Wills and Trusts

Wyatt, Tarrant & Combs, LLP


Leave a comment

Avoidance of Excess Business Holdings Rules

. Treas. Reg. §53.4943-8(b) provides that voting shares owned by a trust are deemed constructively owned by its remainder beneficiaries. The Regulation gives this example:

Thus, if a trust owns 100 percent of the stock of a corporation A, and if, on an actuarial basis, W’s life interest in the trust is 15 percent, Y’s life interest is 25 percent, and Z’s remainder interest is 60 percent, under this paragraph (b), Z will be considered to be the owner of 100 percent of the stock of corporation A.

Treas. Reg. §53.4946-1 provides that the following are disqualified persons with respect to a private foundation:

(i) All substantial contributors to the foundation, as defined in § 507(d)(2) and the regulations thereunder.

(ii) All foundation managers of the foundation as defined in § 4946(b)(1) and paragraph (f)(1)(i) of that section,

(iii) An owner of more than 20 percent of:

(a) The total combined voting power of a corporation,

(b) The profits interest of a partnership,

(c) The beneficial interest of a trust or unincorporated enterprise,

which is (during such ownership) a substantial contributor to the foundation, as defined in § 507(d)(2) and the regulations thereunder,

(iv) A member of the family, as defined in § 4946(d) and paragraph (h) of this section, of any of the individuals described in subdivision (i), (ii), or (iii) of this subparagraph,

(v) A corporation of which more than 35 percent of the total combined voting power is owned by persons described in subdivision (i), (ii), (iii), or (iv) of this subparagraph,

(vi) A partnership of which more than 35 percent of the profits interest is owned by persons described in subdivision (i), (ii), (iii), or (iv) of this subparagraph, and

(vii) A trust, estate, or unincorporated enterprise of which more than 35 percent of the beneficial interest is owned by persons described in subdivision (i), (ii), (iii), or (iv) of this subparagraph.

Treas. Reg. §53.4946-1(a)(5) provides that the combined voting power of a corporation includes voting power represented by holdings of voting stock (actual or constructive) but does not include voting rights held only as a director or trustee. These rules were harnessed to allow closely-held businesses to be held by charity in two different private letter rulings. In PLR 201303021 the IRS allowed nonvoting stock to be held indefinitely by a private foundation where the voting shares were held several different trusts with no one of which owning more than 20 percent of the voting shares. The remainder of each trust would pass to public charities. Family members were allowed to serve as trustees of the trusts, thus allowing family control of the enterprise. In PLR 201311035, 80% of the voting stock of an enterprise was held in a voting trust for the benefit of a public charity, which allowed the nonvoting stock to be held indefinitely by a donor advised fund.


Leave a comment

Conservation Easement Deduction Limitations: Contiguous Parcel and Enhancement Rules

Office of Chief Counsel Memorandum 201334039 (August 23, 2013) provides useful guidance regarding the Contiguous Parcel rules for conservation easements. Those rules are explained as follows:

Under the Contiguous Parcel Rule found in § 1.170A-14(h)(3)(i) (fourth sentence), in the case of a charitable contribution of a conservation easement covering a portion of contiguous property owned by a donor and the donor’s family, the amount of the deduction is the difference between the fair market value of the entire contiguous parcel of property before and after the granting of the easement.1 For purposes of the Contiguous Parcel Rule, “family” includes brothers and sisters (whether by whole or half-blood), spouse, ancestors, and lineal descendants. Section 267(c)(4). “Family” does not include an entity, such as a corporation or partnership, that is classified as separate from its owner under the entity classification rules described below.

Under the Enhancement Rule found in § 1.170A-14(h)(3)(i) (fifth sentence), if the granting of a conservation easement increases the value of any other property owned by the donor or a related person, the amount of the deduction must be reduced by the amount of the increase in the value of the other property, whether or not that other property is contiguous. For purposes of the Enhancement Rule, “related person” has the same meaning as in either § 267(b) or § 707(b). Section 1.170A-14(h)(3)(i) (eighth sentence).

The relationships listed in § 267(b) include, but are not limited to, the relationships between (1) an individual and members of a family (as defined in § 267(c)(4)), and (2) an individual and a corporation more than 50% in value of the outstanding stock of which is owned, directly or indirectly, by or for such individual. The relationships listed in § 707(b) are those between (1) a partnership and a person owning, directly or indirectly, more than 50% of the capital interest, or the profits interest, in such partnership, and (2) two partnerships in which the same persons own, directly or indirectly, more than 50% of the capital interests or profits interests.

Whether parties are related for purposes of the Contiguous Parcel Rule and the Enhancement Rule may depend on property constructively owned by the donor, the donor’s family, or a related party. Section 267(c) sets forth rules to determine constructive ownership of stock under § 267(b). Under § 707(b)(3), the ownership of a capital or profits interest in a partnership is determined in accordance with the rules for constructive ownership of stock provided in § 267(c) (other than § 267(c)(3)).

The Memorandum analyses a dozen commonly occurring fact patterns. Scenario 2 is an example:

SCENARIO 2: CONTIGUOUS AND NONCONTIGUOUS PARCELS OWNED BY DONOR

Donor owns Parcel A and contiguous Parcel B. Donor also owns non-contiguous Parcel C, located near Parcel A. Donor places a conservation easement on Parcel A, and as a result Parcel C will always have a view of a river that abuts Parcel A, thereby increasing the value of Parcel C.

Under the Contiguous Parcel Rule, the amount of the deduction is equal to the difference between the fair market value of the entire contiguous parcel owned by the donor and the donor’s family (as defined in § 267(c)(4)) before and after the granting of the easement.

Additionally, the Enhancement Rule provides that, if the granting of the restriction increases the value of any other property owned by the donor or a related person (within the meaning of § 267(b) or § 707(b)), the amount of the deduction for the conservation contribution is reduced by the amount of the increase in the value of the other property, whether or not that other property is contiguous.

Accordingly, because Donor owns Parcel A and contiguous Parcel B, the amount of the deduction is first determined by valuing the entire contiguous parcel comprised of Parcel A and Parcel B before and after the granting of the easement. Second, because non-contiguous Parcel C is also owned by Donor, the amount of the deduction is reduced by the value of the enhancement to Parcel C from the granting of the easement.

Turney P. Berry
Louisville, Kentucky


Leave a comment

Charitable Lead Annuity Trust Funded With Illiquid Assets Payable to Family Foundation

PLR 201323007 involved a CLAT carefully drafted to avoid problems arising from funding with non-marketable assets where the annuity would pass to a family foundation.  The ruling recites these provisions of the CLAT agreement:

Trust further provides that Taxpayer shall never exercise the power of the trustee described in the immediately preceding sentence. The trustee shall pay Foundation the Annuity Amount each year for the X-year term on the last day of Trust’s taxable year. Notwithstanding any existing or later enacted state law, except on termination of the Annuity Period, no amount may be paid from Trust to or for the use of any person other than an organization describe in each of §§ 170(b)(1)(A), 170(c), 2055(a) and 2522(a).

* * *

Section III(p) provides that on or immediately prior to any valuation of trust assets, the trustee shall report to the valuation trustee the identity of all assets of Trust that do not have a readily ascertainable fair market value. The valuation trustee shall then have any of those assets valued as of the appropriate valuation date and report the value to the trustee. The valuation shall be made independent of the trustee and of any related or subordinate party or disqualified person with respect to Trust. In all events, the valuation trustee and any successor must be an independent trustee. An independent trustee is any party other than a related or subordinate party with respect to Trust within the meaning of § 672(c) or a disqualified person with respect to Trust within the meaning of § 4946 (other than a party who is a disqualified person with respect to Trust solely by reason of service as the trustee of Trust).

* * *

On Date 3, the Board of Directors of Foundation amended Foundation’s bylaws, as follows. Article III, Section 3.2 provides that if at any time Foundation is a beneficiary of a charitable lead trust, a charitable remainder trust or other similar trust, and the charitable trust was established by a director or officer of, or substantial contributor to, Foundation, the director, officer or substantial contributor establishing the charitable trust shall be prohibited from acting on or involvement in matters concerning the receipt, investment, grant or distribution of, or any other decisions involving funds received by Foundation from such charitable trust. In addition, any funds received from a charitable trust shall be segregated into a separately established and dedicated account and separately accounted for on the books and records of Foundation in a manner that clearly allows the tracing of the funds into and out of such separate account.

Article III, Section 3.9 provides that a director who establishes a charitable trust for the benefit of Foundation may not be counted when establishing a quorum to vote on matters relating to the receipt, investment, grant or distribution of, or any other decisions involving funds received by Foundation.

Article VI, Section 5.1 provides that no committee established by the Board of Directors, including a standing committee established under Section 5.5 of the bylaws, shall include as a member a director or officer of, or a substantial contributor to, Foundation who has established a charitable trust of which Foundation is a beneficiary.

On Date 4, a quorum of the Board of Directors, excepting Taxpayer, established a standing committee (Committee) under Section 5.5. of the bylaws, with the sole authority to receive, separately invest and make all investment decisions and administrative, grant and distribution decisions on behalf of Foundation with respect to and regarding all funds received by Foundation from Trust. The bylaws provide that Committee consists of at least three members, at least one of whom is not a director of Foundation and at least one of whom is not related or subordinate to any director of Foundation as defined by § 672(c). All actions by Committee shall require unanimous consent.

Turney P. Berry
Louisville, Kentucky


Leave a comment

Trust Claiming §642(c) Income Tax Deduction and the “Pursuant To” Requirement

PLR 201225004 involved a trust claiming the §642(c) deduction for income distributed to charity.  The issue was the §642(c)(1) requirement that the income be distributed “pursuant to the terms of the governing instrument”

Where the distribution was directed by a beneficiary’s exercise of a lifetime special power of appointment the IRS determined that satisfied the “pursuant to” requirement even though the governing instrument did not specify a charitable bequest.  It only authorized exercise of the power in favor of charity.  This situation may become more common where efforts are made to avoid the 3.8% tax.

Turney P. Berry
Louisville, Kentucky


Leave a comment

Tax Consequences of an Early Termination of a Charitable Remainder Trust

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


Leave a comment

Charitable Deduction Allowed for Undivided Interest in a Unitrust Payment

In PLR 201249002 spouses created a two-life charitable remainder unitrust. They proposed to irrevocably designated a particular charity as the remainder beneficiary of an undivided interest in the trust and then to contribute an identical undivided interest in the unitrust interest to the same charity. The ruling notes that the taxpayers stipulated that when the charity received the unitrust interest, and was the irrevocable remainder beneficiary, those interests would merge for state law purposes and the trustee (who was also the donor spouse) would distribute outright to the charity the relevant portion of the CRUT corpus while continuing to hold the remaining corpus under the terms of the CRUT. The taxpayers also stipulated that the portion distributed to the charity would be “fairly representative” of the adjusted basis of the CRUT assets on the date of distribution.

The IRS approved the transaction, ruling that the donors will receive an income tax deduction for the value of the unitrust interest, that the CRUT’s status would continue, and that “[t]o the extent that in prior years the Trust realized capital gain income, and that income was not included in the income of Donor, such capital gain shall not be included in the income of Donor solely because of the transfer of the undivided interest in the unitrust payment to Charity.”

See also PLR 201321012.

Turney P. Berry
Louisville, Kentucky