3.1.7 CRAT Document Requirements

Very specific document requirements and applicable regulations for charitable remainder annuity trusts are set forth in Sec. 664. The document must specify an annuity amount for a life, lives or a term of up to 20 years. A remainder interest must be created in a qualified exempt charity. Sec. 664(d)(1)(C). If the named charity is not qualified exempt at the time for distribution, an alternative charity must be named in the document or selected by the trustee. Reg. 1.664-2(a)(3). There must be provisions for calculation of annuity amounts in a short initial year and the final tax year. Reg. 1.664-2(a)(2)(iv). An annuity trust must prohibit any additional contributions and must include private foundation provisions. Reg. 1.664-2(b). If the annuity trust is a testamentary trust, it must date back to the date of death, with a provision for corrective payments to include interest for that period of deferral. Reg. 1.664-1(a)(5). Finally, there may not be investment restrictions on the trustee. Reg. 1.664-1(a)(3).

There are also a number of optional provisions for annuity trust documents. The annuity amount may be a dollar amount or a percent of the initial net fair market value. With an independent trustee under Sec. 674(c), the annuity may be allocated among a class of beneficiaries. Under Sec. 664(f), based on a death, marriage, divorce or similar event, part or all of the annuity principal may be distributed to a charity. The obligation to pay the annuity amount may terminate with the payment prior to the death of the last non-charitable income recipient.

After the Tax Reform Act of 1969, it was permissible to write qualified charitable remainder unitrusts and charitable remainder annuity trusts. However, clarification of the appropriate language for drafting trusts was needed. Rev. Rul. 72-395 was the response by the Service to set forth a comprehensive set of language for mandatory and optional provisions for both charitable remainder annuity trusts and charitable remainder unitrusts. Most of the language in charitable trust documents is derived directly from this initial guidance.

Sec. 4 defines the mandatory provisions for charitable remainder annuity trusts. The annuity trust must be for a life, lives, or term of years, must leave a remainder to a qualified charity with provision for an alternate charity if there is no qualified exempt charity, must provide a provision for short taxable years, must prohibit additional contributions and must include the private foundation prohibitions.

Sec. 5 defines optional provisions. The annuity amount may be stated as a fractional percentage, there may a deferral period for a testamentary trust with the payments relating back to date of death, the annuity amount may be allocated to a class in the discretion of the trustee, distributions to charity may be made in kind, it is permissible to terminate the annuity with the payment proceeding the death of the last non-charitable recipient, a testamentary power of revocation may be retained and there may be no investment restrictions on the trustee.

A clarification of Rev. Rul. 72-395 was required for testamentary annuity trusts. The provision that stated that payments from testamentary annuity trusts would accrue from date of death was in the optional section. This ruling made clear that in order to qualify for an estate tax deduction, there would be a mandatory requirement for corrective payments. Therefore, if a trust is funded after date of death, the trustee must make all payments with appropriate interest as though the trust had been funded on date of death.

A charitable remainder trust qualifies for an estate tax charitable deduction under Sec. 2055. However, if it were possible to qualify for a charitable deduction and then under state law to apportion estate tax to the trust principal, the trust would be reduced and the charitable deduction could be overstated.

Rev. Rul. 82-128 clarifies the requirement that a charitable trust may not be invaded to pay gift or estate taxes. For example, if a two-life inter-vivos trust is created for a mother and daughter and the mother retains the testamentary power of revocation over the income interest of the daughter, then there is no current gift and the assets will be included in the estate of the mother. In this circumstance, the trust document must make clear that the trust may not be invaded to pay tax on the value on the daughter's income interest. The estate must make provision in the will, trust or through other means for payment of any potential estate tax from other sources.

If there were a period of deferral between the date of death and the funding of a testamentary trust, then corrective payments would be required. This ruling clarified the corrective payments language. It added specific language that also required payment of 6% interest, the standard interest rate as of the date of the ruling. With a testamentary annuity trust, not only would the trust be required to make the corrective payments, but 6% interest would also need to be calculated and added to the corrective payments.

When the Service initially created the requirement in Rev. Rul. 72-395 to make corrective payments and then stated that the payments would also include 6% interest in Rev. Rul. 82-165, it was not foreseen that interest rates would change. However, as a result of the change in interest rates on December 1 of 1983, it became apparent that the prior language with a fixed rate was not adequate. Therefore, this ruling specified that corrective interests would be made with "the rate of interest that the federal income tax regulations under Sec. 664 of the Internal Revenue Code prescribed for the trust with such computation for such period." In effect, the Service allowed the regulations to amend the interest rate requirement.

Corrective payments of interest may be calculated under Reg. 1.664-1(a)(5)(ii). This formula states that the payment shall be corrective payment plus applicable interest. The language of Rev. Rul. 88-81 noted that the interest should be added in again to the formula. In effect, it is possible that the language could be interpreted to add the interest in twice. Thus, this ruling provides new language that clarifies the issue and simply notes the interest will be computed under the federal regulations at the correct rate and that the corrective payouts shall then be based on Reg. 1.664-1(a)(5)(ii). The payments thus are made with interest included just one time.