Saturday, April 20, 2024
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GiftLaw Note: The testator and spouse desire to establish a lead trust upon the demise of the survivor. The Service rules that the present value of the unitrust interest in a testamentary charitable lead trust will qualify for an estate tax charitable deduction upon the survivor's death. The term of the charitable lead unitrust is to be set at the surviving spouse's death by calculating the amount necessary to produce an initial value for the remainder interest equal to the surviving spouse's available generation-skipping transfer tax exemption. The Service observes that the formula for determining the term of the charitable lead unitrust will be fixed and ascertainable as of the surviving spouse's death. With respect to generation-skipping transfer tax, the charitable lead unitrust will have an exclusion ratio of zero if the appropriate amount of the surviving spouse's exemption is allocated to the trust. Finally, the ordering rules for the payment of the unitrust amount will be disregarded for federal income tax purposes.
This is in response to a letter dated January 29, 1998, and subsequent correspondence submitted on behalf of the taxpayer, requesting the following rulings:
  1. The unitrust amount payable under the Charitable Lead Trust will qualify, under section 2055(e)(2)(B) and the applicable regulations, as a unitrust interest. The estate of the surviving settlor will be entitled to a federal estate tax charitable deduction for the present value of the charitable unitrust interest as of the date of the surviving settlor's of death.
  2. If the appropriate amount of the surviving settlor's generation-skipping transfer tax exemption is allocated to the Charitable Lead Trust on the death of the surviving settlor, the Charitable Lead Trust will have an inclusion ratio of zero for GST purposes.

FACTS:


A husband and wife will execute a joint revocable trust agreement to create Trust. Under Article 5.2 of the trust agreement, at the death of the first Settlor to die (the "deceased settlor"), after the payment of debts, taxes, and expenses, Trust will be divided into three shares, the Survivor's Share, the By-Pass Share, and the Marital Deduction Share.

The Survivor's Share will consist of the surviving settlor's (the survivor) one-half interest in the settlors' community property, the survivor's one-half interest in the decedent's quasi- community property, and the survivor's own separate property and quasi-community property. The Survivor's Share will fund the Survivor's Trust.

Under Article 6.1, the Survivor's Trust will pay to the survivor for life all of the net income, and any amount of principal that the trustee deems proper for the survivor's comfort, welfare, and happiness. In addition, the survivor has the power to withdraw corpus. At the survivor's death, the remainder will be distributed as the survivor appoints under a testamentary general power of appointment.

To the extent the survivor fails to exercise this power of appointment, the trustee will distribute the assets of the Survivor's Trust as follows: Tangible personalty will be distributed among the Settlors' then living issue. Property with a date of death value equal to the lesser of $5 million or 25 percent of the adjusted gross estate (as defined in section 6166 of the Code) of the survivor will be distributed to a "Charitable Lead Trust." The balance of the assets will be distributed outright, as specified, among the Settlors' surviving issue. If any property is not otherwise disposed of, 25 percent will pass to the Charitable Lead Trust and the balance will be distributed among the Settlors' heirs.

Article 6.1, paragraph (h) states the Settlors' intent that the survivor's available GST exemption will he allocated to the Charitable Lead Trust at the survivor's death.

Article 6.5 contains the terms of the Charitable Lead Trust which is to be held by the trustee as a separate fund.

The relevant provisions of the Charitable Lead Trust are as follows:

Under Article 6.5(b), the term of the Charitable Lead Trust begins on the date of the survivor's death and ends as many whole years later as necessary to produce an initial value for the remainder interest that comes closest to, but does not exceed, the survivor's available GST exemption. If the generation-skipping transfer tax exemption has been repealed, the term will be that number of years that comes closest to producing a charitable deduction in the survivor's estate of 80 percent of the total value of the property transferred to the Charitable Lead Trust from the Survivor's Trust. In determining the term of the Charitable Lead Trust, the trustee must use the applicable interest rate under section 7520, for the month preceding the surviving settlor's date of death.

Article 6.5(c)(i) provides that the trustee will annually distribute a unitrust amount equal to 8 percent of the net fair market value of the trust assets valued as of the first day of each taxable year of the trust. This unitrust amount will be distributed to charitable organizations, chosen to by the trustee, that qualify under both section 170(c)(2) and section 2055(a).

The unitrust amount will be paid in cash, in kind, or partly in each, and will be paid in one annual installment on the last day of each year. The amount distributed to the charitable beneficiary will be paid first from ordinary income (excluding unrelated business income), then from short term capital gain, then from long term capital gain, then from unrelated business income, then from tax-exempt income, and finally from trust corpus. Any income of the Charitable Lead Trust for a taxable year of the Charitable Lead Trust in excess of the unitrust amount shall be added to corpus.

Under Article 6.5(c)(ii), in determining the unitrust amount, the trustee shall prorate the same, on a daily basis in the case of a short taxable year. Article 6.5(c)(iii) provides that property may be added to the trust if the addition does not increase the inclusion ratio of the trust for generation-skipping transfer tax purposes.

Article 6.5(c)(iv) provides that the obligation to pay the unitrust amount commences with the date of the survivor's death but payment may be deferred to the end of the taxable year in which the trust is completely funded. Within a reasonable period from that date, the trustee shall pay, in the case of an underpayment, or shall receive from the recipient charities, in the case of an overpayment, the difference between any amounts actually paid to the charities and the amounts payable, plus interest on both amounts, compounded annually.

Under Article 6.5(c)(viii), the trustee is prohibited from engaging in any act of self-dealing as defined in section 4941(d) of the Code, from retaining any excess business holdings as defined in section 4943(c) which would subject the trust to a tax under section 4943, from making any investments which would subject the trust to tax under section 4944, and from making any taxable expenditures as defined in section 4945(d).

Article 6.5(c)(xi) provides that at the termination of the unitrust term, the trustee will divide the corpus of the Charitable Lead Trust, other than any amount due charity, into enough equal shares to create one share for each of the Settlors' then-living children and one share for the then-living issue of each deceased child of the Settlors. The shares for Settlors, children will be held as "Generation-Skipping Trusts" under Article 6.4, and the shares for the issue of a deceased child will be distributed outright. Any property not otherwise disposed of will be distributed among the Settlors' heirs.

Under Article 6.4, each Generation-Skipping Trust held for the benefit of a child of the Settlors will pay to the beneficiary any amount of income or principal the trustee deems proper for the beneficiary's health, support, maintenance, or education. At the beneficiary's death, the trustee will distribute the remainder among any persons, except the beneficiary, the beneficiary's creditors, the beneficiary's estate, or creditors of the beneficiary's estate, as the beneficiary appoints by will.

To the extent a deceased beneficiary fails to appoint that beneficiary's trust, the trust assets will be distributed outright to the then-living issue of the beneficiary, or to the settlor's then- living issue (or to Generation-Skipping Trusts held for their benefit), or to the Settlors' heirs.

Under Article 6.6, if any stock in a subchapter S corporation is to be distributed to a Generation-Skipping Trust created under Article 6.4, that stock must be held in a separate trust for the same beneficiary, with terms identical to those provided under Article 6.4 except that, during the beneficiary's life, all income of that separate trust must be distributed to the beneficiary, principal cannot be distributed to anyone other than the beneficiary, no one can have the power to appoint trust property to anyone other than the beneficiary, and any other requirements under section 1361(d) for a qualified subchapter S trust must be met. The trustee of the separate trust may enter any agreements the trustee deems necessary to maintain subchapter S status for the stock.

Article 6.9 provides that subject to the perpetuities provision in Article 8.1 and the subchapter S provisions of Article 6.6 but despite any other provision, the share of any beneficiary under age 35 to whom a nondiscretionary principal distribution is to be made must be retained in trust. The trust will pay to the beneficiary any amount of income or principal trustee deems proper for the beneficiary's health, support, maintenance, or education. The trust will be distributed outright to the beneficiary at age 35. If the beneficiary dies before reaching age 35, the trust assets will be distributed outright to the then-living issue of the beneficiary, to the then-living issue of the beneficiary's specified parent, to the Settlors' then-living issue, or to the Settlors, heirs.

Article 7.3 provides that each child of Settlors will be trustee of that child's Generation-Skipping Trust, and that all of these children will serve as cotrustees of the Charitable Lead Trust.

Under Article 8.1, every trust created under the trust agreement except the Charitable Lead Trust must terminate no later than 21 years after the death of the last survivor among the Settlors and their issue who are alive at the creation of the trust. A trust will be deemed to be created at the earlier of the date on which the trust becomes irrevocable or the surviving settlor's date of death.

LAW AND ANALYSIS:


ISSUE 1: CHARITABLE DEDUCTION


Section 2055(a) provides that for purposes of the federal estate tax, the value of the taxable estate shall be determined by deducting from the value of the gross estate the amount of all bequests, legacies, devises or transfers to a person or for the use of any corporation organized and operated exclusively for religious, charitable, scientific, literary, or educational purposes, no part of the net earnings of which inures to the benefit of any private stockholder or individual.

Under section 20.2055-2(a), the amount passing to charity must be ascertainable and determinable as of the date of death. Similarly, under section 20-2055-2(b)(1), if the trustee is empowered to divert the property or fund, in whole or in part, to a noncharitable purpose, the deduction is limited to that portion, if any, of the property which is exempt from an exercise of the power.

Section 2055(e)(2) disallows the estate tax charitable deduction where an interest in property (other than an interest described in section 170(f)(3)(B)) passes or has passed from the decedent to a person, or for a use, described in section 2055(a), and an interest (other than an interest which is extinguished upon the decedent's death) in the same property passes or has passed (for less than an adequate and full consideration in money or money's worth) from the decedent to a person, or for a use, not described in section 2055(a), unless -
  1. in the case of a remainder interest, such interest is in a trust which is a charitable remainder annuity trust or a charitable remainder unitrust (described in section 664) or a pooled income fund (described in section 642(c)(5)), or
  2. in the case of any other interest, such interest is in the form of a guaranteed annuity or is a fixed percentage distributed yearly of the fair market value of the property (to be determined yearly).
The rules contained in section 2055(e)(2) were enacted by the Tax Reform Act of 1969 and are applicable, with exceptions not relevant here, to estates of decedents dying after December 31, 1969.

Under section 20.2055-2(e)(1)(i), in the case of decedents dying after December 31, 1969, where an interest in property passes from the decedent for charitable purposes and an interest in the same property passes from the decedent for private purposes, no deduction is allowed under section 2055(a) for the value of the interest passing for charitable purposes unless the interest is a "deductible interest".

Under section 20.2055-2(e)(2)(vii)(a), the term "deductible interest" includes a unitrust interest. Under section 20.2055-2(e)(2)(vii), a "unitrust interest" is a right 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. The unitrust interest maybe paid for a specified term, or the life or lives of named individuals, each of whom must be living at the creation of the trust.

The term of the charitable unitrust interest is not specified in the instrument, but rather, will be determined pursuant to a specified formula. However, the term will be ascertainable and determinable as of the survivor's date of death, because as of this date, all variables in the formula contained in Article 6.5(b) for determining the term of the unitrust interest, will be fixed and determinable.

We conclude that the unitrust amount that is to be paid annually for charitable purposes under the terms of the Charitable Lead Trust will constitute a unitrust interest within the meaning of section 2055(e)(2)(B) and section 20.2055-2(e)(2)(vii). Therefore, on the death of the surviving settlor, an estate tax charitable deduction will be allowed under section 2055(a) for the present value of the unitrust amount payable to charity, determined in accordance with section 20.2055-2(f)(2)(v).

We note that the Charitable Lead Trust provides that the unitrust amount shall be paid first from ordinary taxable income that is not unrelated business income. If such ordinary taxable income is insufficient to satisfy the unitrust amount, it shall be paid from short term capital gain, long term capital gain, unrelated business income, tax-exempt income, and trust corpus, in that order. This ordering of income distributions will not be given effect for federal income tax purposes because the ordering provision has no economic effect independent of the tax consequences. The Charitable Lead Trust is required to pay annually a stated unitrust amount to organizations described in sections 170(c) and 2055(a), regardless of the amount or character of income earned by the trust. Accordingly, income distributed to organizations described in sections 170(c) and 2055(a) shall consist of the same proportion of each class of items of income of the Charitable Lead Trust as the total of each class bears to the total of all classes. See, section 1.642(c)-3(b)(2).

ISSUE 2: GST EXEMPTION


Section 2601 imposes a tax on every generation-skipping transfer (GST) made after October 22, 1986.

Section 2631 provides for a GST exemption of $1,000,000, which may be allocated by the individual, or the individual's executor, to any property of which the individual is the transferor for GST tax purposes under section 2652(a). Under section 2631(b), an allocation, once made, is irrevocable.

Section 2632(a) states that any allocation of an individual's GST exemption may be made at any time on or before the date prescribed for filing the individual's estate tax return (including extensions).

Section 2632(c) provides that any portion of an individual's GST exemption that has not been allocated by the individual or the individual's estate, will be allocated first to property that is the subject of a direct skip occurring at the individual's death, and second, to trusts with respect to which the individual is the transferor and from which a taxable distribution or taxable termination might occur at or after the individual's death. This allocation is made among the direct skips and trusts in proportion to the respective amounts (at the time of allocation) of the nonexempt portions of the properties and trusts.

In general, the generation-skipping transfer tax is computed by multiplying the taxable amount by the "applicable rate." The applicable rate is the highest federal estate tax rate multiplied by the inclusion ratio with respect to the transfer. Under section 2642(a), the inclusion ratio is the excess (if any) of 1 over the applicable fraction determined for the trust from which such transfer is made. The applicable fraction is a fraction -- (A) the numerator of which is the amount of the GST exemption allocated to the trust and (B) the denominator of which is -- (i) the value of the property transferred to the trust reduced by (ii) the sum of (I) the federal estate tax or state death tax actually recovered from the trust attributable to such property, and (II) any charitable deduction allowed under section 2055 and section 2522 with respect to the such property.

Based on the facts submitted, we conclude that, if the appropriate amount of the surviving settlor's GST tax exemption under section 2631 is allocated to the Charitable Lead Trust on the death of the surviving settlor, the Charitable Lead Trust will have an inclusion ratio of zero for GST purposes. Thus, transfers from the trust will not be subject to GST tax.

Except as we have specifically ruled herein, we express no opinion on the federal tax consequences of the transaction under the cited provisions of the Code or under any other provisions of the Code.

This ruling letter 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.

In accordance with the power of attorney on file, we are sending a copy of this letter to your authorized representative.

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

Related Topics On Testamentary Lead Trust Drafting Provisions

3.5.1  Family, or Non-Grantor, Lead Trusts:    There are two basic types of living charitable lead trusts. These are the grantor lead trust and the non-grantor, or family, lead trust.


3.5.6  Gift/Estate Tax Deductions for Lead Trust:    A charitable lead unitrust or annuity trust must pay the fixed unitrust percentage or the fixed annuity to one or more qualified charities each year to qualify for gift or estate tax charitable deductions. Reg. 20.2055-2(e)(2). Reg. 25.2522(c)-3(c)(2).


3.5.8  Lead Trust Generation-Skipping Transfer Taxation:    Generation-skipping transfer taxes (GSTTs) are particularly significant for charitable lead trusts. Since the goal of many grandparents is to allow grandchildren to grow to greater levels of maturity before receiving a significant inheritance, the opportunity to leverage an inheritance through a lead trust for grandchildren is quite attractive. It is possible to pass two to seven times the exemption amount to grandchildren with a testamentary lead trust and still have zero GSTTs.


6.4.4  Testamentary Lead Trust:    A charitable lead trust (CLT) is a powerful planning strategy for moving assets through to heirs. However, parents often raise the question: How long should parents delay the inheritance?



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