[Federal Register Volume 62, Number 75 (Friday, April 18, 1997)]
[Proposed Rules]
[Pages 19072-19078]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 97-9810]
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DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Parts 1 and 25
[REG-209823-96]
RIN 1545-AU25
Guidance Regarding Charitable Remainder Trusts
AGENCY: Internal Revenue Service (IRS), Treasury.
ACTION: Notice of proposed rulemaking and notice of public hearing.
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SUMMARY: This document contains proposed amendments to the regulations
under section 664 of the Internal Revenue Code of 1986 relating to
charitable remainder trusts and under section 2702 relating to special
valuation rules for transfers of interests in trusts. The proposed
amendments contain rules on the conditions under which the governing
instrument may provide for a change in the method of calculating the
unitrust amount, the date by which the annuity amount or the unitrust
amount under the fixed percentage method must be paid to the recipient,
who is required to value unmarketable assets, and when section 2702
applies to certain charitable remainder unitrusts. The proposed
regulations clarify existing law that prohibits allocating
precontribution capital gain to trust income. The proposed amendments
also contain an example illustrating how the ordering rule of section
664(b) applies to distributions from a charitable remainder unitrust
using an income exception method to calculate the unitrust amount. This
document also provides notice of a public hearing on these proposed
regulations.
DATES: Comments and outlines of topics to be discussed at the public
hearing scheduled for September 9, 1997, at 10 a.m. must be received by
August 19, 1997.
ADDRESSES: Send submissions to: CC:DOM:CORP:R (REG-209823-96), room
5228, Internal Revenue Service, POB 7604, Ben Franklin Station,
[[Page 19073]]
Washington, DC 20044. Submissions may also be hand delivered between
the hours of 8 a.m. and 5 p.m. to: CC:DOM:CORP:R (REG-209823-96),
Courier's Desk, Internal Revenue Service, 1111 Constitution Avenue NW.,
Washington, DC. Alternatively, taxpayers may submit comments
electronically via the internet by selecting the ``Tax Regs'' option on
the IRS Home Page, or by submitting comments directly to the IRS
internet site at http://www.irs.ustreas.gov/prod/tax/regs/
comments.html.
The public hearing will be held in the IRS Auditorium, Internal
Revenue Building, 1111 Constitution Avenue, NW., Washington, D.C.
FOR FURTHER INFORMATION CONTACT: Concerning the regulations, Jeffrey A.
Erickson or Mary Beth Collins, (202) 622-3070; concerning submissions
and the hearing, Evangelista Lee, (202) 622-7190 (not toll-free
numbers).
SUPPLEMENTARY INFORMATION:
Paperwork Reduction Act
The collection of information contained in this notice of proposed
rulemaking has been submitted to the Office of Management and Budget
for review in accordance with the Paperwork Reduction Act of 1995 (44
U.S.C. 3507(d)). Comments on the collection of information should be
sent 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, with copies to the Internal Revenue
Service, Attn: IRS Reports Clearance Officer, T:FP, Washington, DC
20224. Comments on the collection of information should be received by
July 17, 1997. Comments are specifically requested concerning:
Whether the proposed collection of information is necessary for the
proper performance of the functions of the Internal Revenue Service,
including whether the information will have practical utility;
The accuracy of the estimated burden associated with the proposed
collection of information;
How the quality, utility, and clarity of the information to be
collected may be enhanced;
How the burden of complying with the proposed collection of
information may be minimized, including through the application of
automated collection techniques or other forms of information
technology; and
Estimates of capital or start-up costs and costs of operation,
maintenance, and purchase of service to provide information.
The collection of information in this proposed regulation is in
Sec. 1.664-1(a)(7). This information is required to allow taxpayers
alternative means of valuing a charitable remainder trust's hard-to-
value assets. This information will be used to determine if a taxpayer
properly claimed a charitable deduction for a contribution to a
charitable remainder trust and if assets in the charitable remainder
trust are properly valued each year. The collection of information is
voluntary. The likely respondents are for-profit entities.
Estimated total annual recordkeeping burden: 75 hours.
Estimated average annual burden hours per respondent: .5 hours.
Estimated number of respondents: 150.
An agency may not conduct or sponsor, and a person is not required
to respond to, a collection of information unless it displays a valid
control number assigned by the Office of Management and Budget.
Books or records relating to a 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
This document proposes amendments to 26 CFR parts 1 and 25 to
provide additional rules under sections 664 and 2702. Section 664,
added to the Internal Revenue Code by section 201 of the Tax Reform Act
of 1969 (Pub. L. 91-172), contains the rules for charitable remainder
trusts. In general, a charitable remainder trust provides for a
specified periodic distribution to one or more noncharitable
beneficiaries for life or for a term of years with an irrevocable
remainder interest held for the benefit of charity. Section 664(c)
provides that a charitable remainder trust is exempt from all taxes
under subtitle A of the Code for any taxable year except a taxable year
in which the trust has unrelated business taxable income under section
512.
There are two types of charitable remainder trusts. A charitable
remainder annuity trust (a CRAT) pays a sum certain at least annually
to one or more noncharitable beneficiaries. A charitable remainder
unitrust (a CRUT) pays a unitrust amount at least annually to one or
more noncharitable beneficiaries. The unitrust amount is generally a
fixed percentage of the net fair market value of the CRUT's assets
valued annually (the fixed percentage method). The unitrust amount can
instead be the lesser of the fixed percentage amount or the trust's net
income (the net income method). Alternatively, the unitrust amount can
be the amount 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 distributions in prior years when the
trust income was less than the fixed percentage amount (the NIMCRUT
method).
Explanation of Provisions
I. Flip Unitrusts
A. General Explanation
The governing instrument of a CRUT must specify the method of
computing the unitrust payments. Section 664(d)(3) provides that the
income exception methods (either the net income method or the NIMCRUT
method) may be used to pay the unitrust amount ``for any year.'' The
legislative history, however, provides that the method used to
determine the unitrust amount may not be discretionary with the
trustee. H.R. Conf. Rep. No. 782, 91st Cong., 1st Sess. 296 (1969),
1969-3 C.B. 644, 655.
Some donors may fund a CRUT with unmarketable assets that produce
little or no income. These donors often want the income beneficiary or
beneficiaries of the CRUT to receive a steady stream of payments based
on the total return available from the value of the assets. The donors
recognize, however, that the CRUT cannot make these payments until it
can convert the unmarketable assets into liquid assets that can be used
to pay the fixed percentage amount. These donors establish CRUTs that
use one of the income exception methods to calculate the unitrust
amount until the unmarketable assets are sold. Following the sale, the
donors may prefer that the CRUT use the fixed percentage method to
calculate the unitrust amount. A trust using such a combination of
methods would be a ``flip unitrust.''
The proposed regulations provide that a donor may establish a flip
unitrust that qualifies as a CRUT if the following conditions are
satisfied. First, to ensure that the CRUT has substantially all
unmarketable assets prior to the switch in methods, at least 90 percent
of the fair market value of the assets held in the trust immediately
after the initial contribution or any subsequent contribution (prior to
the switch in methods) must consist of unmarketable assets.
Unmarketable assets are assets that are not cash, cash equivalents, or
marketable securities (within the meaning of section 731(c)).
Second, because the legislative history indicates that a trustee
should
[[Page 19074]]
not have discretion to change the method used to calculate the unitrust
amount, the governing instrument must provide that the CRUT will use an
income exception method until the earlier of (a) the sale of a
specified unmarketable asset or group of unmarketable assets
contributed at the time the trust was created or (b) the sale of
unmarketable assets such that immediately following the sale, any
remaining unmarketable assets total 50 percent or less of the fair
market value of the trust's assets. For making this determination, the
remaining unmarketable assets are valued as of the most recent
valuation date.
Third, to ensure that the CRUT will use the fixed percentage method
after the unmarketable assets are sold, the CRUT must switch
exclusively to the fixed percentage method for calculating all
remaining unitrust amounts payable to any income beneficiary at the
beginning of the first taxable year following the year in which the
earlier of the above events occurs.
Finally, because the fixed percentage method does not provide for a
makeup amount, any makeup amount described in section 664(d)(3)(B) is
forfeited when the trust switches to the fixed percentage method.
The IRS and Treasury request comments on whether there are
additional circumstances under which a combination of methods should be
addressed in regulations.
B. Proposed Effective Date and Transitional Rules
The amendments allowing a flip unitrust are proposed to be
effective for CRUTs created on or after the date the final regulations
are published in the Federal Register.
If a trust was created before the effective date of this amendment
and its governing instrument contains a flip provision other than the
one permitted by the regulations, the trust may be amended or reformed
to comply with the final regulations. If a trust is created after the
effective date of this amendment and has a flip provision not expressly
permitted by the regulations, the trust will qualify as a CRUT if it is
amended or reformed to use the initial method for computing the
unitrust amount throughout the term of the trust. If a qualified CRUT
is created before or after the effective date of this amendment and its
governing instrument does not contain a flip provision, the trust will
not continue to qualify as a CRUT if it is amended or reformed to add a
flip provision.
The IRS and Treasury invite comments on the least burdensome
methods of changing the terms of a trust's governing instrument.
II. Time for Paying the Annuity Amount or the Unitrust Amount
A. General Explanation
The regulatory provisions permitting a trustee of a charitable
remainder trust to pay the annuity or unitrust amount within a
reasonable period of time following the close of the trust's taxable
year were intended as an administrative convenience for trustees. Under
the income exception methods, the trustee may not be able to determine
the amount of trust income and, thus, the amount to be distributed for
a trust's taxable year until after the close of that year. Therefore, a
trustee may need the additional time to pay the unitrust amount if a
CRUT uses one of the income exception methods.
In contrast, a trustee of a CRAT or a CRUT using the fixed
percentage method can easily determine the annuity or unitrust amount
and pay it before the close of the taxable year to which it relates.
The annuity amount is fixed and determinable as of the date the trust
is created. The fixed percentage unitrust amount is fixed and
determinable as of the annual valuation date, which is specified in the
governing instrument or on the initial Form 5227, Split-Interest Trust
Information Return. The valuation date can be set well before the end
of the taxable year.
The IRS and Treasury believe that certain trustees of charitable
remainder trusts have attempted to abuse the provisions in the current
regulations that permit a trustee to pay the annuity or unitrust amount
within a reasonable time after the close of the taxable year for which
the payment is due. The IRS and Treasury are especially concerned about
accelerated charitable remainder trusts described in Notice 94-78
(1994-2 C.B. 555). Therefore, the regulations propose to amend
Secs. 1.664-2(a)(1)(i) and 1.664-3(a)(1)(i) to 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. These proposed amendments should not require the
amendment or reformation of governing instruments of existing
charitable remainder trusts that allow a trustee to pay the unitrust or
annuity amount after the close of the taxable year. The trustees of
such trusts can comply with the proposed regulations by actually paying
the annuity or unitrust amount within the time permitted by the
proposed amendments.
For CRUTs using an income exception method, the regulations
continue to provide that if the CRUT pays the unitrust amount within a
reasonable time after the close of the trust's taxable year, the trust
is not deemed to have engaged in an act of self-dealing, to have
unrelated debt-financed income, to have received an additional
contribution, or to have failed to function exclusively as a charitable
remainder trust.
B. Proposed Effective Date
These amendments are proposed to be effective for taxable years
ending after April 18, 1997.
The IRS will continue to challenge the purported tax consequences
of accelerated charitable remainder trusts as described in Notice 94-
78.
III. Appraising Unmarketable Assets
A. General Explanation
Under Sec. 1.664-1(a)(1)(iii)(a), a trust may qualify as a
charitable remainder trust only if a deduction is allowable under
sections 170, 2055, 2106, or 2522 for transfers to the trust. The
legislative history of section 664 indicates that Congress contemplated
denying a charitable contribution deduction to a donor who transferred
unmarketable assets to a charitable remainder trust unless an
independent trustee valued the assets. H.R. Rep. No. 413, 91st Cong.,
1st Sess. 60 (1969), 1969-3 C.B. 200, 239. Because the statute does not
contain a corresponding provision, many practitioners have asked
whether a charitable remainder trust that holds unmarketable assets
must have an independent trustee value the assets.
The proposed regulations provide that if a charitable remainder
trust holds unmarketable assets and the trustee is the grantor of the
charitable remainder trust, 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 use 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), to value those assets. A trustee who is not the
grantor, a noncharitable beneficiary, or a related or subordinate party
does not have to use a qualified appraisal from a qualified appraiser
to value the unmarketable assets. Therefore, the grantor, a
noncharitable beneficiary, or a related or subordinate party may be the
sole trustee of a charitable remainder trust if the trustee uses a
current qualified appraisal from a qualified appraiser to compute the
fair
[[Page 19075]]
market value of the trust's unmarketable assets.
B. Proposed Effective Date
The amendments are proposed to be effective for trusts created on
or after the date on which the final regulations are published in the
Federal Register. If the governing instrument of an existing trust
created before the effective date of this amendment already requires an
independent trustee to value the trust's unmarketable assets, the
governing instrument may be amended or reformed to conform with this
provision.
IV. Application of Section 2702 to Certain Charitable Remainder
Unitrusts
A. General Explanation
Section 2702 provides special rules to determine the amount of the
gift when an individual makes a transfer in trust to or for the benefit
of a family member and the individual or an applicable family member
retains an interest in the trust. Under section 2702(a), the retained
interest in these situations is generally valued at zero unless the
interest is a qualified interest. Under section 2702(b), a qualified
interest includes the right to receive fixed payments at least annually
and the right to receive amounts at least annually that are a fixed
percentage of the annual fair market value of the property in the
trust.
Section 2702(a)(3)(A)(iii) was added by section 1702(f)(11)(A)(iv)
of the Small Business Job Protection Act of 1996 (Pub. L. 104-188) as a
technical correction to the Revenue Reconciliation Act of 1990 (Public
Law 101-508). Section 2702(a)(3)(A)(iii) provides that section 2702(a)
shall not apply to any transfer to the extent regulations provide that
such transfer is not inconsistent with the purposes of the section.
According to the legislative history, the regulatory authority could be
used to create an exception from the application of section 2702 for a
qualified charitable remainder trust that does not otherwise create an
opportunity for transferring property to a family member free of
transfer tax. H.R. Rep. No. 586, 104th Cong., 2d Sess. 155-56 (1996).
Under Sec. 25.2702-1(c)(3) of the Gift Tax Regulations, section 2702
does not apply to CRUTs or CRATs.
Some taxpayers have created CRUTs using an income exception method
to take advantage of the section 2702 exclusion granted to charitable
remainder trusts in the regulations. These taxpayers attempt to use
this exclusion and the income exception feature of a CRUT to pass
substantial assets to family members with minimal transfer tax
consequences.
For example, a donor establishes a NIMCRUT to pay the lesser of
trust income or a fixed percentage to the donor for a term of 15 years
or his life, whichever is shorter, and then to the donor's daughter for
her life. If the tables under section 7520 are used to value the
donor's retained interest and the donor's gift to the daughter, the
amount of the donor's gift to the daughter is relatively small compared
to the amount the daughter may actually receive. To illustrate, the
trustee may invest in assets that produce little or no trust income
while the donor retains the unitrust interest, creating a substantial
makeup amount. At the end of the donor's interest, the trustee alters
the NIMCRUT's investments to generate significant amounts of trust
income. The trustee then uses the income to pay to the donor's daughter
the current fixed percentage amount and the makeup amount, which
includes the makeup amount accumulated while the donor was the unitrust
recipient.
The use of a CRUT as described in the above example permits the
shifting of a beneficial interest in the trust from the donor to
another family member and, thus, creates an opportunity for
transferring property to a family member free of transfer tax that is
contrary to section 2702(a)(3)(A)(iii). Therefore, the proposed
regulations will amend Sec. 25.2702-1(c)(3) to provide that the
unitrust interests in a CRUT using an income exception method retained
by the donor or any applicable family member will be valued at zero
when someone other than (1) the donor, (2) the donor's spouse, or (3)
both the donor and the donor's spouse (who is a citizen of the U.S.) is
a noncharitable beneficiary of the trust. In these situations, the
value of the donor's gift is the fair market value of all the property
transferred to the CRUT. The present value of the remainder interest
passing to the charitable organization will qualify for the deduction
under section 2522. Accordingly, the amount used to calculate the
donor's gift tax liability is the value of the property transferred to
the trust less the value of the interest passing to charity.
Section 25.2702-1(c)(3) will continue to exclude from the
application of section 2702 transfers to pooled income funds described
in section 642(c)(5) and to CRATs and CRUTs that pay the unitrust
amount under the fixed percentage method.
B. Proposed Effective Date
This amendment is proposed to be effective for transfers in trust
made on or after May 19, 1997.
V. Prohibition on Allocating Precontribution Gain to Trust Income
A. General Explanation
When assets are transferred to a charitable remainder trust, the
amount of the donor's charitable deduction is generally based in part
on the fair market value of the property transferred to the trust.
Although an income exception CRUT provides a different method for
calculating the unitrust amount than a fixed percentage CRUT, any
charitable deduction for an income exception CRUT is calculated as if
the fixed percentage is distributed each year. Allocating amounts to
trust income that are part of the fair market value of the contributed
property on which the charitable deduction was based would be
inconsistent with Congress's intent to assure that the amount claimed
as a charitable deduction for the contribution to the trust relates to
the projected growth of the assets contributed less the expected
distributions to the income beneficiaries. H.R. Rep. No. 413, 91st
Cong., 1st Sess. 58-59 (1969), 1969-3 C.B. 200, 237-38; S. Rep. No.
552, 91st Cong., 1st Sess. 87 (1969), 1969-3 C.B. 423, 479. Therefore,
the 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 asset when contributed to the trust, must be allocated to
principal.
B. Proposed Effective Date
This amendment is proposed to be effective for sales or exchanges
after April 18, 1997. For sales or exchanges on or before the effective
date of this amendment, the Service will continue to challenge any
attempt to allocate precontribution gain to trust income as being
fundamentally inconsistent with applicable local law and with the
amount of the charitable deduction claimed.
VI. Example Illustrating Rule for Characterizing Distributions From
CRUTs
Section 664(b) contains the ordering rule used to determine the
character of the annuity or unitrust amount in the hands of the
recipient. The legislative history states that the ordering rule
applies to both CRATs and CRUTs. S. Rep. No. 552, 91st Cong., 1st Sess.
90 (1969), 1969-3 C.B. 423, 481. The ordering rule applies to the
unitrust amounts received from all CRUTs
[[Page 19076]]
regardless of the method used by the CRUT to determine the unitrust
amount.
Although the current regulations clearly provide that the ordering
rule of section 664(b) and Sec. 1.664-1(d)(1)(i) applies to all
unitrust amounts received from CRUTs, some practitioners have asked
whether the ordering rule applies to unitrust amounts paid under the
income exception methods. To provide taxpayers with additional
guidance, the proposed regulations add an example of how the ordering
rule operates when the unitrust amount is computed under an income
exception method.
VII. Request for Comments on Income Exception CRUTs Holding Certain
Investments
The IRS and Treasury are aware that taxpayers are using income
exception CRUTs to take advantage of the timing difference between the
receipt of trust income (as defined in section 643(b)) and income for
federal income tax purposes. For example, an income exception CRUT may
hold an interest in a partnership controlled by a trustee of the trust,
a grantor, a beneficiary, or a party related or subordinate to the
trustee, the grantor, or a beneficiary. In such a case, an interested
party controls when the trust will receive the earnings from its
partnership interest and, accordingly, when the unitrust recipient will
receive distributions from the trust. Although the income exception
CRUT has taxable income on its distributive share of partnership items,
the trust does not have trust income until it actually receives a
distribution of its share of the partnership's earnings.
The IRS and Treasury are studying whether investing the assets of
an income exception CRUT to take advantage of the timing difference
between the receipt of trust income and income for federal tax purposes
causes the trust to fail to function exclusively as a charitable
remainder trust. Therefore, the IRS and Treasury request comments on
drafting future guidance on this issue. Revenue Procedure 97-23, to be
published on April 28, 1997, in Internal Revenue Bulletin 1997-17,
provides that the IRS will not issue letter rulings on whether a trust
that will calculate the unitrust amount under section 664(d)(3)
qualifies as a section 664 charitable remainder trust when a grantor, a
trustee, a beneficiary, or a person related or subordinate to a
grantor, a trustee, or a beneficiary can control the timing of the
trust's receipt of trust income from a partnership or a deferred
annuity contract to take advantage of the difference between trust
income under section 643(b) and income for federal income tax purposes
for the benefit of the unitrust recipient.
Special Analyses
It has been determined that this notice of proposed rulemaking is
not a significant regulatory action as defined in EO 12866. Therefore,
a regulatory assessment is not required. It is hereby certified that
these regulations do not have a significant economic impact on a
substantial number of small entities. This certification is based upon
the fact that the recordkeeping requirement in these regulations does
not affect small entities. Therefore, a Regulatory Flexibility Analysis
under the Regulatory Flexibility Act (5 U.S.C. chapter 6) is not
required. Pursuant to section 7805(f) of the Internal Revenue Code,
this notice of proposed rulemaking will be submitted to the Chief
Counsel for Advocacy of the Small Business Administration for comment
on its impact on small business.
Comments and Public Hearing
Before these proposed regulations are adopted as final regulations,
consideration will be given to any comments that are submitted timely
to the IRS. All comments will be available for public inspection and
copying.
A public hearing has been scheduled for September 9, 1997, at 10
a.m. in the IRS Auditorium, Internal Revenue Building, 1111
Constitution Ave, NW., Washington DC. Because of access restrictions,
visitors will not be admitted beyond the Internal Revenue Building
lobby more than 15 minutes before the hearing starts.
The rules of 26 CFR 601.601(a)(3) apply to the hearing.
Persons who wish to present oral comments at the hearing must
submit comments by August 19, 1997, and submit an outline of the topics
to be discussed and the time to be devoted to each topic by August 19,
1997.
A period of 10 minutes will be allotted to each person for making
comments.
An agenda showing the scheduling of the speakers will be prepared
after the deadline for receiving outlines has passed. Copies of the
agenda will be available free of charge at the hearing.
Drafting Information: The principal authors of these proposed
regulations are Mary Beth Collins and Jeffrey A. Erickson, Office of
the Assistant Chief Counsel (Passthroughs and Special Industries), IRS.
However, personnel from other 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.
Proposed Amendments to the Regulations
Accordingly, 26 CFR parts 1 and 25 are proposed to be amended as
follows:
PART 1--INCOME TAXES
Paragraph 1. The authority 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), (d)(1)(iii), and (f)(4)
are added to read as follows (paragraph (f)(4) follows the concluding
text of paragraph (f)(3)):
Sec. 1.664-1 Charitable remainder trusts.
(a) * * *
(7) Valuation of unmarketable assets. If a trust has assets that
are not cash, cash equivalents, or marketable securities (within the
meaning of section 731(c) and the applicable regulations) and the
trustee is the grantor of the charitable remainder trust, a
noncharitable beneficiary, or a related or subordinate party to the
grantor or noncharitable beneficiary within the meaning of section
672(c) and the applicable regulations, the trustee must use 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), to value those
assets. A trustee who is not the grantor of the charitable remainder
trust, a noncharitable beneficiary, or a related or subordinate party
to the grantor or noncharitable beneficiary does not have to use a
current qualified appraisal from a qualified appraiser to value the
trust's assets.
* * * * *
(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
sections 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)(3), 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
[[Page 19077]]
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 effective for trusts created on or
after the date the final regulations are published in the Federal
Register. A trust whose governing instrument requires that an
independent trustee value the trust's unmarketable assets may be
amended or reformed to permit any trustee to value those assets if the
trustee uses 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), in the taxable years beginning on or after the date the final
regulations are published in the Federal Register.
* * * * *
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. The annuity amount must be paid to
the recipient no later than the close of the taxable year for which the
payment is due. The rules contained in this paragraph (a)(1)(i) are
effective 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)(c), (a)(1)(i)(d),
(a)(1)(i)(e), and (a)(1)(i)(f) are added.
3. The third sentence of paragraph (a)(1)(iv) is revised.
4. Paragraph (a)(1)(vi) is added.
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.
(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 (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. 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.
(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 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 if--
(1) At least 90 percent of the fair market value of the assets held
in the trust immediately after either the initial contribution or any
subsequent contribution (prior to the change in methods) to the trust
consists of unmarketable assets;
(2) The governing instrument provides that the change of method
described in this paragraph (a)(1)(i)(c) will be triggered by the
earlier of--
(i) The sale or exchange of a specified asset or group of assets
that was contributed to the trust on its creation; or
(ii) The sale or exchange of unmarketable assets if immediately
following the sale or exchange, the fair market value of any remaining
unmarketable assets total 50 percent or less of the total fair market
value of the trust's assets. For making this determination, the
remaining unmarketable assets must be valued as of the most recent
valuation date;
(3) The change of method described in this paragraph (a)(1)(i)(c)
takes effect at the beginning of the first taxable year following the
year in which the earlier of paragraph (a)(1)(i)(c)(2) (i) or (ii) of
this section occurs; and
(4) 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.
(5) For this paragraph (a)(1)(i)(c), unmarketable assets are assets
that are not cash, cash equivalents, or marketable securities as
defined in section 731(c) and the applicable regulations.
(d) Example. The following example illustrates the rules in
paragraph (a)(1)(i)(c) of this section:
Example. (i) On the creation of charitable remainder unitrust Y,
S contributes four assets--A, B, C, and D. A is a marketable
security under section 731(c) and the applicable regulations. B, C,
and D are unmarketable assets. The fair market value of B, C, and D
is at least 90 percent of the fair market value of all four assets
at the time of contribution.
(ii) The governing instrument of Y provides for calculating the
unitrust amount under the combination of methods described in
paragraph (a)(1)(i)(c) of this section. The initial method for
calculating the unitrust amount is the lesser of the amount of trust
income, as defined in paragraph (a)(1)(i)(b)(3) of this section, or
six percent of the net fair market value of the trust assets valued
annually. The unitrust amount also includes any amount of trust
income for any taxable year that exceeds six percent of the net fair
market value of the trust's assets valued annually to the extent the
total of the amounts paid in prior years was less than the total of
the amounts computed as six percent of the net fair market value of
Y's assets on the valuation dates. After the change in method, the
unitrust amount will equal six percent of the net fair market value
of Y's assets on the valuation dates.
(iii) The governing instrument provides that the change in
method will occur for the first taxable year beginning after both B
and C are sold or the year in which the trust has sold or exchanged
enough unmarketable assets so that the remaining unmarketable assets
total 50 percent or less of the fair market value of the trust's
assets, whichever occurs first.
[[Page 19078]]
(iv) In Year 3, the trustee of Y sells B, one of the three
unmarketable assets. After the sale of B, the fair market value of
all of Y's unmarketable assets is greater than 50 percent of the
fair market value of Y's assets. Therefore, in Year 3, the method
used to calculate the unitrust amount remains the initial method.
(v) In Year 4, the trustee sells D. After the sale of both B and
D, the fair market value of Y's unmarketable assets is 50 percent or
less of the fair market value of Y's assets. In Year 4, however, the
method used to calculate the unitrust amount remains the initial
method.
(vi) In Year 5 and for all subsequent years, the trust must pay
a unitrust amount equal only to six percent of the net fair market
value of Y's assets determined annually. The change in method occurs
in Year 5 because the fair market value of Y's unmarketable assets
totaled 50 percent or less of the fair market value of Y's assets
after the sale of both B and D. The change in method occurs even
though Y still owns C, the other unmarketable asset specified in the
governing instrument.
(vii) By the end of Year 4, Y's total trust income had been less
than the sum of the unitrust amounts based on six percent of the net
fair market value of Y's assets determined annually, leaving a
balance of $1,000. The $1,000 balance can never be distributed to
the unitrust recipient after the change to the fixed percentage
method.
(e) Payment under general rule. When the unitrust amount is
computed under paragraph (a)(1)(i)(a) of this section, the unitrust
amount must be paid to the recipient no later than the close of the
taxable year of the trust for which the payment is due.
(f) Payment under income exception. When the unitrust amount is
computed under paragraph (a)(1)(i)(b) of this section, the unitrust
amount may be paid to the recipient after the close of the taxable year
of the trust for which the payment is due if paid within a reasonable
time after the close of such taxable year. The 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 paragraph (a)(4) of this section) 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. For this paragraph (a)(1)(i)(f), 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.
* * * * *
(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. * * *
* * * * *
(vi) Effective date and reformations. (a) The rules in paragraph
(a)(1)(i)(a) of this section are effective for taxable years ending
after April 18, 1997.
(b) The rules in paragraphs (a)(1)(i) (c) and (d) of this section
are effective for charitable remainder unitrusts created on or after
the date the final regulations are published in the Federal Register.
If a trust was created before the effective date of paragraph
(a)(1)(i)(c) of this section and contains a provision allowing a change
in calculating the unitrust method, the trust may be amended or
reformed to comply with the provisions of paragraph (a)(1)(i)(c) of
this section. If a trust is created after the effective date of
paragraph (a)(1)(i)(c) of this section and contains a provision
allowing a change in calculating the unitrust method that does not
comply with the provisions of paragraph (a)(1)(i)(c) of this section,
the trust will continue to qualify as a charitable remainder unitrust
if it is amended or reformed to use the initial method for computing
the unitrust amount throughout the term of the trust. A qualified
charitable remainder unitrust created before or after the effective
date of paragraph (a)(1)(i)(c) of this section will not continue to
qualify as a charitable remainder unitrust if its governing instrument
is amended or reformed to add a provision allowing a change in the
method for calculating the unitrust amount.
(c) The rules in paragraphs (a)(1)(i)(b) (1), (2), and (3) of this
section are effective for taxable years ending after April 18, 1997 and
for sales or exchanges described in paragraph (a)(1)(i)(b)(3) of this
section that occur after April 18, 1997.
(d) The rules in paragraphs (a)(1)(i) (e) and (f) of this section
are effective for taxable years ending after April 18, 1997.
* * * * *
PART 25--GIFT TAX; GIFTS MADE AFTER DECEMBER 31, 1954
Par. 5. The authority 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 annuity
trust described in section 664(d) (2) if under the terms of the
governing instrument the unitrust amount is computed only under section
664(d)(2)(A); and a transfer to a charitable remainder unitrust
described in sections 664(d) (2) and (3) if the only permitted
recipients of the unitrust amount are the donor, the donor's spouse, or
both the donor and the donor's spouse who is a citizen of the United
States.
(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.
* * * * *
Margaret Milner Richardson,
Commissioner of Internal Revenue.
[FR Doc. 97-9810 Filed 4-17-97; 8:45 am]
BILLING CODE 4830-01-P
