Trust reformation preserves charitable estate tax deductions

Plain-English summary

A decedent's trust paid a unitrust amount to children and descendants, with portions shifting to a foundation as beneficiaries died and the remainder ultimately passing to charity. The trust initially failed to qualify as a charitable remainder unitrust, and a first court reformation still left defects because one descendant's payments could exceed 20 years and a special needs trust did not have the required life term or estate remainder. A second court order limited the descendant's share to the earlier of death or 20 years and named the disabled child's estate as remainder beneficiary of the special needs trust. The IRS found the original charitable interests reformable and the second change a qualified reformation effective at death. It allowed estate tax deductions for the present value of both the charitable remainder and the foundation's unitrust interest, subject to corrected actuarial values.

Ruling snapshot

• Question: Did the court-ordered changes create a qualified reformation that preserved deductions for the trust's charitable interests?
• Outcome: Approved.
• Key authorities: IRC §§ 664(d)(2) and 2055(e)(3); Rev. Rul. 2002-20.

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201947007 Third Party Communication: None
Release Date: 11/22/2019 Date of Communication: Not Applicable
Index Number: 2055.07-00
Person To Contact:
-------------------------------------- ----------------------------, ID No. --------------
-------------------------- -----------------
---------------------------------- Telephone Number:
----------------------
Refer Reply To:
CC:PSI:B04
Re: ------------------------------------------------------- PLR-102027-19
Date:
August 12, 2019

Legend

Decedent = ------------------------------------------------
Trust = ------------------------------------------------------------------------------------------

Date 1 = ---------------------------
Date 2 = -----------------------
Date 3 = ------------------------
Date 4 = --------------------------
Date 5 = ---------------------------
Date 6 = ------------------
Date 7 = ------------------------
Date 8 = ----------------------
Foundation = ----------------------------------------
Child 1 = ------------------------------
Child 2 = -------------------------
Child 3 = -----------------------------------
Child 4 = -----------------------------------------------
Child 5 = ----------------
Child 6 = -----------------------------------------
Child 7 = ----------------------------
Court = ------------------------------------------------------------------------------------------

State = -----------
Trustees = ---------------------------------------------

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

This letter responds to your letter dated December 11, 2018, requesting rulings with
respect to the reformation of a trust under § 2055(e)(3) of the Internal Revenue Code.
PLR-102027-19 2

On Date 1, Decedent created a revocable trust, Trust. The last amendment made to
Trust was Date 2. Under § 6.4, as amended, Trust provides that, upon the death of
Decedent, the residue of the estate is to be administered as a unitrust for the benefit of
Decedent’s six living children, Child 1 through Child 6, and the issue of his predeceased
child, Child 7 (Child 7’s Share). Under § 6.4.1, during the beneficiaries’ lives, the
trustee is to pay or apply for the benefit of the Decedent’s children, Child 1 through
Child 6, and the issue of Child 7 or the survivor of them, three and five-tenths percent of
the aggregate net fair market value of the trust. Further, upon the death of a
beneficiary, the portion of the unitrust amount to which the deceased beneficiary would
have been entitled is to be paid to Foundation. In no event shall the portion of the
unitrust amount to which Child 7’s children, or the survivor of them, are entitled continue
beyond the unitrust payment to be made on Date 8, after which time such payments
shall instead be paid to Foundation. Upon the death of the last surviving beneficiary,
the trustee shall distribute the entire balance of the trust estate along with the income
outright to Foundation. However, if Foundation is not an organization described in
§§ 170(c), 2055(a), and 2522(a) or is no longer in existence at such time, the entire
remaining balance is to be distributed to one or more organizations described in
§§ 170(c), 2055(a), and 2522(a) which are operated for purposes similar to the
charitable purposes of Foundation.

Under § 6.4.3, notwithstanding the provision of § 6.4, any distributions to be made to or
for the benefit of Child 1, are subject to the provision of § 6.4.3. Under that section, a
special needs trust, Trust 1, was established to benefit Child 1 and the unitrust payment
would be paid to Trust 1 to benefit Child 1. Specifically, during Child 1’s lifetime, the
trustee of Trust 1 is authorized to accumulate and hold in a separate account for
Child 1’s benefit all of the distributions to which Child is entitled pursuant to § 6.4. Upon
Child 1’s death or earlier termination, the trustee shall distribute the entire remaining
balance of Trust 1, as provided in § 6.4.1.

Decedent died on Date 3. At Decedent’s death, Trust did not qualify for the estate tax
charitable deduction under § 2055(a) because Trust was not a charitable remainder
unitrust (CRUT) within the meaning of § 664(d)(2). On Date 4, Trustees of Trust filed a
petition with State Court to reform Trust to change the unitrust amount from three and
five-tenths percent to five percent in order to qualify Trust as a CRUT described in
§ 664(d)(2). Date 4 was within 90 days after the last date (including extension) for filing
Decedent's estate tax return. State Court granted the petition and an order was filed on
Date 5 (Date 5 Reformation).

On Date 6, Trustees reviewed Trust, as reformed, and determined that Trust may not
qualify as a CRUT because the payments, even though stated in a fixed percentage, as
required under § 644(d)(2), were not limited to a term of 20 years for Child 7’s Share,
and payments to Trust 1 were not limited to a term or life expectancy.
PLR-102027-19 3

Trustees petitioned State Court to reform Trust:

(i) to provide for the unitrust payout of five percent to be divided among Child 1 through
Child 6, Child 7’s issue, and Foundation;

(ii) to provide that the unitrust payments to Child 7’s Share will cease upon the earlier to
occur of Child 7’s issue death or twenty (20) years from the commencement of the
unitrust payments;

(iii) to name Child 1’s estate as the remainder beneficiary of Trust 1, the special needs
trust.

On Date 7, State Court issued an order approving the reformation of Trust, effective as
of the date of Decedent’s death (Date 7 Reformation). As part of the submission for
this private letter ruling, Trustees of Trust submitted computations that calculate the
value of the charitable interest in Trust for review by the Internal Revenue Service (IRS).
Upon completion of such review, Trustees adjusted the calculations to reflect the correct
values. It is represented that Trustees will petition State Court to amend the court order
to reflect the corrected values, as adjusted by the IRS.

Your authorized representative has requested the following rulings:

1. The charitable interests are “reformable interests” within the meaning of
   § 2055(e)(3)(C).

2. The Date 8 Reformation is a qualified reformation of Trust, within the meaning of
   § 2055(e)(3)(B).

3. A deduction under § 2055(a) will be allowable for the present value of the remainder
   interest in Trust.

4. A deduction under § 2055(a) will be allowable for the present value of Foundation’s
   portion of the unitrust interest.

LAW AND ANALYSIS

Section 664(d)(2) provides, in relevant part, that a CRUT is 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 § 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 or lives of such individual or individuals, (B) from which no amount other than the
PLR-102027-19 4

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 § 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 (by reason of § 664(d)(3)(A)) the aggregate of the amounts paid in prior
years was less than the aggregate of such required amounts.

Section 1.664-1(a)(4) of the Income Tax Regulations provides that, in part, in order for a
trust to be a charitable remainder trust, it must meet the definition of and function
exclusively as a charitable remainder trust from the creation of the trust.

In Rev. Rul. 2002-20, the Service ruled that, a trust may qualify as a charitable
remainder unitrust under § 664 if the unitrust amounts will be paid for the life of a
financially disabled individual to a separate trust that will administer these payments on
behalf of that individual and, upon the individual’s death, will distribute the remaining
assets either to the individual’s estate or, after reimbursing the state for any Medicaid
benefits provided to the individual, subject to the individual’s general power of
appointment.

Section 2001(a) 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 that, in part, for purposes of the tax imposed by § 2001, 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, and transfers to 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 (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 and full consideration in money or money’s worth) from the
PLR-102027-19 5

decedent to a person, or for a use, not described in § 2055(a), no deduction shall be
allowed under § 2055 for the interest that passes or has passed to the person, or for a
use, described in § 2055(a), unless -- (A) 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)), or (B) in the case of any other interest other than a remainder interest,
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 yearly).

Section 2055(e)(3)(A) provides that a deduction shall be allowed under § 2055(a) in
respect of any qualified reformation.

Section 2055(e)(3)(B) defines the term “qualified reformation” to mean a change of a
governing instrument by reformation, amendment, construction, or otherwise that
changes a reformable interest into a qualified interest, but only if -- (i) any difference
between (I) the actuarial value (determined as of the date of the decedent’s death) of
the qualified interest, and (II) the actuarial value (as so determined) of the reformable
interest does not exceed 5 percent of the actuarial value (as so determined) of the
reformable interest, (ii) in the case of (I) a charitable remainder interest, the
nonremainder interest (before and after the qualified reformation) terminated at the
same time, or (II) any other interest, the reformable interest and the qualified interest
are for the same period, and (iii) the change is effective as of the date of the decedent’s
death.

Under § 2055(e)(3)(B), a nonremainder interest (before reformation) for a term of years
in excess of 20 years shall be treated as satisfying § 2055(e)(3)(B)(ii)(I) if such interest
(after reformation) is for a term of 20 years.

Section 2055(e)(3)(C)(i) defines the term “reformable interest” to mean any interest for
which a deduction would be allowable under § 2055(a) at the time of the decedent’s
death but for § 2055(e)(2).

Section 2055(e)(3)(C)(ii) provides that the term “reformable interest” does not include
any interest unless, before the remainder vests in possession, all payments to persons
other than an organization described in § 2055(a) are expressed either in specified
dollar amounts or a fixed percentage of the fair market value of the property. For
purposes of determining whether all such payments are expressed as a fixed
percentage of the fair market value of the property, § 664(d)(3) shall be taken into
account.

Section 2055(e)(3)(C)(iii) provides, in part, that § 2055(e)(3)(C)(ii) does not apply to any
interest if not later than 90 days after the last date (including extensions) for filing an
estate tax return, if an estate tax return is required to be filed, a judicial proceeding is
commenced to change the interest into a qualified interest.
PLR-102027-19 6

Section 2055(e)(3)(D) defines the term “qualified interest” to mean an interest for which
a deduction is allowable under § 2055(a).

In this case, the requirements under § 664(d)(2)(B) and (C) are satisfied under the
original terms of Trust. The requirement under § 664(d)(2)(D), that the value
(determined under § 7520) of the remainder interest is at least 10 percent of the initial
net fair market of all property placed in Trust, was satisfied when Trust was established.
Some of the requirements under § 664(d)(2)(A) were not satisfied after the Date 5
Reformation. Trust was not a qualified interest because the payments were not limited
to a term of 20 years for Child 7’s Share, as required by § 664(d)(2)(A), and Trust 1
failed to satisfy § 664(d)(2)(A) or fall within any of the situations in Rev. Rul. 2002-20
because Trust did not provide for payments to Trust 1 for the life of Child 1, or name
Child 1’s estate as the remainder beneficiary.

However, Trust is a reformable interest under § 2055(e)(3)(C)(i) because a deduction
would have been allowable for the remainder interest but for the requirements of
§ 2055(e)(2). In addition, the noncharitable payments were expressed as a fixed
percentage of the net fair market value of the property, as required by
§ 2055(e)(3)(C)(ii). Therefore, we conclude that Trust meets the requirements of
§ 2055(e)(3)(C)(ii) to have a reformable interest.

We conclude that the Date 7 Reformation is a qualified reformation within the meaning
of § 2055(e)(3)(B). The difference between the actuarial value of the qualified interest
and the actuarial value of the reformable interest does not exceed 5 percent of the
actuarial value of the reformable interest, as required under § 2055(e)(3)(B)(i). This
determination was made upon review of the computations submitted by Trustees and
adjusted by the IRS to reflect the correct value of the charitable interests in Trust.
Further, as required under § 2055(e)(3)(B)(ii)(I), the nonremainder interest (before and
after the qualified reformation) terminates at the same time. In addition, State Court
issued an order approving the reformation of Trust and, pursuant to the order, the
Date 7 reformation is effective as of the date of Decedent’s death, as required under
§ 2055(e)(3)(B)(iii).

Under § 2055(e)(3)(E), the deduction allowed in respect of a qualified reformation may
not exceed the deduction which would have been allowable for the reformable interest
but for § 2055(e)(2).

Accordingly, based on the information submitted and representations made and, we rule
that: (1) the charitable interests passing to Foundation under the terms of Trust, prior to
the qualified reformation, are “reformable interests” as described in § 2055(e)(3)(C), (2)
the Date 7 Reformation will result in a “qualified reformation” of Trust as described in
§ 2055(e)(3)(B), and (3) the present value of the remainder interest in Trust and the
PLR-102027-19 7

present value of Foundation’s portion of the unitrust interest, as reformed on Date 7, will
be interests that qualify for a deduction under § 2055(a).

Except as specifically set forth above, no opinion is expressed concerning the federal
tax consequences of the facts described above under any other provision of the Code.

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.

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.

                                       Sincerely,



                                       Lorraine E. Gardner
                                       Lorraine E. Gardner
                                       Senior Counsel, Branch 4
                                       Office of the Associate Chief Counsel
                                       (Passthroughs & Special Industries)

Enclosures (2)
Copy of this letter
Copy for § 6110 purposes

cc: