TRUSTEE'S DISCRETION TO PREPAY CHARITABLE 'LEAD' ANNUITY PREVENTS DEDUCTION FOR DONATED INTEREST.

Rev. Rul. 88-27

ISSUE

Does a charitable "lead" annuity interest qualify as a guaranteed annuity interest under section 2522(c)(2)(B) of the Internal Revenue Code if the trustee has the discretion to commute and prepay the charitable interest prior to the expiration of the specified term of the annuity?

FACTS

In 1986, A, the donor, transferred $1,000x to an irrevocable trust. The terms of the trust provide that an annuity of $60x per year is to be paid for a period of 10 years to X Charity, a corporation described in section 2522(a) of the Code. Upon the expiration of the 10 year period, the trust is to terminate and the remaining corpus is to be paid to A's child, B. Under the terms of the trust, the trustee is granted the discretion to use trust income or principal to commute and prepay the future annuity payments due X Charity. The trust instrument also provides that the prepayment amount shall be based on the discount rate and methodology used to calculate the present value of annuity payments under the Code and the Gift Tax Regulations in effect at the time of the prepayment.

LAW AND ANALYSIS

Section 2522(a) of the Code provides, in part, that in computing taxable gifts, a deduction is allowed for the amount of all transfers to or for the use of a corporation organized and operated exclusively for charitable purposes.

Section 2522(c)(2) of the Code provides, in part, that where a donor transfers an interest in property to or for a charitable purpose and an interest in the same property passes to or for a noncharitable use, then no deduction is allowed under section 2522(a) unless the charitable transfer is in certain prescribed forms.

Section 2522(c)(2)(B) of the Code provides, in part, that, in the case of a charitable "lead" interest (i.e., any interest, other than a remainder interest, transferred for the use described in section 2522(a)), the interest must be in the form of a guaranteed annuity.

Section 25.2522(c)-3(c)(2)(vi)(a) of the regulations, in part, defines a guaranteed annuity as an arrangement under which a determinable amount is paid, at least annually, for a specified term. An amount is determinable if the exact amount which must be paid under the conditions specified in the instrument of transfer can be ascertained as of the date of the gift. On the other hand, that subdivision of the regulations provides, by means of an example, that an amount is not determinable if the payments may be redetermined after the date of the gift by reference to a fluctuating index which cannot be determined as of the date of the gift.

The issue presented in this case is whether A's transfer to X Charity satisfies the definition of a guaranteed annuity.

Under section 2522(c)(2)(B) of the Code and section 25.2522(c)- 3(c)(2)(vi)(a) of the regulations, a guaranteed annuity must, at least, satisfy the following two requirements: (1) the annuity must represent the right to receive periodic payments over a specified period of time, and (2) the exact amount payable under the annuity must be determinable as of the date of the gift.

Although the charitable annuity created by A provides for the payment to charity of $60x a year for 10 years, the charitable annuity is subject to prepayment at the discretion of the trustee. The amount of any prepayment is determined on a commuted basis at a date subsequent to the date of transfer. Under these circumstances, the interest does not represent the right to receive periodic payments over a specified period of time because the number of payments will be a function of whether, and to what extent, the trustee decides to prepay the charitable annuity. Similarly, the exact amount payable cannot be determined as of the date of the gift because the amount of each payment will be dependent on whether the trustee decides to prepay.

Therefore, A's transfer to charity is not a guaranteed annuity interest within the meaning of section 2522(c)(2)(B) because the charity does not have the right to receive periodic payments over a specified term and the periodic payments that the charity is entitled to receive are not determinable in amount as of the date of the gift.

HOLDING

If the trustee has the discretion to commute and prepay the charitable "lead" annuity interest prior to the expiration of the specified term of the annuity, the interest does not qualify as a guaranteed annuity interest under section 2522(c)(2)(B) of the Code, and under section 2522(a), no deduction is allowed for the amount of the transfer to charity.

The result would be the same even if the trust instrument provided that the prepayment amount were to be calculated using the discount rate and methodology used to calculate the present value of annuity payments under the Code and regulations in effect on the date the annuity was established, because the exact amount payable to charity can not be determined as of the date of the gift.

DRAFTING INFORMATION

The principal author of this revenue ruling is George Masnik of the Individual Tax Division. For further information regarding this revenue ruling contact Mr. Masnik on (202) 566-3466 (not a toll-free call).