PLR 200031034: Proposed unitrust reformation preserves specified charitable tax treatment

Plain-English summary

Trustees proposed to change the payment formula for a charitable remainder unitrust that would receive property after a surviving spouse's death. During its first taxable year, the trust would pay a niece the lesser of trust income or five percent of asset value; in later years it would pay five percent of asset value. The IRS ruled that this proposed reformation would not prevent the trust from qualifying as a charitable remainder unitrust under section 664, would not itself be self-dealing under section 4941, and would allow a charitable estate tax deduction under section 2055(a) for the spouse's estate. These rulings depend on a court order authorizing the change. The IRS expressly declined to decide whether the trust would otherwise qualify as a charitable remainder trust or to address other trust provisions.

Ruling snapshot

• Question: Would the proposed change to the unitrust's payout formula affect its charitable treatment, trigger self-dealing, or prevent the estate tax charitable deduction?
• Outcome: Approved for the proposed reformation, contingent on a court order and subject to the letter's no-opinion caveat about overall trust qualification.
• Key authorities: IRC §§ 664, 2055(a), 4941, and 4947(a)(2); Treas. Reg. §§ 1.664-3(a)(1)(i)(c) and (f)(3).

Full text (IRS public release)

Internal Revenue Service                             Department of the Treasury


Index Number: 2055.12-05; 664.03-02                  Washington, DC 20224
              4941.04-00

Number: 200031034                                    Person to Contact:
Release Date: 8/4/2000
                                                     Telephone Number:

                                                     Refer Reply To:
                                                     CC:DOM:P&SI:4-PLR-114987-99
                                                     Date:
                                                            May 4, 2000


Legend:

Decedent =

Spouse =

Niece =

Trust =

Trustee of Unitrust =

Trustees of Marital Trust =

Charity =

Date 1 =
Date 2 =

State =

Dear              :

      This is in response to your letter dated August 27, 1999, in which you requested rulings
concerning the tax consequences of a proposed reformation to a charitable remainder unitrust.

       On Date 1, Decedent executed Trust. Decedent died on Date 2 and Trust became
irrevocable. Decedent is survived by Spouse. Trust provides for the disposition of property
upon Decedent’s death.

       Paragraph 3.6(a) of Article Three of Trust provides that if spouse survives Decedent,
one-half of the remaining property is to be held as a marital trust for Spouse in accordance with
the provisions of Article Four (“Marital Trust”).

        Paragraph 4.2 of Article Four of Trust provides that all income is to be distributed
currently to Spouse for life at monthly or other convenient intervals, but not less often than
annually.
PLR-114987-99                                 -2-

       Paragraph 4.3 of Article Four of Trust provides that principal is to be distributed as
Trustee deems suitable for care, support, and maintenance of Spouse.

       Paragraph 4.4 of Article Four of Trust provides that upon the death of Spouse all
remaining Trust property is to be administered as a unitrust named for Niece and Charity in
accordance with provisions of Article Five (“Unitrust”).

        Paragraph 5.3 of Article Five of Trust provides that Trustee of Unitrust is to distribute to
Niece for the period of Niece’s life, an amount which is the lesser of 5 percent of the net fair
market value of the trust assets as determined as of the Valuation Date (“Unitrust Amount”) or
the trust income (as defined in § 643(b) of the Code and the Regulations thereunder) for the
taxable year.

         Paragraph 5.5 of Article Five provides that upon Niece’s death, Trustee is to distribute
all of the the remaining income and principal to Charity.

        Paragraph 5.10 of Article Five provides that Trustee of Unitrust is prohibited from
engaging in any act of self-dealing as defined in § 4941(d), from retaining any excess business
holdings as defined in § 4943(c) which would subject Trust to tax under § 4943, from making
any investments which would subject Trust to tax under § 4944, and from making any taxable
expenditures as defined in § 4945(d). Additionally, Trustee is to make distributions at such time
and in such manner as not to subject Trust to tax under § 4942.

        Trustees of Marital Trust propose to reform Unitrust to permit the Unitrust amount to be
paid for an initial period in accordance with § 1.664-3-(a)(1)(i)(b) of the Income Tax
Regulations, and then to be paid as a fixed percentage for the remaining portion of the trust
term in accordance with § 1.664-3-(a)(1)(i)(c).

       The proposed paragraph provides:

       Notwithstanding the foregoing provisions of Article Five, this paragraph 5.14 shall
       supersede paragraphs 5.3 and 5.4 with respect to Unitrust created under 4.4 of this
       agreement.

       (a) Trust Term: The period for payment of the Annual Amount for the trust (“the Trust
       Term”) shall begin on the date of death of [Spouse], and shall end upon the death of the
       Recipient of the trust, [Niece].

       (b) Computation of Annual Amount during First Phase: For each taxable year of the

         trust during the period (“the First Phase”) which begins with the first day of the trust’s
first taxable year and ends on December 31 of the trust’s first taxable year (the last day of the
taxable year of the trust in which the Triggering Event occurs), the Annual Amount shall equal
the lesser of:

               (i) an amount (“Unitrust Amount”) which equals five (5) percent of the net fair
               market of the trust assets as determined on the Valuation Date for that taxable
               year, or
PLR-114987-99                                -3-

               (ii) the trust income for that taxable year as defined in § 643(b) of the Code and
               the Regulations thereunder.

       (c) Triggering Event: The Triggering Event shall be December 31 of the year in which
       [Spouse] dies.

       (d) Computation of Annual Amount during First Phase: For each taxable year of the
       trust during the period (“the Second Phase”) which begins with the first day of the first
       taxable year of the trust after the taxable year of the trust in which the Triggering Event
       occurs and continues for the balance of the Trust Term, the Annual Amount shall be five
       (5) percent of the net fair market value of the trust assets as determined as of the
       Valuation Date for that taxable year.

       (e) Valuation Date: The Valuation Date for a taxable year of a trust shall be the first
       business day of that taxable year. If no Valuation Date occurs in a short taxable year for
       the trust other than the taxable year in which the Trust Term ends, trust assets shall be
       valued, for purposes of computing Unitrust Amount, as of the last day of such short
       taxable year. In the case of the taxable year of the trust in which the Trust Term ends, if
       no Valuation occurs before the day the Trust Term ends, trust assets shall be valued,
       for purposes of computing Unitrust Amount, as of the day the Trust Term ends.

        The terms governing Unitrust became irrevocable on Date 2, however the assets are
presently held in a marital trust which satisfies the requirements for a qualified terminable
interest trust under § 2056(b)(7). Unitrust will not come into existence until the death of the
Spouse. Trustees of Marital Trust filed a petition in State court to reform Unitrust as
provided in proposed paragraph 5.14. The court granted the order conditioned upon the
Internal Revenue Service issuing the following requested rulings:

        1. The proposed reformation will not prevent Unitrust from qualifying as a charitable
remainder unitrust under § 664 when it is created (upon the death of Spouse) or at any point
during its term.

       2. The proposed reformation will not result in an act of self-dealing under § 4941 at the
time the order reforming Article Five is issued, at the time the method for computing Unitrust
amount changes, or at any other time during the term of Unitrust.

        3. The proposed reformation will not cause the present value of the remainder interest
in Unitrust from qualifying for an estate tax charitable deduction under § 2055(a) in Spouse’s
estate.

       Ruling Request 1

        Section 664(d)(2) defines a charitable remainder unitrust as a trust that provides for the
distribution of the unitrust amount, at least annually for life or a term of years, to one or more
persons (at least one of which is not a charitable organization) with an irrevocable remainder
interest to be held for the benefit of, or paid over to, a qualified charitable organization.

       Section 1.664-3(a)(1)(i)(c) provides that the governing instrument may provide that the
PLR-114987-99                                -4-

trust will pay not less often than annually the amount described in § 1.664-3(a)(1)(i)(b) for an
initial period and then pay the amount described in § 1.664-3(a)(1)(i)(a) (calculated using the
same fixed percentage) for the remaining years of the trust.

      Section 1.664-3(a)(1)(i)(f)(1) provides that § 1.664-3(a)(1)(i)(c) applies to charitable
remainder trusts created on or after December 10, 1998.

        Section 1.664-1(a)(4) provides that in order for a trust to be a charitable reminder trust,
it must meet the definition of and function exclusively as a charitable remainder trust from the
creation of the trust. Solely for the purpose of § 664 and the applicable regulations, the trust
will be deemed to be created at the earliest time that neither the grantor nor any other person is
treated as the owner of the entire trust, but in no event prior to the time property is first
transferred to the trust.

        Section 1.664-3(a)(1)(i)(f)(3) of the regulations provides that a charitable remainder
trusts may be reformed to allow for a combination of methods as provided in § 1.664-
3(a)(1)(i)(c) without causing the trust to fail to function exclusively as a charitable remainder
unitrust under § 1.664-1(a)(4), if the trustee begins legal proceedings to reform by June 8, 1999
(extended to June 30, 2000 by Notice 99-31, 1999-23 I.R.B. 6).

       In the present case, property will not be transferred to Unitrust until the death of Spouse.
Trustees of Marital Trust have filed a petition in State court that complies with the special
reformation rules under § 1.664-3(a)(1)(i)(f)(3). Accordingly, we rule that the proposed
reformation of Trust will not prevent Unitrust from qualifying as a charitable remainder unitrust
under § 664(d)(2).

       Ruling Request 2

       Section 4941 imposes an excise tax on each act of self-dealing between a disqualified
person and a private foundation.

        Section 4941(d)(1) defines self-dealing as any direct or indirect – (A) sale or exchange,
or leasing, of property between a private foundation and a disqualified person; (B) lending of
money or other extension of credit between a private foundation and a disqualified person; (C)
furnishing of goods, services, or facilities between a private foundation and a disqualified
person; (D) payment of compensation (or payment or reimbursement of expenses) by a
private foundation to a disqualified person; (E) transfer to, or use by or for the benefit of, a
disqualified person of the income or assets of a private foundation; (F) agreement by a private
foundation to make any payment of money or other property to a government official (as
defined in § 4946(c)), other than certain employment agreements.

       Section 4947(a)(2) generally provides that in the case of a trust which is not exempt
from tax under § 501(a), not all of the unexpired interests of which are devoted to charitable
purposes, and which has amounts in trust for which a charitable deduction was allowed,
§§ 507, 508(e), 4941, 4943, 4944, and 4945 apply as if such trust were a private foundation,
except for amounts in trust for which a charitable deduction was not allowed and which are
segregated from amounts for which a charitable deduction was allowed.

        Section 1.664-3(a)(1)(i)(f)(3) provides that a charitable remainder trust may be reformed
to allow for a combination of methods as provided in § 1.664-3(a)(1)(i)(c) without causing the
PLR-114987-99                                   -5-

trust to fail to function exclusively as a charitable remainder unitrust under § 1.664-1(a)(4) or to
engage in an act of self-dealing under § 4941, if the trustee begins legal proceedings to reform
by June 8, 1999 (extended to June 30, 2000 by Notice 99-31, 1999-23 I.R.B. 6).

        Section 53.4947-1(c)(1)(iii) of the Foundations and Similar Excise Taxes Regulations
provides that a newly created trust shall, for purposes of § 4947(a)(2), be treated as having
amounts in trust for which a deduction was allowed under §§ 170, 545(b)(2), 556(b)(2), 642(c),
2055, 2106(a)(2), or 2522 from the date of its creation, even if a deduction was allowed for such
amounts only at a later date. For purposes of § 53.4947-1(c)(1)(iii), the date of creation of a
charitable remainder trust shall be determined by applying the rules in § 1.664-1(a)(4).

          Section 53.4947-1(c)(6)(iii) provides that a revocable trust that becomes irrevocable upon
the death of the decedent-grantor under the terms of the governing instrument of which the trustee
is required to hold some or all of its net assets in trust after becoming irrevocable for both charitable
and noncharitable beneficiaries is not considered a split-interest trust under § 4947(a)(2) for a
reasonable period of settlement after becoming irrevocable except that § 4941 may apply if the
requirements of § 53.4941(d)-1(b)(3) are not met. After that period, the trust is considered a
split-interest trust under § 4947(a)(2). For such purpose, the term “reasonable period of settlement”
means that period reasonably required (or if shorter, actually required) by the trustee to perform the
ordinary duties of administration necessary for the settlement of the trust. These duties include, for
example, the collection of assets, the payment of debts, taxes, and distributions, and the
determination of rights of the subsequent beneficiaries.

         In the present case, Unitrust will be a split-interest trust as defined in § 4947(a)(2).
When Unitrust becomes a split-interest trust, then § 4941 will fully apply to it as if it were a
private foundation. By the terms of the governing instrument, Unitrust will not receive property
until the death of Spouse. Sections 53.4947-1(c)(1)(iii) and 1.664-1(a)(4) indicate that a
unitrust is not deemed created before property is first transferred to the trust. As the facts do
not indicate any gift of property to the charitable remainder unitrust for which a charitable
deduction was allowed, the trust is not a split-interest trust subject to § 4941 at this time.
Therefore, the proposed reformation cannot be an act of self-dealing. If Unitrust were created
and a split-interest trust subject to § 4941, then Unitrust could still engage in the proposed
reformation so long as it complied with the special reformation rules under § 1.664-
3(a)(1)(i)(f)(3).

        Accordingly, the proposed reformation will not result in an act of self-dealing under
§ 4941either (i) at the time the order reforming Article Five is issued, (ii) at the time the Unitrust
is created (upon the death of the Decedent’s spouse), (iii) at the time the method for computing
the Unitrust amount changes (at the beginning of the calendar immediately following the year in
which the Decedent’s spouse dies) or (iv) at any other time during the term of the Unitrust.

        Ruling Request 3

       Section 2044(a) provides that the gross estate includes property in which the decedent
possesses a qualifying income interest for life, and with respect to which a deduction was
allowed under § 2056(b)(7). Under § 2044(b), property included in the gross estate under
§ 2044 is treated as passing from the decedent for purposes of the estate tax.

        Section 2055(a) provides that the value of the taxable estate at the decedent’s death
shall be determined by deducting from the value of the gross estate the amount of all bequests,
PLR-114987-99                                 -6-

legacies, devises, and transfers to a person or for the use of any corporation organized and
operated exclusively for religious, charitable, scientific, literary, or educational purposes.

       Section 2055(e)(2) provides that, where an interest in property (other than an interest
described in § 170(f)(3)(B)) passes or has passed from the decedent to a person, or for a use,
described in § 2055 (a), and an interest in the same property passes or has passed (for less
than an adequate and full consideration in money or money's worth) from the decedent to a
person, or for a use, not described in subsection (a), no deduction shall be allowed under
§ 2055 for the interest which passed or has passed to the person, or for the use, described in
§ 2055(a) unless, in the case of a remainder interest, such interest is in a trust which is a
charitable remainder annuity trust or a charitable remainder unitrust (described in § 664) or a
pooled income fund (described in § 642(c)(5)).


        Section 20.2055-2(a) of the Estate Tax Regulations provides that if a trust is created or
property is transferred for both a charitable and a private purpose, a deduction may be taken for
the value of the charitable beneficial interest only insofar as that interest is presently
ascertainable, and hence severable from the noncharitable interest.

        Under § 20.2055-2(e)(1)(i), in the case of decedents dying after December 31, 1969,
where an interest in property passes from the decedent for charitable purposes and an interest
in the same property passes from the decedent for private purposes, no deduction is allowed
under § 2055(a) for the value of the interest passing for charitable purposes unless the interest
is a "deductible interest".

        Under § 20.2055-2(e)(2)(vii)(a), the term "deductible interest" also includes a unitrust
interest. The term "unitrust interest" includes a 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 the present case, Trustees of Marital Trust propose to reform Unitrust to permit
Unitrust to use a combination of methods as provided in § 1.664-3(a)(1)(i)(c). Trustees of
Marital Trust have filed a petition in State court that complies with the special reformation rules
under § 1.664-3(a)(1)(i)(f)(3). The proposed reformation of Trust will not prevent Unitrust from
qualifying as a charitable remainder unitrust under § 664(d)(2). Accordingly, we rule that a
federal estate tax charitable deduction will be allowed to Spouse’s estate under § 2055(a).

       The rulings contained in this letter are based upon information and representations
submitted by the taxpayer and accompanied by a penalty of perjury statement executed by an
appropriate party. While this office has not verified any of the material submitted in support of
the request for rulings, it is subject to verification on examination.

      These rulings are expressly contingent on the issuance of a court order authorizing the
proposed reformation.

      We express no opinion on any other provisions of Trust or on the federal tax
consequences of the formation and operation of Unitrust under any other provisions of the
Code. Specifically, no opinion is expressed as to whether Unitrust will qualify as a charitable
remainder trust under § 664.
PLR-114987-99                                 -7-

       The rulings contained in this letter are directed only to the taxpayer(s) requesting it.
Section 6110(k)(3) of the Code provides that it may not be used or cited as precedent.

       Pursuant to a Power of Attorney on file, a copy of this letter is being sent to the
taxpayer.

                                              Sincerely yours,
                                              Robert G. Honigman
                                              Acting Assistant to the Branch Chief
                                              Branch 4
Enclosure
  Copy for section 6110 purposes