|
Thursday, April 25, 2024
 |
GiftLaw Pro |
|
GiftLaw Note:
The taxpayer asserted that a provision allocating post-gift appreciation to income was omitted from a net income with make-up charitable remainder unitrust (Type II) because of a drafting error. The IRS ruled that a judicial modification of the trust to correct the error will not disqualify the trust as a charitable remainder unitrust so long as the court determines the omission was in fact a "scrivener's" error.
|
This letter is in response to a letter from your authorized representative dated May 20, 1997, and subsequent correspondence, requesting rulings regarding the effect of certain proposed amendments to the governing instrument of Trust.
FACTS
The information submitted states that A established Trust on D1. Bank is trustee of Trust and Foundation is the charitable remainder beneficiary of Trust. Trust is governed by the laws of State and is intended to qualify as a charitable remainder unitrust under section 664 of the Internal Revenue Code.
According to affidavits submitted by A, Accountant and Lawyer, A originally planned for Trust to use a fixed percentage payout. However, shortly before Trust was created, Accountant and Lawyer decided that it would be better for Trust to use a net income limitation and that post-contribution appreciation, when realized, would be allocated to income. When Lawyer drafted the final trust agreement Lawyer included in section 3.2 of the trust agreement a provision that the unitrust amount shall be equal to the lesser of trust income for the taxable year, as defined by section 643(b), and 7 percent of the net fair market value of the unitrust assets valued as of the first business day of the taxable year of the unitrust. However, Lawyer inadvertently failed to include a provision allocating realized post-contribution gain to income.
When A went to Accountant's office to sign the trust agreement, Accountant explained to A that a net income limitation had been included in the agreement and that Trust's income would include all post-contribution appreciation when realized. A agreed to this change and signed the trust agreement. At that time, no one noticed that a provision allocating realized post-contribution appreciation to income had not been included in the agreement.
Based on a claim of scrivener's error, A proposes amending the trust agreement so that it provides that all post-contribution gains realized on a sale or exchange of an asset of Trust shall be allocated to income. Additionally, A proposes amending the trust agreement to provide that, except to the extent provided in section 3.2, any income of Trust for any taxable year shall be added to principal.
LAW & ANALYSIS
Section 664(d)(2) provides that for purposes of section 664, a charitable remainder unitrust is a trust (A) from which a fixed percentage (that is not less than 5 percent) of the net fair market value of its assets, valued annually, is to be paid, not less often than annually, to one or more persons (at least one of which is not an organization described in section 170(c) and, in the case of individuals, only to an individual who is living at the time of the creation of the trust) for a term of years (not in excess of 20 years) or for the life or lives of such individual or individuals, (B) from which no amount other than the payments described in section 664(d)(2)(A) may be paid to or for the use of any person other than an organization described in section 170(c), and (C) following the termination of the payments described in section 664(d)(2)(A), the remainder interest in the trust is to be transferred to, or for the use of, an organization described in section 170(c) or is to be retained by the trust for such a use.
Section 664(d)(3) provides that the trust instrument may provide that the trustee shall pay the income beneficiary the amount of the trust income, if such amount is less than the amount required to be distributed under section 664(d)(2)(A), and any amount of the trust income that is in excess of the amount required to be distributed under section 664(d)(2)(A), to the extent that (by reason of subparagraph (A)) the aggregate of the amounts paid in prior years was less than the aggregate of such required amounts.
Section 1.664-3(a)(1)(i)(b)(1) of the Income Tax Regulations provides that the amount of trust income for purposes of section 664(d)(3) is the amount of trust income as defined in section 643(b) and the regulations thereunder.
Section 643(b) provides that, for purposes of subparts A through D, part I, subchapter J, chapter 1, the term "income", when not preceded by the words "taxable", "distributable net", "undistributed 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 that the 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.
Section 1.643(b)-1 provides, however, that trust provisions that depart fundamentally from concepts of local law in the determination of what constitutes income are not recognized. For example, if a trust instrument directs that all the trust income shall be paid to A, but defines ordinary dividends and interest as corpus, the trust will not be considered one that under its governing instrument is required to distribute all its income currently for purposes of section 642(b) (relating to the personal exemption) and section 651 (relating to "simple" trusts).
Under the law of State, all receipts paid as consideration for the sale or other transfer of property forming a part of a trust's principal shall be deemed principal. Cite 1. Thus, capital gains generally are allocated to principal under State law. However, State law also provides that the grantor of a trust may direct the manner of allocation of income and principal. Cite 2.
Section 1.664-3(a)(4) provides, in part, that the trust may not be subject to a power to invade, alter, amend, or revoke for the beneficial use of a person other than an organization described in section 170(c). Notwithstanding the preceding sentence, the grantor may retain the power exercisable only by will to revoke or terminate the interest of any recipient other than an organization described in section 170(c).
In Commissioner v. Estate of Bosch, 387 U.S. 456 (1967), the Court considered whether a state trial court's characterization of property rights conclusively binds a federal court or agency in a federal estate tax controversy. The Court concluded that the decision of a state trial court as to an underlying issue of state law should not be controlling when applied to a federal statute. Rather, the highest court of the state is the best authority on the underlying substantive rule of state law to be applied in the federal matter. If there is no decision by that court, then the federal authority must apply what it finds to be state law after giving "proper regard" to the state trial court's determination and to relevant rulings of other courts of the state. In this respect, the federal agency may be said, in effect, to be sitting as a state court.
Provided that a State court determines that a scrivener's error was made in drafting Trust and that Trust is modified by amending the trust agreement as discussed above, and provided that the court's modification of Trust is in accordance with State law properly applied, we conclude as follows: - The proposed modification of Trust will not violate section 664 and the regulations thereunder. Accordingly, the modification of Trust will not adversely affect Trust's qualification as a charitable remainder unitrust under section 664.
- Trust's governing instrument will provide that post- contribution gains, when realized, will be allocated to trust income. Such an allocation is permitted under State law. Such a provision complies with the requirements for a charitable remainder unitrust described in section 664(d)(2) and (d)(3) and the regulations thereunder. Therefore, inclusion of this provision in the trust agreement will not adversely affect Trust's qualification as a charitable remainder unitrust under section 664 and will be respected for purposes of computing the unitrust amount under section 664(d)(3).
The rulings above are expressly contingent on the issuance of a court order and modification of the trust, as described above.
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 otherwise qualifies as a charitable remainder trust under section 664.
A copy of this ruling should be attached to Trust's tax return for the year in which its governing instrument is amended. 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), this ruling may not be cited or used as precedent.
Sincerely yours,
____
J. Thomas Hines
Senior Technician Reviewer
Office of Assistant Chief Counsel
(Passthroughs and Special Industries)
|
|
|
|
