There are many strategies that a professional advisor can use to help clients exit from planned gifts. All require a clear understanding of the partial interest rule.
The general rule is that a gift of a partial interest is not deductible unless it consists of a remainder interest in a unitrust, annuity trust, pooled income fund, personal residence or a farm. The exceptions are not permitted if the partial interest was created as a way to get around the partial interest rule. There are three important exceptions:
An income tax charitable deduction is allowable for a partial interest gift if the donor retains an insubstantial interest in the property contributed.
An exception exists when the donor's gift of a partial interest represents the donor's entire interest in the property.
An exception exists if a donor makes a gift of a fractional or percentage interest that is an undivided portion of the donor's entire interest in the property and the gift extends over the entire term of the donor's interest in the property.
Here are eight ways for your client to leave his CRUT behind. The list begins with the simplest strategy and includes increasingly complex options.
Gift the Unitrust Income Interest — A donor often can make a gift of the CRUT income interest to the charitable remainder beneficiary. The donor's gift of his unitrust income interest consists of a gift of his entire interest in the property and thus qualifies for an income tax charitable contribution deduction.
The calculation of your client's income tax charitable deduction is explained in the Treasury regulations for unitrusts and annuity trusts.
Your client also receives a gift tax charitable contribution deduction for the present value of the gift of the unitrust income interest on the date of gift. Note, though, that the gift tax charitable deduction requirements differ from the income tax charitable deduction rules. The gift tax requirements create traps if they are not carefully observed.
The key question is whether or not the donor has made a gift of the same property for private purposes.
Gift a Portion of the Unitrust Income Interest — The Internal Revenue Service has approved a gift of a portion of a unitrust income interest. The unitrust may not qualify as a charitable remainder trust (CRT) exempt from income tax if a client makes a gift of the income interest to a charity that is not designated as the remainder beneficiary.
Counsel should consult state law to see if it permits a gift of part of an income interest. Some states allow partial termination of the trust. Other states require a division into two separate trusts prior to the assignment in order to accomplish the distribution in the most expedient manner.
The client's income tax charitable deduction for a gift of a unitrust income interest is a gift of a capital asset.
A Power to Assign to a Charity Is a Built-in Exit — A client may be able to terminate a CRUT early and make a direct distribution to charity if the trust document provides a power to assign the trust principal to charity. In Private Letter Ruling 200124010, the IRS approved the early termination of a unitrust and a direct distribution of the unitrust principal to the charitable remainderman beneficiaries. The unitrust document included a power to assign any portion of the unitrust to a charity before the donor's death.
Partition the CRUT — The Service has approved the partition of a CRUT. The partition of a spousal unitrust may be beneficial in the event of a divorce. An alternative approach might be for one spouse simply to cash out his income interest and the other spouse to continue to receive the CRT income.
Deploy the Actuarial Interest Option — A donor and the charitable remainder beneficiary often can terminate a CRT and divide the trust property according to their actuarial interests. The termination may require court approval. The income recipient realizes capital gain when he receives his distribution. The income recipient has a zero basis for the purpose of this distribution.
The IRS has concluded that state law provisions permitting an early termination could be considered implied terms in the trust. The donor's receipt of the present value of the income interest was entirely capital gain.
The Service has permitted a client to “cash out” a term of years unitrust. The IRS also has permitted the early termination of a CRUT when the donor changed the charitable remainder beneficiary to a private foundation.
Sell the Unitrust Income Interest to Charitable Remainder Beneficiary — The Service has approved the sale of an income interest to the charitable remainder beneficiary. There is a potential self-dealing issue if the charitable remainder beneficiary is a private foundation. The Service has so far declined to rule on this situation.
Sell the Unitrust to a Third Party — The unitrust income recipient and the charitable remainder beneficiary may together sell the entire unitrust or annuity yrust to a third party. The income recipient realizes capital gain, but is subject to the normal basis rules of Treasury Regulations Section 1.1001-1(f)(1). The Internal Revenue Code Section 1001(e)(1) exception is available, because the entire interest in the trust is being sold to a third party.
Gift the Unitrust Income Interest in Exchange for a Charitable Gift Annuity — A client can make a gift of a unitrust income interest to the charitable remainder beneficiary in exchange for a charitable gift annuity based on the value of the unitrust income interest.
Reform the CRUT — The parties may be able to obtain a judicial reformation of a CRT. The Service has sanctioned state law reformations of CRTs when they're necessary to effectuate the parties' original intention.
Based on scrivener's error, the IRS permitted reformation of :
a net income plus makeup unitrust permitted the addition of post contribution capital gain to income;
a CRUT to permit addition of a power to change the charitable remainder beneficiary;
a defective charitable remainder annuity trust (CRAT) permitted to qualify the trust;
a net income plus make-up unitrust to a standard CRUT;
a CRUT permitted to change the valuation date; and
a CRAT to change to a CRUT.
a CRT to include private foundation as a charitable remainder beneficiary.
Here are three ways to get out of a CRAT, from the most straightforward to the most complicated option requiring court approval:
Gift the Annuity Trust Income Interest to the Charitable Remainder Beneficiary — The client can make a charitable gift of his annuity trust income interest to the charitable remainder beneficiary. The donor receives a current income tax charitable contribution deduction for the present value of the income interest on the date of gift. The client also receives a gift tax charitable contribution deduction for a gift of the annuity trust income interest. The gift tax rules, however, are not identical to the income tax rules. They create a tax trap if not carefully observed.
Make a Current Gift of the Growth in the CRAT — A client may be able to make a current gift of the growth in a CRAT to the charitable remainder beneficiary. The key is the client must retain enough property in the annuity trust to pay the annuity income. The client receives no income tax charitable contribution deduction for the gift of the excess principal to the charitable remainder beneficiary.
In PLR 199929033, the IRS ruled that a proposed amendment permitting the trustee of an annuity trust to distribute up to a fixed amount of the trust principal to the charitable remainder beneficiary would not disqualify the trust under IRC Section 664. The annuity trust was located in a state which permitted non-judicial resolution agreements to give trustees additional or necessary powers not included in the trust agreement or given by law if the additional powers are not inconsistent with the provisions or purposes of the trust.
Petition the Court for an Amendment Permitting Gifts of Principal and Income — A donor can petition a court to approve an amendment to a CRAT to authorize gifts of income and principal to the charitable remainder beneficiary. The trustees of a CRAT asked the Service for permission to amend a CRAT to permit gifts of income and principal to qualified charitable organizations selected by the trustee — but only to the extent that the annuity trust principal would not be reduced below a level necessary to ensure payment of the five percent annuity income. The Service concluded that the proposed modification to permit gifts of income and principal would not disqualify the trust as a CRAT under IRC Section 664.
The Service noted that Treas. Reg. Section 1.664-(e)(1) provides that an amount distributed by a CRT to an organization described in IRC Section 170(c) other than the annuity or unitrust amount shall be considered as a distribution of corpus and of those categories of income specified in Treas. Regs. Section 1.664-1(d)(1) in an order reverse to that described in Treas. Regs. Section 1.664-1(d)(1). The character of such amounts shall be determined as of the end of the taxable year of the trust in which the distribution is made after the character of the annuity or unitrust amount has been determined.
How does a client get out of a charitable gift annuity? One possibility: a donor often can make a gift of the charitable gift annuity income interest to the charitable organization that issued the gift annuity contract. A donor also can make a gift of his deferred gift annuity income interest back to the charitable organization that issued the deferred payment gift annuity.
For pooled-income funds, there are these three possible outs (again from the simplest to more complex):
Gift the Pooled Income Fund Income Interest — A client often can make a gift of his pooled income fund income interest to the charitable remainder organization. The donor receives a current income tax charitable contribution deduction for gift. The trustee distributes a pro rate share of the pooled fund principal to the charitable remainder beneficiary as a current gift.
Gift the Pooled Income Fund Income Interest in Exchange for a Charitable Gift Annuity — A donor to a pooled income fund might give his income interest to the charitable remainder beneficiary in exchange for a charitable gift annuity. Gifts of pooled income fund income interests in exchange for charitable gift annuities have not been approved. There is no specific IRC provision or other authority for this approach. Counsel for donors and charities considering this strategy should examine carefully all of the issues involved.
The pooled income fund income interest should be treated like any gift of capital gain property in exchange for a gift annuity. The capital gain should be recognized over the donor's lifetime.
Merge a Charity's Pooled Income Funds — Some charitable organizations have multiple pooled income funds. The various pooled income funds typically have different investment objectives. The Service has approved the merger of two pooled income funds.
Here are five ways to exit gifts with retained life estates: (Rorie: simpliest to complex)
Make a Charitable Gift of a Life Estate — The Client can give the life interest to the charitable remainder organization. The client receives both an income tax and gift tax charitable contribution deduction for the gift
Lease the Life Estate Property to Create Income Stream — A client often can lease the property to obtain an income stream.
Sell the Life Estate Property to a Third Party — The donor and the charitable remainder beneficiary can together sell the property to a third party. The division of the sale proceeds is based on the Service's methodology for valuing the respective interests.
Sell the Life Estate Property to a Charitable Beneficiary — The client can consider a sale of the life estate to the charitable remainder beneficiary. The calculation of the value of the donor's retained life estate would use the Service's methodology for valuing the respective interests.
Give the Life Estate Property in Exchange for a Charitable Gift Annuity — The client also can consider a gift of her life estate in the property to a charitable organization in exchange for a charitable gift annuity.
And last but certainly not least, here are two ways to get rid of a charitable lead annuity trust (CLAT):
Prepay the Charitable Annuity Income Stream — The Service has approved the early termination of a CLT // /CLAT HERE INSTEAD OF CLT?///. The trustees prepaid the charitable annuity without discount and terminated the CLAT.
Extend the Charitable Annuity Income Steam — The Service also approved the early termination of a CLAT that had 11 years remaining on the 15-year trust term. The trustees executed an amended and restated the CLAT agreement that extended the trust term to 15 years and provided that the trustees would retain the lead trust assets in excess of 110 percent of the remaining undiscounted annuity payments.
THINK “WHAT'S FAIR?”
Charitable giving exit strategies provide creative planning opportunities for donors and for charitable organizations. The key is to plan and implement the strategy in a way that is fair to the donor, the government and the charitable organization.
Internal Revenue Code Section 170(2) and 170(f)(3)(A).
IRC Sections 170(2) and 170(f)(3)(A).
Revenue Ruling 75-66. See also Private Letter Rulings 8152072, 200445023 and 200445024.
Treasury Regulations Section 1.170A-6(a) and 1.170A-7(a)(2)(i).
IRC Section 170(f) (3)(B)(ii) and Treas. Regs. Section 1.170A-7(b)(1).
Treas. Regs. Sec. 1.170A-6(a)(2) and 1.170A-7(a)(2)(i). See Rev. Rul. 86-60, 1986-1 CB 302.
Treas. Regs. Sec. 1.664-(2(c) for unitrusts and Treas. Regs. Sec. 1.664-4 for annuity trusts. See also IRC Section 7520 and PLRs 200408031, 200324035 and 200314021.
IRC Section 2522; Treas. Regs. Sec. 25.2522 (c)-3(c)(1) and (2).
IRC Section 2522.
Treas. Regs. Secs. 1.664-2(a)(3)(i). and 1.664-3(a)(3)(i).
PLRs 200207026, 200205008 and 200140027.
Treas. Regs. Section 1.170A-4(b)(1); Rev. Rul. 72-243, 72-1 C.B. 233 (2nd Cir 1946) cert. den. 330 U.S. 826 (1946). See for example, PLRs 200152018, 198613046, 198311063, and 198052092. See also IRC Section 170 (b)(1)(A); Treas. Regs. Section 1,170A-8(b); IRC Section 170 (b)(1)(c)(i); Treas. Regs. Section 1.170A-8(d)(1); IRC Section 170 (b)(1)(B) and IRC Section 170 (b)(1)(B)(ii); Reg. Section 1.170A-8(c)(2)(ii); PLR 199550026 and Treas. Regs. Section 1.664-(3)(a)(4).
Treas. Regs. Sec. 1.664-3(a)(4). See PLR 200124010
Treas. Regs. Section 1.664-3(a)(4). See also Treas. Regs. Section 1.664-3(a)(4); and see PLR 200124010.
PLRs 9851006, 9903001, 200120016, 20014328, 200221042 and 200539008.
PLRs 200614032, 200525014, 200441024, 200324035, 200252092 and 200208039.
Rev. Rul. 72-243, 1072-1 CB 233.
IRC Section 1001(e)(1).
IRC Section 509(a).
PLRs 200314021, 200231011, 200152018, 200127023 and 8948023.
PLR 200338006. See also, for example, PLR 200244011.
PLR 200233005. See also, for example, PLRs 200233006 and 200233007.
Treas. Regs. Section 1.170A-7(a)(2)(i).
Treas. Regs. 25.2522(c)-3(c).
IRC TREASURY OR IRC??? Reg. Sec. 1.642(c)-6B. See also PLR 8611023.
IRS Publication 1457
IRS Pub. 1457. See also Rev. Rul. 84-43, 1984-ICB 27 and Rev. Rul. 80-172, 1980 2CB56.
Treas. Regs. Sec. 1.170A-12(a)
Rev. Rul. 84-43. See also for example Rev. Rul. 87-37 and Rev. Rul. 75-420.