Wills and Trusts

Wyatt, Tarrant & Combs, LLP

Tax Consequences of an Early Termination of a Charitable Remainder Trust

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Since 2008, the IRS has refused to rule on the tax consequences of an early termination of a CRT where the trust beneficiaries receive their actuarial shares of the trust assets.  PLR 201325018 dealt with such issue because the ruling had been pending since before 2008!  The CRT was a net income with make-up payout provisions.  Presumably, that was the reason for the lengthy time required.  With respect to the actuarial valuation, the ruling states:

The actuarial relationship between a life estate and a remainder interest is complementary, according to the regulations noted above. The life estate represents the right to receive income from an asset during a time period, while the remainder interest reflects the right to the asset itself after the period. By comparison, the payout interest in a flat rate unitrust is the right to receive a specified percentage each year regardless of the income.

While the unitrust remainder interest may not be a standard remainder interest, it nevertheless is quantifiable in actuarial terms. It is readily possible to compute actuarial factors for the remainder interest in a flat-rate unitrust. The Service has published tables to be used in computing unitrust interests, and these factors can be understood as ordinary unitrust factors.

A NIMCRUT (charitable remainder unitrust with a net make-up feature) does not necessarily pay a stated percentage of the trust value each year. Rather, it pays the lesser of the stated percentage of trust income plus any excess income over the stated percentage, to the extent that the aggregate of amounts paid in prior years was less than the stated percentage.

Thus, the income beneficiaries have a potential right to amounts in excess of the rates specified in § 7520, a right that is dependent on the happening of events which are not so remote as to be negligible. The computed charitable remainder interest must be minimized to reflect amounts that reasonably may be paid to the beneficiaries for a charitable deduction to be available.

We note that the maximum beneficiary payments would be payments up to the amount of the stated percentage. Thus, the available deduction for the remainder interest is reflected in a remainder factor which assumes that the trust pays the stated percentage each year. This assumption is required under § 1.664-4(a)(3). Accordingly, the remainder factor provided in the regulations for a NIMCRUT represents a special factor, which accounts for the non-standard charitable remainder interest, and which reflects the non-negligible potential for the payout to exceed the § 7520 rate.

One reasonable method not resulting in a greater allocation of assets to Husband and Wife than appropriate is the following:

The computation of the remainder interest is found using a special factor as indicated in § 1.7520-3(b)(1)(ii). The special remainder factor is found by using the methodology stated in § 1.664-4 for computing the factor for a remainder interest in a unitrust, with the following modification: where § 1.664-4(a)(3) of the regulations provides an assumption that the trust’s stated payout percentage is to be paid out each year, instead the assumed payout shall be that of a fixed percentage which is equal to the lesser of the trust’s stated payout percentage or the § 7520 rate for the month of termination. The special factor for the non-charitable payout interest is 1 minus the special remainder factor.

Based on this methodology, the calculation of Husband and Wife’s income interest is made in the following manner:

The § 7520 rate for March 2013 and April 2013 is 1.4 percent under Rev. Rul. 2013-7. Assuming the termination occurs in either of these months, the lesser of this rate and the trust’s stated percentage is 1.4 percent. Throughout these months the donor is age 72 and the spouse is age 70 (age nearest birthday).

Based on Table 2000CM in § 20.2031-7(d)(7), interest at 1.4 percent, an unadjusted payout rate of 1.4 percent, and annual payments made at the beginning of each year, the present value of the remainder interest in a unitrust which falls in at the death of the last to die of 2 persons aged 70 and 72 is $0.77971 for each $1.00 of the trust estate. The present value of the payout interest in the same unitrust until such death is $1.00 minus $0.77971 or $0.22029 for each $1.00 of the trust estate.

In this case, the income beneficiaries are not expected to receive more than they would during the full term of Trust under the above-described methodology for valuing their interests in a charitable remainder trust with a net income make-up feature. Further, you represent that state law provides for early termination under the facts presented.

In addition, Husband and Wife’s personal physicians have conducted physical examinations and have stated under penalties of perjury that they find no medical condition expected to result in a shorter-than-average longevity; and Husband and Wife have signed similar statements.

Furthermore, because the effect of the transactions is to vest the income interests with the income beneficiaries and the remainder interest in the remainder beneficiary, the trust no longer will be a split-interest trust and § 4947(a)(2) will no longer apply and § 507 will not apply.

Capital Gains

Proceeds received by the life tenant of a trust, in consideration for the transfer of the life tenant’s entire interest in the trust to the holder of the remainder interest, are treated as an amount realized from the sale or exchange of a capital asset under § 1222. See Rev Rul. 72-243, 1972-1 C.B. 233; McAllister v. Commissioner, 157 F.2d 235 (2nd Cir.), cert. den. 330 U.S. 826 (1946).

Turney P. Berry
Louisville, Kentucky

Author: robmalinesq

I am an estate planning and probate attorney in Memphis, Tennessee.

Leave a reply. Please note that although this blog may be helpful in informing clients and others who have an interest in information privacy and security, it is not intended to be legal advice. The information on this blog also should not be relied upon to form an attorney-client relationship.

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