Formula term qualified charitable lead annuity interest

Plain-English summary

A revocable trust directed its residue to a charitable lead annuity trust after the deaths of the grantor and spouse, either directly or through a marital trust. The charitable trust would pay a five-percent annuity for a term calculated by formula to produce an estate-tax charitable deduction equal, or as close as possible, to the value transferred. The IRS ruled that the formula produced a determinable specified term and therefore satisfied the guaranteed-annuity requirement of section 2055. It also ruled that the survivor’s estate could deduct the annuity’s present value if the stated charitable, marital-trust, election, and administration conditions were met.

Ruling snapshot

• Question: Can a formula-calculated trust term satisfy the specified-term rule for a charitable lead annuity, and is the annuity interest deductible?
• Outcome: approved, subject to the trust, charitable-recipient, marital-deduction, and administration conditions stated in the ruling
• Key authorities: IRC §§ 2055, 2056, 7520; Treas. Reg. § 20.2055-2

Full text (IRS public release)

Internal Revenue Service                                       Department of the Treasury
                                                               Washington, DC 20224

Number: 201933007                                              Third Party Communication: None
Release Date: 8/16/2019                                        Date of Communication: Not Applicable
Index Number: 2055.12-07, 2055.00-00
                                                               Person To Contact:
------------------------------------------------------------   ----------------------------, ID No. -----
-----------------------                                        Telephone Number:
--------------------------------                               ----------------------
--------------------------------------                         Refer Reply To:
                                                               CC:PSI:B04
                                                               PLR-133541-18
                                                               Date:
                                                               April 22, 2019
         Re: ------------------------


Legend

Grantor                    = ------------------------------------------------
Revocable Trust            = --------------------------------------------
Marital Trust              = ------------------
CLAT                       = --------------------------------------------------------
Date 1                     = -------------------
Date 2                     = ----------------------
Charity                    = ------------------------
x                          = ----

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

This letter responds to your authorized representative’s letter dated October 30, 2018,
requesting rulings under § 2055 of the Internal Revenue Code.

The facts and representations are as follows:

On Date 1, Grantor established Revocable Trust, a revocable trust. Revocable Trust
was amended and restated on Date 2. Grantor is the trustee of Revocable Trust.

Article I, Paragraph D of Revocable Trust sets forth the dispositive provisions applicable
upon Grantor’s death. Specifically, after (i) the payment of debts, taxes, and expenses
pursuant to Paragraph C of Article I; (ii) the distribution of Grantor’s personal property
and the making of specific bequests to certain individuals; and (iii) the distribution of
amounts to establish a generation-skipping tax exempt trust and a trust equal to the
allowable credit under § 2011, the remainder of Revocable Trust will be distributed to
either a marital trust, Marital Trust, to benefit Grantor’s spouse, Spouse, if Spouse
survives Grantor, or to a charitable lead annuity trust (CLAT), if Grantor survives
Spouse.
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Paragraph C(7) of Article I provides that if Grantor survives Spouse, upon the death of
Grantor, any taxes owed shall be charged against, and reduce the amount passing to
the CLAT.

Article II, Paragraph A sets forth the provisions governing Marital Trust. Specifically,
Spouse is entitled to all the income from the trust and the trustee has the discretion to
distribute principal to Spouse as necessary to provide for the health, education,
maintenance, and/or support of Spouse. Marital Trust grants Spouse a testamentary
power of appointment to appoint the assets of Marital Trust to various individuals and
charities. To the extent Spouse fails to exercise this power or is otherwise in default of
such exercise, the assets of Marital Trust will be distributed to the CLAT. If Revocable
Trust is not revoked or amended, Marital Trust, as drafted, is intended to qualify for the
marital deduction under § 2056.

If Spouse does not survive Grantor, upon the death of Grantor, the residue of
Revocable Trust will be distributed to the CLAT. Article II, Paragraph B sets forth the
terms of the CLAT. Specifically, commencing with the date of death of the survivor of
Grantor and Spouse, and in each taxable year of the CLAT prior to the Termination
Date, the trustee shall pay the Annuity Amount to the Annuity Beneficiary.

The Annuity Amount is an amount equal to five percent (5%) of the fair market value of
the initial trust estate (as finally determined for federal estate tax purposes in the estate
of the survivor of the Grantor and Spouse). The Annuity Amount will be prorated, on a
daily basis, by the trustee for (i) a short taxable year, and (ii) the taxable year in which
the Termination Date occurs. The Annuity Amount will be paid annually on the last day
of the taxable year of the CLAT. The first taxable year of the CLAT begins with the date
of the death of the survivor of Grantor and Spouse and ends on the last day of such
calendar year. Thereafter, the CLAT will be on a calendar year.

The Annuity Beneficiary is Charity. However, if the Annuity Beneficiary is not an exempt
organization described in §§ 170(c), 2522(a) or (b), and 2055(a), the Annuity Amount
will be paid to such one or more exempt organizations, as the trustee shall select.

The term of years and Termination Date of the CLAT is established by formula under
Paragraph B(4) of Article II, as follows. Payment of the Annuity Amount terminates at
the end of that number of years, rounded up to the nearest whole year, starting on the
date of death of the survivor of Grantor and Spouse which, taking into account (i) the
lowest federal mid-term rate which may be elected under § 7520; (ii) the frequency of
the payment of the Annuity Amount; (iii) the Annuity Amount; and (iv) such valuation
methods, tables, factors, and applicable rates prescribed by the appropriate provisions
of the Code, results in a charitable deduction for federal estate tax purposes in the
estate of the survivor of Grantor and Spouse equal to (or as close as possible to) one
hundred percent (100%) of the fair market value of the property transferred to the CLAT
PLR-133541-18                                 3


as finally determined for federal estate tax purposes in the estate of the survivor of
Grantor and Spouse. Specifically, the trustee:

       (i)       shall determine or obtain from the personal representative of the estate
                 of the survivor of the Grantor and Spouse, the fair market value (Initial
                 FMV) of the property transferred to the CLAT as finally determined for
                 federal estate tax purposes in the estate of the survivor of the Grantor
                 and Spouse;

       (ii)      shall determine the Annuity Amount by multiplying the Initial FMV of the
                 CLAT by the annual percentage payout rate of five percent (5%);

       (iii)     shall then divide the Initial FMV of the CLAT by the Annuity Amount;

       (iv)      shall determine the two term-of-years annuity factors between which fall
                 the result determined in (iii) above, using the factors based on the
                 applicable Treasury regulations or publications issued by the Internal
                 Revenue Service using the applicable assumed rate of return
                 prescribed by § 7520.

       (v)       The number of whole years for which the CLAT must be in effect in
                 order to produce a charitable deduction in an amount that will be equal
                 to or as close as possible to the fair market value of the property
                 transferred to the CLAT as finally determined for federal estate tax
                 purposes in the estate of the survivor of Grantor and Spouse, will be
                 that number of years which corresponds to the greater of the two
                 annuity factors determined in (iv) above. If the values used by the
                 trustee in determining the Termination Date are incorrectly determined
                 or if the Termination Date as determined is not correctly determined
                 initially, then, within a reasonable time after the correct determination is
                 made, the trustee shall lengthen or shorten the term of the CLAT to the
                 correct duration.

If the trustee does not obtain a favorable private letter ruling from the Service, the term
of years will be x years starting on the date of death of the survivor of Grantor and
Spouse.

Upon the Termination Date, the remaining principal of the CLAT, together with all
accumulated and undistributed income, will be added to other family trusts.

Paragraph B(5) of Article II provides that no additional contributions may be made to the
CLAT after the initial contribution.
PLR-133541-18                                 4


Paragraph B(7) of Article II provides that notwithstanding any other provisions of
Revocable Trust, the CLAT is subject to the following provisions: (i) the trustee shall not
engage in any act of self-dealing as defined in § 4941(d), nor make any taxable
expenditures as defined in § 4945(d); and (ii) except to the extent provided in
§ 4947(b)(3), the trustee shall not retain any excess business holdings (as defined in
§ 4943(c)), which would subject the CLAT to tax under § 4943, nor shall the trustee
acquire any assets which would subject the CLAT to tax under § 4944 or retain any
assets which would, if acquired by the trustee, subject the CLAT to tax under § 4944.

You have requested the following rulings:

       1. The use of the formula set forth in Article II, Paragraph B(4) of Revocable
          Trust satisfies the requirement that a guaranteed annuity must be paid for a
          specified term of years under § 2055(e)(2)(B).

       2. The estate of the survivor of Grantor and Spouse will be entitled to a federal
          estate tax deduction under § 2055(a) for the present value of the annuity
          interest payable to Charity, as determined in accordance with § 20.2055-
          2(f)(2)(iv).

Rulings 1 and 2

Section 2001 imposes a tax on the transfer of the taxable estate of every decedent who
is a citizen or resident of the United States.

Section 2055(a) provides, in part, that for purposes of the federal estate tax, the value of
the taxable estate is determined by deducting from the value of the gross estate the
amount of all bequests, legacies, devises, or transfers to or for the use of certain
charitable organizations.

Section 2055(b) provides that property includible in the decedent’s gross estate under
§ 2041 (relating to powers of appointment) received by a donee described in this
section shall, for purposes of this section, be considered a bequest of such decedent.

Section 2055(c) provides that if the tax imposed by § 2001, or any estate, succession,
legacy, or inheritance taxes, are, either by the terms of the will, by the law of the
jurisdiction under which the estate is administered, or by the law of the jurisdiction
imposing the particular tax, payable in whole or in part out of the bequests, legacies, or
devises otherwise deductible under this section, then the amount deductible under this
section shall be the amount of such bequests, legacies, or devises reduced by the
amount of such taxes.
PLR-133541-18                                 5

Section 2055(d) provides that the amount of the charitable deduction under this section
for any transfer shall not exceed the value of the transferred property required to be
included in the gross estate.

Section 2055(e)(1) provides that no deduction is allowed under § 2055(a) for a transfer
to or for the use of an organization or trust described in § 508(d) or § 4948(c)(4) subject
to the conditions specified in such section.

Section 2055(e)(2)(B) disallows the deduction under § 2055(a) where the lead interest
in property passes to a charitable or other organization described in § 2055(a) and the
remainder interest in the same property passes to a noncharitable beneficiary, unless
the lead interest is in the form of a guaranteed annuity or is a fixed percentage of the
fair market value of all the property (to be determined yearly) and distributed annually.

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.

Section 20.2055-2(e)(1) provides, in part, that in the case of decedents dying after
December 31, 1969, where an interest in property passes or has passed from the
decedent for charitable purposes and an interest (other than an interest which is
extinguished upon the decedent’s death) in the same property passes or has passed
from the decedent for private purposes (for less than an adequate and full consideration
in money or money’s worth) after October 9, 1969, no deduction is allowed under
§ 2055 for the value of the interest which passes or has passed for charitable purposes
unless the interest in property is a deductible interest described in subparagraph (2) of
§ 20.2055-2(e).

Subparagraph (2)(vi) of § 20.2055-2(e) provides, in relevant part, that a “deductible
interest” for purposes of subparagraph (1) includes a charitable interest in property
where the charitable interest is a guaranteed annuity interest, whether or not such
interest is in trust. For this purpose, the term “guaranteed annuity interest” means the
right pursuant to the instrument of transfer to receive a guaranteed annuity. A
guaranteed annuity is an arrangement under which a determinable amount is paid
periodically, but not less often than annually, for a specified term of years or for the life
or lives of certain individuals, each of whom must be living at the date of death of the
decedent and can be ascertained at such date. An interest payable for a specified term
of years can qualify as a guaranteed annuity interest even if the governing instrument
contains a savings clause intended to ensure compliance with a rule against
perpetuities. The savings clause must utilize a period for vesting of 21 years after the
deaths of the measuring lives who are selected to maximize, rather than limit, the term
of the trust. An amount is determinable if the exact amount which must be paid under
the conditions specified in the instrument of transfer can be ascertained as of the
PLR-133541-18                                6

appropriate valuation date. For example, the amount to be paid may be a stated sum
for a term of years.

Section 20.2055-2(e)(2)(vi)(e) provides that where a charitable interest in the form of a
guaranteed annuity interest is in trust and the present value, on the appropriate
valuation date, of all the income interests for a charitable purpose exceeds 60 percent
of the aggregate fair market value of all amounts in such trust (after the payment of
estate taxes and all other liabilities), the charitable interest will not be considered a
guaranteed annuity interest unless the governing instrument of the trust prohibits both
the acquisition and the retention of assets which would give rise to a tax under § 4944 if
the trustee had acquired such assets.

Section 2056(a) provides that the value of the taxable estate will, except as limited by
§ 2056(b), be determined by deducting from the value of the gross estate an amount
equal to the value of any interest in property which passes or has passed from the
decedent to his surviving spouse, but only to the extent that such interest is included in
determining the value of the gross estate.

Section 2056(b)(1) provides that where, on the lapse of time, on the occurrence of an
event or contingency, or on the failure of an event or contingency to occur, an interest
passing to the surviving spouse will terminate or fail, no deduction will be allowed with
respect to the interest if the decedent transfers to any person other than the surviving
spouse an interest in the property, and if by reason of the transfer the other person may
possess or enjoy any part of the property after the termination or failure of the interest
transferred to the surviving spouse.

Section 2056(b)(7)(A) provides that, in the case of qualified terminable interest property,
for purposes of § 2056(b)(1), no part of the property will be considered as transferred to
any person other than the surviving spouse.

Section 2056(b)(7)(B) provides that the term “qualified terminable interest property”
(QTIP) means property that passes from the decedent, in which the surviving spouse
has a qualifying income interest for life, and to which an election under § 2056(b)(7)
applies. The surviving spouse has a qualifying income interest for life if: (i) the
surviving spouse is entitled to all the income from the property, payable annually or at
more frequent intervals, or has a usufruct interest for life in the property, and (ii) no
person has a power to appoint any part of the property to any person other than the
surviving spouse. A specific portion of property will be treated as separate property. An
election under paragraph (b)(7) with respect to any property will be made by the
executor on the return of tax imposed by § 2001. The election, once made, is
irrevocable.

Section 2044(a) and (b) provide that, for purposes of the federal estate tax, the gross
estate of a decedent will include the value of property with respect to which a deduction
PLR-133541-18                                7

was allowed for the transfer of the property to the decedent under § 2056(b)(7). Section
2044(c) treats this property as passing from the decedent.

Analysis

In this case, the Annuity Amount is an amount equal to five percent (5%) of the fair
market value of the initial trust estate (as finally determined for federal estate tax
purposes in the estate of the survivor of the Grantor and Spouse). Accordingly, the
amount of the annual annuity payment will be a determinable amount, ascertainable as
of the date of death of the survivor of Grantor and Spouse. However, a formula set forth
in Article II, Paragraph B(4) of the CLAT is used to determine the specific term of years
for which the annuity payments will be made. The computation of the term is based in
part on the initial net fair market value of assets passing to the CLAT as finally
determined for federal estate tax purposes. Thus, the provision for determining the term
of years of the CLAT is permissible because the term, although not expressly stated in
the instrument, is determinable as of the date of death of the survivor of Grantor and
Spouse, based on the formula in the instrument. Because the term of the CLAT is
ascertainable as of the date of death of the survivor of Grantor and Spouse, under the
terms of the instrument, we conclude that the CLAT satisfies the “specified term”
requirement of § 20.2055-2(e)(2)(vi). Based upon the facts submitted and the
representations made, we conclude that the use of the formula set forth in Article II,
Paragraph B(4) of Revocable Trust satisfies the requirement that a guaranteed annuity
must be paid for a specified term of years under § 2055(e)(2)(B).

In addition, based upon the facts submitted and the representations made and provided
that the CLAT is established and administered under the provisions of Article II of
Revocable Trust, as submitted, and further provided that the CLAT is a valid trust under
state law, we conclude that if Grantor survives Spouse, and dies without modifying or
revoking Revocable Trust, Grantor’s estate will be entitled to a deduction under
§ 2055(a) for the present value of the annuity from the CLAT provided the recipient of
the annuity from the CLAT is a charitable organization described in §§ 170(c), 2055(a),
and 501(c)(3). Further, we conclude that if Spouse survives Grantor, and Grantor dies
without modifying or revoking Revocable Trust, Spouse’s estate will be entitled to a
deduction under § 2055(a) for the present value of the annuity from the CLAT provided:
(i) the recipient of the annuity from the CLAT is a charitable organization described in
§§ 170(c), 2055(a), and 501(c)(3); (ii) the terms of Marital Trust satisfy the requirements
of § 2056(b)(7); (iii) the election under § 2056(b)(7) is properly made for the assets of
Marital Trust; and (iv) Spouse does not exercise her testamentary power of appointment
such that the assets of Marital Trust actually pass to the CLAT.

To the extent any estate, succession, legacy, or inheritance taxes are paid from the
residue prior to funding the CLAT pursuant to the terms of Revocable Trust or by the
law of the jurisdiction under which the estate is administered, the amount of the
PLR-133541-18                                  8

charitable deduction in either estate is determined using the actual amount passing to
the CLAT after payment of such taxes. Section 2055(c).

This ruling is based on the facts and 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 the ruling take effect, the ruling will have no force or effect.

Except as specifically ruled herein, we express no opinion on the federal tax
consequences of the transaction under the cited provisions or under any other
provisions of the Code. In particular, we express no opinion as to whether or not the
charitable beneficiary designated in Revocable Trust is described in §§ 170(b)(1)(A),
2055(a), and 2522(a).

This ruling is directed only to the taxpayer requesting it. Section 6110(k)(3) of the Code
provides that it may not be used or cited as precedent.

In accordance with the Power of Attorney on file with this office, a copy of this letter is
being sent to your authorized representative.

                                       Sincerely,


                                       Leslie H. Finlow
                                       Leslie H. Finlow
                                       Senior Technician Reviewer, Branch 4
                                       Office of Associate Chief Counsel
                                       (Passthroughs & Special Industries)




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