Opinion ID: 76014
Heading Depth: 2
Heading Rank: 2

Heading: Deductibility of Charitable Remainders

Text: 8 A federal estate tax is imposed on the transfer of the taxable estate of every decedent who is a citizen or resident of the United States. I.R.C. § 2001(a) (West 2002). A deduction is generally available for that portion of the estate that is directly devised to charitable organizations. Id. § 2055(a)(2). When property or money is given directly to the charity at the death of the decedent, then the amount of a charitable deduction that may be taken by the estate is easily calculated. However, when a decedent donates a remainder interest in property to charity, the valuation of the charitable deduction becomes more difficult. The estate tax return might be filed before the charity's interest in the property becomes possessory and can be conclusively valued for purposes of claiming a charitable deduction. This temporal disconnect provides an avenue by which unscrupulous estates may claim a large charitable deduction, then manage the split-interest property in such a way that the benefit to the non-charitable beneficiaries is maximized, with the charity ultimately receiving much less value than that claimed as a deduction on the estate tax return. 9 Recognizing this problem, Congress strictly limited the deductibility of charitable remainders by requiring that such an interest pass to the charity in the context of a charitable remainder annuity trust (CRAT), a charitable remainder unitrust, or a pooled income fund. Id. § 2055(e)(2)(A). The trust in this case was established as a CRAT and does not fit the definition for the other two options. A CRAT, by statutory definition, is a trust 10 (A) from which a sum certain (which is not less than 5 percent of the initial net fair market value of all property placed in trust) is to be paid, not less often than annually, to one or more persons (at least one of which is not a [charitable organization] and, in the case of individuals, only to an individual who is living at the time of the creation of the trust) for a term of years (not in excess of 20 years) or for the life or lives of such individual or individuals, 11 (B) from which no amount other than the payments described in subparagraph (A) may be paid to or for the use of any person other than [a charitable organization], 12 (C) following the termination of the payments referred to in subparagraph (A), the remainder interest in the trust is to be transferred to, or for the use of, [a charitable organization] or is to be retained by the trust for such a use. 13 Id. § 664(d)(1) (West 1986) (amended 1997). 2 14 Paragraph (A) of the CRAT requirements limits the interest of the non-charitable beneficiaries to a yearly sum certain based on the initial fair market value of the trust's assets. This fixed interest eliminates the impetus for investments that maximize the non-charitable beneficiaries' interests, and, accordingly, prevents the redirection of trust assets away from the charitable remaindermen. As noted by the Tax Court, this requirement also ensures that the trust does not accumulate untaxed wealth for charities, which would sidestep the income distribution requirements for private foundations. See Atkinson, 115 T.C. at 32. The CRAT is required to pay the non-charitable annuity from the first year of its existence. Treas. Reg. § 1.664-2(a)(5) (as amended in 2001). 3 15 Paragraph (B) prohibits any disbursement of trust assets beyond the fixed annuity interests and the charitable remainder, again buttressing the charitable remainder and the correlative deduction. Should the trust leave open the possibility of making other payments beyond the annuity, it is disqualified as a CRAT. Treas. Reg. § 1.664-1(a)(6) (Example 3) (as amended in 2001). Each of these requirements attempts to make the valuation of the charitable remainder at the death of the grantor conform more closely to the actual interest that will one day pass to charity. 16 To preserve the estate's ability to claim a charitable deduction for a remainder interest in property, the trust must not only be set up as a CRAT, but it must also comply with the CRAT statutory requirements from its formation to the final disposition of the trust's assets. Treas. Reg. § 1.664-1(a)(4) (as amended in 2001). As noted by the IRS in this litigation, without the limitations ..., the intent of Congress in enacting [the CRAT rules] could be defeated by the creation of CRATs that have their documents in order but that fail to function as CRATs after their creation. Appellee's Brief, at 32.