Rev. Rul. 80-123

ISSUE

Must the governing instrument of a testamentary charitable remainder trust contain mandatory provisions conforming to section 1.664-1(a)(5) of the Income Tax Regulations in order for the charitable interest to qualify for an estate tax charitable deduction?

LAW AND ANALYSIS

Section 2055(e)(2)(A) of the Internal Revenue Code provides that if a remainder interest in property passes for a charitable purpose and an interest in the same property passes for a private purpose then, with certain limited exceptions, no charitable deduction is allowed for the charitable remainder interest unless the interest is in a trust which is a charitable remainder annuity trust or unitrust (described in section 664 of the Code) for a pooled income fund (described in section 642(c)(5)).

The transfer of a remainder interest in trust will qualify for an estate tax charitable deduction only if the interest is in a trust which is a charitable remainder trust at the date of death of the decedent and the charitable interest is susceptible of valuation on the date of the decedent's death. Section 20.2055-2(a) of the Estate Tax Regulations. Valuation of the charitable interest is based on the assumption that a specified unitrust or annuity amount will be distributed over a specified period of time determinable and beginning as of the date of death.

Section 1.664-1(a)(4) of the regulations provides that in order for a trust to qualify as a charitable remainder trust, it must satisfy the definition of and function exclusively as a charitable remainder trust from the creation of the trust. For purposes of section 664 the trust is deemed created at the earliest time that neither the grantor nor any other person is treated as owner of the trust corpus for income tax purposes, but in no event prior to the time that the trust is funded.

Notwithstanding the rule that for the tax exemption purposes of section 664 charitable remainder trusts are not deemed to be created until they are funded, section 1.664-1(a)(5) provides a special rule regarding the deemed creation date for federal estate tax purposes. This rule provides that for purposes of section 2055, the charitable remainder trusts are deemed to be created as of the date of death of the grantor, even though the trust is not yet funded and even though no payments will be made by the trust until the end of a reasonable period of estate administration at which time the trust will be funded. The rule allows a deferral in commencement of the annuity or unitrust payments provided the obligation to pay begins as of the date of death and local law or the governing instrument authorizes the delay. When the trust is fully funded, the trustee is required to pay out or receive whichever is appropriate, the difference between what, if anything, has been paid out and what should have been paid out during the interim between death and full funding.

The remainder of the section prescribes the method for retroactively determining the proper amounts payable, in the event the unitrust or annuity amount is deferred.

Rev. Rul. 72-395, 1972-2 C.B. 340, explains the requirements for charitable remainder trusts and sets forth sample provisions for drafting trust instruments. The requirements of section 1.664-1(a)(5) of the regulations are treated as an optional provision in sections 5.02 and 7.02 of Rev. Rul. 72-395.

The amount of the deduction allowed for charitable remainder trusts under section 2055(a) is computed as of the date of death. The computation assumes the trust is operative, and making payouts as of this date, and that any accretions to or invasions of trust corpus are being made as necessitated by the difference in the required payout and the actual income earned during this period.

In reality, these events do not occur until a later date when the trust is funded. State law governing the administration of trusts and estates normally would determine who is entitled to the income earned, during the period of administration of the estate, by the assets that will eventually fund the trusts. However, it is unlikely that application of state law will produce the same distributions, accretions and invasions presumed in the deduction computation.

In order to overcome these practical difficulties involved with testamentary trusts, the regulations created a special rule for estate tax purposes.

The provisions for corrective payments contained in section 1.664-1(a)(5) require, in effect, that the proper amount payable during the period of administration will be distributed, or any excess payment will be recovered. Thus, the provision ensures that the trust disbursements will be based on the same premises applied in the computation of the deduction. Applying these corrective payment rules makes the value of the charitable interest ascertainable and assures consistency in computing the amount of the deduction and the actual payments of the annuity or unitrust amounts. Deeming the trust to be created on the date of death satisfies the requirement of section 2055 that the trust be qualified as of the date of death.

Not only must a testamentary trust contain a deferral provision for purposes of section 2055 of the Code, but it also must contain a deferral provision for purposes of qualification as a charitable remainder trust under section 664 of the Code. If the deferral provision of section 1.664-1(a)(5) of the regulations is not included in the governing instrument of the trust, then, as explained above, no charitable deduction will be allowable, and, under section 1.664-1(a)(1)(iii)(a) of the regulations, the trust will not meet the definition of a charitable remainder trust. HOLDING

A governing instrument of a testamentary charitable remainder trust must contain mandatory provisions conforming to section 1.664-1(a)(5) of the regulations in order for the charitable interest to qualify for an estate tax charitable deduction; that is, the governing instrument must provide that the obligation to pay the unitrust or annuity amount begins on the date of death, and for corrective payments in the case of an underpayment or overpayment of the annuity or unitrust amount determined to be payable.

Rev. Rul. 72-395 is hereby modified to the extent that it implies that the provisions contained in section 1.664-1(a)(5) of the regulations are optional for testamentary charitable remainder trusts.

Pursuant to the authority contained in section 7805(b), the principles of this revenue ruling apply only in the case of transfers to testamentary charitable remainder trusts by decedents dying after May 5, 1980 (the date this revenue ruling appeared in the I.R.B.) except that they do not apply in the case of transfers under the terms of wills executed on or before May 5, 1980: (a) If the decedent dies after May 5, 1980, but before May 5, 1981, without having amended any dispositive provision of this will after May 5, 1980, by codicil or otherwise; (b) If the decedent dies after May 5, 1980, and at no time after that date had the right to change the portions of the will which pertain to the passing of the property to, or for the use of an organization described in section 2055(a); or (c) If no dispositive provision of the will is amended by the decedent, by codicil or otherwise, after May 5, 1980, and before May 5, 1981, and the decedent is on May 5, 1981, and at all times thereafter under a mental disability (as defined in section 1.642(c)-2(b)(3)(ii) of the Income Tax Regulations) to amend the will by codicil or otherwise.

EFFECT ON OTHER REVENUE RULINGS

Rev. Rul. 72-395 is modified.