32 the quick brown fox jumps

28 the quick brown fox jumps over the 24 the quick brown fox jumps over the lazy
22 the quick brown fox jumps over the lazy dog

I am kind of not a PowerPoint guy, so I hope you'll bear with me

exiting the underproductive CRT

irrational exuberance

quantitative easing

the fiscal cliffs

47 or 99

when this stuff matters high stated unitrust payout principal balances down fixed annuity decimating principal NIMCRUT with no "flip" provision or with triggering event unlikely to occur - reduced life expectancy of contingent or defeasible successor income beneficiary - immediate needs of charitable remainderman - ditto income bene - anticipated changes in marginal tax rates -

an aside

from 11insitrusts09winbull.pdf

from 11insitrusts09winbull.pdf

from 11insitrusts09winbull.pdf

from 11insitrusts09winbull.pdf

from 11insitrusts09winbull.pdf

from 11insitrusts09winbull.pdf

what we are talking about

commutation, surrender, exchange

commutation: - each party receives its actuarial share outright - treated as sale of lead interest to remainderman - holder of lead interest treated as having zero basis

surrender: - holder of lead interest surrenders to remainderman - charitable deduction for actuarial value - subject to contribution limits for appreciated property

exchange: - surrender in exchange for gift annuity - treated as bargain sale - present value of annuity treated as long term gain, recognized ratably over expected return multiple

Rev. Rul. 86-60 Situation 1: surrender by CRAT settlor to remainder charity - qualifies for both income and gift tax charitable deductions - method of calculating deductions not mentioned

Rev. Rul. 86-60, cont'd Situation 2: surrender by both settlor and successor annuitant - surrender by successor annuitant qualifies because it is the only interest he ever had in the property however,

Rev. Rul. 86-60, cont'd - surrender by settlor qualifies only because it is in the form of a fixed annuity
citing section 2522(c)(2) - no deduction for partial interest where another interest is retained, transferred, "or has been transferred"

re valuation of annuity interest

Reg. 25.7520-3(b)(2)(v), example 5 - where annuity payout as percentage of initial value is higher than 7520 rate, "the annuity must be valued as an annuity payable for a term of years or until the prior death of the annuitant, with the term of years determined by when the fund will be exhausted by the annuity payments."

the forest for the trees

threshold condition 1: - trust not initially created for purpose of evading partial interest rule of section 170(f)(3)(A)

threshold condition 2: - life expectancy of income beneficiary not less than would be indicated by tables under Reg. 1.72-9
[not an express condition of Rev. Rul. 86-60]

threshold condition 2, cont'd

- life expectancy condition first mentioned in PLR 200252092 - commutation of a 20 pct. unitrust - term of five years or earlier death of both settlors

threshold condition 2, cont'd

but compare Reg. 25.7520-3(b)(3) - mortality component may not be used if individual used as measuring life "dies or is terminally ill at the time the gift is completed"

Reg. 25.7520-3(b)(3), cont'd

defn. "terminally ill" - at least 50 pct. probability individual will die within one year - but if individual survives eighteen months, "presumed to have not been terminally ill" - unless contrary established by "clear and convincing evidence"

keeping in mind: - structuring the transaction to get a favorable advance ruling versus - surviving a challenge if the transaction were structured differently or if the tax consequences were reported differently

but what about Circular 230 - sec. 10.34, w/ respect to returns and other filings, ref. 6694(a)(2) - "substantial authority" if undisclosed - "reasonable" if disclosed - "more likely than not" if shelter or "reportable" transaction [cf. Notice 2008-99, 2008-47 I.R.B. 1194, infra]

but what about Circular 230, cont'd - sec. 10.35 (covered opinions) to be withdrawn under regs. proposed 09/14/12 - proposed revisions to sec. 10.37 (written opinions) set "reasonableness" standard - not to take into account likelihood of issue being raised on audit

but what is "substantial authority" Reg. 1.6662-4(d)(3) defn. - weight of authorities in support "substantial in relation to" weight of authorities against - IRS pronouncements, court decisions, legislative history, etc. - not what some guy says in a paper at a conference

what is "substantial authority," cont'd from Reg. 1.6662-4(d)(3)(iii) "a private letter ruling is not authority if revoked or if inconsistent with a subsequent proposed regulation, revenue ruling or other administrative pronouncement published in the Internal Revenue Bulletin"

from Estate of McLendon v. Comm'r, 5th Cir. 03/10/98

but to return to the subject at hand

key issues from the letter rulings

1. calculating the deduction for an outright surrender (income tax, gift tax) 2. calculating the amounts to be distributed to each party in a commutation a. disqualification under 664(d) b. self-dealing per 53.4947-1(c)(2)(i) 3. calculating the amount to be recognized as gain in a commutation or exchange

the net income limitation

PLR 200205008 (10/23/01) - partial surrender of survivor's interest in NIMCRUT to one of two remaindermen - deduction limited to lesser of present value of stated percentage payout or straight income interest - references to Reg. 20.2031-7(d) and Reg. 25.2522(c)-3(d)(2)(v), but no direct authority

from PLR 200205008

the net income limitation, cont'd

PLR 200208039 (11/29/01) - judicial commutation of eight pct. NICRUT, w/ consent of state attorney general - taxpayer last survivor of several successive income benes - trust invested for total return, yielding less than three pct. currently

from PLR 200208039

from PLR 200208039

the net income limitation, cont'd

PLRs 200524014 and 200525008 (03/15/05) - judicial commutation of portion of ten pct. NIMCRUT, w/ consent of state attorney general - remainder designated to private operating foundation w/ respect to which settlor was disqualified person - nothing said about life expectancies

the net income limitation, cont'd

"we express no opinion as to the method of determining the present value of the unitrust interest [ ] for purposes of calculating the amount of the income and gift tax charitable deductions[.]" but no self-dealing, ref. Reg. 53.4941(d)-2(f)(2), "incidental or tenuous benefit"

the net income limitation, cont'd

similarly, PLR 200808018 (11/07/07) - nonjudicial commutation of portion of seven pct. flipCRUT - term of years w/ contingent, defeasible payout to "family trust" - again, "no opinion" on method of determining present value - no mention of self-dealing

the tipping point

the net income limitation, cont'd

PLR 200525014 (03/30/05) - judicial commutation of fifteen pct. NICRUT, w/ consent of state attorney general - remainder designated to private nonoperating foundation w/ respect to which settlors were disqualified persons - taxpayers conceded capital gain, zero basis issues

the net income limitation, cont'd

- nothing said about trust not having been created for purpose of evading partial interest rule - closely held stock sold, thus "purpose to provide management no longer exists"

the net income limitation, cont'd

- revoked by PLR 200614032 (01/09/06), no explanation given - replaced by PLR 200616035 (01/25/06) - altered facts - most notably, reserved power to redesignate exercised in favor of public charities

a steep learning curve

the net income limitation, cont'd

PLR 200725044 (03/27/07) - nonjudicial commutation of ten pct. NIMCRUT - remainder to private nonoperating foundation redesignated to public charities - no mention of capital gain, zero basis issues

from PLR 200725004

from PLR 200725004

another aside

the "special factor"

- Reg. 1.7520-3(b)(1)(ii) defn. "restricted interest" - "subject to a contingency, power, or other restriction," whether provided by terms of governing instrument or caused by circumstances note: PLR 200725004 does not say the net income limitation is in fact a restriction

the "special factor," cont'd

- section 4947(a)(2) treats a split interest trust as a private foundation for purposes of self-dealing rules - Reg. 53.4947-1(c)(2)(i) makes an exception for amounts paid to the income bene of a split interest trust unless a deduction was allowed "with respect to the income interest" query: was a deduction allowed w/ respect to the difference betw. the stated unitrust payout and a straight income interest at the current 7520 rate

again keeping in mind: - structuring the transaction to get a favorable advance ruling versus - surviving a challenge if the transaction were structured differently or if the tax consequences were reported differently

commutation as capital transaction

- the letter rulings fairly consistently cite Rev. Rul. 72-243, 1972-1 C.B. 233 - in effect, a belated acquiescence in McAllister v. Comm'r, 157 F.2d 235 (2d Cir. 1946), cert. den., 330 U.S. 826 (1946) [IRS had argued assignment of income] - ruling issued in 1972 to address transitional issues on 1969 enactment of section 1001(e)

commutation as capital transaction

what Rev. Rul. 72-243 literally says is "the life tenant's sale of her entire interest in a testamentary trust to the remainderman is a sale of a capital asset" no more

commutation as capital transaction, cont'd

what section 1001(e)(1) says: "In determining gain or loss from the sale or other disposition of a term interest in property, that portion of the adjusted basis of such interest which is determined pursuant to section 1014, 1015, or 1041 (to the extent that such adjusted basis is a portion of the entire adjusted basis of the property) shall be disregarded." [emphasis supplied]

commutation as capital transaction, cont'd

but let's look at the cross references - specifically, section 1015(b) - carryover basis for property "acquired by a transfer in trust . . . other than by gift" [emphasis supplied] - ordinarily understood to refer to a sale

commutation as capital transaction, cont'd

- Reg. 1.1015-1(b) allocates basis betw. income and remainder interests per actuarial factors [cross reference Regs. 1.1014-5(a) and 20.2031-7] - adjusting to reflect "change in relative values on account of the lapse of time" so far, so good . . .

commutation as capital transaction, cont'd

but then, in determining gain or loss on disposition, "that part of the adjusted uniform basis assignable . . . to the interest sold or otherwise disposed of shall be disregarded to the extent and in the manner provided by section 1001(e) and [Reg.] 1.1001-1(f)" okay, so, what did the legislature intend

deep background

from JCS-16-70

from JCS-16-70

from JCS-16-70

from JCS-16-70

from JCS-16-70

[no caption]

the "no rulings" list

Rev. Proc. 2008-3, 2008-1 I.R.B. 110 - sec. 4.01, no advance rulings on whether commutation is treated as (40) sale or disposition under sec. 1001(a), or (41) sale or exchange of capital asset under sec. 1221(a)

the "no rulings" list, cont'd

Rev. Proc. 2008-3, 2008-1 I.R.B. 110 - sec. 5.10, no advance rulings pending formal guidance on whether commutation disqualifies trust under section 664(d) [moved to sec. 4.10(39) in Rev. Proc. 2010-3, 2009-1 C.B. 107]

another shoe dropping

Notice 2008-99, 2008-47 I.R.B. 1194 - "transaction of interest" - "coordinated" sale of income and remainder interests to unrelated third party, where appreciated assets contributed to the trust had been sold and proceeds reinvested [emphasis supplied] - exploiting exception at section 1001(e)(3)

Notice 2008-99, cont'd

- parties required to report per Reg. 1.60114(b)(6) include - "each recipient of the term interest" - the trust itself - the charity, unless it disposed of its interest on or before 10/31/08 - "material advisor" paid more than $5k [but not the purchaser]

Notice 2008-99, cont'd

Conrad Teitell, writing for ACGA, commented: - in event of either commutation or sale to third party, income bene's basis should be calculated with reference to "uniform" basis rules, adjusted by undistributed gains per Reg. Sec. 1.664-1 - formal guidance should allow qualified appraisal of net income interests

how are we fixed for time

contingent, defeasible interests

PLR 8805024 (11/05/87) - no deduction for partial surrender of spouse's contingent successive interest, because defeasible by settlor's exercise of reserved testamentary power to revoke [in PLR 9550026 (09/18/95) and PLR 9721014 (02/19/97), spouse renounced]

contingent, defeasible interests, cont'd

note Rev. Rul. 79-243, 1979-2 C.B. 343 - reserved testamentary power to revoke successive income interest renders transfer incomplete for gift tax purposes - could be used for successive interest in spouse, regardless of section 2523(g)

contingent, defeasible interests, cont'd

PLR 200802024 (09/14/07) - settlor released reserved testamentary power, spouse joined in surrender to remainderman - completed gift eligible for marital deduction per section 2523(g), despite fact her successive interest is contingent, and despite fact others might possess or enjoy a part of her interest if the contingency fails

contingent, defeasible interests, cont'd

note Rev. Rul. 79-295, 1979-2 C.B. 349 - individual transferred undivided half interest in trust remainder to charity [vested, but not in possession] - deduction allowable under section 2522(c)(2), because - transfer not made in further trust and - transferor had no other interest in the property at or before the time of transfer

contingent, defeasible interests, cont'd

note Rev. Rul. 2008-41 re division of remainder trust in event of divorce - "situation 2" supposes unitrust or annuity payout in equal shares, or all to survivor - safe harbor supposes each spouse relinquishes survivorship right [many PLRs involve scenarios outside this harbor]

contingent, defeasible interests, cont'd

PLR 200912036 (12/22/08) - nonjudicial commutation - five pct. NIMCRUT payable jointly to husband and wife, and after death of survivor in equal shares to two sons - no reserved testamentary power to revoke successive interests to sons - husband has shortened life expectancy - all three reconvey to wife - she agrees to disregard husband's life in calculating values

exchange for gift annuity

only one ruling on point PLR 200152018 (09/26/01), surrender of straight five pct. unitrust for gift annuity - treated as bargain sale - deduction for amount by which present value of unitrust interest exceeds present value of gift annuity - subject to 30 pct. deduction limit - undistributed realized gains not recognized

exchange for gift annuity, cont'd

- long term gain in amount of present value of annuity over [zero] basis, recognized ratably over expected return multiple - exception at section 1001(e)(3) not applicable "because the remainder beneficiary is not receiving the entire interest in [the trust] in a single transaction" - but what if the settlor had reserved a power to redesignate [cf. Notice 2008-99]

32 the quick brown fox jumps

28 the quick brown fox jumps over the 24 the quick brown fox jumps over the lazy
22 the quick brown fox jumps over the lazy dog

putting some numbers to it

putting some numbers to it

- in July, 2001 the ACGA imposed an additional requirement that the present value of the residuum of a gift annuity be at least 20 pct. - with the 7520 rate at 1.2 pct., an annuity at the recommended rate, paid quarterly at the end of the quarter, would not meet that requirement for an annuitant younger than 61 - the recommended rate for an annuitant aged 61 is 4.4 pct.

putting some numbers to it, cont'd

- with the 7520 rate at 1.2 pct., the present value of a five pct. straight unitrust, paid quarterly at the end of the quarter, for a bene aged 61 is 60.782 pct. - if the unitrust is holding $1M, the payout is $50k, and the present value of the unitrust interest is $607,820 - funded that amount, a gift annuity paying 4.4 pct. would pay $26,744

putting some numbers to it, cont'd

- of that amount, $20,144 would be treated as long term gain and $6,606 would be treated as ordinary income - the expected return multiple is 23.8 years, after which the entire $26,744 would be treated as ordinary income - the transfer would generate a charitable deduction of $128,382

state law issues

state law issues

1. many of the surrender rulings rely on the common law doctrine of merger not having been abrogated 2. many of the judicial commutation rulings involve state law that requires the participation of the state attorney general 3. as adopted in some states, the Uniform Trust Code, - at sec. 411(a), permits nonjudicial modification or termination of on consent of settlor and all benes, even if inconsistent with "material purpose" of trust

state law issues, cont'd

- at sec. 411(b), permits judicial termination of a noncharitable irrevocable trust on consent of all benes, if continuation not necessary to achieve "material purpose" - at sec. 411(c), states that a spendthrift provision is not presumed to constitute "material purpose" - at sec. 412(a), permits judicial modification or termination of a noncharitable irrevocable trust if, because of unanticipated circumstances, to do so would "further the purposes of the trust"

from prefatory note to Uniform Trust Code (2010 rev.)

from comment to section 103, Uniform Trust Code (2010 rev.)

from Ladysmith Rescue Squad v. Newlin, 694 S.E.2d 604, 280 Va. 195 (06/10/10)

from Ladysmith Rescue Squad v. Newlin, 694 S.E.2d 604, 280 Va. 195 (06/10/10)

fin

some rulings involving CRATs

- current income in excess of amount required to pay annuity - principal in excess of amount required to fund annuity payout

some rulings involving CRATs, cont'd

PLR 9929033 - already paying excess income - nonjudicial modification to permit distribution of principal PLR 200010035 - judicial modification to require distribution of excess income and to permit distribution of principal PLR 200052035 - judicial modification to permit distribution both of excess income and of principal

some rulings involving CRATs, cont'd

PLR 200617026 - judicial modification to permit distributions of principal PLR 200950032 - same parties, adding a second tier

some rulings involving CRATs, cont'd

PLR 200922013 through 200922027 (fifteen rulings) - already paying excess income - judicial termination as to excess over amount required to fund annuity payout - remainderman to purchase commercial annuities payable to family groups
https://www.charitableplanning.com/commentary/comments/1445830

applying similar reasoning to CRUTS

Reg. 1.664-3(a)(4) - permits trust instrument to allow current distributions, apart from the unitrust payout, to exempt entity, provided that if the distribution is made in kind, adjusted basis of property distributed is "fairly representative" of adjusted basis of "property available" for distribution - similar provision at Reg. 1.664-2(a)(4) re annuity trusts

applying similar reasoning to CRUTS, cont'd

statutory defn. CRAT at section 664(d)(1) and statutory defn. CRUT at section 664(d)(2) both state minimum five pct. payout in terms of distributions to one or more persons "at least one of which is not" a section 170(c) org thus, one could modify to cut the remainderman in on a piece of the current payout

32 the quick brown fox jumps

28 the quick brown fox jumps over the 24 the quick brown fox jumps over the lazy
22 the quick brown fox jumps over the lazy dog