Charitable Remainder Trust

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. ยง 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.