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Tax Court Limits Charitable Contribution Deduction for Remainder Interests in CRTs.

(Parker Tax Publishing August 27, 2015)

Where the payout of two NIMCRUTs is the lesser of the trust income or a fixed percentage, an annual distribution amount equal to the fixed percentage stated in the trust instruments must be used to determine whether the estate of the decedent who created the NIMCRUTs is eligible for a charitable contribution deduction. Est. of Schaefer v. Comm'r, 145 T.C. No. 4 (2015).

During his lifetime, Arthur Schaefer established two irrevocable charitable remainder unitrusts (CRUTs). Each trust was designed so that one of Arthur's sons would receive distributions during his life or a term of years with the remainder going to a charity. Each trust instrument states that the trustee must make distributions to the noncharitable beneficiary (i.e., Arthur's sons) of the lesser of the net trust accounting income for the taxable year and a fixed percentage of the net fair market value of the trust assets, valued annually. Each trust instrument also allows the trustee to make additional distributions, limited to trust income, if previous distributions did not equal the fixed percentage. Trusts using this provision are net income with makeup charitable remainder unitrusts (NIMCRUTs).

For each trust to qualify as a charitable remainder trust, thereby making the estate eligible for a charitable contribution deduction, Code Sec. 664(d)(2) requires that the value of the remainder interest must be at least 10 percent of the net fair market value of the property contributed. Code Sec. 664(e) describes how to value a charitable remainder interest. It provides that, for purposes of determining the amount of any charitable contribution, the remainder interest of a CRUT is computed on the basis that an amount equal to 5 percent of the net fair market value of its assets (or a greater amount, if required under the terms of the trust instrument) is to be distributed each year.

The IRS and estate disagreed on how to take into account distributions from a NIMCRUT when valuing the remainder interest. The IRS pointed to Reg. Sec. 1.664-4(a)(3), which indicates that the fixed percentage is distributed implicitly without regard to the net income limitation in the case of a NIMCRUT. The estate argued that NIMCRUT distributions are determined not under this rule but under an exception to this rule in Reg. Sec. 1.664-3(a)(1)(i)(b). According to the estate, in valuing the remainder interest, the distributions are calculated by using the Code Sec. 7520 rate to determine the trust's expected income, so long as the Code Sec. 7520 rate is above 5 percent of the net fair market value of the assets. The IRS argued that the remainder interest is valued using a distribution rate equal to the fixed percentage in the trust instrument.

The Tax Court found the text of Code Sec. 664(e) ambiguous. In describing the distribution to be taken into account for valuation purposes, Code Sec. 664(e) does not expressly use the words "sum certain" or "fixed percentage", the court noted. Instead Code Sec. 664(e) provides that a distribution rate "equal to 5 percent of the net fair market value of its assets (or a greater amount, if required under the terms of the trust instrument)" is to be used. The Tax Court said it was unable to determine on its face whether this provision meant the sum certain (in the case of a CRAT) or the fixed percentage (in the case of a CRUT) or whether it meant something different. The court found the regulations were also ambiguous, and turned to other administrative guidance.

The court noted that, in Rev. Rul. 72-395 and Rev. Proc. 2005-54, the IRS asserts that the remainder interest of a NIMCRUT is valued using the fixed percentage stated in the trust instrument, regardless of the fact that distributions are limited to trust income. After reviewing the legislative history of Code Sec. 664, the Tax Court found the IRS's guidance to be persuasive. Both pieces of guidance, the court said, were thoroughly reasoned and provided examples and explanations based on the applicable provisions. Additionally, the court said, the guidance has withstood the test of time, and the IRS's position also has remained consistent and has been the subject of little litigation.

The legislative history and the administrative guidance, the court said, pointed to only one conclusion - that the value of the remainder interest of a NIMCRUT must be calculated using the greater of 5 percent or the fixed percentage stated in the trust instrument. Accordingly, the court concluded that the estate had to use an annual distribution amount of 11 percent or 10 percent of the net fair market value of the trust assets when valuing the remainder interests of the two trusts. Because the parties had previously stipulated that the estate would not be entitled to a charitable contribution deduction if the remainder interests were valued using this method, the estate was not entitled to a charitable deduction.

For a discussion of the rules relating to CRUTs, see Parker Tax ¶57,115. (Staff Editor Parker Tax Publishing)

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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