IRS Challenges Validity of Charitable Trust Structure

IRS Challenges Validity of Charitable Trust Structure

Internal Revenue Service

In generic legal advice, the IRS concluded that a marketed structure purporting to use a <a href="/research/federal/usc26/664" resolve="/lr/resolve/section-664/cppw" title="section 664">section 664</a> charitable remainder annuity trust (CRAT) to eliminate capital gain on the sale of highly appreciated property fails to meet the requirements of <a href="/research/federal/usc26/664" resolve="/lr/resolve/section-664/cppw" title="section 664">section 664</a>. In this structure, a taxpayer establishes and funds a trust purported to qualify as a CRAT. The trustee may provide for the annuity amount by purchasing one or more annuities, including single-premium immediate annuities (SPIAs), with the cost of the annuity or annuities to be less than 90 percent of the initial fair market value of the trust property. In each tax year of the trust, the trustee shall pay to the beneficiary “during their lifetime for a period of five years” an annuity amount equal to the greater of 10 percent of the initial FMV of all property transferred to the trust or the payments received by the trustee from one or more SPIAs purchased by the trustee. That provision — allowing a payment to the income beneficiary above the amount determined at the funding of the trust based on a percentage of the initial FMV of the trust assets — causes the trust to fail to qualify under <a href="/research/federal/usc26/664#cppw-0000017" resolve="/lr/resolve/section-664d1b/cppw#cppw-0000017" title="section 664(d)(1)(B)">section 664(d)(1)(B)</a> because such excess payments are not described in <a href="/research/federal/usc26/664#cppw-0000016" resolve="/lr/resolve/section-664d1a/cppw#cppw-0000016" title="section 664(d)(1)(A)">section 664(d)(1)(A)</a>, the IRS said. The trust agreement also provides that instead of the remainder distribution to the charitable organization, the trustee may pay to the charity 10 percent of the initial FMV of the trust property plus $100. The charity will then have no further rights under the trust and won’t receive the remainder at the end of the trust term. Denying the remainder to the charity, the IRS said, would disqualify the CRAT because under <a href="/research/federal/usc26/664#cppw-0000018" resolve="/lr/resolve/section-664d1c/cppw#cppw-0000018" title="section 664(d)(1)(C)">section 664(d)(1)(C)</a> such a payment is mandatory. The IRS concluded that when this structure is used, the validity of the CRAT should be challenged on the basis of disqualifying terms in the instrument and subsequent operational failures. The IRS should disallow any charitable deductions claimed for the value of the remainder and the treatment of the trust as a taxable entity since its creation, according to the memorandum.

In generic legal advice, the IRS concluded that a marketed structure purporting to use a section 664 charitable remainder annuity trust to eliminate capital gain on the sale of highly appreciated property fails to meet the requirements of section 664.

In generic legal advice, the IRS concluded that a marketed structure purporting to use a section 664 charitable remainder annuity trust (CRAT) to eliminate capital gain on the sale of highly appreciated property fails to meet the requirements of section 664. In this structure, a taxpayer establishes and funds a trust purported to qualify as a CRAT. The trustee may provide for the annuity amount by purchasing one or more annuities, including single-premium immediate annuities (SPIAs), with the cost of the annuity or annuities to be less than 90 percent of the initial fair market value of the trust property. In each tax year of the trust, the trustee shall pay to the beneficiary “during their lifetime for a period of five years” an annuity amount equal to the greater of 10 percent of the initial FMV of all property transferred to the trust or the payments received by the trustee from one or more SPIAs purchased by the trustee. That provision — allowing a payment to the income beneficiary above the amount determined at the funding of the trust based on a percentage of the initial FMV of the trust assets — causes the trust to fail to qualify under section 664(d)(1)(B) because such excess payments are not described in section 664(d)(1)(A), the IRS said. The trust agreement also provides that instead of the remainder distribution to the charitable organization, the trustee may pay to the charity 10 percent of the initial FMV of the trust property plus $100. The charity will then have no further rights under the trust and won’t receive the remainder at the end of the trust term. Denying the remainder to the charity, the IRS said, would disqualify the CRAT because under section 664(d)(1)(C) such a payment is mandatory. The IRS concluded that when this structure is used, the validity of the CRAT should be challenged on the basis of disqualifying terms in the instrument and subsequent operational failures. The IRS should disallow any charitable deductions claimed for the value of the remainder and the treatment of the trust as a taxable entity since its creation, according to the memorandum.

Sec. 664 Charitable remainder trusts

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IRS Challenges Validity of Charitable Trust Structure