Home Estate Planners Corner

Nonqualified Charitable Remainder Trusts Worth a Look

Donors and their advisers generally want to ensure that a charitable remainder trust satisfies all the requirements of Code §664 and thereby qualifies for income, gift and estate charitable deductions.  But the estate tax charitable deduction may not be necessary if the client’s estate is likely to be sheltered by the estate tax credit (currently anyone with a taxable estate under $3.5 million).

Consider Otto, who has an estate of $2 million. He wants to benefit his only sister, Ursula, and have the assets eventually pass to his favorite charity. But Otto doesn’t want Ursula’s interest to be limited to a fixed dollar amount or percentage, as it would be with an annuity trust or unitrust. He instead would like her to receive all the income generated by the trust assets.  Otto would also like to give the trustee the right to distribute corpus to Ursula if she needs additional funds.  Otto could create a testamentary trust for Ursula’s benefit and instruct that the assets pass at her death to charity. The result? Otto’s estate is not entitled to a charitable deduction, but it is more than sheltered by the estate tax credit.  At Ursula’s death, no part of the trust is included in her gross estate, unless Ursula held a general power of appointment. Charity is entitled to as much or little as is left in the trust at Ursula’s death.

Are there drawbacks to a nonqualified charitable remainder trust?  The trust is not a tax-exempt entity, so the sale of assets within the trust will not avoid capital gains tax. This may not be a concern with a testamentary trust, where the assets funding the trust will receive a stepped-up basis at Otto’s death. Taxes may be a problem, however, if the trust is funded with U.S. savings bonds or other income in respect of a decedent (IRD).

Charitable Estate Planning for Married Donors

A spouse’s interest in a testamentary charitable remainder trust or pooled income fund will qualify for the unlimited estate tax marital deduction, if properly planned [IRC §§2056(b)(7), (8)].  A qualified terminable interest property (QTIP) trust with charity as remainderman can generate a 100% estate tax marital deduction when the first spouse dies [IRC §2056(b)(7)] and a 100% estate tax charitable deduction at the death of the surviving spouse [IRC §§2044(c), 2055].  This is a simple, flexible arrangement that permits a testator to provide for a spouse, yet ultimately benefit charity.

Among other things, QTIP trusts are required to pay all trust income, at least once a year, to a surviving spouse, and no other person can be an income beneficiary.  Such a trust would not be a qualified charitable remainder trust, in which payments are made as “unitrust” or annuity payouts.  But a charitable deduction would be unnecessary because the trust would qualify for the unlimited estate tax marital deduction.  Would spouses ever want to establish testamentary qualified remainder trusts for a surviving spouse?  The answer is yes – if there are to be income beneficiaries in addition to the surviving spouse.  Such a trust would fail as a QTIP trust, but could nonetheless generate an estate tax charitable deduction.  A testamentary charitable remainder unitrust for a surviving spouse also might make sense as a receptacle for IRD or if the survivor wanted to use the trust as a philanthropic vehicle.  The spouse could make additional contributions to the unitrust, realize income tax and capital gains tax savings, and provide further benefit to the charitable remainderman.  Additional contributions are not permitted for charitable remainder annuity trusts [Reg. §1.664-2(b)].

A private letter ruling (PLR 9122029, 2-28-91) permitted a spouse to bequeath property to a QTIP trust that pays the surviving spouse income for life, then empties into a charitable remainder trust for children.  The estate of the first spouse to die qualifies for the marital deduction, assuming the executor makes a timely QTIP election [IRC §2056(b)(7)].  The surviving spouse’s estate will include the value of the assets passing to the charitable remainder trust – but the estate will qualify for a charitable deduction equal to charity’s remainder interest [IRC §§2044(c) and 2055(e)(2)(A)].  The same technique reasonably should apply to a charitable lead trust.  Why not just make the children survivor beneficiaries of a qualified charitable remainder trust for the spouse?  Under IRC §2056(b)(8), the interest of the surviving spouse will not qualify for the estate tax marital deduction at the first spouse’s death because he or she is not the sole noncharitable beneficiary.

Charitable Bequests of “Disadvantaged Property” 

Certain assets have poor income tax results if contributed to charity during life.  Bequests of such property, on the other hand, can be 100% deductible for estate tax purposes.

Ordinary income property.  Several years ago, Ted DeGrazia, an artist living in the Southwest, burned about $1 million worth of his paintings when he learned they would be subject to federal estate tax.  Had he given some thought to the matter, he might have found it better to bequeath the paintings to a museum, university or other charitable institution.  If the artist had given the paintings to charity during life, his charitable contribution would have been limited under IRC §170(e)(1)(A) to his cost basis – what he paid for paint and canvas.  Paintings in the hands of the artist are one kind of “ordinary income property,” defined as property the sale of which would produce any ordinary income or short-term capital gain.  No such reduction applies to the estate tax charitable deduction; thus the artist’s estate would have been allowed a deduction for the full fair market value of the paintings had he bequeathed them to charity.

Tangible personal property.  If an individual makes a lifetime gift to charity of tangible personal property (e.g., a painting, boat or a coin collection), and the charity puts the gift to an “unrelated use,” the donor’s contribution will be reduced by 100% of any long-term capital gain present in the property [Reg. §1.170A-4(b)(3)(i)].  No reduction occurs, however, with bequests of personal property.

IRS Revises Process for Switch to Public Charity Status

The Pension Protection Act specifically excludes Code §509(a)(3) supporting organizations
from receiving qualified charitable distributions from IRAs [Code §408(d)(8)((B)(i)].  As a result, many organizations, including foundations established as fundraising entities for public charities, have found it desirable to seek reclassification of their “public charity” status.  The IRS now has issued Announcement 2009-62, amending procedures by which a supporting organization can request a change.

Organizations seeking to change their public charity classification from a Code §509(a)(3) supporting organization to a §509(a)(1) or (a)(2) organization should submit a written request for a determination as to public charity status pursuant to Revenue Procedure 2009-4, 2009-1 I.R.B. 118.  The request for reclassification must include the following:

1. A subject line or other indicator on the first page of the request in bold, underlined or all capitals font indicating “REQUEST FOR DETERMINATION AS TO PUBLIC CHARITY STATUS.”
2. A statement requesting reclassification from section 509(a)(3) to another public charity classification under sections 509(a)(1) and 170(b)(1)(A)(vi) or section 509(a)(2).
3. Either (a) a copy of the organization’s signed Form 990, Parts I through XI, or Form 990-EZ, Parts I through VI, with the completed Schedule A, Public Charity Status and Public Support, as filed with the Internal Revenue Service for the taxable year immediately preceding the taxable year in which the request is made; or (b) the organization’s support information for the past five completed tax years, using the organization’s overall method of accounting used to complete the Form 990 or Form 990-EZ for such years.

This information may be provided to the Internal Revenue Service on a completed Schedule A, Public Charity Status and Public Support, to the Form 990 or Form 990-EZ (2008 or later year, as
appropriate).  Like all requests for a determination, the request must be signed under penalties of
perjury by the organization’s officer, director, trustee or other authorized official. The complete reclassification request should be mailed to:

IRS-TEGE
Attn: Correspondence Unit, Room 4024
P.O. Box 2508
Cincinnati, OH 45201

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