CHARITABLE LEAD UNITRUSTS QUALIFY FOR ESTATE TAX CHARITABLE DEDUCTION; GSTT AND SELF-DEALING TAX WILL NOT BE IMPOSED

Reference:

Section 2055 -- Estate Tax Charitable Deduction
UIL Number(s) 2055.00-00, 2601.00-00, 4941.04-00

Full Text:

Date: May 4, 1995

Refer Reply to: CC:DOM:P&SI:4/TR-31-2313-94

LEGEND:
Settlors = * * *
Family Trust = * * *
Unitrust 1 = * * *
Unitrust 2 = * * *
Corporate Trustee = * * *

Dear * * *

This is in response to your August 24, 1994 letter requesting rulings on behalf of Settlors, concerning whether property held in certain trusts will qualify for the estate tax charitable deduction under section 2055(a) of the Internal Revenue Code and certain other rulings.

Settlors, husband and wife, propose to amend and restate a trust, Family Trust, that was originally executed on April 7, 1989. As restated, Family Trust may be amended, altered, or revoked in whole or in part by a writing signed by Settlors together and delivered to the trustee. Family Trust, during Settlors' joint lives, will pay the trust net income to Settlors at least monthly and so much of the principal as Settlors may direct.

On the death of the first Settlor to die, Family Trust will be divided into two trusts, Unitrust 1 and the Survivor's Trust. The trustee will allocate sufficient assets to Unitrust 1 to totally exhaust the decedent-settlor's unused Generation Skipping Transfer Tax exemption as defined in section 2631. The trustee will allocate the following assets to the Survivor's Trust: the survivor's interest in community property; one-half of all accrued and undistributed income of Family Trust; the survivor's community and separate property interest in life insurance proceeds received by reason of the decedent settlor's death; and the remainder of the decedent settlor's probate estate. All state and federal taxes payable upon the death of the decedent settlor will be payable by the Survivor's Trust. If husband survives wife, then husband will be the initial individual trustee of Unitrust 1 and Corporate trustee will be the second initial trustee. Following husband's death (or if husband predeceases wife), Settlor's children will succeed Settlors as the individual trustees.

Under the terms of the Survivor's Trust, the trustee will pay the net income of the trust to the surviving settlor for life and as much principal (up to the entire amount) as the surviving settlor directs. In addition, the surviving settlor will have a general testamentary power of appointment over the trust assets remaining at death. Upon the surviving settlor's death, the trustee shall first pay the estate taxes and certain other expenses from the trust assets. Thereafter, the trustee shall pay the then remaining principal and all accrued and undistributed income as the surviving settlor appoints. In default of appointment, any remaining principal and accrued and undistributed income of the trust estate shall first be allocated to Unitrust 2 in an amount sufficient to totally exhaust the decedent's unused generation-skipping transfer tax exemption. Any remaining assets shall be divided into equal shares to provide one share for each living child of Settlors and one share collectively for the children of a deceased child.

Commencing on the death of the first settlor to die and continuing for a term of 18 years, Unitrust 1 shall pay a unitrust amount to charity equal to 7 percent of the net fair market value of the trust principal and income determined annually as of the yearly valuation date. The charities to which the unitrust amount is payable may be changed from time to time by Settlors, by the surviving settlor or by the unanimous approval of the individual trustees serving at any particular time. The unitrust amount shall only be paid to charitable organizations which are described in sections 170(c)(2), 2055(a) and 2522(a).

On termination of the charitable term, Unitrust 1 shall continue to be held for the benefit of the great grandchildren ("Beneficiaries") then living and the children ("Secondary Beneficiaries") of any deceased great grandchild of Settlors. The net income of Unitrust 1 shall be paid out in convenient installments to Beneficiaries in equal shares. The Secondary Beneficiaries of a deceased great grandchild will be entitled to one share of net income until the Secondary Beneficiary's parent would have been thirty-five. In the year any great grandchild attains the age of thirty-five years, one share, based on the total number of Beneficiaries then living, shall be distributed to him or her and his or her interest in Unitrust 1 will terminate. Likewise, Secondary Beneficiaries will receive a share of Unitrust 1 at such time as their parent would have attained the age of thirty-five. The interest of any Beneficiary in Unitrust 1 who dies without children, shall be terminated. When the youngest living Beneficiary of Settlors attains the age of thirty- five and his or her share has been distributed to him or her, Unitrust 1 shall terminate.

Commencing on the death of the surviving settlor and continuing for a term of 18 years, Unitrust 2 shall pay a unitrust amount to charity equal to 7 percent of the net fair market value of the trust principal and income determined annually as of the yearly valuation date. On termination of the charitable term, Unitrust 2 shall be held under provisions identical to those of Unitrust 1, providing, in general, payment of the net trust income to the Beneficiaries (or Secondary Beneficiaries) and providing for distribution of a share of principal as each Beneficiary attains age 35.

The trustee of both Unitrust 1 and Unitrust 2 is prohibited from engaging in any act of self-dealing as defined in section 4941(d), from retaining any excess business holdings as defined in section 4943(c) which would subject the trusts to tax under section 4943, from acquiring or retaining any investments which would subject the trusts to tax under section 4944 or from making any taxable expenditures as defined in section 4945(d). In addition, the trustee must make distributions at such time and in such manner as not to subject the trusts to tax under section 4942.

RULING REQUEST 1:

Will Unitrust 1 and Unitrust 2 be classified as trusts within the meaning of section 301.7701-4(a) of the Procedure and Administration Regulations?

Concerning your ruling request 1, we are unable to rule. Section 7.02 of Revenue Procedure 95-1, 1995-1 I.R.B. 9, 22, provides that the Service will not issue a ruling on hypothetical situations. Inasmuch as Unitrust 1 and Unitrust 2 may be revoked in whole or in part at any time prior to the death of the decedent settlor, any conclusions drawn regarding the classification of Unitrust 1 and Unitrust 2 would be hypothetical. Accordingly, we decline to rule on your requests concerning the classification of Unitrust 1 and Unitrust 2.

RULING REQUEST 2:

a. With respect to Unitrust #1, will the taxable estate of the Deceased taxpayer be entitled to a federal estate tax deduction under section 2055 for the fair market value of the charitable lead unitrust interest that passes to the designated charitable beneficiaries?

b. With respect to Unitrust #2, will the taxable estate of the surviving settlor be entitled to a federal estate tax deduction under section 2055 for the fair market value of the charitable lead unitrust interest that passes to the designated charitable beneficiaries?

Section 2055(a) provides, for estate tax purposes, that the value of the taxable estate shall be determined by deducting from the value of the gross estate the amount of all bequests, legacies, devises, or transfers for public, charitable, and religious uses.

Section 2055(e)(2) provides that where an interest in property (other than an interest described in section 170(f)(3)(B)) passes or has passed from the decedent to a person, or for a use, described in section section 2055(a), and an interest (other than an interest which is extinguished upon the decedent's death) in the same property passes or has passed (for less than an adequate an full consideration in money or money's worth) from the decedent to a person, or for a use, not described in section 2055(a), no deduction shall be allowed for the interest which passes or has passed to the person, or for the use, described in section 2055(a), unless, in the case of an interest other than a remainder interest,

* * * *

(B) . . . such interest is in the form of a guaranteed annuity or is a fixed percentage distributed yearly of the fair market value of the property (to be determined annually).

Section 20.2055-2(e)(2)(vii)(a) of the Estate Tax Regulations provides, in part, that for purposes of section 2055, the term "unitrust interest" means the right pursuant to the instrument of transfer to receive payment, not less often than annually, of a fixed percentage of the net fair market value, determined annually, of the property which funds the unitrust interest. In computing the net fair market value of the property which funds the unitrust interest, all assets and liabilities shall be taken into account without regard to whether particular items are taken into account in determining the income from the property. The net fair market value of the property which funds the unitrust interest may be determined on any one date during the year or by taking the average of valuations made on more than one date during the year, provided that the same valuation date or dates and valuation methods are used each year. Where the charitable interest is a unitrust interest to be paid by a trust and the governing instrument of the trust does not specify the valuation date or dates, the trustee shall select such date or dates and shall indicate his selection on the first return on Form 1041 which the trust is required to file. Payments under a unitrust interest may be paid for a specified term or for the life or lives of an individual or individuals, each of whom must be living at the date of death of the decedent and can be ascertained at such date. For example, the unitrust interest may be paid for the life of A plus a term of years.

Section 20.2055-2(e)(2)(vii)(b) provides that charitable interest is a unitrust interest only if it is a unitrust interest in every respect. For example, if the charitable interest is the right to receive from a trust each year a payment equal to the lesser of a sum certain or a fixed percentage of the net fair market value of the trust assets, determined annually, such interest is not a unitrust interest.

In the present case, the charitable beneficiaries will receive 7 percent of the net fair market value of the trust principal and income determined annually as of the yearly valuation date. The unitrust amount may only be paid to organizations described in section 2055(a). During the term of the unitrust, no payments may be made for private purposes.

Based on the information provided, we conclude that the charitable interest in Unitrust 1, and the charitable interest in Unitrust 2 will constitute unitrust interests within the meaning of section 20.2055-2(e)(2)(vii)(a). Therefore, the value of the charitable unitrust interest in Unitrust 1 at decedent-settlor's death will qualify for the estate tax charitable deduction under section 2055(a). In addition, to the extent that the surviving settlor does not exercise his or her testamentary general power of appointment over the remaining assets in the Survivor's Trust, such that Unitrust 2 is funded, the value of the unitrust interest in Unitrust 2 will qualify for the estate tax charitable deduction under section 2055(a) at the surviving settlor's death.

RULING REQUEST 3:

With respect to each charitable lead unitrust, what is the amount of the estate tax deduction attributable to the charitable lead unitrust interest, as determined under section 2055?

Rev. Proc. 95-1, 1995-1 I.R.B. 9, 18, section 5.05 provides that the National Office issues prospective letter rulings on transactions affecting the estate tax on the prospective estate of a living person and affecting the estate tax on the estate of a decedent before the decedent's estate tax return is filed. The National Office will NOT issue letter rulings for prospective estates regarding computations of tax, actuarial factors and factual matters.

RULING REQUEST 4:

With respect to Unitrust 1 and Unitrust 2, will a "taxable termination occur on the expiration of the charitable lead unitrust term under section 2612(a) for purposes of the generation-skipping transfer tax?

Section 2601 imposes a tax on every generation-skipping transfer. Section 2611 provides that a generation-skipping transfer means a taxable distribution, a taxable termination or a direct skip.

Section 2612(b) provides that a taxable distribution means any transfer from a trust to a skip person (other than a taxable termination or a direct skip).

Section 2612(a)(1) provides that a taxable termination occurs when an interest in a trust terminates (by death, lapse of time, release of power, or otherwise) unless immediately after such termination, a non-skip person has an interest in such property or at no time after such termination may a distribution (including distributions on termination) be made from such trust to a skip person.

Section 2612(c) provides that a direct skip means a transfer (subject to estate or gift tax) of an interest in property to a skip person.

Section 2613(a) provides that the term "skip person" means (1) a natural person assigned to a generation that is two or more generations below the generation assignment of the transferor or (2) a trust if all interests in such trust are held by skip persons.

Section 2651(b) provides, in general, that an individual who is a lineal descendant of a grandparent of the transferor shall be assigned to that generation which results from comparing the number of generations between the grandparent and such individual with the number of generations between the grandparent and the transferor.

Section 2651(e)(2) provides that except as provided in section 2651(e)(3), if an estate, trust, partnership, corporation, or other entity has an interest in property, each individual having a beneficial interest in such entity shall be treated as having an interest in such property and shail be assigned to a generation under the foregoing provisions of this subsection.

Section 2651(e)(3) provides that any organization described in section 511(a)(2), any charitable trust described in section 511(b)(2), and any governmental entity, shall be assigned to the transferor's generation.

In the present case, the charitable beneficiaries of the lead unitrust interests will be assigned to Settlors' generation and the great grandchildren (or their children) would be assigned to a generation at least two generations below the generation of Settlors. The charities, interests in Unitrust 1 and Unitrust 2 terminate on the expiration of the 18 year period. After the charities' interests terminate, no non-skip person will have any interest in Unitrust 1 or Unitrust 2. Accordingly, on the expiration of the charitable term of Unitrust 1 and Unitrust 2, a taxable termination will occur under section 2612(a).

RULING REQUEST 5:

Will a generation-skipping tax be imposed on the termination of the charitable interests in Unitrust 1 and Unitrust 2?

Under section 2602, the generation-skipping transfer tax is computed by multiplying the taxable amount (defined in sections 2621 through 2624) by the applicable rate. The applicable rate is defined in section 2641, as the maximum federal estate tax rate under section 2001 multiplied by the inclusion ratio.

Section 2631(a) provides that for purposes of determining the inclusion ratio, every individual shall be allowed a GST exemption of $1,000,000 which may be allocated by such individual (or his executor) to any property with respect to which such individual is the transferor.

Section 2632(a) provides that any allocation by an individual of his or her GST exemption under section 2631(a) may be made at any time on or before the date prescribed for filing the estate tax return for such individuals estate regardless of whether such return is required to be filed.

Section 2642(a)(1) provides, generally, that the inclusion ratio with respect to any property transferred in a generation-skipping transfer shall be the excess (if any) of 1 over the applicable fraction determined for the trust from which such transfer is made.

Section 2642(a)(2) provides that the applicable fraction is a fraction --

Section 2642(b)(2)(A) provides that if property is transferred as a result of the death of the transferor, the value of such property for purposes of section 2642(a) shall be its value for purposes of chapter 11; except that, if the requirements prescribed by the Secretary respecting allocation of post-death changes in value are not met, the value of such property shall be determined as of the time of the distribution concerned.

Section 2642(b)(2)(B) provides that any allocation of GST exemption to property transferred as a result of the death of the transferor shall be effective on and after the date of the death of the transferor.

In the present case, Unitrust 1 will be funded on the death of the first settlor to die. Unitrust 2 will be funded on the death of surviving settlor. Each trust will be funded with sufficient assets to totally exhaust the decedent-settlor's unused Generation Skipping Transfer Tax exemption as defined in section 2631. The governing instrument of the Family Trust provides that any estate taxes imposed on either settlor's estate are not to be paid out of Unitrust 1 or Unitrust 2. Accordingly, the numerator of the applicable fraction for each trust will be the GST exemption allocated to that trust. The denominator of the applicable fraction for each trust will be value of the property passing to that trust less the present value of the charitable lead unitrust. Assuming each trust is funded timely, based on the formula provided, and sufficient GST exemption is timely allocated, then each trust will have an inclusion ratio of zero and thus, will not be subject to the generation skipping transfer tax on termination of the charitable lead interest.

RULING REQUEST 6:

Upon the decedent-settlor's death, will the sale of assets by Family Trust to certain family members of Settlors in exchange for cash and promissory notes and the subsequent distribution of the cash and promissory notes to Unitrust 1, constitute an act of self dealing within the meaning of section 4941?

Upon the surviving-settlor's death will the sale of assets by Family Trust to certain family members of Settlors in exchange for cash and promissory notes, and the subsequent distribution of the cash and the promissory notes to Unitrust 2 constitute an act of self dealing within the meaning of section 4941?

Rev. Proc. 95-4, 1995-1 I.R.B. 97, gives guidance to taxpayers on issues under the jurisdiction of the Assistant Commissioner (Employee Plans and Exempt Organizations) and it explains the kinds of guidance and the manner in which guidance is requested by taxpayers and provided by the Service. Section 8.02 of Rev. Proc. 95-4, provides that the Service will not issue letter rulings on alternative plans of proposed transactions or on hypothetical situations.

RULING REQUEST 7:

With respect to Unitrust 1 and Unitrust 2, will the trustee's power to designate additional charitable organizations to be beneficiaries of either Unitrust 1 or Unitrust 2 constitute a general power of appointment within the meaning of section 2041?

Section 2041(a)(2) provides, in general, that the value of the gross estate shall include the value of all property to the extent of any property with respect to which the decedent has at the time of death a general power of appointment created after October 21, 1942, or with respect to which the decedent has at any time exercised or released such a power of appointment by a disposition which is of such nature that if it were a transfer of property owned by the decedent, such property would be includible in the decedent's gross estate under 2035 to 2038, inclusive.

Section 2041(b)(1) provides, in part, that the term general power of appointment means a power which is exercisable in favor of the decedent, his estate, his creditors, or the creditors of his estate.

In the present case, the individual trustees may only change the charity to which the unitrust amount is paid by unanimous approval and they may only appoint the unitrust amount to a charitable organization described in sections 170(c)(2), 2055(a) and 2522(a). Under no circumstances may an individual trustee appoint any of the property to such trustee, the trustee's estate, the trustee's creditors or the creditors of the trustee's estate. Accordingly, the individual trustee's power to appoint new charities as beneficiaries of either Unitrust 1 or Unitrust 2 will not be a general power of appointment under section 2041. In addition, such power will not disqualify Unitrust 1 or Unitrust 2. See, Rev. Rul. 78-101, 1978-1 C.B. 301, providing that a trustee's power to select charitable beneficiaries, restricted to organizations meeting the requirements of section 2522(a), will not disqualify an otherwise qualified charitable lead unitrust.

This ruling is based on the facts presented and the applicable law in effect on the date of this letter. If there is a change in material fact or law (local or federal) before the transactions considered in this ruling take effect, the ruling will have no force or effect.

Except as we have ruled above, we express no opinion as to the tax consequences of your transaction under the cited provisions of the Code or under any other provisions of the Code.

This ruling is directed only to the taxpayer who requested it. Section 6110(j)(3) provides that it may not be used or cited as precedent.

Sincerely,

Assistant Chief Counsel
(Passthroughs and Special Industries)

By: George L. Masnik
Chief, Branch 4

Enclosure
Copy for section 6110 purposes