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Sunday, April 28, 2024
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GiftLaw Pro |
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GiftLaw Note:
When a unitrust is created, the donors retain the rights to an income interest and the charity receives irrevocably the remainder interest. This income interest retained by donors is a property right under state law and thus should be transferable like any other property rights. The Service allowed the donors to transfer their income interest to the remainder recipient. When the income interest is transferred, since it is their only interest in the trust, there will be a charitable deduction under Sec. 170 of the Code for the value of the income interest gifted. To calculate that interest, run the unitrust again with the value on the date of the gift of income interest. The deduction is the income value. For example, if the trust was originally $400,000, but has grown to $500,000, run the deduction with the $500,000 value, the current date and the current Rate of the Month. If the remainder value is $200,000, their deduction is $300,000. The $500,000 total value less the $200,000 remainder value equals the $300,000 gift deduction. This is of course an appreciated-type gift deductible to 30% of AGI. Since the charity now owns both the income and the remainder interest, under the doctrine of merger, the trust no longer exists and the charity may use the trust principal for appropriate charitable purposes.
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This is in response to your February 8, 1996 letter and subsequent correspondence requesting a ruling concerning the transfer of an interest in a charitable remainder unitrust to charity.
The following facts have been represented. In 1986, X and Y, as donors, and Z, as trustee, entered into a charitable remainder unitrust agreement. The donors transferred certain community property to the trustee. During the donors' lifetimes, the trustee is to pay to X and Y, for so long as they both shall live, and then to the survivor of them, an amount equal to five percent of the net fair market value of the trust assets valued annually or the amount of the annual net trust income, whichever is less. In addition to the unitrust amount, Z is to pay to X and Y, or to the survivor of them, any amount of net income which is in excess of the amount required to be distributed, to the extent that the aggregate of the amounts paid in prior years was less than the aggregate of five percent of the then fair market value of the trust assets for each such year. The payments to X and Y, or to the survivor of them, are to be made quarterly on the last day of each quarter of the taxable year.
X and Y represent that when Trust was created in 1986, there was no intention to divide the income and remainder interests in order to avoid the partial interest rules in section 170(f).
Upon the death of the survivor of X and Y, Z, as trustee, is to distribute the trust property free of trust to Z, as beneficiary, to invest the property for the benefit of University. If upon termination of the trust, University is not a tax-exempt organization described in sections 170(b)(1)(A), 170(c), 2055(a), and 2522(a), Z is to distribute the trust corpus to a tax exempt organization that does meet the requirements of these sections. Preference is to be given to a tax-exempt college or university.
Each of the donors reserved the right to appoint and direct by his or her will, that the trust fund attributable to his or her share of the transfer to the trust shall, upon his or her death be transferred to Z (if University is a tax-exempt organization), whether or not he or she is survived by the other donor.
X and Y propose to make a gift of their entire interest in the unitrust to Z. Prior to the transfer, X will renounce X's contingent right to receive, upon Y's death, the portion of the unitrust interest that is attributable to Y's community property contribution to the unitrust. Y will renounce Y's contingent right to receive, upon X's death, the portion of the unitrust interest that is attributable to X's community property contribution to the unitrust. X will then assign X's entire interest in the unitrust to Z. Y will assign Y's entire interest in the unitrust to Z.
As a result of the proposed transfers, the income interests and the remainder will merge and under state law the trust will terminate. Z will have a fee interest in all the property that had been held in trust.
The rulings requested that are within our jurisdiction are as follows:- The transfer of X's and Y's entire income interest in Unitrust to the remainder beneficiary will qualify for the gift tax charitable deduction under section 2522.
- The transfer of X's and Y's entire income interest in Unitrust to the remainder beneficiary will qualify for the income tax charitable deduction under section 170.
Ruling #1
Section 2501(a) imposes a tax for each calendar year on the transfer of property by gift during such calendar year by an individual, resident or nonresident.
Section 2511(a) provides that the gift tax applies to a transfer by way of gift whether the transfer is in trust or otherwise, whether the gift is direct or indirect, and whether the property is real or personal, tangible or intangible.
Section 25.2511-2(b) of the Gift Tax Regulations provides that a gift is complete to the extent that a donor has so parted with dominion and control as to leave the donor with no power to change its disposition, whether for his own benefit, or the benefit of another.
Section 2522 provides for a gift tax charitable deduction for the value of property transferred to organizations described in section 2522(a). However, section 2522(c)(2) provides that if a donor transfers an interest in property for charitable purposes and an interest in the same property is retained by the donor, or is transferred or has been transferred (for less than adequate and full consideration) for private purposes, no gift tax deduction is allowed under section 2522 unless, in the case of an interest other than a remainder interest, such interest is in the form of a guaranteed annuity or a fixed percentage distributed yearly of the annual fair market value of the property (a unitrust interest).
Under section 25.2522(c)-3(c)(2)(vii), for purposes of the gift tax charitable deduction, the term "unitrust interest" means an irrevocable right pursuant to an instrument of transfer to receive payment, not less often than annually, of a fixed percentage of the net fair market value determined annually, of the property which funds the unitrust interest.
In the present case, X and Y each retained the right to revoke by will the secondary life estate of the other in the property that each had transferred to the trust. Thus, upon creation of the trust, neither X nor Y had made a transfer for private purposes within the meaning of section 2522(c)(2) and section 25.2522(c)-3(c)(1)(i). See Rev. Rul. 79-243, 1979-2 C.B. 343. It is proposed that X will renounce X's contingent right to receive, upon Y's death, the portion of the income interest that is attributable to Y's community property contribution to the unitrust and Y will renounce Y's contingent right to receive, upon X's death, the portion of the income interest that is attributable to X's community property contribution. Thereafter, X and Y will transfer their income interests to Z. After the transfers by X and Y of their interests in the Unitrust to Z, X and Y will retain no interest in the trust property.
When X and Y transfer their interests in the Unitrust to Z, X and Y are not retaining any interest in the Unitrust and X and Y are not transferring and have not previously transferred an interest in the Unitrust for private purposes. Accordingly, their transfers are not required by section 2522(c)(2) to be in the form of a unitrust interest within the meaning of section 25.2522(c)-3(c)(2)(vii).
Based on the facts submitted and the representations made, we conclude that X and Y will be entitled to a gift tax charitable deduction under section 2522 for the value of the entire income interests that X and Y propose to transfer to Z. See, Rev. Rul. 86-60, 1986-1 C.B. 302, Situation 1.
Ruling #2
Section 170(a)(1) provides that there shall be allowed as a deduction any charitable contribution (as defined in section 170(c)) payment of which is made within the taxable year.
Section 170(f)(2)(B) provides that no deduction is allowed under section 170(a) 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 trust for purposes of section 671.
Section 170(f)(3)(A) provides that a contribution (not made by a transfer in trust) of less than a taxpayer's entire interest in property is not allowed as a charitable contribution deduction except to the extent such a contribution would have been allowed as a deduction had it been transferred in trust.
Under section 1.170A-7(a)(1) of the Income Tax Regulations, in the case of a charitable deduction, not made by a transfer in trust, of any interest in property which consists of less than the donor's entire interest in such property, no deduction is allowed under section 170 for the value of such interest unless the interest is described in section 1.170A-7(b)(2). Under that section, a deduction is allowed under section 170 for the value of a charitable contribution not in trust of a partial interest in property which is less than the donor's entire interest in the property and which would be deductible under section 170(f)(2) and section 1.170A-6 if such interest had been transferred in trust.
Section 1.170A-7(a)(2)(i) provides that a deduction is allowed without regard to section 1.170A-7(a)(1) for a contribution of a partial interest in property if such interest is the taxpayer's entire interest in the property, such as an income interest or a remainder interest. Thus, if securities are given to A for life, with the remainder over to B, and B makes a charitable contribution of his remainder interest to an organization described in section 170(c), a deduction is allowed under section 170 for the present value of B's remainder interest in the securities. If, however, the property in which such partial interest exists was divided in order to create such interest and thus avoid section 170(f)(3)(A), the deduction will not be allowed. Thus, for example, assume that a taxpayer desires to contribute to a charitable organization an income interest in property held by him, which is not of a type described in section 1.170A-7(b)(2). If the taxpayer transfers the remainder interest in such property to his son and immediately thereafter contributes the income interest to a charitable organization no deduction shall be allowed under section 170 for the contribution of the taxpayer's entire interest consisting of the retained income interest.
Rev. Rul. 86-60, 1986-1 C.B. 302, considers whether a donation qualifies for the charitable contribution deduction under section 170 of the Code, if a taxpayer, A, who is the grantor/life beneficiary of a charitable remainder annuity trust (CRAT) donates A's annuity interest in the CRAT to the remainder beneficiary of the CRAT. In 1980, A had created a CRAT described in section 664(d)(1). A retained an annuity interest in the CRAT for life. The remainder beneficiary was a charitable organization described in section 170(c). In 1984, A transferred the annuity interest in the CRAT to the remainder beneficiary of the CRAT. Rev. Rul. 86-60 states as a fact that no interests were created for the purpose of avoiding the rules of sections 170(f)(2) and (f)(3)(A).
Rev. Rul. 86-60 concludes, based on section 1.170A-7(a)(2)(i) of the Regulations, that the gift by A, the grantor, to the remainder beneficiary, of A's entire annuity in the CRAT qualifies for a charitable contribution deduction under section 170 of the Code.
The present case is analogous to the situation in Rev. Rul. 86-60. X and Y each retained an income interest in Unitrust, which they created over ten years ago. X and Y now propose to transfer their entire income interests to Z, the remainder beneficiary of Unitrust. The income interests that X and Y propose to transfer are their only interests in the trust property. It is represented that X and Y did not divide their interests in the property in 1986 to avoid the partial interest rules. The representation by X and Y is creditable in part because of the 10-year period between the creation of Unitrust and the proposed contribution.
Accordingly, based on the facts submitted and the representations made, we conclude that, under section 1.170A-7(a)(2)(i), the transfer of X's and Y's entire income interests in Unitrust to the remainder beneficiary will qualify for an income tax charitable contribution deduction under section 170, subject to the percentage limitations of section 170.
A copy of this letter should be attached to X and Y's gift tax return and to their income tax return for the year of the transfer. Copies are enclosed for those purposes.
Except as we have specifically ruled herein, we express no opinion as to the consequences of this transaction under the cited provisions or under any other provisions of the Code.
This ruling is directed only to the taxpayer who requested it. Section 6110(j)(3) of the Code provides that it may not be used or cited as precedent.
Sincerely yours,
Assistant Chief Counsel
(Passthroughs and Special Industries)
By ____
Frances D. Schafer
Senior Technician Reviewer
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