[Federal Register Volume 63, Number 237 (Thursday, December 10, 1998)]
[Rules and Regulations]
[Pages 68188-68194]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 98-32559]
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DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Parts 1, 25, and 602
[TD 8791]
RIN 1545-AU25
Guidance Regarding Charitable Remainder Trusts and Special
Valuation Rules for Transfers of Interests in Trusts
AGENCY: Internal Revenue Service (IRS), Treasury.
ACTION: Final regulations.
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SUMMARY: This document contains final regulations relating to
charitable remainder trusts and to special valuation rules for
transfers of interests in trusts. The final regulations provide
additional guidance regarding charitable remainder trusts. The final
regulations affect charitable remainder trusts and their beneficiaries.
DATES: Effective date: These regulations are effective December 10,
1998.
Applicability dates: For dates of applicability of these
regulations, see the explanations under SUPPLEMENTARY INFORMATION.
FOR FURTHER INFORMATION CONTACT: Mary Beth Collins or Jeff Erickson,
(202) 622-3080 (not a toll-free number).
SUPPLEMENTARY INFORMATION:
[[Page 68189]]
Paperwork Reduction Act
The collection of information contained in these final regulations
has been reviewed and approved by the Office of Management and Budget
in accordance with the Paperwork Reduction Act (44 U.S.C. 3507) under
control number 1545-1536. Responses to this collection of information
are required to allow taxpayers alternative means of valuing a
charitable remainder trust's unmarketable assets.
An agency may not conduct or sponsor, and a person is not required
to respond to, a collection of information unless the collection of
information displays a valid control number.
The estimated annual burden per respondent varies from .25 to .75
hours, depending on individual circumstances, with an estimated average
of .5 hours.
Comments concerning the accuracy of this burden estimate and
suggestions for reducing this burden should be sent to the Internal
Revenue Service, Attn: IRS Reports Clearance Officer, OP:FS:FP,
Washington, DC 20224, and to the Office of Management and Budget, Attn:
Desk Officer for the Department of the Treasury, Office of Information
and Regulatory Affairs, Washington, DC 20503.
Books or records relating to this collection of information must be
retained as long as their contents may become material in the
administration of any internal revenue law. Generally, tax returns and
tax return information are confidential, as required by 26 U.S.C. 6103.
Background
On April 18, 1997, the IRS published in the Federal Register (62 FR
19072) a notice of proposed rulemaking (REG-209823-96) regarding
sections 664 and 2702. Comments responding to the proposed regulations
were received, and a public hearing was held on November 18, 1997.
After considering the comments received and the statements made at the
public hearing, the proposed regulations are adopted as revised by this
Treasury decision.
Explanation of Provisions
This document amends 26 CFR parts 1 and 25 to provide additional
rules under sections 664 and 2702. Section 664 contains the rules for
charitable remainder trusts (CRTs). In general, a CRT provides for a
specified periodic distribution to one or more beneficiaries (at least
one of whom is a noncharitable beneficiary) for life or for a term of
years with an irrevocable remainder interest held for the benefit of
charity.
There are two types of CRTs: a charitable remainder annuity trust
(CRAT) and a charitable remainder unitrust (CRUT). A CRAT pays a sum
certain at least annually to the beneficiaries (the annuity amount). A
CRUT pays a unitrust amount at least annually to the beneficiaries.
Generally, the unitrust amount is a fixed percentage of the net fair
market value of the CRUT's assets valued annually (fixed percentage
CRUT). The unitrust amount can instead be calculated under one of two
income exception methods (income exception CRUT). Under the first
method, the unitrust amount is the lesser of the fixed percentage
amount or the trust's annual net income (net income method). Under the
second method, the unitrust amount is determined under the net income
method plus any amount of income that exceeds the current year's fixed
percentage amount to make up for any shortfall in payments from prior
years when the trust income was less than the fixed percentage amount
(NIMCRUT method). The shortfall in payments from prior years is
commonly referred to as the ``make-up amount.''
The revisions to the proposed regulations are discussed below.
I. Flip Unitrusts
A. Triggering Events
The proposed regulations provide specific rules for when a trust
may convert from one of the income exception methods of computing the
unitrust amount to the fixed percentage method (flip unitrust). The
proposed rule was designed for taxpayers who ultimately wanted the
unitrust amount to be computed on the fixed percentage method but
funded the trust with unmarketable assets that generate little annual
income. A number of commentators agreed with the policy underlying the
proposed rule. Some commentators requested that we permit flip
unitrusts for all income exception CRUTs regardless of the
marketability of the trust assets. Other commentators suggested that
the final regulations clarify whether the proposed rule was a safe
harbor or the exclusive circumstance for which a flip unitrust would be
permitted.
In response, the final regulations expand the availability of the
flip unitrust to certain other situations that the IRS and Treasury
believe are consistent with the legislative history indicating that a
trustee should not have discretion to change the method used to
calculate the unitrust amount. H.R. Conf. Rep. No. 782, 91st Cong., 1st
Sess. 296 (1969), 1969-3 C.B. 644, 655.
The final regulations allow the governing instrument of a CRUT to
provide that the CRUT will convert once from one of the income
exception methods to the fixed percentage method for calculating the
unitrust amount if the date or event triggering the conversion is
outside the control of the trustees or any other persons. The final
regulations include examples of permissible and impermissible
triggering events. For example, permissible triggering events with
respect to any individual include marriage, divorce, death, or birth of
a child. Also, the sale of an unmarketable asset such as real estate is
a permissible triggering event. Examples of impermissible triggering
events include the sale of marketable assets and a request from the
unitrust recipient or the unitrust recipient's financial advisor that
the trust convert to the fixed percentage method.
The final regulations also provide that the conversion to the fixed
percentage method occurs at the beginning of the taxable year that
immediately follows the taxable year in which the triggering date or
event occurs. Any make-up amount described in section 664(d)(3)(B) is
forfeited when the trust converts to the fixed percentage method.
The proposed regulations define unmarketable assets as assets other
than cash, cash equivalents, or marketable securities (within the
meaning of section 731(c)). Commentators asked for clarification of the
term unmarketable assets and recommended changing the scope of this
class of assets. In response, the final regulations define unmarketable
assets as assets other than cash, cash equivalents, or assets that can
be readily sold or exchanged for cash or cash equivalents. For example,
unmarketable assets include real property, closely-held stock, and
unregistered securities for which there is no available exemption
permitting public sale.
Commentators requested that the final regulations permit
conversions from the fixed percentage method to one of the income
exception methods and conversions from a CRAT to a CRUT. The flip
unitrust allowed in the final regulations is the only type of
permissible conversion. Thus, a CRAT cannot convert to a CRUT without
losing its status as a CRT. Similarly, a CRUT using the fixed
percentage method cannot convert to an income exception method without
losing its status as a CRT.
B. Effective Date and Transitional Rules
The rules for flip unitrusts are effective for CRUTs created on or
after December 10, 1998. The proposed regulations allowed reformations
in
[[Page 68190]]
limited circumstances. In response to comments, the final regulations
expand the circumstances in which reformation is available. The final
regulations allow income exception CRUTs to be reformed to add
provisions allowing a conversion to the fixed percentage method
provided the triggering event does not occur in a year prior to the
year in which the court issues the order reforming the trust. Adding
the conversion provisions will not cause the CRUT to fail to function
exclusively as a CRT and will not be an act of self-dealing under
section 4941 if the trustee initiates legal proceedings to reform the
trust by June 8, 1999.
II. Time for Paying the Annuity Amount or the Unitrust Amount
The proposed regulations provide that the payment of the annuity
amount or the unitrust amount determined under the fixed percentage
method must be made by the close of the taxable year in which it is
due. The rules were proposed in response to abuses associated with the
use of accelerated CRTs described in Notice 94-78 (1994-2 C.B. 555).
After receiving a significant number of comments on the proposed rules,
the IRS issued Notice 97-68 (1997-48 I.R.B. 11), which provided
guidance on complying with the proposed rules for the 1997 taxable
year.
One commentator recommended applying the proposed rules only to
trusts created after the date the final regulations are published.
Another commentator suggested adopting the rules in Notice 97-68 for
all trusts created after a certain date. Although recent legislative
changes have reduced the potential tax benefits of accelerated CRTs,
the IRS and Treasury continue to be concerned about the potential abuse
of the post-year-end grace period to produce a tax-free return of
appreciation in the assets contributed to a CRAT or a fixed percentage
CRUT. Therefore, the final regulations adopt rules similar to those in
Notice 97-68 with certain modifications. The rules are effective for
taxable years ending after April 18, 1997.
For CRATs and fixed percentage CRUTs, the annuity or unitrust
amount may be paid within a reasonable time after the close of the year
for which it is due if (a) the character of the annuity or unitrust
amount in the recipient's hands is income under section 664(b)(1), (2),
or (3); and/or (b) the trust distributes property (other than cash)
that it owned as of the close of the taxable year to pay the annuity or
unitrust amount and the trustee elects on Form 5227, ``Split-Interest
Trust Information Return,'' to treat any income generated by the
distribution as occurring on the last day of the taxable year for which
the amount is due. In addition, for CRATs and fixed percentage CRUTs
that were created before December 10, 1998, the annuity or unitrust
amount may be paid within a reasonable time after the close of the
taxable year for which it is due if the percentage used to calculate
the annuity or unitrust amount is 15 percent or less.
III. Appraising Unmarketable Assets
Under section 664(d)(2)(A), a CRUT must value its assets annually.
The proposed regulations provide that, if a CRT holds unmarketable
assets and the only trustee is the grantor, a noncharitable
beneficiary, or a related or subordinate party to the grantor or the
noncharitable beneficiary within the meaning of section 672(c) and the
applicable regulations, the trustee must value those assets using a
current qualified appraisal, as defined in Sec. 1.170A-13(c)(3), from a
qualified appraiser, as defined in Sec. 1.170A-13(c)(5).
The final regulations follow the proposed regulations and provide
that the trust's unmarketable assets must be valued by an independent
trustee, or by a qualified appraisal from a qualified appraiser. The
proposed regulations define an independent trustee as a person who is
not the grantor, a noncharitable beneficiary or a related or
subordinate party to the grantor, or the noncharitable beneficiary
within the meaning of section 672(c) and the applicable regulations.
The final regulations add the grantor's spouse to the list of persons
to whom an independent trustee cannot be related or subordinate. A co-
trustee who is an independent trustee may value the trust's
unmarketable assets.
Finally, in response to comments, the final regulations define
unmarketable assets as assets other than cash, cash equivalents, or
assets that can be readily sold or exchanged for cash or cash
equivalents. For example, unmarketable assets include real property,
closely-held stock, and unregistered securities for which there is no
available exemption permitting public sale.
The rules for valuing unmarketable assets are effective for trusts
created on or after December 10, 1998.
IV. Application of Section 2702 to Certain CRUTs
Under the proposed regulations, unitrust interests in an income
exception CRUT that are retained by the donor or any applicable family
member will be valued at zero when a noncharitable beneficiary of the
trust is someone other than (1) the donor, (2) the donor's U.S. citizen
spouse, or (3) both the donor and the donor's U.S. citizen spouse.
Commentators stated that income exception CRUTs without a make-up
provision should be exempt from section 2702. The IRS and Treasury
believe that, in addition to the NIMCRUT method, the net income method
can be used to circumvent the intent of section 2702. Therefore, the
final regulations do not exempt from section 2702 CRUTs that use only
the net income method.
Commentators also stated that the proposed rule encompassed other
transfers that section 2702 was not intended to include. A commentator
noted that the proposed rule would value a transferor's interest at
zero even though the transferor merely retained a secondary life
estate. The final regulations clarify that section 2702 will not apply
when there are only two consecutive noncharitable beneficial interests
and the transferor holds the second of the two interests.
Commentators also asked whether section 2702 may apply to flip
unitrusts. The potential abuse associated with income exception CRUTs
also exists with flip unitrusts. Therefore, under the final
regulations, section 2702 applies to a flip unitrust if the CRUT does
not fall within one of the exemptions.
V. Prohibition on Allocating Precontribution Gain to Trust Income
and Make-up Amount as a Liability
The proposed regulations clarify that the proceeds from the sale of
an income exception CRUT's assets, at least to the extent of the fair
market value of the assets when contributed to the trust, must be
allocated to trust principal. Some commentators stated that the rule is
inconsistent with the rule concerning income under section 643(b).
Other commentators questioned whether the make-up amount under the
NIMCRUT method should be treated as a liability when valuing the
trust's assets.
The final regulations maintain the prohibition on allocating
precontribution gain to trust income for an income exception CRUT.
However, the governing instrument, if permitted under applicable local
law, may allow the allocation of post-contribution capital gains to
trust income. Taxpayers do not have to treat the make-up amount as a
liability when valuing the assets of a NIMCRUT.
VI. Example Illustrating Rule for Characterizing Distributions From
CRUTs
The proposed regulations contain an example of how the ordering
rule under section 664(b) operates when the
[[Page 68191]]
unitrust amount is computed under an income exception method. No
comments were received on this example. Thus, the final regulations
adopt the example without any changes.
Effect on Other Documents
Notice 97-68 (1997-48 I.R.B. 11) is obsolete as of December 10,
1998.
Special Analyses
It has been determined that this Treasury decision is not a
significant regulatory action as defined in EO 12866. Therefore, a
regulatory assessment is not required. It also has been determined that
section 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5)
does not apply to these regulations, and because the regulation does
not impose a collection of information on small entities, the
Regulatory Flexibility Act (5 U.S.C. chapter 6) does not apply.
Therefore, a Regulatory Flexibility Analysis is not required. Pursuant
to section 7805(f), the notice of proposed rulemaking preceding these
regulations was submitted to the Chief Counsel for Advocacy of the
Small Business Administration for comment on its impact on small
business.
Drafting Information. The principal authors of these regulations
are Mary Beth Collins and Jeff Erickson, Office of the Assistant Chief
Counsel (Passthroughs and Special Industries), IRS. However, other
personnel from offices of the IRS and Treasury Department participated
in their development.
List of Subjects
26 CFR Part 1
Income taxes, Reporting and recordkeeping requirements.
26 CFR Part 25
Gift taxes, Reporting and recordkeeping requirements.
26 CFR Part 602
Reporting and recordkeeping requirements.
Adoption of Amendments to the Regulations
Accordingly, CFR parts 1, 25, and 602 are amended as follows:
PART 1--INCOME TAXES
Paragraph 1. The authority citation for part 1 continues to read in
part as follows:
Authority: 26 U.S.C. 7805 * * *
Par. 2. In Sec. 1.664-1, paragraphs (a)(7) and (d)(1)(iii) are
added and paragraph (f)(4) is added following the concluding text of
paragraph (f)(3) to read as follows:
Sec. 1.664-1 Charitable remainder trusts.
(a) * * *
(7) Valuation of unmarketable assets--(i) In general. If
unmarketable assets are transferred to or held by a trust, the trust
will not be a trust with respect to which a deduction is available
under section 170, 2055, 2106, or 2522, or will be treated as failing
to function exclusively as a charitable remainder trust unless,
whenever the trust is required to value such assets, the valuation is--
(a) Performed exclusively by an independent trustee; or
(b) Determined by a current qualified appraisal, as defined in
Sec. 1.170A-13(c)(3), from a qualified appraiser, as defined in
Sec. 1.170A-13(c)(5).
(ii) Unmarketable assets. Unmarketable assets are assets that are
not cash, cash equivalents, or other assets that can be readily sold or
exchanged for cash or cash equivalents. For example, unmarketable
assets include real property, closely-held stock, and an unregistered
security for which there is no available exemption permitting public
sale.
(iii) Independent trustee. An independent trustee is a person who
is not the grantor of the trust, a noncharitable beneficiary, or a
related or subordinate party to the grantor, the grantor's spouse, or a
noncharitable beneficiary (within the meaning of section 672(c) and the
applicable regulations).
* * * * *
(d) * * * (1) * * *
(iii) Example. The following example illustrates the application of
this paragraph (d)(1):
Example. (i) X is a charitable remainder unitrust described in
section 664(d)(2) and (3). The annual unitrust amount is the lesser
of the amount of trust income, as defined in Sec. 1.664-
3(a)(1)(i)(b), or six percent of the net fair market value of the
trust assets valued annually. The net fair market value of the trust
assets on the valuation date in 1996 is $150,000. During 1996, X has
$7,500 of income after allocating all expenses. All of X's income
for 1996 is tax-exempt income. At the end of 1996, X's ordinary
income for the current taxable year and undistributed ordinary
income for prior years are both zero; X's capital gain for the
current taxable year is zero and undistributed capital gain for
prior years is $30,000; and X's tax-exempt income for the current
year is $7,500 and undistributed tax-exempt income for prior years
is $2,500.
(ii) Because the trust income of $7,500 is less than the fixed
percentage amount of $9,000, the unitrust amount for 1996 is $7,500.
The character of that amount in the hands of the recipient of the
unitrust amount is determined under section 664(b). Because the
unitrust amount is less than X's undistributed capital gain income,
the recipient of the unitrust amount treats the distribution of
$7,500 as capital gain. At the beginning of 1997, X's undistributed
capital gain for prior years is reduced to $22,500, and X's
undistributed tax-exempt income is increased to $10,000.
* * * * *
(f) * * *
(4) Valuation of unmarketable assets. The rules contained in
paragraph (a)(7) of this section are applicable for trusts created on
or after December 10, 1998. A trust in existence as of December 10,
1998 whose governing instrument requires that an independent trustee
value the trust's unmarketable assets may be amended or reformed to
permit a valuation method that satisfies the requirements of paragraph
(a)(7) of this section for taxable years beginning on or after December
10, 1998.
* * * * *
Par. 3. In Sec. 1.664-2, paragraph (a)(1)(i) is revised to read as
follows:
Sec. 1.664-2 Charitable remainder annuity trust.
(a) * * *
(1) * * * (i) Payment of sum certain at least annually. The
governing instrument provides that the trust will pay a sum certain not
less often than annually to a person or persons described in paragraph
(a)(3) of this section for each taxable year of the period specified in
paragraph (a)(5) of this section.
(a) General rule applicable to all trusts. A trust will not be
deemed to have engaged in an act of self-dealing (within the meaning of
section 4941), to have unrelated debt-financed income (within the
meaning of section 514), to have received an additional contribution
(within the meaning of paragraph (b) of this section), or to have
failed to function exclusively as a charitable remainder trust (within
the meaning of Sec. 1.664-1(a)(4)) merely because the annuity amount is
paid after the close of the taxable year if such payment is made within
a reasonable time after the close of such taxable year and the entire
annuity amount in the hands of the recipient is characterized only as
income from the categories described in section 664(b)(1), (2), or (3),
except to the extent it is characterized as corpus described in section
664(b)(4) because--
(1) The trust distributes property (other than cash) that it owned
at the close of the taxable year to pay the annuity amount; and
(2) The trustee elects to treat any income generated by the
distribution as
[[Page 68192]]
occurring on the last day of the taxable year in which the annuity
amount is due.
(b) Special rule for trusts created before December 10, 1998. In
addition to the circumstances described in paragraph (a)(1)(i)(a) of
this section, a trust created before December 10, 1998 will not be
deemed to have engaged in an act of self-dealing (within the meaning of
section 4941), to have unrelated debt-financed income (within the
meaning of section 514), to have received an additional contribution
(within the meaning of paragraph (b) of this section), or to have
failed to function exclusively as a charitable remainder trust (within
the meaning of Sec. 1.664-1(a)(4)) merely because the annuity amount is
paid after the close of the taxable year if such payment is made within
a reasonable time after the close of such taxable year and the sum
certain to be paid each year as the annuity amount is 15 percent or
less of the initial net fair market value of the property irrevocably
passing in trust as determined for federal tax purposes.
(c) Reasonable time. For this paragraph (a)(1)(i), a reasonable
time will not ordinarily extend beyond the date by which the trustee is
required to file Form 5227, ``Split-Interest Trust Information
Return,'' (including extensions) for the taxable year.
(d) Example. The following example illustrates the rules in
paragraph (a)(1)(i)(a) of this section:
Example. X is a charitable remainder annuity trust described in
section 664(d)(1) that was created after December 10, 1998. The
prorated annuity amount payable from X for Year 1 is $100. The
trustee does not pay the annuity amount to the recipient by the
close of Year 1. At the end of Year 1, X has only $95 in the
ordinary income category under section 664(b)(1) and no income in
the capital gain or tax-exempt income categories under section
664(b)(2) or (3), respectively. By April 15 of Year 2, in addition
to $95 in cash, the trustee distributes to the recipient of the
annuity a capital asset with a $5 fair market value and a $2
adjusted basis to pay the $100 annuity amount due for Year 1. The
trust owned the asset at the end of Year 1. Under Sec. 1.664-
1(d)(5), the distribution is treated as a sale by X, resulting in X
recognizing a $3 capital gain. The trustee elects to treat the
capital gain as occurring on the last day of Year 1. Under
Sec. 1.664-1(d)(1), the character of the annuity amount for Year 1
in the recipient's hands is $95 of ordinary income, $3 of capital
gain income, and $2 of trust corpus. For Year 1, X satisfied
paragraph (a)(1)(i)(a) of this section.
(e) Effective date. This paragraph (a)(1)(i) is applicable for
taxable years ending after April 18, 1997.
* * * * *
Par. 4. Section 1.664-3 is amended as follows:
1. Paragraphs (a)(1)(i)(a), (a)(1)(i)(b)(1), and (a)(1)(i)(b)(2)
are revised.
2. Paragraphs (a)(1)(i)(b)(3), (a)(1)(i)(b)(4), (a)(1)(i)(b)(5),
and (a)(1)(i)(c) through (a)(1)(i)(l) are added.
3. The third sentence of paragraph (a)(1)(iv) is revised.
The added and revised provisions read as follows:
Sec. 1.664-3 Charitable remainder unitrust.
(a) * * *
(1) * * * (i) * * * (a) General rule. The governing instrument
provides that the trust will pay not less often than annually a fixed
percentage of the net fair market value of the trust assets determined
annually to a person or persons described in paragraph (a)(3) of this
section for each taxable year of the period specified in paragraph
(a)(5) of this section. This paragraph (a)(1)(i)(a) is applicable for
taxable years ending after April 18, 1997.
(b) * * *
(1) The amount of trust income for a taxable year to the extent
that such amount is not more than the amount required to be distributed
under paragraph (a)(1)(i)(a) of this section.
(2) An amount of trust income for a taxable year that is in excess
of the amount required to be distributed under paragraph (a)(1)(i)(a)
of this section for such year to the extent that (by reason of
paragraph (a)(1)(i)(b)(1) of this section) the aggregate of the amounts
paid in prior years was less than the aggregate of such required
amounts.
(3) For this paragraph (a)(1)(i)(b), trust income means income as
defined under section 643(b) and the applicable regulations.
(4) For this paragraph (a)(1)(i)(b), proceeds from the sale or
exchange of any assets contributed to the trust by the donor must be
allocated to principal and not to trust income at least to the extent
of the fair market value of those assets on the date of contribution.
(5) The rules in paragraphs (a)(1)(i)(b)(1), (2), and (3) of this
section are applicable for taxable years ending after April 18, 1997,
and the rule in paragraph (a)(1)(i)(b)(4) is applicable for sales or
exchanges that occur after April 18, 1997.
(c) Combination of methods. Instead of the amount described in
paragraph (a)(1)(i)(a) or (b) of this section, the governing instrument
may provide that the trust will pay not less often than annually the
amount described in paragraph (a)(1)(i)(b) of this section for an
initial period and then pay the amount described in paragraph
(a)(1)(i)(a) of this section (calculated using the same fixed
percentage) for the remaining years of the trust only if the governing
instrument provides that--
(1) The change from the method prescribed in paragraph (a)(1)(i)(b)
to the method prescribed in paragraph (a)(1)(i)(a) is triggered on a
specific date or by a single event whose occurrence is not
discretionary with, or within the control of, the trustees or any other
persons;
(2) The change from the method prescribed in paragraph (a)(1)(i)(b)
of this section to the method prescribed in paragraph (a)(1)(i)(a) of
this section occurs at the beginning of the taxable year that
immediately follows the taxable year during which the date or event
specified under paragraph (a)(1)(i)(c)(1) of this section occurs; and
(3) Following the trust's conversion to the method described in
paragraph (a)(1)(i)(a) of this section, the trust will pay at least
annually to the permissible recipients the amount described only in
paragraph (a)(1)(i)(a) of this section and not any amount described in
paragraph (a)(1)(i)(b) of this section.
(d) Triggering event. For purposes of paragraph (a)(1)(i)(c)(1) of
this section, a triggering event based on the sale of unmarketable
assets as defined in Sec. 1.664-1(a)(7)(ii), or the marriage, divorce,
death, or birth of a child with respect to any individual will not be
considered discretionary with, or within the control of, the trustees
or any other persons.
(e) Examples. The following examples illustrate the rules in
paragraph (a)(1)(i)(c) of this section. For each example, assume that
the governing instrument of charitable remainder unitrust Y provides
that Y will initially pay not less often than annually the amount
described in paragraph (a)(1)(i)(b) of this section and then pay the
amount described in paragraph (a)(1)(i)(a) of this section (calculated
using the same fixed percentage) for the remaining years of the trust
and that the requirements of paragraphs (a)(1)(i)(c)(2) and (3) of this
section are satisfied. The examples are as follows:
Example 1. Y is funded with the donor's former personal
residence. The governing instrument of Y provides for the change in
method for computing the annual unitrust amount as of the first day
of the year following the year in which the trust sells the
residence. Y provides for a combination of methods that satisfies
paragraph (a)(1)(i)(c) of this section.
Example 2. Y is funded with cash and an unregistered security
for which there is no available exemption permitting public sale
under the Securities and Exchange Commission rules. The governing
instrument of Y provides that the change in method for computing the
annual unitrust amount is triggered on the earlier of the date when
the
[[Page 68193]]
stock is sold or at the time the restrictions on its public sale
lapse or are otherwise lifted. Y provides for a combination of
methods that satisfies paragraph (a)(1)(i)(c) of this section.
Example 3. Y is funded with cash and with a security that may be
publicly traded under the Securities and Exchange Commission rules.
The governing instrument of Y provides that the change in method for
computing the annual unitrust amount is triggered when the stock is
sold. Y does not provide for a combination of methods that satisfies
the requirements of paragraph (a)(1)(i)(c) of this section because
the sale of the publicly-traded stock is within the discretion of
the trustee.
Example 4. S establishes Y for her granddaughter, G, when G is
10 years old. The governing instrument of Y provides for the change
in method for computing the annual unitrust amount as of the first
day of the year following the year in which G turns 18 years old. Y
provides for a combination of methods that satisfies paragraph
(a)(1)(i)(c) of this section.
Example 5. The governing instrument of Y provides for the change
in method for computing the annual unitrust amount as of the first
day of the year following the year in which the donor is married. Y
provides for a combination of methods that satisfies paragraph
(a)(1)(i)(c) of this section.
Example 6. The governing instrument of Y provides that if the
donor divorces, the change in method for computing the annual
unitrust amount will occur as of the first day of the year following
the year of the divorce. Y provides for a combination of methods
that satisfies paragraph (a)(1)(i)(c) of this section.
Example 7. The governing instrument of Y provides for the change
in method for computing the annual unitrust amount as of the first
day of the year following the year in which the noncharitable
beneficiary's first child is born. Y provides for a combination of
methods that satisfies paragraph (a)(1)(i)(c) of this section.
Example 8. The governing instrument of Y provides for the change
in method for computing the annual unitrust amount as of the first
day of the year following the year in which the noncharitable
beneficiary's father dies. Y provides for a combination of methods
that satisfies paragraph (a)(1)(i)(c) of this section.
Example 9. The governing instrument of Y provides for the change
in method for computing the annual unitrust amount as of the first
day of the year following the year in which the noncharitable
beneficiary's financial advisor determines that the beneficiary
should begin receiving payments under the second prescribed payment
method. Because the change in methods for paying the unitrust amount
is triggered by an event that is within a person's control, Y does
not provide for a combination of methods that satisfies paragraph
(a)(1)(i)(c) of this section.
Example 10. The governing instrument of Y provides for the
change in method for computing the annual unitrust amount as of the
first day of the year following the year in which the noncharitable
beneficiary submits a request to the trustee that the trust convert
to the second prescribed payment method. Because the change in
methods for paying the unitrust amount is triggered by an event that
is within a person's control, Y does not provide for a combination
of methods that satisfies paragraph (a)(1)(i)(c) of this section.
(f) Effective date--(1) General rule. Paragraphs (a)(1)(i)(c), (d),
and (e) of this section are applicable for charitable remainder trusts
created on or after December 10, 1998.
(2) General rule regarding reformations of combination of method
unitrusts. If a trust is created on or after December 10, 1998 and
contains a provision allowing a change in calculating the unitrust
amount that does not comply with the provisions of paragraph
(a)(1)(i)(c) of this section, the trust will qualify as a charitable
remainder unitrust only if it is amended or reformed to use the initial
method for computing the unitrust amount throughout the term of the
trust, or is reformed in accordance with paragraph (a)(1)(i)(f)(3) of
this section. If a trust was created before December 10, 1998 and
contains a provision allowing a change in calculating the unitrust
amount that does not comply with the provisions of paragraph
(a)(1)(i)(c) of this section, the trust may be reformed to use the
initial method for computing the unitrust amount throughout the term of
the trust without causing the trust to fail to function exclusively as
a charitable remainder unitrust under Sec. 1.664-1(a)(4), or may be
reformed in accordance with paragraph (a)(1)(i)(f)(3) of this section.
Except as provided in paragraph (a)(1)(i)(f)(3) of this section, a
qualified charitable remainder unitrust will not continue to qualify as
a charitable remainder unitrust if it is amended or reformed to add a
provision allowing a change in the method for calculating the unitrust
amount.
(3) Special rule for reformations of trusts that begin by June 8,
1999. Notwithstanding paragraph (a)(1)(i)(f)(2) of this section, if a
trust either provides for payment of the unitrust amount under a
combination of methods that is not permitted under paragraph
(a)(1)(i)(c) of this section, or provides for payment of the unitrust
amount under only the method prescribed in paragraph (a)(1)(i)(b) of
this section, then the trust may be reformed to allow for a combination
of methods permitted under paragraph (a)(1)(i)(c) of this section
without causing the trust to fail to function exclusively as a
charitable remainder unitrust under Sec. 1.664-1(a)(4) or to engage in
an act of self-dealing under section 4941 if the trustee begins legal
proceedings to reform by June 8, 1999. The triggering event under the
reformed governing instrument may not occur in a year prior to the year
in which the court issues the order reforming the trust, except for
situations in which the governing instrument prior to reformation
already provided for payment of the unitrust amount under a combination
of methods that is not permitted under paragraph (a)(1)(i)(c) of this
section and the triggering event occurred prior to the reformation.
(g) Payment under general rule for fixed percentage trusts. When
the unitrust amount is computed under paragraph (a)(1)(i)(a) of this
section, a trust will not be deemed to have engaged in an act of self-
dealing (within the meaning of section 4941), to have unrelated debt-
financed income (within the meaning of section 514), to have received
an additional contribution (within the meaning of paragraph (b) of this
section), or to have failed to function exclusively as a charitable
remainder trust (within the meaning of Sec. 1.664-1(a)(4)) merely
because the unitrust amount is paid after the close of the taxable year
if such payment is made within a reasonable time after the close of
such taxable year and the entire unitrust amount in the hands of the
recipient is characterized only as income from the categories described
in section 664(b)(1), (2), or (3), except to the extent it is
characterized as corpus described in section 664(b)(4) because--
(1) The trust distributes property (other than cash) that it owned
at the close of the taxable year to pay the unitrust amount; and
(2) The trustee elects to treat any income generated by the
distribution as occurring on the last day of the taxable year for which
the unitrust amount is due.
(h) Special rule for fixed percentage trusts created before
December 10, 1998. When the unitrust amount is computed under paragraph
(a)(1)(i)(a) of this section, a trust created before December 10, 1998
will not be deemed to have engaged in an act of self-dealing (within
the meaning of section 4941), to have unrelated debt-financed income
(within the meaning of section 514), to have received an additional
contribution (within the meaning of paragraph (b) of this section), or
to have failed to function exclusively as a charitable remainder trust
(within the meaning of Sec. 1.664-1(a)(4)) merely because the unitrust
amount is paid after the close of the taxable year if such payment is
made within a reasonable time after the close of such taxable year and
the fixed percentage to be paid each year as the unitrust amount is 15
percent or less of the net fair market value of the trust assets as
determined under paragraph (a)(1)(iv) of this section.
[[Page 68194]]
(i) Example. The following example illustrates the rules in
paragraph (a)(1)(i)(g) of this section:
Example. X is a charitable remainder unitrust that calculates
the unitrust amount under paragraph (a)(1)(i)(a) of this section. X
was created after December 10, 1998. The prorated unitrust amount
payable from X for Year 1 is $100. The trustee does not pay the
unitrust amount to the recipient by the end of the Year 1. At the
end of Year 1, X has only $95 in the ordinary income category under
section 664(b)(1) and no income in the capital gain or tax-exempt
income categories under section 664(b) (2) or (3), respectively. By
April 15 of Year 2, in addition to $95 in cash, the trustee
distributes to the unitrust recipient a capital asset with a $5 fair
market value and a $2 adjusted basis to pay the $100 unitrust amount
due for Year 1. The trust owned the asset at the end of Year 1.
Under Sec. 1.664-1(d)(5), the distribution is treated as a sale by
X, resulting in X recognizing a $3 capital gain. The trustee elects
to treat the capital gain as occurring on the last day of Year 1.
Under Sec. 1.664-1(d)(1), the character of the unitrust amount for
Year 1 in the recipient's hands is $95 of ordinary income, $3 of
capital gain income, and $2 of trust corpus. For Year 1, X satisfied
paragraph (a)(1)(i)(g) of this section.
(j) Payment under income exception. When the unitrust amount is
computed under paragraph (a)(1)(i)(b) of this section, a trust will not
be deemed to have engaged in an act of self-dealing (within the meaning
of section 4941), to have unrelated debt-financed income (within the
meaning of section 514), to have received an additional contribution
(within the meaning of paragraph (b) of this section), or to have
failed to function exclusively as a charitable remainder trust (within
the meaning of Sec. 1.664-1(a)(4)) merely because payment of the
unitrust amount is made after the close of the taxable year if such
payment is made within a reasonable time after the close of such
taxable year.
(k) Reasonable time. For paragraphs (a)(1)(i) (g), (h), and (j) of
this section, a reasonable time will not ordinarily extend beyond the
date by which the trustee is required to file Form 5227, ``Split-
Interest Trust Information Return,'' (including extensions) for the
taxable year.
(l) Effective date. Paragraphs (a)(1)(i) (g), (h), (i), (j), and
(k) of this section are applicable for taxable years ending after April
18, 1997.
* * * * *
(iv) * * * If the governing instrument does not specify the
valuation date or dates, the trustee must select such date or dates and
indicate the selection on the first return on Form 5227, ``Split-
Interest Trust Information Return,'' that the trust must file. * * *
* * * * *
PART 25--GIFT TAX; GIFTS MADE AFTER DECEMBER 31, 1954
Par. 5. The authority citation for part 25 continues to read in
part as follows:
Authority: 26 U.S.C. 7805. * * *
Par. 6. In Sec. 25.2702-1, paragraph (c)(3) is revised to read as
follows:
Sec. 25.2702-1 Special valuation rules in the case of transfers of
interests in trust.
* * * * *
(c) * * *
(3) Charitable remainder trust. (i) For transfers made on or after
May 19, 1997, a transfer to a pooled income fund described in section
642(c)(5); a transfer to a charitable remainder annuity trust described
in section 664(d)(1); a transfer to a charitable remainder unitrust
described in section 664(d)(2) if under the terms of the governing
instrument the unitrust amount can be computed only under section
664(d)(2)(A); and a transfer to a charitable remainder unitrust if
under the terms of the governing instrument the unitrust amount can be
computed under section 664(d)(2) and (3) and either there are only two
consecutive noncharitable beneficial interests and the transferor holds
the second of the two interests, or the only permissible recipients of
the unitrust amount are the transferor, the transferor's U.S. citizen
spouse, or both the transferor and the transferor's U.S. citizen
spouse.
(ii) For transfers made before May 19, 1997, a transfer in trust if
the remainder interest in the trust qualifies for a deduction under
section 2522.
* * * * *
PART 602--OMB CONTROL NUMBERS UNDER THE PAPERWORK REDUCTION ACT
Par. 7. The authority citation for part 602 continues to read as
follows:
Authority: 26 U.S.C. 7805.
Par. 8. In Sec. 602.101, paragraph (c) is amended by adding a new
entry in numerical order to the table to read as follows:
Sec. 602.101 OMB Control numbers.
* * * * *
(c) * * *
------------------------------------------------------------------------
CFR part or section where identified
and described Current OMB control No.
------------------------------------------------------------------------
* * * * *
1.664-1(a)(7)....................... 1545-1536
* * * * *
------------------------------------------------------------------------
Approved: December 1, 1998.
Robert E. Wenzel,
Deputy Commissioner of Internal Revenue.
Donald C. Lubick,
Assistant Secretary of the Treasury (Tax Policy).
[FR Doc. 98-32559 Filed 12-9-98; 8:45 am]
BILLING CODE 4830-01-P
