Thursday March 28, 2024

5.3.4 Unitrust and Annuity Trust Applications

Unitrust and Annuity Trust Applications

Planning Options for Businesses:  If the charitable remainder unitrust or annuity trust is to be funded with stock in a family business that is a C corporation, it may be advisable to not include the excess business holding language.

Business Strategies:  There are several strategies for handling the excess business holding rules even if counsel for donors decides to include this language in the document.
Starting with Rev. Rul.72-395, the specimen language for charitable remainder trusts (CRTs) provided by the IRS includes a requirement that CRTs be subject to the excess business holding rules of Sec. 4943. However, the regulations under Sec. 664 that govern charitable remainder unitrusts (CRUTs) and charitable remainder annuity trusts (CRATs) do not mandate the inclusion of this language.

Planning Options for Businesses


If the CRUT or CRAT is to be funded with stock in a family business that is a C corporation, it may be advisable to not include the excess business holding language. Without the Sec. 4943 IRS specimen language in the trust document, it should be permissible for a CRT to hold the stock for a longer duration.

Note that this planning option effectively works only for CRUTs and for C corporations. A CRT is not permitted to be a Subchapter S shareholder. Transferring S corporate stock to the trust would invalidate the S election and cause the corporation to be a C corporation.

Transfer of assets by a partnership or LLC could cause the CRT to have unrelated business income (UBI). If an active trade or business is involved, transfer of these assets to a CRUT could subject the unitrust to a 100% excise tax on the UBI. Sec. 664(c)(2)(A). While the tax may not be large if the asset is sold quickly, many grantors may prefer to avoid the tax on UBI.

To avoid UBI, a donor who plans to contribute active business assets to a CRT can lease those assets to a third party prior to making the contribution. If this lease is in place before the assets are contributed to a CRT, the only income the CRT will ever receive from the assets is fixed rent from the lease. Fixed rent payments are passive income and not taxable UBI. Sec. 512(c).

There is also another possible solution for active businesses. If a buyer is "waiting in the wings," the business interest may be transferred into a charitable trust and sold in an expeditious manner to the waiting buyer. While it will be essential to avoid a prearranged sale, the time that the business is held in the trust may be just a few days. As a result, there may be a very modest amount of unrelated business income subject to the 100% excise tax.

Finally, a charitable lead trust - whether an annuity trust or unitrust - is governed by a specific rule in Sec. 4947(b)(3) that mandates the use of the excess business holding rules if the charitable deduction is greater than 60%.

Business Strategies


There are several strategies for handling the excess business holding rules even if the counsel for donors decides to include this language in the document. In many cases, real estate is a major asset of the business and is leased to a third party. So long as the lease is a fixed payments lease and not a share of profits lease that turns the leasee into a partner under Sec. 512(c) of the Code, the lease will produce passive income and will not produce UBI. The real estate may be transferred to the CRT and be sold in a commercially appropriate manner.

For other business enterprises, it may be appropriate to create a lease to insulate the trust from UBI. After the business is leased to a third party, the trust may be funded with the business interest. So long as the business entity is sold within five years and while the lease is still in existence, there will not be any problems. Even if the sale could not be completed within five years, there is still the option to appeal to the Service and obtain an extension.

Private Letter Rulings

PLR 200136025 No Unrelated Business Taxable Income (UBTI) When Limited Partnership (LP) Gives Royalty Interest to Charitable Trust:   M is a tax-exempt charitable trust, which is classified as a private foundation under Sec. 509(a). B is a substantial contributor to M. B owns almost all of the interests in N, a limited partnership, which owns and operates a ski resort. N now wishes to make a contribution to M of a royalty interest in N's taxable income.


      Quiz-Basic



© Copyright 1999-2024 Crescendo Interactive, Inc.