Rev. Rul. 2008-41; 2008-30 IRB 1 (8 Jul 2008)

Part I

Section 664. -- Charitable Remainder Trusts
(Also: §§ 507, 1015, 1223, 4941, 4945, 4947)


ISSUES

Under the facts of this revenue ruling:

(1) Does the pro rata division of a trust that qualifies as a charitable remainder trust (CRT) under § 664(d) of the Internal Revenue Code into two or more separate trusts cause the trust or any of the separate trusts to fail to qualify as a CRT under § 664(d)?

(2) When a trust that qualifies as a CRT under § 664(d) is divided pro rata into two or more separate trusts, is the basis under § 1015 of each separate trust's share of each asset the same share of the basis of that asset in the hands of the trust immediately before the division of the trust, and, under § 1223, does each separate trust's holding period for an asset transferred to it by the original trust include the holding period of the asset as held by the original trust immediately before the division?

(3) Does the pro rata division of a trust that qualifies as a CRT under § 664(d) into two or more separate trusts terminate under § 507(a)(1) the trust's status as a trust described in, and subject to, the private foundation provisions of § 4947(a)(2), and result in the imposition of an excise tax under § 507(c)?

(4) When a trust that qualifies as a CRT under § 664(d) is divided pro rata into two or more separate trusts, does the division constitute an act of self-dealing under § 4941?

(5) When a trust that qualifies as a CRT under § 664(d) is divided pro rata into two or more separate trusts, does the division constitute a taxable expenditure under § 4945?

FACTS

Situation 1. Trust qualifies as either a charitable remainder annuity trust (CRAT) described in § 664(d)(1) or a charitable remainder unitrust (CRUT) described in § 664(d)(2). Under the terms of Trust, two or more individuals (recipients) are each entitled to an equal share of the annuity or unitrust amount, payable annually, during the recipient's lifetime, and upon the death of one recipient, each surviving recipient becomes entitled for life to an equal share of the deceased recipient's annuity or unitrust amount. Thus, the last surviving recipient becomes entitled to the entire annuity or unitrust amount for his or her life. Upon the death of the last surviving recipient, the assets of Trust are to be distributed to one or more charitable organizations described in § 170(c) (remainder beneficiaries).

Trust has not committed any act (or failure to act) in the past giving rise to liability for tax under chapter 42 (Private Foundations and Certain Other Tax-Exempt Organizations). Moreover, Trust has made no distributions to charitable beneficiaries.

The state court having jurisdiction over Trust has approved a pro rata division of Trust into as many separate and equal trusts as are necessary to provide one such separate trust for each recipient living at the time of the division, with each separate trust being intended to qualify as the same type of CRT (i.e., CRAT, CRUT, net income CRUT with makeup) as Trust. Either the court's order or the trust agreement itself incorporates the provisions described in these facts that will govern the separate trusts.

The separate trusts may have different trustees. To carry out the division of Trust into separate trusts, each asset of Trust is divided equally among and transferred to the separate trusts. For purposes of determining the character of distributions to the recipient of each separate trust, each separate trust upon the division of Trust is deemed to have an equal share of Trust's income in each tier described in § 664(b) and, similarly, on each subsequent consolidation of separate trusts by reason of the death of a recipient, the income in each tier of the consolidated trust is the sum of the income in that tier formerly attributed to the trusts being combined. The recipients pay all the costs associated with the division of Trust into separate trusts, including (i) legal fees relating to the court proceeding, and (ii) the administrative costs of the creation and funding of the separate trusts.

Each of the separate trusts has the same governing provisions as Trust, except that: (i) immediately after the division of Trust, each separate trust has only one recipient, and each recipient is the annuity or unitrust recipient of only one of the separate trusts (that recipient's separate trust); (ii) each separate trust is administered and invested independently by its trustee(s); (iii) upon the death of the recipient, each asset of that recipient's separate trust is to be divided on a pro rata basis and transferred to the separate trusts of the surviving recipient(s), and the annuity amount payable to the recipient of each such separate CRAT is thereby increased by an equal share of the deceased recipient's annuity amount (the unitrust amount of each separate CRUT is similarly increased as a result of the augmentation of the CRUT's corpus, and each separate CRUT incorporates the requirements of § 1.664-3(b) of the Income Tax Regulations with respect to the subsequent computation of the unitrust amount from that trust); and (iv) upon the death of the last surviving recipient, that recipient's separate trust (being the only separate trust remaining) terminates, and the assets are distributed to the remainder beneficiaries.

The remainder beneficiaries of Trust are the remainder beneficiaries of each of the separate trusts and are entitled to the same (total) remainder interest after the division of Trust as before. In addition, each recipient is entitled to receive from his or her separate trust the same annuity or unitrust amount as the recipient was entitled to receive under the terms of Trust. Because the annual net fair market value of the assets in each of the separate trusts may vary from one another due to differing investment strategies of the separate trusts, in situations where Trust is a CRUT, the amount of the unitrust payments from each separate CRUT may vary over time, both from year to year and among the separate CRUTs. Nevertheless, the unitrust percentage of each separate CRUT remains the same as each recipient's share of the unitrust percentage under the terms of Trust, and the recipients and the remainder beneficiaries are entitled to the same benefits after the division of Trust as before.

For example, assume Trust is a CRUT. Under the terms of Trust, X, Y, and Z are entitled to share equally the annual payments of a 15 percent unitrust amount (5 percent each) while all three are living, and upon the death of one recipient, the surviving recipients are entitled to the deceased recipient's share. Thus, if X dies first, the surviving recipients (Y and Z) are entitled to share equally in the annual payments of the 15 percent unitrust amount (7.5 percent each) while both are living. Thereafter, if Y predeceases Z, then upon the death of Y, Z is entitled to receive annual payments of the entire 15 percent unitrust amount for life. Upon the division of Trust, three separate trusts are created (one for each of X, Y, and Z) and each of the separate trusts holds one-third of the assets of Trust. X, Y, and Z are each entitled to annual payments of a 15 percent unitrust amount from his or her separate trust (15 percent of one-third of the assets is equivalent to 5 percent of all the assets of Trust). After the division of Trust and upon the death of X, each asset of X's separate trust is divided on a pro rata basis and transferred to Y and Z's separate trusts. Y and Z each remain entitled to annual payments of a 15 percent unitrust amount from his or her respective separate trust, each of which is now funded with the equivalent of one-half the assets of Trust (15 percent of one-half of the assets is equivalent to 7.5 percent of all the assets of Trust). Upon the death of Y, the assets of Y's separate trust are transferred to Z's separate trust, and Z remains entitled to annual payments of a 15 percent unitrust amount from Z's separate trust. These are the same interests to which X, Y, and Z would have been entitled under the terms of Trust if Trust had not been divided into separate trusts.

Situation 2. The facts are the same as in Situation 1 except that Trust has only two recipients who are U.S. citizens married to each other but in the process of obtaining a divorce, and, instead of the provision described in (iii) of Situation 1, each separate trust in Situation 2 has governing provisions providing that upon the death of the recipient, that recipient's separate trust terminates and the assets of that separate trust then are distributed to the remainder beneficiaries. Because the remainder beneficiaries of Trust (and thus of each separate trust) receive a distribution of one-half of the assets of Trust upon the death of the first spouse to die and the remaining half of the assets upon the death of the surviving spouse (rather than a distribution of all of the assets of Trust upon the later death of the surviving recipient), the value of the remainder payable to the remainder beneficiaries as a result of the division of Trust into separate trusts may be larger than the present value of that interest as computed at the creation of Trust; no additional charitable deduction is permitted, however.

Each recipient (spouse) is entitled to receive from his or her separate trust the same share of the annuity or unitrust amount as the recipient was entitled to receive under the terms of Trust. However, each spouse relinquishes all interests in Trust to which he or she would have been entitled by reason of having survived the other (survivorship right).

LAW AND ANALYSIS

Issue 1. Qualification of Trusts under § 664(d)

Section 664(d)(1) provides that a CRAT is a trust:

(A) from which a sum certain (which is not less than 5 percent or more than 50 percent of the initial net fair market value of all property placed in trust) is to be paid, not less often than annually, to one or more persons (at least one of which is not an organization described in § 170(c) and, in the case of individuals, only to an individual who is living at the time of the creation of the trust) for a term of years (not in excess of 20 years) or for the life or lives of such individual or individuals;

(B) from which no amount other than the payments described in § 664(d)(1)(A) and qualified gratuitous transfers described in § 664(d)(1)(C) may be paid to or for the use of any person other than an organization described in § 170(c);

(C) the remainder interest of which (following the termination of the payments described in § 664(d)(1)(A)), is to be transferred to, or for the use of, an organization described in § 170(c) or is to be retained by the trust for such a use or, to the extent the remainder interest is in qualified employer securities (as defined in § 664(g)(4)), all or part of such securities are to be transferred to an employee stock ownership plan (as defined in § 4975(e)(7)) in a qualified gratuitous transfer (as defined in § 664(g)); and

(D) the remainder interest of which has a value (determined under § 7520) that is at least 10 percent of the initial net fair market value of all property placed in trust.

Section 664(d)(2) provides that a CRUT is a trust:

(A) from which a fixed percentage (which is not less than 5 percent nor more than 50 percent) of the net fair market value of its assets, valued annually, is to be paid, not less often than annually, to one or more persons (at least one of which is not an organization described in § 170(c) and, in the case of individuals, only to an individual who is living at the time of the creation of the trust) for a term of years (not in excess of 20 years) or for the life or lives of such individual or individuals;

(B) from which no amount other than the payments described in § 664(d)(2)(A) and qualified gratuitous transfers described in § 664(d)(2)(C) may be paid to or for the use of any person other than an organization described in § 170(c);

(C) the remainder interest of which (following the termination of the payments described in § 664(d)(2)(A)), is to be transferred to, or for the use of, an organization described in § 170(c) or is to be retained by the trust for such a use or, to the extent the remainder interest is in qualified employer securities (as defined in § 664(g)(4)), all or part of such securities are to be transferred to an employee stock ownership plan (as defined in § 4975(e)(7)) in a qualified gratuitous transfer (as defined in § 664(g)); and

(D) the remainder interest of which, with respect to each contribution of property to the trust, has a value (determined under § 7520) that is at least 10 percent of the net fair market value of such property as of the date such property is contributed to the trust.

Section 1.664-1(a)(4) provides, in part, that in order for a trust to be a CRT, it must meet the definition of and function exclusively as a CRT from the creation of the trust.