98-32559. Guidance Regarding Charitable Remainder Trusts and Special Valuation Rules for Transfers of Interests in Trusts  

  • [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
    
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    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
    
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    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
    
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    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
    
    
    

Document Information

Published:
12/10/1998
Department:
Internal Revenue Service
Entry Type:
Rule
Action:
Final regulations.
Document Number:
98-32559
Pages:
68188-68194 (7 pages)
Docket Numbers:
TD 8791
RINs:
1545-AU25: Guidance Regarding Charitable Remainder Trust
RIN Links:
https://www.federalregister.gov/regulations/1545-AU25/guidance-regarding-charitable-remainder-trust
PDF File:
98-32559.pdf
CFR: (8)
26 CFR 1.664-1(d)(1)
26 CFR 1.170A-13(c)(3)
26 CFR 1.170A-13(c)(5)
26 CFR 602.101
26 CFR 1.664-1
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