Generally, charitable gifts in which thedonor retains an income interest will notresult in a charitable deduction. However,the charitable remainder trust (CRT) is anarrow exception to the general rule of nondeductibility.When the remainder interest is in acharitable remainder unitrust (CRUT),a charitable remainder annuity trust, ora pooled income fund, it is deductible.As such, its technical requirements,found in Internal Revenue Code Section664 and the accompanying regulations,must be carefully followed.
Private letter rulings indicate thatthe IRS believes there should be considerableflexibility in rearranging andrestructuring CRTs to suit the desiresof the beneficiaries. Although theserulings cannot be generally used asprecedent, they do reveal an interestingtrend in this area—one that shouldencourage estate planners to consider new planningopportunities. The following are some ofthose letter rulings.
Two CRUTs may be better than 1. In thisinstance, a physician creates a CRUT that paysout a 5% unitrust amount first to the physicianand then, upon death, to their spouse.The physicianreserves the power to change the charitableremainder beneficiaries and to change the distributionamong them. When the spouse dies, thephysician proposes to split the CRUT into 2CRUTs—representing 85% and 15% of theassets, respectively. The terms of the 2 trustswould be the same, and the assets would bedivided so that each trust fairly represents therelative bases of assets in the trust before thedivision. The physician also proposes to irrevocablyname a specific charity as the remainder beneficiaryof the 15% CRUT. In the next step ofthe plan, the physician would assign the unitrustinterest in the 15% CRUT to that named beneficiary. The income and remainder interests inthe 15% CRUT would be merged, itwould terminate, and, under thestate's applicable merger law, itsassets would be distributed to thedesignated charity.
The IRS ruled that the physician,in this case, is entitled to anincome tax charitable deductionequal to the value of the unitrustinterest in the 15%CRUT assigned to thecharity. The physicianis entitled to a gift taxcharitable deductionin the same amount. Itis also ruled that the85% CRUT would continueto qualify as a CRUT.
The facts in this ruling are that the physiciancreated a net income CRUT under the terms ofwhich the lesser of the net income or a fixedpercentage of the trust asset's value was payableto the physician for their lifetime and then totheir spouse for their lifetime if they survive.Upon the death of both the physician and theirspouse, the trust terminates and the assets areto be distributed to charities: y to Charity A; zto Charity B; and z to 1 or more qualified charitableorganizations.
ANOTHER FOR INSTANCE
In this case, the physician dies and Charity Bapproaches the spouse and asks them to helpwith its immediate funding needs. The spouseproposes to transfer to Charity B an undividedportion (not all) of the unitrust interest. The rulingstates that "[Spouse] will transfer all right,title, and interest in and to [an undisclosed percentage]fractional share of the unitrust paymentsfrom the trust." It is representedin the ruling that Charity A—the other designated remainderbeneficiary—will consentto the transfer. It isalso represented thatunder applicable statelaw, the undivided portion(based on the undisclosedpercentage) in which thespouse proposes to transferto Charity B will mergewith a proportionate part ofthe Charity B's remainder interestin the trust. The trust will terminate as to thatpercentage and the assets representing that percentagewill be distributed to Charity B.
In essence, the IRS ruled that the spouse'stransfer of this undivided portion instead of all ofthe unitrust interest still qualified for an income taxcharitable deduction and for a gift tax charitablededuction. Additionally, the IRS ruled that remainingtrust interest, after distribution of the assets toCharity B, will continue to qualify as a CRT.
CRTs are complex estate planning techniquesthat require carefully drafted documents with appropriatetechnical language. However, the IRShas signaled its willingness, within limits, to beflexible with regard to the restructuring of thesetrusts to meet legitimate objectives of the beneficiaries. In certain cases, creative techniques maybe available to rearrange CRT plans that no longermeet the needs of the trust beneficiaries.
David W. Keister is managing
director and chief
trust officer of estate
planning and trust administration
Chase Trust Company
in Bethesda, Md. He
welcomes questions or
comments at 240-497-5007 or firstname.lastname@example.org.