Friday April 26, 2024

Rev. Rul. 2002-20
GiftLaw Note: Charitable remainder unitrusts may be drafted for a life, lives, a term of years or a combination of life or lives and a term of years. However, if a beneficiary is subject to a disability, then it may be desirable for the trust to have discretionary payment options. Thus, some grantors have preferred to create a charitable remainder trust that makes distributions to a second trust. The second trust is usually described as a "special needs trust" and permits discretionary distributions for the support and care of an individual with a financial, physical or mental disability.

In Rev. Rul. 2002-20; 2002-17 IRB 794 (29 Apr 2002), the Service set forth guidelines for charitable remainder trusts that make payments to special needs trusts. First, if the charitable remainder trust is for a term of 20 years or less, then it may make distribution to a special needs trust. However, if the charitable remainder trust is payable for a lifetime, then it should meet several requirements. First, the trust must be for one lifetime and the beneficiary must be under a disability that renders him or her unable to manage personal financial affairs, as defined in Sec. 6511(h)(2)(A). Second, the unitrust and special needs trust should follow one of three formats.

I. Flow-Through Trust. The trust may be a "Flow-Through Trust," in which the unitrust payouts are made to the special needs trust and then are distributed to the beneficiary. Additional distributions may be made under a trustee discretionary power. The remainder will be distributed to the income recipient's estate.

II. Discretionary Trust. Alternatively, the special needs trust may have a discretionary payment provision, which permits the trustee to make payments that would not supplant governmental benefits otherwise available. With a discretionary special needs trust, the remainder of the trust is payable to the estate of the special needs person.

III. Discretionary with Power of Appointment Trust. Finally, a discretionary trust may be created with the income recipient holding a testamentary general power of appointment. If the special needs person does not exercise the general power when he or she passes away, then the remainder may be distributed to family or to charity.

Since unitrust payments may be made for the benefit of the income recipient, the unitrust and special needs trust combination is permitted because the payments are in effect received by the special needs person. The above options are also available for an annuity trust and special needs trust.

ISSUE


May a trust qualify as a charitable remainder unitrust under § 664 of the Internal Revenue Code, if the unitrust amounts are paid to a separate trust for the life of an individual who is "financially disabled," as defined in § 6511(h)(2)(A)?

FACTS


An individual concurrently creates Trust A, a trust that otherwise qualifies as a charitable remainder unitrust, and a separate trust, Trust B. Under the governing instrument of Trust A, annual unitrust amounts will be paid to Trust B for the life of C. C is an individual who is financially disabled, that is, C is unable to manage C's own financial affairs by reason of a medically determinable physical or mental impairment that can be expected to result in death or that has lasted or can be expected to last for a continuous period of not less than 12 months.

Situation 1. Under the governing instrument of Trust B, a designated portion of the amount it receives from Trust A will be paid to C each month. If, at any time in the sole judgment of the trustee, the monthly payment to C is insufficient to provide adequately for the care, support, and maintenance of C, or is insufficient for the needs of C for any reason, additional amounts will be paid as needed to or on behalf of C from Trust B. Upon C's death, the balance remaining in Trust B will be distributed to C's estate.

Situation 2. Under the governing instrument of Trust B, the trustee may make distributions of income and principal, as determined in the trustee's sole and absolute discretion, for the financial aid and best interests of C in a manner that supplements but does not supplant any governmental benefits otherwise available to C. Upon C's death, the balance remaining in Trust B will be distributed to C's estate.

Situation 3. Under the governing instrument of Trust B, the trustee may make distributions of income and principal, as determined in the trustee's sole and absolute discretion, for the financial aid and best interests of C in a manner that supplements but does not supplant any governmental benefits otherwise available to C. Upon C's death, the governing instrument requires the trustee to reimburse the state for the total costs of medical assistance provided to C under the state's Medicaid plan. C is given a testamentary general power of appointment over the balance remaining in Trust B. If C fails to exercise the power, the balance will be distributed, in equal shares, to C's sister and to X, a charitable organization.

LAW AND ANALYSIS


A charitable remainder unitrust is a trust from which a unitrust amount is payable at least annually during its term with an irrevocable remainder interest held for the benefit of charity. Under § 664 (d)(2)(A), the unitrust amount is a fixed percentage (not less than 5 percent and not more than 50 percent) of the net fair market value of the trust assets, valued annually. The unitrust amount is to be paid to one or more persons (at least one of which is not an organization described in § 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 the individual or individuals.

Section 1.664-3(a)(5)(i) of the Income Tax Regulations provides that the period for which the unitrust amount is payable begins with the first year of the charitable remainder trust and continues either for the life or lives of a named individual or individuals or for a term of years not to exceed 20 years. Only an individual or an organization described in § 170(c) may receive an amount for the life of an individual.

In general, a charitable remainder unitrust may pay unitrust amounts to a second trust only for a term of 20 years or less. In Situations 1, 2, and 3, the unitrust amounts are payable to Trust B for the life of C, not for a term of years. However, in each of these situations, the sole function of Trust B is to receive and administer the unitrust amounts for the benefit of C, who is unable to manage C's own financial affairs by reason of a medically determinable mental or physical impairment. Upon C's death, the assets remaining in Trust B will be distributed either to C's estate or, after reimbursing the state for any Medicaid benefits provided to C, will be subject to C's general power of appointment. In these situations, the use of the assets in Trust B during C's life and at C's death is consistent with the manner in which C's own assets would be used. C, therefore, is considered to have received the unitrust amounts directly from Trust A for purposes of § 664 (d)(2)(A). Accordingly, the term of Trust A may be for the life of C and is not limited to a term of years.

The same result would apply if Trust A were a charitable remainder annuity trust.

HOLDING


A trust may qualify as a charitable remainder unitrust under § 664 if the unitrust amounts will be paid for the life of a financially disabled individual to a separate trust that will administer these payments on behalf of that individual and, upon the individual's death, will distribute the remaining assets either to the individual's estate or, after reimbursing the state for any Medicaid benefits provided to the individual, subject to the individual's general power of appointment.

EFFECT ON OTHER REVENUE RULINGS


Rev. Rul. 76-270 (1976-2 C.B. 194) which addresses facts covered by Situation 1, is amplified and superseded.

DRAFTING INFORMATION


The principal author of this revenue ruling is Jan Bennett Geier of the Office of Associate Chief Counsel (Passthroughs and Special Industries). For further information regarding this revenue ruling, contact Ms. Geier at (202) 622-7830 (not a toll-free call).



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