PLR 1030015: Judicial reformation of CRUT approved without self-dealing consequence

Plain-English summary

The IRS approved the judicial reformation of an irrevocable trust that was intended to be a charitable remainder unitrust but mistakenly included provisions for a net-income charitable remainder unitrust. The court's reformation was effective from the trust's creation date, and the IRS concluded that it did not violate section 664 or prevent the trust from qualifying as a CRUT under section 664(d)(2), assuming the reformed terms were otherwise valid. The IRS also concluded that the reformation would not be an act of self-dealing under section 4941. The conclusion relied on the drafting attorney's affidavit, the trust's administration as a CRUT, and the representation that the income beneficiary had not claimed a deduction for the income interest. The ruling did not express an opinion on whether the trust was or had been a charitable remainder trust under section 664 apart from the specific conclusions stated.

Ruling snapshot

• Question: Could an irrevocable trust be judicially reformed as a CRUT without violating section 664 or creating self-dealing?
• Outcome: Approved
• Key authorities: IRC §§ 664, 4941, 4946, 4947, 170, 2055, 2522, and 6110

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201030015 Third Party Communication: None
Release Date: 7/30/2010 Date of Communication: Not Applicable
Person To Contact:
Index Number: 664.03-02, 664.03-00, -------------------- - ID No. -------------
Telephone Number:
4941.00-00
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Refer Reply To:
------------------------------------ CC:PSI:B2
----------------------------------------------------------- PLR-130339-08
----------------- Date:
-------------------------- February 02, 2010

Legend
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PLR-130339-08 2

Dear ----------------:

This letter responds to your letter dated June 18, 2008, and subsequent
correspondence, submitted on behalf of Trust by Trust's authorized representative,
requesting rulings under §§ 664 and 4941 of the Internal Revenue Code regarding the
proposed reformation of Trust as a charitable remainder unitrust (CRUT).

The information submitted states that on D1, A and B created Trust with the intention
that Trust qualify as a CRUT with a fixed percentage unitrust amount described under
§ 664(d)(2). A is the trustee of Trust. C, the child of A and B, is the Trust income
beneficiary. A and B established Trust with the assistance of an attorney. However, due
to a drafting error, the attorney failed in Trust executed to omit certain net income
charitable remainder trust (NICRUT) provisions from an earlier draft of Trust.
Consequently, Trust inadvertently contained certain NICRUT provisions.

The introductory paragraph of Trust describes a CRUT. However, Trust provides that
the unitrust amount payable to C is the lesser of (1) Trust income during the taxable
year, as defined in § 643(b), and, (2) x% of the net fair market value of the assets of
Trust valued as of the first day of each taxable year of Trust. Since the inception of
Trust, the trustee of Trust has administered Trust as a CRUT.

On D2, in order to correct the scrivener's error and because Trust is irrevocable, A
sought an order from Court authorizing an amendment ab initio of Trust. No parties
objected to the proposed reformation. On D3, Court issued an order reforming Trust to a
CRUT, ab initio, subject to the Internal Revenue Service issuing a private letter ruling
that the reformation of Trust will not disqualify Trust as a charitable remainder trust.

The drafting attorney has submitted an affidavit stating that he failed to omit certain
NICRUT provisions from an earlier draft of Trust after A and B decided to create a
CRUT. C has submitted an affidavit stating that she has not taken, and will not take, a
deduction for any amounts payable to her under the terms of the original or reformed
Trust.

You now request the following rulings:

Ruling 1: The judicial reformation of Trust does not violate § 664, and Trust qualifies as
a charitable remainder trust under § 664(d)(2) as of D1.

Ruling 2: The judicial reformation of Trust will not constitute an act of self dealing within
the meaning of § 4941.

Ruling 1

Section 664(d)(2) provides that for purposes of § 664, a charitable remainder unitrust is
PLR-130339-08 3

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 section 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 of or lives of such individual or individuals, (B) from
which no amount other than the payments described in § 664(d)(2)(A) and other than
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) following the
termination of the payments described in § 664(d)(2)(A), the remainder interest in the
trust 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, and (D) with respect to each contribution of
property to the trust, the value (determined under section 7520) of such remainder
interest in such property 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 664(d)(3) provides that notwithstanding the provisions of § 664(d)(2)(A) and (B),
the trust instrument may provide that the trustee shall pay the income beneficiary for
any year -- (A) the amount of the trust income, if such amount is less than the amount
required to be distributed under § 664(d)(2)(A), and (B) any amount of the trust income
which is in excess of the amount required to be distributed under § 664(d)(2)(A), to the
extent that the aggregate of the amounts paid in prior years was less than the
aggregate of such required amounts.

Section 1.664-3(a)(4) of the Income Tax Regulations provides that the trust may not be
subject to a power to invade, alter, amend, or revoke for the beneficial use of a person
other than an organization described in § 170(c).

Based solely on the information submitted and representations made, we conclude that
the judicial reformation of Trust, as of D1, does not violate § 664. Furthermore,
assuming that the terms of the reformed Trust are otherwise valid under § 664, the
reformed Trust will be treated as a valid CRUT under § 664(d)(2), as of D1.

Ruling 2

Section 4941(a)(1) imposes an excise tax on disqualified persons for each act of self-
dealing between a disqualified person, as defined in § 4946, and a private foundation.

Section 4941(d)(1)(E) defines self-dealing as including any direct or indirect transfer to,
or use by or for the benefit of, a disqualified person of the income or assets of a private
foundation.

Section 4946(a)(1) provides that the term “disqualified person” with respect to a private
foundation includes a person who is a substantial contributor to the foundation
PLR-130339-08 4

(including the creator of a trust), a family member of a substantial contributor (including
children), and a foundation manager (including a trustee).

Section 4947(a)(2) provides, in pertinent part, 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, § 4941 and other provisions apply as if such trust were a private
foundation.

Section 4947(a)(2)(A) provides, in pertinent part, that the provisions of § 4947(a)(2) do
not apply with respect to the amounts payable under the terms of such split-interest
trust to its income beneficiaries.

Sections 53.4947-1(c)(2) and 53.4947-1(c)(2)(ii), Example (1), of the regulations
indicate, in pertinent part, that the payments of income under the term of the trust by a
charitable remainder unitrust to its individual income beneficiaries do not result in any
tax on self-dealing under § 4941.

As a charitable remainder unitrust under as of § 664(d)(2), Trust is a split-interest trust
described in § 4947(a)(2). By being described in § 4947(a)(2), Trust is subject to the
provisions of § 4941 and certain other provisions, as if it were a private foundation. A
private foundation is subject to § 4941, which imposes an excise tax on acts of self-
dealing. A and B, settlors, are disqualified persons with respect to Trust because they
are substantial contributors to Trust. C, the income beneficiary, is a disqualified person
because she is the daughter of A and B. Therefore, because the proposed judicial
reformation of Trust based on a drafting error may have the effect of increasing the
annual amount payable to C, any such increase could be considered to be a transfer to,
or use by, or for the benefit of, a disqualified person of income or assets of a private
foundation and may be considered to be an act of self-dealing under § 4941.

However, under § 4947(a)(2), the self-dealing rules of § 4941 do not apply to any
amounts payable under the terms of a split-interest trust to income beneficiaries as long
as no deduction was allowed for such income interest under §§ 170(f)(2)(B),
2055(e)(2)(B), or 2522(e)(2)(B) with respect to the income interest of any such
beneficiary. C represents that no deduction, under the above Code sections, was taken
by C with respect to any amounts of income payable to her by Trust. As a result, the
self-dealing rules of § 4941 do not apply to C as an income beneficiary.

Regarding whether A and B as substantial contributors are subject to the self-dealing
rules of § 4941, the circumstances presented above indicate that there is no act of self-
dealing, since we are satisfied that the signatory parties to Trust never intended to
create a NICRUT. Certain facts are indicative of this intent such as the fact that the
drafting attorney submitted an affidavit indicating that Trust was supposed to be a
CRUT instead of a NICRUT as well as Trust stating that the signatory parties, A and B,
PLR-130339-08 5

indicated that this was a drafting error and that they never intended to create a NICRUT.
Trust also represented that Trust was administered as a CRUT in accordance with its
understanding of A and B’s intent.

The proposed judicial reformation of Trust will not be an act of self-dealing under
§ 4941.

Except as specifically set forth above, no opinion is expressed as to the federal tax
consequences of the above described facts under any other provision of the Code.
Specifically, no opinion is expressed concerning whether Trust is or was a charitable
remainder trust within the meaning of § 664.

This ruling is directed only to the taxpayer who requested 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 with this office, a copy of this letter is being sent
to Trust's authorized representative.

                                    Sincerely,



                                    Bradford R. Poston
                                    Senior Counsel, Branch 2
                                    Office of the Associate Chief Counsel
                                    (Passthroughs & Special Industries)

Enclosures: 2
Copy of this letter
Copy for § 6110 purposes