SERVICE PREVIEWS PROCEDURE FOR DETERMINING PRESENT VALUE OF ANNUITIES, LIFE INTERESTS, AND REMAINDER OR REVERSIONARY INTERESTS.

Notice 89-24

The purpose of this notice is to provide guidance to taxpayers in determining the present value of an annuity, an interest for life or for a term of years, or a remainder or reversionary interest under section 7520 of the Internal Revenue Code. The methods established under section 7520 and this notice apply for valuation purposes under several Code provisions that include sections 170, 642, 664, 2031, 2055, 2512, 2522, and 2624.

BACKGROUND

In general, actuarial factors used in determining the present value of an annuity, an interest for life, or a remainder or reversionary interest are, for federal estate, gift, and certain income tax purposes, based on two components: the life expectancy of a designated individual or individuals (the "mortality component") and the assumed rate of return (the "interest rate component"). Valuation factors for determining the present value of interests measured by a term certain are based on two components: a term of years component and an interest rate component. For gifts made before May 1, 1989, and for estates of decedents dying before that date, the mortality component is computed on the basis of Table 1 of United States Life Tables: 1969-71 and the interest rate component is assumed to be 10 percent per annum. Actuarial factors used in the valuation of interests that are measured by one life can be found in sections 1.642(c)-6(d)(3) and 1.664-4(b)(5) of the Income Tax Regulations, section 20.2031-7(f) of the Estate Tax Regulations, and section 25.2512-5(f) of the Gift Tax Regulations. Actuarial factors used in the valuation of interests that are measured by two lives are contained in Internal Revenue Service (Service) Publication 723E (12- 83), Actuarial Values II: Factors at 10 Percent Involving One and Two Lives. In addition, actuarial factors used in the valuation of charitable remainder unitrust interests and pooled income fund interests that are measured by two lives are contained in I.R.S. Publication 723C (9-84), Actuarial Values I: Valuation of Last Survivor Charitable Remainders, Part C, and I.R.S. Publication 723D (9-84) Actuarial Values I: Valuation of Last Survivor Charitable Remainders, Part D, respectively. The current method for determining actuarial factors, as described in this paragraph, is applicable to gifts made before May 1, 1989, and estates of decedents dying before May 1, 1989.

Section 5031 of the Technical and Miscellaneous Revenue Act of 1988 ((P.L. 100-647) 102 Stat. 3342) amended the Internal Revenue Code by adding section 7520. Generally, under section 7520, the value of an annuity, interest for life or for a term of years, or remainder or reversionary interest is determined under new tables that are to be prescribed by the Secretary. Section 7520 is applicable to gifts made after April 30, 1989, and to estates of decedents dying after that date.

INTEREST RATES AND SOURCE OF TABLES FOR TRANSFERS AFTER APRIL 30, 1989

With respect to the interest rate component, the new valuation tables under section 7520 of the Code are to be based, in part, on the interest rate that the Service announces monthly in a news release and publishes in a revenue ruling in the Internal Revenue Bulletin. This rate is 120 percent of the applicable federal midterm rate compounded annually (rounded to the nearest two-tenths of one percent) in effect under section 1274(d)(1) of the Code for the month in which the valuation date falls. For example, the applicable federal midterm interest rate for February 1989, as set forth in Rev. Rul. 89-15, 1989-6 I.R.B. 9, is 9.42 percent; 120 percent of this amount is 11.36 percent. Thus, if section 7520 were effective as of February 1, 1989 (instead of May 1, 1989), then the rate for February under section 7520 would be determined by rounding the rate of 11.36 to 11.4 percent.

With respect to the mortality component, the new valuation tables will be based on the most recent mortality experience available. The Service will publish these tables in publications that may be purchased from the Superintendent of Documents, United States Government Printing Office, Washington, D.C. 20404.

CHARITABLE CONTRIBUTIONS MADE AFTER APRIL 30, 1989

Section 7520(a) of the Code provides in part that, if an income, estate, or gift tax charitable contribution is allowed for any part of the property transferred, the taxpayer may use the federal midterm rate for the month of the transfer or for either of the 2 months preceding the month in which the valuation date falls. In the case of transfers of more than one interest in the same property, each interest must be valued on a basis consistent with the valuation of all other such interests. For example, if a taxpayer transfers property to a charitable remainder trust in October 1989, the taxpayer may use an interest rate based upon the federal midterm rate for August, September, or October 1989; however, the taxpayer must use the same rate for both the noncharitable lead interest and the charitable remainder interest. For charitable contributions made in May or June 1989, if the taxpayer elects to use the federal midterm rate for the preceding 2 months, which may include March and April, the valuation factors for March or April that involve the lives of one or more individuals will be computed on the basis of Table 1 of United States Life Tables: 1969-71 and interest at 120 percent of the applicable federal midterm rate for March or April. Thus, the March and April actuarial factors (in the case of contributions made in May or June) will not be based on the new mortality component.

Charitable contribution transfers and other transfers of partial interests in property actually made in March or April 1989 will continue to be valued with actuarial factors based solely on Table 1 of United States Life Tables: 1969-71 and an assumed interest rate of 10 percent per annum.

In the case of gifts made after April 30, 1989, and estates of decedents dying after that date, if no charitable deduction is allowable for any portion of the property transferred, then all interests therein must be valued on the basis of 120 percent of the applicable federal midterm rate for the month in which the transfer is made.

INITIAL GUIDANCE ON NEW VALUATION FACTORS

(a) VALUATION OF INTERESTS MEASURED BY A TERM CERTAIN AFTER APRIL 30, 1989

Although the Service publications setting forth the new tables of valuation factors are not yet available, many of these factors may be determined by taxpayers prior to issuance of the publications. Taxpayers who expect to make transfers after April 30, 1989, of partial interests in property measured by a term of years may find applicable term certain factors in commercially available financial publications that contain present value tables computed to six significant figures. Taxpayers may also compute the term certain valuation factors for valuing a remainder interest, an income interest, or an annuity interest. These computations are illustrated by the following examples:

EXAMPLE 1: COMPUTATION OF A REMAINDER INTEREST. Assume that a donor makes a gift of an interest in a trust for an 8-year term certain after April 30, 1989, and needs to value the remainder interest. Assume also that 120 percent of the applicable federal midterm rate for the month is 10.8 percent. The applicable factor for valuing a remainder interest based on a term of years may be determined by use of the following mathematical formula:

           Remainder Factor =  1

Based upon interest at 10.8 percent per annum, the present worth of $1.00 due at the end of 8 years is $0.440232. EXAMPLE 2: COMPUTATION OF AN INCOME INTEREST. Assume the same facts as in Example 1, except that the donor needs to value the income interest. The valuation factor for a term certain income interest may be computed by using this formula:

Income Factor = 1.000000 - Remainder Factor

Thus, if 120 percent of the applicable federal midterm rate for the month is 10.8 percent and the remainder factor as computed in Example 1, above, is .440232, the income factor for an income interest in a trust for a term of 8 years is 1.000000 minus .440232, which equals .559768.

EXAMPLE 3: COMPUTATION OF AN ANNUITY INTEREST. Assume that a donor makes a gift of an annuity interest for an 8-year term certain after April 30, 1989. Assume also that 120 percent of the applicable federal midterm rate for the month is 10.8 percent. The valuation factor for a term certain annuity interest may be computed by using this formula:

      Annuity Factor = Income Factor

Thus, if 120 percent of the applicable federal midterm rate for the month is 10.8 percent and the income factor, as computed in Example 2 above, is .559768, the valuation factor for an annuity interest for a term of 8 years is .559768 divided by 10.8 percent, which equals 5.1830.

Example 3 may be used to compute term certain valuation factors for charitable remainder annuity interests.

(b) VALUATION OF INTERESTS MEASURED BY ONE OR MORE LIVES IN THE CASE OF CHARITABLE CONTRIBUTIONS MADE IN MAY AND JUNE 1989

In valuing a charitable remainder interest in a transfer that is made to a pooled income fund after April 30, 1989, the federal midterm rate is disregarded. Instead, such interests are valued on the basis of the applicable yearly rate of return of the pooled income fund at the time of the transfer and the applicable mortality table. Taxpayers who plan to make charitable contributions to pooled income funds in May or June 1989 and who wish to rely on the actuarial factors that are applicable for the preceding 2 months, which may include March and April can, in the case of remainder interests that are measured by a single life, obtain the applicable factors from Table G of section 1.642(c)-6(d)(3) of the regulations. Thus, in the case of contributions in May or June, taxpayers are permitted to elect to use actuarial factors for the 2 months preceding the contribution, notwithstanding the fact that the federal midterm rate is disregarded in valuing pooled income funds.

EXAMPLE 4: COMPUTATION OF A REMAINDER INTEREST TRANSFERRED TO A POOLED INCOME FUND. Assume that in May 1989 a donor, aged 45, transfers property to a pooled income fund, retaining the income interest for life. Assume also, that at the time of the transfer, the highest yearly rate of return of the fund for its three preceding taxable years is 10.2 percent and 120 percent of the applicable federal midterm rate for one of the 2 months before May is 11.4 percent. The donor elects to value the transfer based on the prior mortality experience contained in Table G. The applicable yearly rate of return for the fund is used when valuing a remainder interest transferred to a pooled income fund. The applicable valuation factor is .11121 that is found in Table G under the column for 10.2 percent yearly rate of return. The value of the transferred interest multiplied by this factor represents the present worth of the remainder interest in property transferred by a donor, aged 45, to a pooled income fund having a yearly rate of return of 10.2 percent.

The valuation factors for valuing transfers to pooled income funds based on two lives are found in Table G(2) of Service Publication 723D (9-84), cited above.

Taxpayers who make qualifying charitable contributions in May or June 1989 of certain partial interests in property (other than contributions to charitable remainder unitrusts and pooled income funds) that are measured by a single life, and who wish to elect under section 7520(a), can obtain the applicable factors for March and April for valuing many such interests from Table G, cited above.

EXAMPLE 5: COMPUTATION OF A QUALIFYING REMAINDER INTEREST IN A FARM. Assume that a donor, aged 40, makes a gift to a charity of a remainder interest in farmland in May 1989. Assume, for purposes of illustration, that 120 percent of the applicable federal midterm rate for one of the 2 months before May, which the donor elects to use, is 11.4 percent. The applicable remainder interest actuarial factor, which may be found in Table G in the column listing factors for the yearly rate of return of 11.4 percent, is .06828. This is the present worth of $1.00 due at the death of a person aged 40 based on an interest rate of 11.4 percent.

Taxpayers who plan to make contributions of certain partial interests in property to charity after April 30, 1989, and who wish to value remainder interests that are measured by two lives may obtain the applicable factors for the months of March and April 1989 from Table G(2), cited above.

ADMINISTRATIVE PRONOUNCEMENT

This document serves as an "administrative pronouncement" as that term is described in section 1.6661-3(b)(2) of the regulations and may be relied upon to the same extent as a revenue ruling or revenue procedure.

DRAFTING INFORMATION

The principal author of this notice is William L. Blodgett of the Office of the Assistant Chief Counsel (Passthroughs and Special Industries). For further information about this notice, call Mr. Blodgett at (202) 377-9666 (not a toll-free call).