Thursday, March 28, 2024
GiftLaw Pro
GiftLaw Note: The Service has generally been reluctant to allow commutation of lead trust payments. In theory, under state law, both the income and remainder recipients own property interests. Thus, it should be permissible to buy or sell those interests at a fair value. Nevertheless, the Service has been reluctant to allow major changes in irrevocable trusts. Specifically, the Service has been reluctant to allow charitable lead trusts to accelerate payments to charities and, thereby, accelerate the remainder interests to families. In the view of the Service, allowing this commutation or acceleration of payments would be "inconsistent with the regulatory requirements for charitable lead interests." Thus, commutation does not seem to be a viable option.

This is in response to your authorized representative's April 4, 1997, letter, and prior correspondence, requesting a ruling under section 2055 of the Internal Revenue Code. Specifically, you request a ruling that the judicial termination of the charitable lead unitrust will not result in the disqualification of the trust property for the charitable deduction under section 2055.

Grantor died testate in 1995. Under the terms of Grantor's inter vivos trust (the "Trust"), upon Grantor's death, after payment of certain pre-residuary bequests, one-half of the residue is to be held in a charitable lead unitrust (the Unitrust) and the remaining one-half is to pass in equal shares to the Grantor's daughters, A and B (or the descendants of a predeceased daughter).

The term of the Unitrust is 12 years. On termination of the Unitrust, the remaining principal and income (other than any amount due a charitable organization) is to be divided into such number of equal shares as to create one share with respect to each then living grandchild of Grantor and one share for the descendants of each deceased grandchild of Grantor. The trustee is to select the charitable organizations to which the unitrust interest will be paid, limited to organizations described in sections 170(c) and 2055(a), to receive the unitrust amount.

The terms of the Unitrust further provide as follows:

[N]o power is conferred upon the Trustee of the [Unitrust] that would be inconsistent with the qualification of said trust as a charitable lead trust so that the value of the interest passing to a Charitable Organization is deductible as a charitable unitrust interest under section 2055(e) of the Code and so that the distribution of the Unitrust Amount to a Charitable Organization will be deductible to the extent provided by section 642(c) of the Code.

Grantor was the original trustee of the Trust. On Grantor's death, Grantor's daughters, A and B, became the successor trustees in accordance with the terms of the Trust.

The Unitrust has not yet been funded. The trustees propose to petition the appropriate circuit court and request authorization to commute the Unitrust and to pay to a charitable organization the present value (determined under section 7520) of the charitable unitrust interest, determined as of Grantor's death. The balance of the bequest to the Unitrust will be paid to the designated remainder beneficiaries.

Section 2055(a) allows a deduction from the value of a decedent's gross estate for the amount of bequests to or for the use of any organization organized and operated exclusively for religious, charitable, scientific, literary, or educational purposes.

Section 2055(e)(2)(B) provides that no deduction is allowed where an interest in property is transferred for both charitable and noncharitable purposes unless, in the case of an interest other than a remainder interest in property, the charitable interest is in the form of a guaranteed annuity or a fixed percentage distributed yearly of the fair market value of the property to be determined yearly (unitrust interest). Section 2522(c)(2)(B) provides similar rules applicable in the case of the gift tax charitable deduction.

Section 20.2055-2(e)(2)(vii) of the Estate Tax Regulations states, in part, that the term unitrust interest means the right pursuant to the instrument of transfer to receive a 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 computing the net fair market value of the property which funds the unitrust interest, all assets and liabilities shall be taken into account without regard to whether particular items are taken into account in determining the income from the property. The net fair market value of the property which funds the unitrust interest may be determined on any one date during the year or by taking the average of valuations made on more than one date during the year, provided that the same valuation date or dates and valuation methods are used each year. Payments under a unitrust interest must be paid 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. See also, section 25.2522-3(c)(2)(vii) of the Gift Tax Regulations containing similar provisions applicable for gift tax purposes.

In Rev. Rul. 88-27, 1988-1 C.B. 331, the trustees of an inter vivos charitable guaranteed annuity trust were granted the discretion to commute and prepay the charitable interest prior to the expiration of the specified term of the annuity. The ruling holds that if the trustee has the discretion to commute and prepay the charitable lead annuity interest prior to the expiration of the specified term of the annuity, the interest does not qualify as a guaranteed annuity interest under section 2522(c)(2)(B) and consequently, no deduction under section 2522 will be allowed for the amount of the transfer to charity. The ruling reasoned that, under section 25.2522(c)-3(c)(2)(vi)(a), a guaranteed annuity must satisfy at least two requirements: (1) the annuity must represent the right to receive periodic payments over a specified period of time and (2) the exact amount payable under the annuity must be determinable as of the date of the gift. Under the facts presented, the amount of any prepayment was determined on a commuted basis at a date subsequent to the date of transfer. Under these circumstances, the charitable interest did not represent the right to receive periodic payments over a specified period because the number of payments would be a function of whether, and to what extent, the trustee decided to prepay the charitable annuity. Similarly, the exact amount payable could not be determined as of the date of the gift, because the amount of each payment was dependent on whether the trustee decided to prepay.

The rationale and holding of Rev. Rul. 88-27, regarding a guaranteed annuity interest is equally applicable in the case of a unitrust interest, as presented in this case. Under the revenue ruling, commutation and prepayment is inconsistent with the regulatory requirements for charitable lead interests and the allowance of a charitable deduction for the charitable interest. Further, in this case, the interest received by charity as a result of the commutation will not be the interest that passed to charity under Decedent's revocable trust on which any allowable charitable deduction should be based. Accordingly, if the charitable interest is commuted, as proposed, an estate tax charitable deduction will not be allowed for the property received by charity.

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 transaction considered in the ruling takes effect, the ruling will have no force or effect. If 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.

Except as specifically ruled above, no opinion is expressed as to the federal tax consequences of the transaction described under any other provisions of the Internal Revenue Code.

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

Sincerely,
Assistant Chief Counsel
(Passthroughs and Special Industries)
By ____
George L. Masnik
Chief, Branch 4




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