Rev. Rul. 65-144

Advice has been requested as to the Federal gift and income tax consequences of certain transfers made by a donor under the following circumstances.

The donor taxpayer established an irrevocable trust. The trust agreement directs the trustees to distribute the net income to, or for the use or benefit of X for life, thereafter to Y for such time as he survives, and thereafter to Z for such time as he survives the survivor of the first two named persons. The trust will terminate upon the death of the survivor of the above-named income beneficiaries and, at that time, the then trust assets and accumulated or undistributed income, if any, are to be distributed to certain educational institutions and hospitals.

The trust agreement provides, in part, that the trustees shall hold and manage the turst estate with the following powers and authorities:

G. In their discretion to allocate to either principal or income or between them any and all taxes (especially capital gains taxes) which they may be required to pay on behalf of this trust estate; notwithstanding the local rule of construction, the Turstee shall have the power to determine whether any expense, charge, or loss is to be borne by income or principal, or partly by income and partly by principal.

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J. To apportion stock, extraordinary and liquidating dividends and profits on sales, received by them between income and principal in such manner as they may deem fit and to determine what constitutes such dividends. The Trustee shall not be bound by local practice or the provisions of the Uniform Principal and Income Act. His determinations shall be final and binding upon all parties concerned.

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N. If, as a result of any Treasury Ruling or provisions of the Internal Revenue Code or the Regulations promulgated thereunder, the pwers, authorities or discretions vested in the turstees herein are construed or considered to render the charitable remainder provided herein as nonseverable or not subject to specific ascertainment, the powers, authorities and discretions of the trustees are hereby revoked to the extent necessary to make them consistent and conform to said rulings, code provisions, or Regulations to the end that the charitable remainder provided herein shall be deductible for Federal Tax purposes.

Section 25.2522(a)-2(a) of the Gift Tax Regulations provides, in part, that if a trust is created or property is transferred for both a charitable and a private purpose, deduction may be taken of the value of the charitable beneficial interest only insofar as that interest is presently ascertainable, and hence severable from the noncharitable interest.

In Commissioner v. Frederic W. Procter , 142 Fed.(2d) 824 (1944), cert. denied, 323 U.S. 756 (1944), one of the issues involved the taxpayer's denial of liability for Federal gift tax because the trust indenture contained the following provision:

ELEVENTH: The settlor is advised by counsel and satisfied that the present transfer is not subject to Federal gift tax. However, in the event it should be determined by final judgment or order of a competent federal court of last resort that any part of the transfer in trust hereunder is subject to gift tax, it is agreed by all the parties hereto that in that event the excess property hereby transferred which is decreed by such court to be subject to gift tax, shall automatically be deemed not to be included in the conveyance in trust hereunder and shall remain the sole property of Frederic W. Procter free from the trust hereby created.

As to this issue, the United States Circuit Court of Appeals for the Fourth Circuit said, in part:

We do not think that the gift tax can be avoided by any such device as this. Taxpayer has made a present gift of a future interest in property. He attempts to provide that, if a federal court of last resort shall hold the gift subject to gift tax, it shall be void as to such part of the property given as is subject to the tax. This is clearly a condition subsequent and void because contrary to public policy. A contrary holding would mean that upon a decision that the gift was subject to tax, the court making such decision must hold it not a gift and therefore not subject to tax. Such a holding, however, being made in a tax suit to which the donees of the property are not parties, would not be binding upon them and they might later enforce the gift notwithstanding the decision of the Tax Court. It is manifest that a condition which involves this sort of trifling with the judicial process cannot be sustained.

The court held that the condition in the case was contrary to public policy for three reasons: first, it has the tendency to discourage the collection of tax by the public officials charged with its collection, since the only effect of an attempt to enforce the tax would be to defeat the gift; second, the effect of the condition would be to obstruct the administration of justice by requiring the courts to pass upon a moot question; and third, because the condition is to the effect that the final judgment of a court is to be held for naught because of the provision of an indenture necessarily before a court when the judgment is rendered.

In the instant case, under the provisions of paragraphs G and J of the trust agreement, it is clear that all or portions of the trust corpus may be diverted from charitable to noncharitable uses, and that, consequently, without the saving provisions of paragraph N of the trust agreement, none of the charitable beneficial interests are presently ascertainable, and hence severable, from the noncharitable interests within the meaning of section 25.2522(a)-2(a) of the regulations. It is further evident, by virtue of essentially the same basic considerations relied upon in the Procter case, that paragraph N of the trust agreement constitutes a mere attempt to impose a condition subsequent with respect to certain powers otherwise granted to the trustees therein named which is wholly void and ineffective in law because of being contrary to public policy.

Therefore, it is held that no deduction under sections 2522(a) and 170(c) of the Internal Revenue Code of 1954 may be allowed in the instant case with respect to the present worth of the charitable remainder interests in the trust estate for Federal gift and income tax purposes.