guaranteed annuity interest in trust if the present value on the date of gift of all the income interests for a charitable purpose exceeds 60 percent of the aggregate fair market value of all amounts in the trust. Under these circumstances, the charitable interest will not be considered a guaranteed annuity interest unless the governing instrument prohibits both the acquisition and the retention of assets which would give rise to a tax under section 4944 if the trustee had acquired the assets.
In the present case, the annuity payable under the terms of the proposed trust satisfies the requirements described above and, therefore, will be a guaranteed annuity for purposes of section 2522(c)(2)(B). Accordingly, we conclude that a portion of the contribution by the taxpayer to the proposed charitable lead annuity trust will be eligible for a charitable gift tax deduction under section 2522(a).
ISSUE 4 (EXCLUSION OF TRUST PROPERTY FROM GROSS ESTATE)
Section 2033 provides for the inclusion in the gross estate of any property in which the decedent had an interest at the time of his death.
Section 2035(d) provides that only transfers of property that would have been included under sections 2036, 2037, 2038, or 2042 are includible in the gross estate if these transfers are made within three years of death. Other transfers made within three years of death are not includible in the gross estate. Sections 2036, 2037, and 2038 provide for the inclusion in the gross estate of property of which the decedent has made a transfer and in which the decedent has either retained an interest in the property or a power over the property. section 2042 provides for the inclusion in the gross estate of the proceeds of life insurance over which the decedent has retained any incidents of ownership.
Section 2041 provides that the gross estate shall include any property with respect to which the decedent has, at the time of his death, a general power of appointment or with respect to which the decedent has at any time released or exercised such power of appointment by a disposition which, had the property been owned by the decedent, such property would be includible in the decedent's gross estate under sections 2035 through 2038, inclusive. A general power of appointment is a power which is exercisable in favor of the decedent, his estate, his creditors, or the creditors of his estate, except where the decedent's power is limited by an ascertainable standard relating to the health, education, support, or maintenance of the decedent.
In the present case, the taxpayer proposes to create a charitable lead annuity trust that will be irrevocable. A fixed amount based on a percentage of the property originally transferred to the trust will be distributed annually to various qualified charitable organizations for a 10-year term. Thereafter, the corpus and remaining income will be distributed to the taxpayer's then-living issue per stirpes. The taxpayer retains no interest or reversion in the trust and no right to alter, amend, or revoke the trust. In addition, the taxpayer holds no general power of appointment over the trust property. Accordingly, we conclude that the corpus of the proposed charitable lead annuity trust will not be includible in the gross estate of the taxpayer under sections 2033, 2035 through 2038, or 2041, if the taxpayer should die during the charitable lead term of the trust.
Except as we have specifically ruled herein, we express no opinion under the cited provisions or under any other provision of the Code.
This ruling is 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 transactions considered in the ruling take effect, the ruling will have no force or effect. If the taxpayer is in doubt whether there has been a change in material fact or law, a request for reconsideration of this ruling should be submitted to this office.
This ruling is directed only to the taxpayer who requested it. Section 6110(j)(3) provides that it may not be used or cited as precedent. A copy of this letter should be attached to the taxpayer's federal income tax and gift tax returns filed for the year in which the trust is created. Copies are enclosed for that purpose.
Sincerely yours,
Assistant Chief Counsel
(Passthroughs and Special Industries)
By ____
Frances D. Schafer
Senior Technician Reviewer
Branch 4
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