Easy Trap For Charitable Trusts - Inadvertent "Abusive"
Charitable Remainder
Trust T.D. 8926 TD 8926
Federal
Register: January 5, 2001 (Volume 66, Number 4)]
[Rules
and Regulations]
From
the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr05ja01-7]
DEPARTMENT
OF THE TREASURY
Internal
Revenue Service
26
CFR Part 1
[TD
8926]
RIN
1545-AX62
Prevention
of Abuse of Charitable Remainder Trusts
AGENCY:
Internal Revenue Service (IRS), Treasury.
ACTION:
Final regulations.
SUMMARY:
This document finalizes regulations that modify the application [[Page
1035]] of the rules governing the character of certain distributions
from a charitable remainder trust. These regulations are necessary to
prevent taxpayers from using charitable remainder trusts to achieve
inappropriate tax avoidance. The regulations affect charitable remainder
trusts described in section 664 and certain beneficiaries of those
trusts.
EFFECTIVE
DATES: These regulations are effective January 5, 2001. For dates of
applicability of these regulations, see Secs. 1.643(a)-8(d),
1.664-2(a)(1)(i)(e), and 1.664-3(a)(1)(i)(l).
FOR
FURTHER INFORMATION CONTACT: Catherine Moore (202) 622-3070.
SUPPLEMENTARY
INFORMATION:
Background
On
October 18, 1999, proposed regulations (REG-116125-99) to amend Secs.
1.643(a)-8 and 1.664-1 of the Income Tax Regulations (26 CFR Part 1)
were published in the Federal Register (64 FR 56718). Several written
comments were received in response to the notice of proposed rulemaking,
and a public hearing was held on February 9, 2000. After considering all
the comments, the proposed regulations under sections 643 and 664 are
adopted as revised by this Treasury decision. The comments received and
the revisions made are discussed below.
Explanation
of Provisions and Summary of Comments
I.
General Background
The
proposed regulations were issued in response to certain abusive
transactions that attempt to use a section 664 charitable remainder
trust to convert appreciated assets into cash while avoiding tax on the
gain from the disposition of the assets. In these abusive transactions,
a taxpayer typically contributes highly appreciated assets to a
charitable remainder trust having a relatively short term and a
relatively high payout rate. Rather than sell the assets to obtain cash
to pay the annuity or unitrust amount to the beneficiary, the trustee
borrows money, enters into a forward sale of the assets, or engages in
some similar transaction. The borrowing, forward sale, or other similar
transaction does not result in current income to the trust; thus, the
parties attempt to characterize the distribution of cash to the
beneficiary as a tax-free return of corpus under section 664(b)(4). The
proposed regulations provide that, in this situation, the trust shall be
treated as having sold a pro rata portion of the trust assets.
II.
Public Comments
One
commentator argued that the transactions targeted by the regulations are
not abusive because they comply with the statutory changes made to
section 664 by the Taxpayer Relief Act of 1997 (1997 Act), Public Law
105-34, 111 Stat. 788 (1997). Those statutory changes require that the
annual payout rate to noncharitable beneficiaries not exceed 50 percent
of the value of the property contributed to the charitable remainder
trust and that the actuarial value of the charity's remainder interest
be not less than 10 percent of the value of such property. Although the
charitable remainder trusts involved in transactions targeted by the
proposed regulations are drafted to comply with these statutory changes,
the transactions result in the same kind of abuse that Congress was
concerned about in the 1997 Act. It does not follow that because
Congress did not anticipate in 1997 this latest abuse that Congress
intended to allow it.
In
the legislative history to the 1997 Act, Congress labeled the
accelerated charitable remainder trusts it was targeting as ``abusive
and * * * inconsistent with the purpose of the charitable remainder
trust rules.'' S. Rep. No. 33, 105th Cong., 1st Sess. 201 (1997).
Congress noted the efforts of the Treasury Department and the IRS
to combat abuse in the area through issuing proposed regulations in
1997, stating:
The
Committee intends that the provision of the Committee bill does not
limit or alter the validity of regulations proposed by the Treasury
Department on April 18, 1997, or the Treasury Department's authority to
address this or other abuses of the rules governing the taxation of
charitable remainder trusts or their beneficiaries.
S.
Rep. No. 33 at 201. Thus, Congress has neither prohibited nor
discouraged further regulatory activity in the charitable remainder
trust area. To the contrary, based on the legislative history to the
1997 Act, Congress intended the Treasury Department to continue to take
all necessary action to prevent abuses in this area.
Several
commentators questioned the authority to issue the regulations under
section 643(a)(7). Two commentators maintained that the proposed
egulations overstep the bounds of administrative rulemaking in that
section 643(a)(7) was enacted along with the foreign trust provisions of
the Small Business Job Protection Act of 1996 (SBJP Act), Public Law
104-88, 110 Stat. 1755 (1996), and therefore applies only to foreign
trusts. One commentator, citing the introductory clause of section
664(a), ``[n]otwithstanding any other provision of this subchapter,''
argued that the Treasury Department and the IRS are prohibited from
applying section 643(a)(7) to charitable remainder trusts. Some
commentators maintained that section 643(a)(7) does not authorize the
promulgation of regulations imposing a deemed sale where no actual sale
has occurred. These commentators implied that regulatory authority under
section 643(a)(7) should be limited to the concept of distributable net
income (DNI). The Treasury Department and the Internal Revenue Service
disagree with these views.
Although
the SBJP Act included dramatic changes in the foreign trust area, the
trust anti-abuse rule was not limited to foreign trusts and in fact
contains no reference to foreign trusts. Furthermore, the Treasury
Department and the IRS believe that Congress put the anti-abuse rule in
section 643 because that section contains the rules applicable to all of
Part 1 of Subchapter J of the Internal Revenue Code. Section 643(a)(7)
gives the Secretary of the Treasury the authority to ``prescribe such
regulations as may be necessary or appropriate to carry out the purposes
of this part, including regulations to prevent avoidance of such
purposes'' (emphasis added).
``Part''
in this context refers to Part 1 of Subchapter J and encompasses
sections 641 through 685, including section 664 governing charitable
remainder trusts. The legislative history to the SBJP Act clarifies that
the anti-abuse rule is not limited to foreign trusts or the DNI rules.
The House Conference Report states:
[The
rule] authorizes the Secretary of the Treasury to issue regulations, on
or after the date of enactment, that may be necessary or appropriate to
carry out the purposes of the rules applicable to
states, trusts, and beneficiaries, including regulations to
prevent the avoidance of those purposes. H.R. Conf. Rep. No. 737, 104th
Cong., 2d Sess. 335 (1996).
In
addition, the plain language of section 664(a) does not prohibit the
promulgation of regulations that apply section 643(a)(7) to abusive
charitable remainder trust transactions. Section 664(a) states in full:
Notwithstanding
any other provision of this subchapter, the provisions of this section
shall, in accordance with regulations prescribed by the Secretary, apply
in the case of a charitable remainder annuity trust and a charitable
remainder unitrust.
This
language provides that the provisions of section 664 apply in the case
of a charitable remainder annuity trust and charitable remainder
unitrust. The Treasury Department and the IRS, [[Page 1036]] however, do
not view this language as providing that no other provisions of
subchapter J can apply in the case of abusive charitable remainder trust
transactions. Applying these regulations to abusive charitable remainder
trust transactions does not conflict with or override the provisions of
section 664. Accordingly, the Treasury Department and the IRS believe
that the plain language of section 664(a) does not prohibit promulgation
of these regulations.
After
considering the comments questioning the authority to promulgate and
finalize the proposed regulations, the Treasury Department and the IRS
have concluded that the regulations are an appropriate exercise of their
regulatory authority and are authorized by the regulatory authority
granted to them under section 643(a)(7) and 664(a).
Another
commentator, while supporting the proposed regulations in general,
suggested that the regulations contain a more precise definition of the
targeted abuse. In response to this comment, the stated purpose in Sec.
1.643(a)-8(a) has been modified to include a specific reference to the
rules regarding the characterization of distributions from charitable
remainder trusts in the hands of the recipients.
That
same commentator requested clarification of whether a deemed sale by a
charitable remainder trust under Sec. 1.643(a)-8(b) would generate
unrelated business taxable income (UBTI) within the meaning of section
512. Section 664(c) provides that whether a charitable remainder trust
has UBTI for any taxable year, and thus is subject to tax for that year,
is determined under the normal rules of sections 512, 513, and 514. The
proposed regulations do not affect this general rule. However, an
example in the final regulations clarifies that, to the extent that a
borrowing by a charitable remainder trust is recharacterized as a deemed
sale by the trust under Sec. 1.643(a)-8(b), the borrowing is not
``acquisition indebtedness'' within the meaning of section 514(c).
Another
commentator suggested eliminating the provisions in Secs. 1.664-2(a)(1)(i)(a)
and 1.664-3(a)(1)(i)(g) of the regulations requiring that the annuity
amount or the fixed percentage unitrust amount generally be paid by the
end of the year for which it is due.
That
commentator contended that the payment rule is no longer necessary in
light of the proposed regulations. The Treasury Department and the IRS
believe that the proposed regulations serve a function different from
the payment rule. The proposed regulations seek to eliminate tax-free
distributions from charitable remainder trusts due to manipulation of
the character of distributions from those trusts. The payment rule, on
the other hand, eliminates tax-free distributions from charitable
remainder trusts due to manipulation of the timing of the distributions.
A particular distribution could run afoul of either of these rules, or
both rules.
In
response to this comment, and to further clarify the different functions
of the two rules, some minor changes have been made to the proposed
regulation to eliminate references to timing and to clarify the
application of the deemed sale rule. In addition, in order to make it
less likely that a non-abusive trust would violate the payment rule, two
new exceptions have been added to Secs. 1.664-2(a)(1)(i)(a) and
1.664-3(a)(1)(i)(g). These new exceptions provide that a distribution of
cash made within a reasonable period of time after the close of the year
may be characterized as corpus under section 664(b)(4) to the extent it
was attributable to (i) a contribution of cash to the trust with respect
to which a deduction was allowable under section 170, 2055, 2106, or
2522, or (ii) a return of basis in any asset contributed to the trust
with respect to which a deduction was allowable under section 170, 2055,
2106, or 2522, and sold by the trust during the year for which the
annuity or unitrust amount was due.
One
commentator asserted that the proposed regulations should not apply to
charitable remainder trusts established prior to the date the proposed
regulations were published in the Federal Register. This commentator
compared the effective date of the proposed regulations to the effective
date of the 1997 Act's trust provisions. Each of the changes made by the
1997 Act applies to transfers made to trusts after the date specified in
the 1997 Act, while the regulations apply to distributions made by
trusts after October 18, 1999.
The
Treasury Department and the IRS do not believe this assertion has merit.
These effective dates are not comparable because the 1997 Act and these
regulations apply to different aspects of charitable remainder trusts.
The 1997 Act changed the requirements a trust must meet to qualify as a
charitable remainder trust. Whether a trust qualifies as a charitable
remainder trust is determined at the time property is transferred to the
trust. As a result, it was appropriate to set the effective dates for
the 1997 Act with respect to the time that transfers were made to a
trust. The regulations, on the other hand, change the character of a
distribution from a charitable remainder trust. The character of a
distribution from a charitable remainder trust is not determined until
after the distribution is made.
Accordingly,
the regulations can be applied, without being retroactive, to
distributions made after the date the proposed regulations were filed
with the Federal Register. Section 7805(b)(1). Furthermore, the Treasury
Department and the IRS would have had the authority under section
7805(b)(3) to write regulations that take effect retroactively to
prevent abuse. The abuse targeted by these regulations is well
documented in Notice 94-78 (1994-2 C.B. 555), the legislative history to
the 1997 Act, the changes to the charitable remainder trust regulations
that were finalized in 1998 (TD 8791, 1999-5 I.R.B. 7), and Notice
2000-15 (2000-12 I.R.B. 826).
Finally,
the preamble to the proposed regulations requested comments on two
specific issues:
(1)
Whether there are situations where the application of the proposed
regulation would be inappropriate, and
(2)
whether an approach that more directly related the distributed funds to
the asset that is the subject of the borrowing or forward sale would be
more appropriate. No comments were received on either of these issues.
Special
Analyses
It
has been determined that this Treasury decision is not a significant
regulatory action as defined in Executive Order 12866.
Therefore,
a regulatory assessment is not required. It is hereby certified that
these regulations will not have a significant economic impact on a
substantial number of small entities. This certification is based on the
understanding of the Treasury Department and the IRS that the number of
charitable remainder trusts engaging in transactions affected by these
regulations is not substantial, and none are small entities within the
meaning of the Regulatory Flexibility Act (5 U.S.C. chapter 6).
Therefore, a Regulatory Flexibility Analysis under the Regulatory
Flexibility Act (5 U.S.C. chapter 6) is not required.
Pursuant
to section 7805(f) of the Code, the preceding notice of proposed
rulemaking was submitted to the Chief Counsel for Advocacy of the Small
Business Administration for comment on its impact on small business.
Drafting
Information
The
principal authors of these regulations are Mary Beth Collins and
Catherine Moore, Office of Chief Counsel (Passthroughs and Special
Industries). However, other personnel [[Page 1037]] from the IRS and
Treasury Department participated in their development.
List
of Subjects in 26 CFR Part 1
Income
taxes, Reporting and recordkeeping requirements.
Adoption
of Amendments to the Regulations
Accordingly,
26 CFR part 1 is amended as follows:
PART
1--INCOME TAXES
Paragraph
1. The authority citation for part 1 is amended by adding an entry in
numerical order to read in part as follows:
Authority:
26 U.S.C. 7805 * * *
Section
1.643(a)-8 also issued under 26 U.S.C. 643(a)(7). * * *
Par.
2. Section 1.643(a)-8 is added to read as follows:
Sec.
1.643(a)-8 Certain distributions by charitable remainder trusts.
(a)
Purpose and scope. This section is intended to prevent the avoidance of
the purposes of the charitable remainder trust rules regarding the
characterizations of distributions from those trusts in the hands of the
recipients and should be interpreted in a manner consistent with this
purpose. This section applies to all charitable remainder trusts
described in section 664 and the beneficiaries of such trusts.
(b)
Deemed sale by trust. (1) For purposes of section 664(b), a charitable
remainder trust shall be treated as having sold, in the year in which a
distribution of an annuity or unitrust amount is made from the trust, a
pro rata portion of the trust assets to the extent that the distribution
of the annuity or unitrust amount would (but for the application of this
paragraph (b)) be characterized in the hands of the recipient as being
from the category described in section 664(b)(4) and exceeds the amount
of the previously undistributed
(i)
Cash contributed to the trust (with respect to which a deduction was
allowable under section 170, 2055, 2106, or 2522); plus
(ii)
Basis in any contributed property (with respect to which a deduction was
allowable under section 170, 2055, 2106, or 2522) that was sold by the
trust.
(2)
Any transaction that has the purpose or effect of circumventing the
rules in this paragraph (b) shall be disregarded.
(3)
For purposes of paragraph (b)(1) of this section, trust assets do not
include cash or assets purchased with the proceeds of a trust borrowing,
forward sale, or similar transaction.
(4)
Proper adjustment shall be made to any gain or loss subsequently
realized for gain or loss taken into account under paragraph (b)(1) of
this section.
(c)
Examples. The following examples illustrate the rules of paragraph (b)
of this section:
Example
1. Deemed sale by trust. Donor contributes stock having a fair market
value of $2 million to a charitable remainder unitrust with a unitrust
amount of 50 percent of the net fair market value of the trust assets
and a two-year term. The stock has a total adjusted basis of $400,000.
In Year 1, the trust receives dividend income of $20,000. As of the
valuation date, the trust's assets have a net fair market value of
$2,020,000 ($2 million in stock, plus $20,000 in cash). To obtain
additional cash to pay the unitrust amount to the noncharitable
beneficiary, the trustee borrows $990,000 against the value of the
stock. The trust then distributes $1,010,000 to the beneficiary before
the end of Year 1. Under section 664(b)(1), $20,000 of the distribution
is characterized in the hands of the beneficiary as dividend income. The
rest of the istribution, $990,000, is attributable to an amount received
by the trust that did not represent either cash contributed to the trust
or a return of basis in any contributed asset sold by the trust during
Year 1.
Under
paragraph (b)(3) of this section, the stock is a trust asset because it
was not purchased with the proceeds of the borrowing.
Therefore,
in Year 1, under paragraph (b)(1) of this section, the trust is treated
as having sold $990,000 of stock and as having realized $792,000 of
capital gain (the trust's basis in the shares deemed sold is $198,000).
Thus, in the hands of the beneficiary, $792,000 of the distribution is
characterized as capital gain under section 664(b)(2) and $198,000 is
characterized as a tax-free return of corpus under section 664(b)(4). No
part of the $990,000 loan is treated as acquisition indebtedness under
section 514(c) because the entire loan has been recharacterized as a
deemed sale.
Example
2. Adjustment to trust's basis in assets deemed sold.
The
facts are the same as in Example 1. During Year 2, the trust sells the
stock for $2,100,000. The trustee uses a portion of the proceeds of the
sale to repay the outstanding loan, plus accrued interest. Under
paragraph (b)(4) of this section, the trust's adjusted basis in the
stock is $1,192,000 ($400,000 plus the $792,000 of gain recognized in
Year 1). Therefore, the trust recognizes capital gain (as described in
section 664(b)(2)) in Year 2 of $908,000.
Example
3. Distribution of cash contributions. Upon the death of D, the proceeds
of a life insurance policy on D's life are payable to T, a charitable
remainder annuity trust. The terms of the trust provide that, for a
period of three years commencing upon D's death, the trust shall pay an
annuity amount equal to $x annually to A, the child of D. After the
expiration of such three-year period, the remainder interest in the
trust is to be transferred to charity Z.
In
Year 1, the trust receives payment of the life insurance proceeds and
pays the appropriate pro rata portion of the $x annuity to A from the
insurance proceeds. During Year 1, the trust has no income.
Because
the entire distribution is attributable to a cash contribution (the
insurance proceeds) to the trust for which a charitable deduction was
allowable under section 2055 with respect to the present value of the
remainder interest passing to charity, the trust will not be treated as
selling a pro rata portion of the trust assets under paragraph (b)(1) of
this section. Thus, the distribution is characterized in A's hands as a
tax-free return of corpus under section 664(b)(4).
(d)
Effective date. This section is applicable to distributions made by a
charitable remainder trust after October 18, 1999.
Par.
3. Section 1.664-1 is amended as follows:
1.
Paragraph (d)(1)(iii) is redesignated as paragraph (d)(1)(iv).
2.
New paragraph (d)(1)(iii) is added.
The
addition reads as follows:
Sec.
1.664-1 Charitable remainder trusts.
*
* * * *
(d)
* * *
(1)
* * *
(iii)
Application of section 643(a)(7). For application of the
anti-abuse
rule of section 643(a)(7) to distributions from charitable remainder
trusts, see Sec. 1.643(a)-8.
*
* * * *
Par.
4. Sec. 1.664-2 is amended as follows:
1.
Paragraphs (a)(1)(i)(a)(1) and (a)(1)(i)(a)(2) are revised.
2.
Paragraph (a)(1)(i)(a)(3) is added.
3.
Paragraph (a)(1)(i)(e) is amended by adding a sentence at the
end.
The
revision and additions read as follows:
Sec.
1.664-2 Charitable remainder annuity trust.
(a)
* * *
(1)
* * * (i) * * *
(a)
* * *
(1)
The trust pays the annuity amount by distributing property (other than
cash) that it owned at the close of the taxable year to pay the annuity
amount, and the trustee elects to treat any income generated by the
distribution as occurring on the last day of the taxable year in which
the annuity amount is due;
(2)
The trust pays the annuity amount by distributing cash that was
contributed to the trust (with respect to which a deduction was
allowable under section 170, 2055, 2106, or 2522); or
(3)
The trust pays the annuity amount by distributing cash received as a
return of basis in any asset that was contributed to the trust (with
respect to which a deduction was allowable under section 170, 2055,
2106, or 2522), and [[Page 1038]] that is sold by the trust during the
year for which the annuity amount is due.
*
* * * *
(e)
* * * However, paragraphs (a)(1)(i)(a)(2) and (3) of this section apply
only to distributions made on or after January 5, 2001.
*
* * * *
Par.
5. Sec. 1.664-3 is amended as follows:
1.
Paragraphs (a)(1)(i)(g)(1) and (a)(1)(i)(g)(2) are revised.
2.
Paragraph (a)(1)(i)(g)(3) is added.
3.
Paragraph (a)(1)(i)(l) is amended by adding a sentence at the end.
The
revision and additions read as follows.
*
* * * *
(g)
* * *
(1)
The trust pays the unitrust amount by distributing property (other than
cash) that it owned at the close of the taxable year, and the trustee
elects to treat any income generated by the distribution as occurring on
the last day of the taxable year in which the unitrust amount is due;
(2)
The trust pays the unitrust amount by distributing cash that was
contributed to the trust (with respect to which a deduction was
allowable under section 170, 2055, 2106, or 2522); or
(3)
The trust pays the unitrust amount by distributing cash received as a
return of basis in any asset that was contributed to the trust (with
respect to which a deduction was allowable under section 170, 2055,
2106, or 2522), and that is sold by the trust during the year for which
the unitrust amount is due.
*
* * * *
(l)
* * * Paragraphs (a)(1)(i)(g)(2) and (3) apply only to
distributions
made on or after January 5, 2001.
*
* * * *
Robert
E. Wenzel,
Deputy
Commissioner of Internal Revenue.
Approved:
December 13, 2000.
Jonathan
Talisman,
Acting
Assistant Secretary of the Treasury (Tax Policy).
TD
8923
Charitable Lead Trusts
[Federal Register: January 5, 2001 (Volume 66, Number 4)]
[Rules and Regulations]
[Page 1040-1044]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr05ja01-9]
DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Parts 1, 20, and 25
[TD 8923]
RIN 1545-AX74
Lifetime Charitable Lead Trusts
AGENCY: Internal Revenue Service (IRS), Treasury.
ACTION: Final regulations.
SUMMARY: This document contains final regulations relating to the definitions of a guaranteed annuity interest and a unitrust interest
for purposes of the income, gift, and estate tax charitable
deductions.
The regulations affect taxpayers who make transfers to charitable
lead trusts. The regulations restrict the permissible terms for charitable
lead trusts and are necessary to ensure that the amount the taxpayer claims as a charitable deduction reasonably correlates to the amount
ultimately passing to the charitable organization.
DATES: Effective Dates: These regulations are effective January 5, 2001.
Applicability Dates: For dates of applicability of these regulations, see Secs. 1.170A-6(e), 20.2055-2(e)(3)(iii), and
25.2522(c)-3(e).
FOR FURTHER INFORMATION CONTACT: Scott S. Landes at (202) 622-3090.
SUPPLEMENTARY INFORMATION:
Background
On April 5, 2000, the IRS published in the Federal Register (65 FR 17835) a notice of proposed rulemaking (REG-100291-00) relating to
the permissible terms for charitable guaranteed annuity interests and unitrust interests. This document adopts final regulations with
respect to the notice of proposed rulemaking. Written comments were received
with respect to the proposed regulations, but no public hearing was requested or held. A summary of the principal comments received is
provided below.
In general, in order to qualify as a guaranteed annuity interest or unitrust interest for purposes of the income, estate, and gift tax
charitable deductions under sections 170(c), 2055(e)(2), and 2522(c)(2), respectively, the permissible term for the charitable
lead interest must be either a specified term of years, or the life or
lives of individuals living at the date of the transfer. The proposed regulations limit the individuals who may be used as measuring lives
to the donor, the donor's spouse, and a lineal ancestor of all the remainder beneficiaries. This proposed limitation is intended to
eliminate abusive schemes utilizing
seriously ill individuals, who are unrelated to the grantor or the
remainder beneficiaries, as measuring lives for charitable lead trusts.
Commentators argued that by limiting the
class of individuals who can be used as measuring lives in a charitable
lead trust, the regulations preclude the use of these trusts in certain
nonabusive situations. In response to these comments, several changes
were made to the final regulations to provide a greater degree of
flexibility for selecting a measuring life.
The final regulations expand the class of
permissible measuring lives to include an individual who, with respect
to all non-charitable remainder beneficiaries, is either a lineal
ancestor or the spouse of a lineal ancestor of those beneficiaries.
Thus, remainder beneficiaries can include stepchildren and
step-grandchildren of the individual who is the measuring life, and
charitable organizations (described in section 170, 2055, or 2522).
The final regulations also provide that a
trust will satisfy the requirement that all non charitable remainder
beneficiaries are lineal descendants of the individual who is the
measuring life, or that individual's spouse, if there is less than a 15%
probability that individuals who are not lineal descendants will receive
any trust corpus. This probability must be computed at the date of
transfer to the trust taking into consideration the interests of all
individuals living at that time. This change will afford drafters the
flexibility to provide for alternative remainder beneficiaries in the
event the primary remainder beneficiary and his or her descendants
predecease the individual who is the measuring life for the term of the
charitable interest.
---The application of the probability test
may be illustrated by assuming a grantor establishes a charitable lead
annuity trust (CLAT) that provides for the annuity to be paid to a
charity for the life of A who is age 75 on the date the CLAT is created.
On A's death, the corpus is to pass to A’s only child, B, age 50 on
the date the CLAT is created. If B predeceases A, the corpus is to pass
to B's issue then living and if B has no living issue at that time, then
to A's heirs at law (which class could include A's siblings, uncles,
aunts, nieces and nephews). B has no living children on the date the
CLAT is created. Based on the current applicable Life Table contained in
Sec. 20.2031-7 of the Estate Tax Regulations (Life Table 90CM), the
probability that B will predecease A, and the trust will pass to
individuals who are not lineal descendants of A is 10.462%, taking into
account the interests of remainder beneficiaries living at the time the
trust was created. Since the probability that any trust corpus will pass
to beneficiaries who are not lineal descendants of A is less than 15%,
the CLAT will satisfy the requirement that all non-charitable remainder
beneficiaries are lineal descendants of A or A's spouse.
Several commentators identified
hypothetical situations where an individual who is either unrelated to
the remainder beneficiaries, or a remote family member, could be used as
a measuring life to achieve an estate-planning objective. The
commentators suggested three alternative standards that would expand the
class of permissible measuring lives.
None of these suggestions has been adopted.
First, one commentator suggested that the
regulations allow a charitable lead trust to use as a measuring life an
ancestor of any remainder beneficiary rather than an ancestor of all
remainder beneficiaries. Under the suggested standard, the charitable
lead trust could provide a nominal remainder interest for descendants of
the measuring life, with the balance passing to the grantor's family
members. Thus, the standard would do little to prevent the abuse the
regulations are intended to address.
Second, one commentator suggested that the
regulations provide that an individual is a permissible measuring life
if all remainder beneficiaries are natural objects of the individual's
bounty. However, the determination of whether a person is the natural
object of one’s bounty requires an inquiry into facts that may be
difficult to ascertain or verify. Such a subjective standard would
create uncertainty and would be difficult to administer.
Third, one commentator suggested that if
the charitable interest is payable for the life of an individual, then
the trust must require that, in the event the individual fails to
survive to a normal life expectancy, a guaranteed lump sum will be paid
to charity (determined actuarially), that will make up for the shortfall
in the charitable annuity. A provision requiring such a payment in the
event of the premature death of the measuring life would be complex and
inconsistent with the valuation rules of section 7520. In addition, this
requirement would in substance convert a life interest to a term of
years interest and in some cases allow that term interest to be
commuted. Thus, such a requirement may conflict with other rules
prohibiting commutation or prepayment of the charitable lead interest.
In summary, the Treasury Department and the
IRS acknowledge that there may be situations in which the grantor, for a
valid estate planning objective, may desire to use an individual as a
measuring life who does not satisfy the criteria in the regulations (for
example, where a remainder beneficiary is dependent on a non-family
member for support and the trust corpus is intended to provide that
support after the death of the non-family member). However, the Treasury
Department and the IRS believe that in these situations the grantor's
objectives can be satisfied through the use of other permissible estate
planning techniques. In situations where a charitable lead trust is
utilized, the Treasury Department and the IRS believe that the final
regulations allow adequate flexibility for achieving legitimate estate
planning objectives while providing reasonable safeguards to preclude
abusive arrangements.
Special Analyses
It has been determined that this Treasury
decision is not a significant regulatory action as defined in Executive
Order 12866.Therefore, a regulatory assessment is not required. It has
also been determined that section 553(b) of the Administrative Procedure
Act (5U.S.C. chapter 5) and the Regulatory Flexibility Act (5 U.S.C.
chapter6) do not apply to these regulations, and therefore, a Regulatory
Flexibility Analysis is not required. Pursuant to section 7805(f) of the
Internal Revenue Code, the notice of proposed rulemaking preceding these
regulations was submitted to the Small Business Administration for
comment on its impact on small business.
Drafting Information
The principal author of these regulations
is Scott S. Landes, Office of the Chief Counsel, IRS. Other personnel
from the IRS and the Treasury Department participated in their
development.
Adoption of Amendments to the Regulations
Accordingly, 26 CFR parts 1, 20, and 25 are amended as follows:
PART 1--INCOME TAXES
Paragraph 1. The authority citation for
part 1 is amended by adding an entry in numerical order to read in part
as follows:
Authority: 26 U.S.C. 7805 * * *
Section 1.170A-6 also issued under 26 U.S.C.
170(f)(4); 26U.S.C. 642(c)(5). * * *
Par. 2. Section 1.170A-6 is amended as
follows:
1. Paragraph (c)(2)(i)(A) is amended as
follows:
a. In the first sentence, the comma is
removed.
b. In the second sentence, the language
``of years'' is added after the word ``term'', the language ``an
individual or individuals'' is removed, and ``certain individuals'' is
added in its place.
c. The third sentence is removed, and six
new sentences are added in its place.
d. In the penultimate sentence, the
language ``of years'' is added after the word ``term'', the language
``an individual'' is removed, and``the donor'' is added in its place.
2. Paragraph (c)(2)(ii)(A) is amended as
follows:
a. In the fifth sentence, the language ``of
years'' is added after the word ``term'', ``an individual or
individuals'' is removed, and``certain individuals'' is added in its
place.
b. The last sentence is removed, and six
new sentences are added in its place.
3. Paragraph (e) is amended by adding four
sentences to the end of the paragraph.
4. The authority citation at the end of the
section is removed.
The additions read as follows:
Sec. 1.170A-6 Charitable contributions in
trust.
* * * * *
(c) * * *
(2) * * *
(i) * * * (A) * * * Only one or more of the
following individuals may be used as measuring lives: the donor, the
donor's spouse, and an individual who, with respect to all remainder
beneficiaries (other than charitable organizations described in section
170, 2055, or 2522), is either a lineal ancestor or the spouse of a
lineal ancestor of those beneficiaries. A trust will satisfy the
requirement that all non-charitable remainder beneficiaries are lineal
descendants of the individual who is the measuring life, or that
individual's[[Page 1042]]spouse, if there is less than a 15% probability
that individuals who are not lineal descendants will receive any trust
corpus. This probability must be computed, based on the current
applicable Life Table contained in Sec. 20.2031-7, at the time property
is transferred to the trust taking into account the interests of all
primary and contingent remainder beneficiaries who are living at that
time. An interest payable for a specified term of years can qualify as
guaranteed annuity interest even if the governing instrument contains a
savings clause intended to ensure compliance with a rule against
perpetuities. The savings clause must utilize a period for vesting of21
years after the deaths of measuring lives who are selected to maximize,
rather than limit, the term of the trust. The rule in this paragraph
that a charitable interest may be payable for the life or lives of only
certain specified individuals does not apply in the case of a charitable
guaranteed annuity interest payable under a charitable remainder trust
described in section 664. * * *
* * * * *
(ii) * * * (A) * * * Only one or more of
the following individuals may be used as measuring lives: the donor, the
donor's spouse, and an individual who, with respect to all remainder
beneficiaries (other than charitable organizations described in section
170, 2055, or 2522), is either a lineal ancestor or the spouse of a
lineal ancestor of those beneficiaries. A trust will satisfy the
requirement that all non-charitable remainder beneficiaries are lineal
descendants of the individual who is the measuring life, or that
individual's spouse, if there is less than a 15% probability that
individuals who are not lineal descendants will receive any trust
corpus. This probability must be computed, based on the current
applicable Life Table contained in Sec. 20.2031-7, at the time property
is transferred to the trust taking into account the interests of all
primary and contingent remainder beneficiaries who are living at that
time. An interest payable for a specified term of years can qualify as a
unitrust interest even if the governing instrument contains a savings
clause intended to ensure compliance with a rule against perpetuities.
The savings clause must utilize a period for vesting of 21 years after
the deaths of measuring lives who are selected to maximize, rather than
limit, the term of the trust. The rule in this paragraph that a
charitable interest may be payable for the life or lives of only certain
specified individuals does not apply in the case of a charitable
unitrust interest payable under a charitable remainder trust described
in section 664.
* * * * *
(e) Effective date. * * * In addition, the
rule in paragraphs
(c)(2)(i)(A) and (ii)(A) of this section
that guaranteed annuity interests and unitrust interests, respectively,
may be payable for a specified term of years or for the life or lives of
only certain individuals applies to transfers made on or after April 4,
2000. If a transfer is made to a trust on or after April 4, 2000 that
uses an individual other than one permitted in paragraphs (c)(2)(i)(A)
and
(ii)(A) of this section, the trust may be
reformed to satisfy this rule. As an alternative to reformation,
rescission may be available for a transfer made on or before March 6,
2001. See Sec. 25.2522(c)-3(e) of this chapter for the requirements
concerning reformation or possible rescission of these interests.
PART 20--ESTATE TAX; ESTATES OF DECEDENTS
DYING AFTER AUGUST 16,1954
Par. 3. The authority citation for part 20
continues to read in part as follows:
Authority: 26 U.S.C. 7805 * * *
Par. 4. Section 20.2055-2 is amended as
follows:
1. Paragraph (e)(2)(vi) (a) is amended as
follows:
a. In the third sentence, the language ``of
years'' is added after the word ``term'', the language ``an individual
or individuals'' is removed, and ``certain individuals'' is added in its
place.
b. The fourth sentence is removed, and six
new sentences are added in its place.
c. In the penultimate sentence, the
language ``of years'' is added after the word ``term'', the language
``an individual'' is removed, and
``the decedent's spouse'' is added in its
place.
2. Paragraph (e)(2)(vii)(a) is amended as
follows:
a. In the sixth sentence, the language ``of
years'' is added after the word ``term'', the language ``of an
individual or individuals'' is removed, and ``of certain individuals''
is added in its place.
b. The last sentence is removed, and six
new sentences are added in its place.
3. Paragraph (e)(3) is amended as follows:
a. The period at the end of paragraph
(e)(3)(ii)(c) is removed, a comma is added and the word ``and'' is added
after the comma.
b. A new paragraph (e)(3)(iii) is added.
The additions read as follows:
Sec. 20.2055-2 Transfers not exclusively
for charitable purposes.
* * * * *
(e) * * *
(2) * * *
(vi) * * * (a) * * * Only one or more of
the following individuals may be used as measuring lives: the decedent's
spouse, and an individual who, with respect to all remainder
beneficiaries (other than charitable organizations described in section
170, 2055, or 2522), is either a lineal ancestor or the spouse of a
lineal ancestor of those beneficiaries. A trust will satisfy the
requirement that all non-charitable remainder beneficiaries are lineal
descendants of the individual who is the measuring life, or that
individual's spouse, if there is less than a 15% probability that
individuals who are not lineal descendants will receive any trust
corpus. This probability must be computed, based on the current
applicable Life Table contained in Sec. 20.2031-7, as of the date of the
decedent's death taking into account the interests of all primary and
contingent remainder beneficiaries who are living at that time. An
interest payable for a specified term of years can qualify as a
guaranteed annuity interest even if the governing instrument contains a
savings clause intended to ensure compliance with a rule against
perpetuities. The savings clause must utilize a period for vesting of 21
years after the deaths of measuring lives who are selected to maximize,
rather than limit, the term of the trust. The rule in this paragraph
that a charitable interest may be payable for the life or lives of only
certain specified individuals does not apply in the case of a charitable
guaranteed annuity interest payable under a charitable remainder trust
described in section 664. * * *
* * * * *
(vii) * * * (a) * * * Only one or more of
the following individuals may be used as measuring lives: the decedent's
spouse, and an individual who, with respect to all remainder
beneficiaries (other than charitable organizations described in section
170, 2055, or 2522), is either a lineal ancestor or the spouse of a
lineal ancestor of those beneficiaries. A trust will satisfy the
requirement that all non-charitable remainder beneficiaries are lineal
descendants of the individual who is the measuring life, or that
individual's spouse, if there is less than a 15% probability that
individuals who are not lineal descendants will receive any trust
corpus. This probability must be computed, based on the current
applicable Life Table contained in[[Page 1043]]Sec. 20.2031-7, as of the
date of the decedent's death taking into account the interests of all
primary and contingent remainder beneficiaries who are living at that
time. An interest payable for a specified term of years can qualify as a
unitrust interest even if the governing instrument contains a savings
clause intended to ensure compliance with a rule against perpetuities.
The savings clause must utilize a period for vesting of 21 years after
the deaths of measuring lives who are selected to maximize, rather than
limit, the term of the trust. The rule in this paragraph that a
charitable interest may be payable for the life or lives of only certain
specified individuals does not apply in the case of a charitable
unitrust interest payable under a charitable remainder trust described
in section 664.
* * * * *
(3) * * *
(iii) The rule in paragraphs (e)(2)(vi)(a)
and (vii)(a) of this section that guaranteed annuity interests or
unitrust interests, respectively, may be payable for a specified term of
years or for the life or lives of only certain individuals is generally
effective in the case of transfers pursuant to wills and revocable
trusts where the decedent dies on or after April 4, 2000. Two exceptions
from the application of this rule in paragraphs (e)(2)(vi)(a) and (vii)(a)
of this section are provided in the case of transfers pursuant to a will
or revocable trust executed on or before April 4, 2000. One exception is
for a decedent who dies on or before July 5, 2001, without having
republished the will (or amended the trust) by codicil or otherwise. The
other exception is for a decedent who was on April 4, 2000, under a
mental disability to change the disposition of the decedent's property,
and either does not regain competence to dispose of such property before
the date of death, or dies prior to the later of: 90 days after the date
on which the decedent first regains competence, or July 5,2001, without
having republished the will (or amended the trust) by codicil or
otherwise. If a guaranteed annuity interest or unitrust interest created
pursuant to a will or revocable trust where the decedent dies on or
after April 4, 2000, uses an individual other than one permitted in
paragraphs (e)(2)(vi)(a) and (vii)(a) of this section, and the interest
does not qualify for this transitional relief, the interest may be
reformed into a lead interest payable for a specified term of years. The
term of years is determined by taking the factor for valuing the annuity
or unitrust interest for the named individual measuring life and
identifying the term of years (rounded up to the next whole year) that
corresponds to the equivalent term of years factor for an annuity or
unitrust interest. For example, in the case of an annuity interest
payable for the life of an individual age 40 at the time of the
transfer, assuming an interest rate of 7.4% under section7520, the
annuity factor from column 1 of Table S(7.4), contained in IRS
Publication 1457, Book Aleph, for the life of an individual age 40is
12.0587 (Publication 1457 is available from the Superintendent of
Documents, U.S. Government Printing Office, Washington, DC 20402).
Based on Table B(7.4), contained in
Publication 1457, Book Aleph, the factor 12.0587 corresponds to a term
of years between 31 and 32 years. Accordingly, the annuity interest must
be reformed into an interest payable for a term of 32 years. A judicial
reformation must be commenced prior to the later of July 5, 2001, or the
date prescribed by section 2055(e)(3)(C)(iii). Any judicial reformation
must be completed within a reasonable time after it is commenced. A
non-judicial reformation is permitted if effective under state law,
provided it is completed by the date on which a judicial reformation
must be commenced. In the alternative, if a court, in a proceeding that
is commenced on or before July 5, 2001, declares any transfer made
pursuant to a will or revocable trust where the decedent dies on or
after April 4, 2000, and on or before March 6, 2001, null and void
abinitio, the Internal Revenue Service will treat such transfers in a
manner similar to that described in section 2055(e)(3)(J).
* * * * *
PART 25--GIFT TAX; GIFTS MADE AFTER
DECEMBER 31, 1954
Par. 5. The authority citation for part 25
continues to read in part as follows:
Authority: 26 U.S.C. 7805 * * *
Par. 6. Section 25.2522(c)-3 is amended as
follows:
1. Paragraph (c)(2)(vi)(a) is amended as
follows:
a. In the third sentence, the language ``of
years'' is added after the word ``term'', the language ``a named
individual or individuals''is removed, and ``certain individuals'' is
added in its place.
b. The fourth sentence is removed, and six
new sentences are added in its place.
c. In the sentence beginning ``For example,
the amount'', the language ``of years'' is added after the word
``term'', the language``an individual'' is removed, and ``the donor'' is
added in its place.
2. Paragraph (c)(2)(vii)(a) is amended as
follows:
a. In the sixth sentence, the language ``of
years'' is added after the word ``term'', the language ``an individual
or individuals'' is removed, and ``certain individuals'' is added in its
place.
b. The last sentence is removed, and six
new sentences are added in its place.
3. Paragraph (e) is amended by adding nine
new sentences to the end of the paragraph.
The additions read as follows:
Sec. 25.2522(c)-3 Transfers not exclusively
for charitable, etc., purposes in the case of gifts made after July 31,
1969.
* * * * *
(c) * * *
(2) * * *
(vi) * * * (a) * * * Only one or more of
the following individuals may be used as measuring lives: the donor, the
donor's spouse, and an individual who, with respect to all remainder
beneficiaries (other than charitable organizations described in section
170, 2055, or 2522), is either a lineal ancestor or the spouse of a
lineal ancestor of those beneficiaries. A trust will satisfy the
requirement that all non-charitable remainder beneficiaries are lineal
descendants of the individual who is the measuring life, or that
individual's spouse, if there is less than a 15% probability that
individuals who are not lineal descendants will receive any trust
corpus. This probability must be computed, based on the current
applicable Life Table contained in Sec. 20.2031-7, at the time property
is transferred to the trust taking into account the interests of all
primary and contingent remainder beneficiaries who are living at that
time. An interest payable for a specified term of years can qualify as a
guaranteed annuity interest even if the governing instrument contains a
savings clause intended to ensure compliance with a rule against
perpetuities. The savings clause must utilize a period for vesting of 21
years after the deaths of measuring lives who are selected to maximize,
rather than limit, the term of the trust. The rule in this paragraph
that a charitable interest may be payable for the life or lives of only
certain specified individuals does not apply in the case of a charitable
guaranteed annuity interest payable under a charitable remainder trust
described in section 664. * * *
* * * * *
(vii) * * * (a) * * * Only one or more of
the following individuals may be used as measuring lives: the donor, the
donor's spouse, and an individual
[[Page 1044]]
who, with respect to all remainder
beneficiaries (other than charitable organizations described in section
170, 2055, or 2522), is either a lineal ancestor or the spouse of a
lineal ancestor of those beneficiaries. A trust will satisfy the
requirement that all non-charitable remainder beneficiaries are lineal
descendants of the individual who is the measuring life, or that
individual's spouse, if there is less than a 15% probability that
individuals who are not lineal descendants will receive any trust
corpus. This probability must be computed, based on the current
applicable Life Table contained in Sec. 20.2031-7, at the time property
is transferred to the trust taking into account the interests of all
primary and contingent remainder beneficiaries who are living at that
time. An interest payable for a specified term of years can qualify as a
unitrust interest even if the governing instrument contains a savings
clause intended to ensure compliance with a rule against perpetuities.
The savings clause must utilize a period for vesting of 21 years after
the deaths of measuring lives who are selected to maximize, rather than
limit, the term of the trust. The rule in this paragraph that a
charitable interest may be payable for the life or lives of only certain
specified individuals does not apply in the case of a charitable
unitrust interest payable under a charitable remainder trust described
in section 664.
* * * * *
(e) Effective date. * * * In addition, the
rule in paragraphs(c)(2)(vi)(a) and (vii)(a) of this section that
guaranteed annuity interests or unitrust interests, respectively, may be
payable for a specified term of years or for the life or lives of only
certain individuals applies to transfers made on or after April 4, 2000.
If a transfer is made on or after April 4, 2000, that uses an individual
other than one permitted in paragraphs (c)(2)(vi)(a) and (vii)(a) of
this section, the interest may be reformed into a lead interest payable
for a specified term of years. The term of years is determined by taking
the factor for valuing the annuity or unitrust interest for the named
individual measuring life and identifying the term of years(rounded up
to the next whole year) that corresponds to the equivalent term of years
factor for an annuity or unitrust interest. For example, in the case of
an annuity interest payable for the life of an individual age 40 at the
time of the transfer, assuming an interest rate of 7.4% under section
7520, the annuity factor from column 1 of Table S(7.4), contained in IRS
Publication 1457, Book Aleph, for the life of an individual age 40 is
12.0587 (Publication 1457 is available from the Superintendent of
Documents, U.S. Government Printing Office, Washington, DC 20402). Based
on Table B(7.4), contained in Publication1457, Book Aleph, the factor
12.0587 corresponds to a term of years between 31 and 32 years.
Accordingly, the annuity interest must be reformed into an interest
payable for a term of 32 years. A judicial reformation must be commenced
prior to October 15th of the year following the year in which the
transfer is made and must be completed within a reasonable time after it
is commenced. A non-judicial reformation is permitted if effective under
state law, provided it is completed by the date on which a judicial
reformation must be commenced. In the alternative, if a court, in a
proceeding that is commenced on or before July 5, 2001, declares any
transfer, made on or after April 4, 2000, and on or before March 6,
2001, null and void abinitio, the Internal Revenue Service will treat
such transfers in a manner similar to that described in section
2055(e)(3)(J).
Robert E. Wenzel,
Deputy Commissioner of Internal Revenue.
Approved: December 20, 2000.
Jonathan Talisman,
Acting Assistant Secretary of the Treasury.
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