Articles Posted in Trust

Basic Trust Taxation Rules It is estimated that $4.8 trillion in wealth will be inherited or transferred from one generation to the next by 2015, with much of it transferred through a variety of trusts. Filings of trust returns (Form 1041) are now the third most frequently filed income tax return behind individual and corporate returns. Although the vast majority of these transfers are legal, there is widespread potential for fraud.In the last few years, the Internal Revenue Service has detected a proliferation of abusive trust tax evasion schemes. These promotions are targeted towards wealthy individuals, small business owners, and professionals such as doctors and lawyers.Abusive trust arrangements typically are promoted by the promise of such benefits as:

  • Reduction or elimination of income subject to tax.
  • Deductions for personal expenses paid by the trust.
  • Depreciation deductions of an owner’s personal expenses paid by the trust.
  • Depreciation deductions of an owner’s personal residence and furnishings.
  • A stepped-up basis for property transferred to the trust.
  • The reduction or elimination of self-employment taxes.
  • The reduction or elimination of gift and estate taxes.

Abusive trust arrangements often use trusts to hide the true ownership of assets and income or to disguise the substance of transactions. Although these schemes give the appearance of separating responsibility and control from the benefits of ownership, as would be the case with legitimate trusts, the taxpayer in fact controls them.

These arrangements frequently involve more than one trust, each holding different assets of the taxpayer (the taxpayer’s business, equipment, home, automobile, etc.), as well as interests in other trusts. The trusts are vertically layered, with each trust distributing income to the next layer. Funds may flow from one trust to another trust by way of rental agreements, fees for services, purchase and sale agreements, and distributions. The goal is to use inflated or nonexistent deductions to reduce taxable income to nominal amounts.

Although the individual abusive promotions vary, two basic schemes have been identified:

  • The domestic package, and
  • The foreign package.

These schemes are often promoted by a network of promoters and sub-promoters who have charged $5,000 to $70,000 for their packages. This fee enables taxpayers to have trust documents prepared, to utilize foreign and domestic trustees as offered by promoters, and to use foreign bank accounts and corporations. In some instances, tax return preparer services are also made available.

Taxpayers should be aware that abusive trust arrangements will not produce the tax benefits advertised by their promoters and that the IRS is actively examining these types of trust arrangements. Furthermore, in appropriate circumstances, taxpayers and/or the promoters of these trust arrangements may be subject to civil and/or criminal penalties.

To understand fully the trust schemes offered today, it is important to focus on some basic trust taxation rules.

A valid trust is a legal arrangement creating a separate legal entity. The duties, powers and responsibilities of the parties to this arrangement are determined by state statute and the trust agreement. To create a trust, legal title to property is conveyed to a trustee, who is then charged with the responsibility of using that property for the benefit of another person, called the beneficiary, who really has all the benefits of ownership, except for bare legal title. The IRS recognizes numerous types of legal trust arrangements, and they are commonly used for estate planning, charitable purposes, and holding of assets for beneficiaries. The trustee manages the trust, holds legal title to trust assets, and exercises independent control.

All income a trust receives, whether from foreign or domestic sources, is taxable to the trust, to the beneficiary, or to the grantor of the trust unless specifically exempted by the Internal Revenue Code (IRC).

Foreign trusts to which a U.S. taxpayer has transferred property are treated as grantor trusts as long as the trust has at least one U.S. beneficiary. The income the trust earns is taxable to the grantor under the grantor trust rules. Grantor trusts are not recognized as separate taxable entities, because under the terms of the trust, the grantor retains one or more powers and remains the owner of the trust income. In such a case, the trust income is taxed to the grantor, whether or not the income is distributed to another party.

A legitimate trust is allowed to deduct distributions to beneficiaries from its taxable income, with a few modifications. Therefore, trusts can eliminate income by making distributions to other trusts or other entities as long as they are named as beneficiaries. This distribution of income is key to understanding the nature of the abusive schemes. In the abusive schemes, bogus expenses are charged against trust income at each trust layer. After the deduction of these expenses, the remaining income is distributed to another trust, and the process is repeated. The result of the distributions and deductions is to reduce the amount of income ultimately reported to the IRS.

Filing requirements for legitimate trusts are discussed below:

  • A domestic trust must file a Form 1041, U.S. Income Tax Return for Estates and Trusts, for each taxable year. If the trust is classified as a Domestic Grantor Trust, it is not generally required to file a Form 1041, provided that the individual taxpayer reports all items of income on his own Form 1040, U.S. Individual Income Tax Return. Thus, the individual pays the total tax liability upon the filing of his return for that taxable year. All income received by a trust, whether from foreign or domestic sources, is taxable to the trust, to the beneficiary, or to the grantor unless specifically exempted by the Internal Revenue Code.
  • Foreign trusts are subject to special filing requirements. If a trust has income that is effectively connected with a U.S. trade or business, it must file Form 1040NR, U.S. Nonresident Alien Income Tax Return. Form 3520, Annual Return to Report Transactions With Foreign Trusts and Receipt of Foreign Gifts, must be filed on the creation of or transfer of property to certain foreign trusts. Form 3520-A, Annual Information Return of Foreign Trusts With U.S. Owner, must also be filed annually. Foreign trusts may be required to file other forms as well.
  • In addition to filing trust returns as just described, a taxpayer may be required to file U.S. Treasury Form TD F 90-22.1, Foreign Bank and Financial Accounts Report, if the taxpayer has an interest of over $10,000 in foreign bank accounts, securities, or other financial account. Also, a taxpayer may be required to acknowledge an interest in a foreign bank account, security account or foreign trust on Schedule B, Interest and Dividend Income, that is attached to Form 1040.

Keywords: trust tax help, estate tax help, estate taxes, IRS Estate Tax, 706 tax help
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Linked trusts were eligible to be S shareholders PLR 200912005

Mike Habib, EA Tax Relief & Tax Resolution Services

IRS has privately ruled that a trust having a second trust as a remainder beneficiary could choose to be treated as an electing small business trust (ESBT) and thus was eligible to be a shareholder of an S corporation. IRS also concluded that the second trust was not a charitable remainder trust. As a result, the second trust will be eligible to be treated as an ESBT when it becomes a potential current beneficiary of the first trust.

Facts. Trust 1, which was created under Will 1, is the sole shareholder of Company, a C corporation. Company intends to elect to be treated as an S corporation. Trust 1 has individual beneficiaries and remainder beneficiaries. The remainder beneficiaries of Trust 1 are all individuals except for Trusts 2 and 3, which were created under Will 2. Trust 3 is a tax-exempt Code Sec. 501(c)(3) organization. Trust 2 has individual beneficiaries. Upon the death of the last of them, Trust 2 will terminate and the trust estate will be added to Trust 3.

Trust 2 is required to pay, not less often than annually, either a sum certain (not less than 5% nor more than 50% of the initial net fair market value (FMV) of all property placed in trust), or a fixed percentage (which is not less than 5% nor more than 50%) of the net fair market value of its assets, valued annually, to one or more persons.

Trust 1 has not made an election to be a qualified subchapter S trust (QSST) and is not exempt from income tax. All current beneficiaries of Trust 1 received their trust interests by inheritance and not by purchase.

Rulings sought. Trust 1 asked IRS to rule that it is eligible to be an ESBT under Code Sec. 1361(e), and is thus eligible to be an S corporation shareholder under Code Sec. 1361(b)(1)(B) and Code Sec. 1361(c)(2) . It also asked IRS to rule that Trust 2 is not a charitable remainder trust under Code Sec. 664(d).

Background. An S corporation is a small business corporation for which an election under Code Sec. 1362(a) is in effect for a tax year. (Code Sec. 1361(a)(1)) A small business corporation cannot have as a shareholder a person (other than an estate, a trust described in Code Sec. 1361(c)(2), or an organization described in Code Sec. 1361(c)(6)) who is not an individual.

An ESBT may be an S shareholder. (Code Sec. 1362(c)(2)(A)(v)) An ESBT must meet the following requirements:

(1) The trust must not have any beneficiaries other than individuals, estates, or charitable organizations described in Code Sec. 170(c)(2) through Code Sec. 170(c)(5) (relating to various charitable organizations, war veterans organizations, fraternal lodges, and cemetery organizations). Nonresident aliens may be beneficiaries (but not potential current beneficiaries). Organizations described in Code Sec. 170(c)(1) (i.e, state governments, U.S. possessions, political subdivisions of states or U.S. possessions, and the U.S. and the District of Columbia) may also be ESBT beneficiaries. However, they may only hold contingent interests and may not be potential current beneficiaries. (Code Sec. 1361(e)(1)(A)(i))

(2) No interest in the trust may have been acquired by purchase. (Code Sec. 1361(e)(1)(A)(ii)) (3) An election to be an ESBT must apply to the trust. (Code Sec. 1361(e)(1)(A)(iii)) (4) A QSST election must not have been made with respect to any stock held by the trust. (Code Sec. 1361(e)(1)(B)(i)) (5) The trust must not be a tax-exempt trust, a charitable remainder annuity trust (CRAT), or a charitable remainder unitrust (CRUT). (Code Sec. 1361(e)(1)(B)(ii), Code Sec. 1361(e)(1)(B)(iii))

Reg. § 1.1361-1(m)(1)(ii)(A) provides that for purposes of Reg. § 1.1361-1, a beneficiary includes a person who has a present, remainder, or reversionary interest in the trust. Under Reg. § 1.1361-1(m)(1)(ii)(B), a distributee trust is the beneficiary of the ESBT only if the distributee trust is an organization described in Code Sec. 170(c)(2) or Code Sec. 170(c)(3). In all other situations, any person who has a beneficial interest in a distributee trust is a beneficiary of the ESBT. (Reg. § 1.1361-1(m)(1)(ii)(B))

A distributee trust is a trust that receives or may receive a distribution from an ESBT, whether the rights to receive the distribution are fixed or contingent, or immediate or deferred. (Reg. § 1.1361-1(m)(1)(ii)(B))

A potential current beneficiary is, with respect to any period, any person who at any time during such period is entitled to, or at the discretion of any person may receive, a distribution from the principal or income of the trust (determined without regard to any power of appointment to the extent such power remains unexercised at the end of such period). (Code Sec. 1361(e)(2)) For purposes of determining whether a corporation is a small business corporation, each potential current beneficiary of an ESBT generally is treated as a shareholder of the corporation. (Reg. § 1.1361-1(m)(4)(i)) No person is treated as a potential current beneficiary solely because that person holds any future interest in the trust.

Reg. § 1.1361-1(m)(4)(iv) contains the rules for determining who are the potential current beneficiaries of an ESBT if a distributee trust becomes entitled to, or at the discretion of any person, may receive a distribution from principal or income of an ESBT. If the distributee trust is not a trust described in Code Sec. 1362(c)(2)(A), then the distributee trust is the potential current beneficiary of the ESBT and the corporation’s S corporation election terminates. (Reg. § 1.1361-1(m)(4)(iv)(B))

If the distributee trust is a trust described in Code Sec. 1362(c)(2)(A), the persons who would be its potential current beneficiaries if the distributee trust were an ESBT are treated as the potential current beneficiaries of the ESBT. (Reg. § 1.1361-1(m)(4)(iv)(C)) For this purpose, a trust will be deemed to be so described if it would qualify for a QSST election or an ESBT election if it owned S corporation stock. (Reg. § 1.1361-1(m)(4)(iv)(D))

A charitable remainder trust () is a trust formed to make current distributions to one or more noncharitable income beneficiaries and to pay the entire remainder to charity or use it for a charitable purpose. A CRT must be either a charitable remainder annuity trust (CRAT) or a charitable remainder unitrust (CRUT). A CRAT is a trust which is to pay its income beneficiary or beneficiaries a specified sum each year that can’t be less than 5% nor more than 50% of the initial net FMV of all property placed in trust. A CRUT is a trust which is to pay the income beneficiary or beneficiaries a fixed percentage each year, not less than 5% nor more than 50% of the net FMV of its assets, as valued annually. Some variations are permitted.

Ruling 1. IRS concluded that Trust 2 is a distributee trust. Therefore, its beneficiaries will be treated as the beneficiaries of Trust 1 for ESBT qualification purposes. Consequently, Trust 1 is eligible to elect to be treated as an ESBT and is thus eligible to be an S shareholder.

Ruling 2. IRS concluded that Trust 2 is not a charitable remainder trust. Therefore, Trust 2 will not be ineligible to be treated as an ESBT when it becomes a potential current beneficiary of Trust 1. Consequently, Trust 2 will qualify for deemed Code Sec. 1361(c)(2)(A) treatment under Reg. § 1.1361-1(m)(4)(iv)(D).

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Estate not taxed on transfer of decedent’s pension to charitable beneficiary PLR 200845029

IRS has privately ruled that an estate will not be taxed on a distribution of the decedent’s pension benefits to a charitable beneficiary of the estate.

Facts. An individual, whom we’ll call, Smith, died owning an interest in a defined benefit pension plan (the Plan Interest) of which his estate (Estate) was the beneficiary. His will (Will) named Charity as a residuary beneficiary. The executor of Estate proposes to assign the benefit of the Plan Interest to Charity in partial satisfaction of Charity’s share of the residue. The Will gave the executor the power to distribute property in kind and state law further allows distributions in kind without any requirement that they be made on a pro-rata basis.

Background. Income earned by an individual before death that isn’t included on his final return because of his accounting method (usually income that has been earned or accrued but hasn’t been actually or constructively received by a cash method taxpayer) is known as income in respect of a decedent or IRD. A decedent’s IRD must be reported, for the tax year when received, by:

  • the decedent’s estate, if it acquired the right to receive the item of income from the decedent;
  • the person who, by reason of the decedent’s death, acquires the right to the income whenever this right isn’t acquired by the decedent’s estate from the decedent; or
  • the person who acquires the right from the decedent by bequest, devise or inheritance, if the amount is received after distribution by the decedent’s estate of the right to the income. (Code Sec. 691(a)(1))

A transfer of a right to receive IRD is taxable to the transferor in the year of the transfer in an amount equal to the fair market value of the right or the amount received for it, whichever is greater. For this purpose, a transfer includes a sale, exchange, or other disposition, or the satisfaction of an installment obligation at other than face value, but does not include transmission at death to the estate of the decedent or a transfer to a person pursuant to the person’s right to receive the amount by reason of the decedent’s death or by bequest, devise, or inheritance from the decedent. (Code Sec. 691(a)(2))

If the estate of a decedent or any person transmits the right to IRD to another who would be required by Code Sec. 691(a)(1) to include such income when received in his gross income, only the transferee will include such income when received in his gross income. In this situation, a transfer within the meaning of Code Sec. 691(a)(2) has not occurred. (Reg. § 1.691(a)-4(b))

Under Reg. § 1.691(a)-4(b), if a right to IRD is transferred by an estate to a specific or residuary legatee, only the specific or residuary legatee must include such income in gross income when received.

Favorable ruling. The ruling concluded that the assignment of the Plan Interest to Charity in partial satisfaction of its share of the residue of Estate won’t be a transfer within the meaning of Code Sec. 691(a)(2). Thus, only Charity will include the amounts of IRD in the Plan Interest in its gross income when the distribution or distributions from the Plan Interest are received by Charity.

Observation: Thus, while the pension benefits are included in Charity’s income, as a practical matter, since Charity is a tax-exempt entity, this means the pension benefits will escape tax.

Tiered discount allowed in real estate FLP gift tax case In Astleford, a memorandum decision, the Tax Court permitted a taxpayer to apply a tiered discount in the context of a family limited partnership owning interests in real estate.

Facts. On 8/1/96, Mrs. Astleford formed the Astleford Family Limited Partnership (“AFLP”) to facilitate the continued ownership, development, and management of various real estate investments and partnership interests she owned and to facilitate gifts that she intended to make to her three adult children. On the same day, Mrs. Astleford transferred to AFLP ownership of an elder care facility. Also on the same day, Mrs. Astleford gave each of her three children a 30% limited partner interest in AFLP and retained for herself a 10% general partner interest.

On 12/1/97, Mrs. Astleford made additional capital contributions to AFLP by transferring to AFLP a 50% interest in Pine Bend Development Co. (“Pine Bend”), a general partnership, and her interest in 14 other real estate properties. The Pine Bend general partnership agreement did not contain any provisions relating to the transfers of interests in Pine Bend or whether such transferred interests would be general partner or assignee interests. Pine Bend owned 3,000 acres of land of which 1,187 acres consisted of agricultural farmland (“Rosemount property”).

As a result of the additional capital contributions made on 12/1/97, Mrs. Astleford’s general partner interest in AFLP increased significantly, and her children’s respective limited partner interests in AFLP decreased significantly. However, also on 12/1/97, Mrs. Astleford gave to each of her three children additional limited partner interests in AFLP. These gifts had the effect of reducing Mrs. Astleford’s AFLP general partner interest back down to approximately 10% and increasing the children’s AFLP limited partner interests back up to approximately 30% each.

On audit of the 1996 and 1997 gift tax returns, the IRS increased the fair market value of a number of the properties that were transferred to AFLP and also decreased the discounts for lack of control and lack of marketability that were applied to the interests transferred.

Analysis. There were three issues before the court: first, the value of the Rosemount property; second, whether the 50% Pine Bend interest should be valued as a general partner interest or as an assignee interest; and third, the amount of the discount for lack of control and lack of marketability that should apply to the gift of the 50% Pine Bend general partner interest and to the gift of the AFLP limited partner interests.

With respect to the Rosemount property, the valuation expert for Mrs. Astleford applied an absorption discount based on his opinion that a sale of the entire Rosemount property would flood the local market for farmland and would therefore reduce the per-acre price at which the Rosemount property could be sold. Believing that the Rosemount property would sell over the course of four years and would appreciate 7% each year, the expert performed a cash flow analysis using a present value discount rate of 25%.

The IRS‘s expert did not apply an absorption discount since he concluded that the entire Rosemount property likely could be sold in a single year without an absorption discount based on the fact that in 1970, the 3,000 acres of land (including the Rosemount property) had been purchased by Pine Bend in a single transaction. The IRS‘s expert also concluded that even if an absorption discount was appropriate, the 25% present value discount rate used by Mrs. Astleford’s expert was excessive. The IRS‘s expert argued that the present value discount rate should track the 9.2% rate of return on equity which farmers in the area actually earned.

The court believed that due to the size of the Rosemount property in relation to the number of acres sold each year in the area, it was unlikely that all 1,187 acres of the Rosemount property would be sold in a single year without a price discount. However, the court also believed that the present value discount rate of 25% used by Mrs. Astleford’s expert was unreasonably high because it relied on statistics relating to developers of real estate who expect greater returns given the greater risks involved in development. Since over 75% of the Rosemount property was leased to farmers, these rental payments would provide a source of future income to a prospective purchaser. The court found that given this low level of risk, a 10% rate of return would be sufficient to induce a purchase of the Rosemount property.

With respect to Pine Bend, the parties disputed the nature of the interest transferred by Mrs. Astleford to AFLP and therefore the appropriate amount of the discount for lack of control and lack of marketability that should apply. Because the other 50% general partner of Pine Bend did not consent to Mrs. Astleford’s transfer of her general partner interest in Pine Bend to AFLP, Mrs. Astleford’s expert treated the 50% Pine Bend interest transferred to AFLP as an assignee interest and applied a 5% discount. The position of Mrs. Astleford’s expert was based on applicable state law that provided that a holder of an assignee interest has only a profits interest but no influence on management.

The court agreed with the IRS that the substance-over-form doctrine applied to treat the interest in Pine Bend that Mrs. Astleford transferred to AFLP as a general partner interest. The court based its conclusion on its finding that since Mrs. Astleford was the sole general partner of AFLP, she was essentially in the same management position relative to the 50% Pine Bend interest whether she is to be viewed as having transferred to AFLP a Pine Bend assignee interest (and thereby retaining Pine Bend management rights) or as having transferred those management rights to AFLP as a result of the transfer of a Pine Bend general partner interest (in which case she reacquired those same management rights as sole general partner of AFLP). The court also noted that the transfer documents treated Mrs. Astleford’s Pine Bend transfer as a transfer of all of her rights and interests in Pine Bend, thereby suggesting that a general partner interest–not an assignee interest–was transferred.

Next, the court addressed the amount of the discount for lack of control and lack of marketability that should apply (1) to the limited partnership interests in AFLP given to Mrs. Astleford’s three children, and (2) to the 50% Pine Bend general partnership interest she transferred to AFLP. In determining these discounts, Mrs. Astleford’s expert relied on data for real estate limited partnerships (“RELPs”) while the IRS‘s expert relied on data for real estate investment trusts (“REITs”). The court did not believe that either the RELP data or the REIT data was superior to the other. According to the court, RELPs more closely resembled AFLP, and the RELP secondary market is not so low as to render the available RELP data unreliable. However, the court also said that that the large number of REIT sales transactions tended to produce more reliable data compared to the limited number of RELP sales transactions. In addition, the court stated that the differences between REITs and AFLP may be minimized given the large number of REITs from which to choose comparables.

But REITs sometimes trade at prices higher than net asset value. The court recognized that this fact does not mean that a lack of control discount is nonexistent but suggests that a REIT’s share price is in part affected by two factors, one positive (the liquidity premium) and one negative (lack of control). Therefore, in analyzing REIT comparables and their trading prices, the court found it is appropriate to quantify and then to reverse out of the trading prices, any liquidity premiums that are associated with REIT comparability data. The court stated that this calculation results in a REIT discount for lack of control that can be applied to the partner interests gifted.

To determine the appropriate liquidity premium to apply to the REIT, the court examined the difference in average discounts in private placements of registered and unregistered stock–reasoning that the difference represents pure liquidity concerns since a public market is available to owners of registered stock but not to the owners of unregistered stock. After performing these calculations, the court applied a lack of control discount of 16.17% for the 1996 gifts and a discount of 17.47% for the 1997 gifts of AFLP by Mrs. Astleford to her children.

With respect to the discount for lack of marketability, the expert for Mrs. Astleford applied a discount of 15% and the IRS expert applied a discount of 21.23% for the 1996 gifts. The court, without any discussion, used the higher discount applied by the IRS expert. For the 1997 gifts, the court applied a lack of marketability discount of 22%.

In valuing the 50% Pine Bend general partner interest, the IRS‘s expert concluded that because the Pine Bend partner interest was simply an asset of AFLP, the discounts he applied at the AFLP level obviated the need to apply an additional and separate discount at the Pine Bend level. The court disagreed and held that a 30% combined discount for lack of control and lack of marketability was appropriate. In a footnote, the court mentioned that the Tax Court has rejected multiple discounts in the context of tiered entities where the lower level interest constituted a significant portion of the parent entity’s assets. However, in this case, the 50% Pine Bend interest constituted less than 16% of the net asset value of AFLP and was only one of 15 real estate investments that were held by AFLP.

Comments. Astleford is noteworthy for several reasons. First, this case demonstrates that the Tax Court in appropriate situations will allow substantial discounts. While the IRS has had victories in the context of Section 2036, if the taxpayer is able to satisfy the requirements of that section, substantial discounts will be available. Second, the court allowed discounts for lack of control and lack of marketability at both the subsidiary partnership level and at the parent partnership level. Third, Astleford illustrates that when large tracts of land are involved, practitioners should consider applying absorption discounts. Fourth, this case illustrates one method of determining the amount of the discount for lack of control when analyzing REIT data. While this case does not necessarily make new law, it reminds us of some concepts with which we should all be familiar.

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Charitable remainder trust can be divided into separate trusts without adverse tax consequences Rev Rul 2008-41, 2008-30 IRB Mike Habib, EA

In the context of two fairly detailed factual situations, a new revenue ruling makes it clear that a charitable remainder trust (CRT) can be divided into two or more separate CRTs without adverse tax consequences. If properly effected, the separate trusts will continue to qualify as CRTs, the division won’t be a sale, and no excise taxes will arise under Code Sec. 507(c), Code Sec. 4941 or Code Sec. 4945.

Background. In general, a charitable remainder trust (CRT) provides for a specified periodic distribution to one or more noncharitable beneficiaries for life or for a term of years with an irrevocable remainder interest held for the benefit of charity. A CRUT pays a unitrust amount at least annually to the beneficiaries as opposed to a charitable remainder annuity trust or CRAT, which pays a sum certain at least annually to the beneficiaries. (Code Sec. 664)

A CRT is exempt from income tax but is subject to tax on unrelated business taxable income. (Code Sec. 664(c)) Income, gift and estate tax deductions are allowed for the value of the charity’s remainder interest in a CRT. (Code Sec. 170(f)(2), Code Sec. 2522(c)(2)(A), Code Sec. 2055(e)(2)(A)) To qualify as a CRT, numerous requirements must be met. They are spelled out in Code Sec. 664(d).

Situation 1 facts. A summary of the key facts in Situation 1 follows: Trust qualifies as either a CRAT or CRUT. Under its terms, two or more individuals (recipients) are each entitled to an equal share of the annuity or unitrust amount, payable annually, during the recipient’s lifetime, and upon the death of one recipient, each surviving recipient becomes entitled for life to an equal share of the deceased recipient’s annuity or unitrust amount. Thus, the last surviving recipient becomes entitled to the entire annuity or unitrust amount for his or her life. Upon the death of the last surviving recipient, Trust’s assets are to be distributed to one or more Code Sec. 170(c) charitable organizations (remainder beneficiaries).

The state court having jurisdiction over Trust has approved a pro rata division of Trust into as many separate and equal trusts as are necessary to provide one such separate trust for each recipient living at the time of the division, with each separate trust being intended to qualify as the same type of CRT.

The separate trusts may have different trustees. To carry out the division of Trust into separate trusts, each asset of Trust is divided equally among and transferred to the separate trusts. The recipients pay all the costs associated with the division of Trust into separate trusts.

Each of the separate trusts has the same governing provisions as Trust, except that: (i) immediately after the division of Trust, each separate trust has only one recipient, and each recipient is the annuity or unitrust recipient of only one of the separate trusts (that recipient’s separate trust); (ii) each separate trust is administered and invested independently by its trustee(s); (iii) upon the death of the recipient, each asset of that recipient’s separate trust is to be divided on a pro rata basis and transferred to the separate trusts of the surviving recipient(s), and the annuity amount payable to the recipient of each such separate CRAT is thereby increased by an equal share of the deceased recipient’s annuity amount (the unitrust amount of each separate CRUT is similarly increased as a result of the augmentation of the CRUT’s corpus, and each separate CRUT incorporates the requirements of Reg. § 1.664-3(b) with respect to the subsequent computation of the unitrust amount from that trust); and (iv) upon the death of the last surviving recipient, that recipient’s separate trust (being the only separate trust remaining) terminates, and the assets are distributed to the remainder beneficiaries.

The remainder beneficiaries of Trust are the remainder beneficiaries of each of the separate trusts and are entitled to the same (total) remainder interest after the division of Trust as before.

Situation 2 facts. The facts are similar in Situation 2 except that the recipients are a married couple in the process of divorcing and on the death of the first recipient to die, the remainder of that separate trust goes to the charities. The trust assets do not first go to the survivor recipient as was the case before the division. Thus, the charity can wind up with more than under the original scenario but no increased charitable deduction is allowed.

Favorable rulings. IRS issued these favorable rulings with respect to both Situations 1 and 2:

    (1) The pro rata division of a trust that qualifies as a CRT under Code Sec. 664(d) into two or more separate trusts does not cause the trust or any of the separate trusts to fail to qualify as a CRT under Code Sec. 664(d).

(2) The division is not a sale, exchange, or other disposition producing gain or loss, the basis under Code Sec. 1015 of each separate trust’s share of each asset is the same share of the basis of that asset in the hands of the trust immediately before the division of the trust, and, under Code Sec. 1223, each separate trust’s holding period for an asset transferred to it by the original trust includes the holding period of the asset as held by the original trust immediately before the division.

(3) The division does not terminate under Code Sec. 507(a)(1) the trust’s status as a trust described in, and subject to, the private foundation provisions of Code Sec. 4947(a)(2) and does not result in the imposition of an excise tax under Code Sec. 507(c).

(4) The division does not constitute an act of self-dealing under Code Sec. 4941.

(5) The division does not constitute a taxable expenditure under Code Sec. 4945.