Rev. Rul. 88-82

1988-2 C.B. 336, 1988-39 I.R.B. 37.

                       Internal Revenue Service

                                 Revenue Ruling

         CHARITABLE TRANSFERS; GUARANTEED ANNUITY CHARITABLE LEAD TRUST

                         Published: September 26, 1988

SECTION 2522. - CHARITABLE AND SIMILAR GIFTS, 26 CFR 25.2522(c)-3: Transfers not exclusively for charitable, etc., purposes in the case of gifts made after July 31, 1969

(Also Sections 170, 2055, 4947; 1.170A-6, 20.2055-2, 53.4947-2.)

  Charitable transfers; guaranteed annuity charitable lead trust. A gift tax charitable deduction is allowable under section 2522 of the Code for the value of a guaranteed charitable lead annuity where the income earned in any year in excess of the amount needed for the annuity is added to trust corpus. A similar deduction is not allowable where income earned in excess of the amount needed for the charitable annuity is paid currently to the noncharitable remaindermen.

  Rev. Rul. 88-82 involves two situations. In Situation 1, an individual created, in 1988, an irrevocable inter vivos trust that provided for the payment of a guaranteed annuity of 10-1/2 percent of the initial net fair market value of the trust's assets in eight equal annual installments to named charitable organizations. Annuity payments are to be made from income and, if necessary, from corpus. Income earned in any year in excess of that year's annuity payment is to be accumulated and added to the corpus. Although the trust instrument prohibits the trust from engaging in transactions that would give rise to tax under sections 4941, 4942, and 4945, it does not contain restrictions relating to the requirements of sections 4943 and 4944. At the expiration of the eight-year charitable annuity term, the balance of the trust estate is to be distributed in equal shares to the settlor's children per stirpes.

  Situation 2 involves a trust similar to that described in Situation 1, except that any income earned by the trust in any year in excess of the amount needed for the annuity payment is to be paid currently to the individuals named in the trust as remainderpersons.

  ISSUES. At issue is whether the settlor of the guaranteed annuity charitable lead trust with noncharitable remainderpersons may claim a section 2522 gift tax deduction where income earned in excess of the required annuity payment is added to corpus, even though the trust instrument does not contain restrictions relating to the requirements of sections 4943 and 4944. Also at issue is whether a gift tax deduction will be allowed where any income earned in excess of the amount needed for the annuity payment is paid currently to the noncharitable remainderpersons.

  HOLDINGS. The Service has held that, in Situation 1, the settlor is entitled to a charitable gift tax deduction under section 2522 for the value of the guaranteed annuity interest passing to charity. In Situation 2, however, the Service held that no gift tax deduction is allowable.

  ANALYSIS. The Service noted that section 4947(b)(3)(A) allows a trust to hurdle its lack of section 4943 or 4944 provisions if it meets certain distribution requirements. Those requirements are provided in regulation section 25.2522(c)-3(c)(2)(vi)(e), which requires, in effect, that either: (1) the guaranteed annuity interest payable to charity not exceed 60 percent of the aggregate fair market value of all amounts in the trust or (2) the trust instrument contains provisions that prohibit both the acquisition and the retention of assets that would give rise to tax under section 4944 if the trustee had acquired these assets. Since the trust did not contain the provisions necessary to meet the second prong of this test, the Service applied the first prong and found that the value of the guaranteed annuity interest is 56.02 percent of the trust corpus. Accordingly, the trust will qualify for a gift tax deduction.

  Turning to Situation 2, the Service concluded that the charitable interest would fail to qualify under regulation section 25.2522(c)- 3(c)(2)(vi)(f) because the excess earnings are to be paid to noncharitable remainderpersons before the expiration of the guaranteed annuity interest. Specifically, the Service based its holding on the grounds that: (1) the income interest of the trust is not devoted solely to charitable purposes and (2) the trust instrument does not contain any restrictions relating to the requirements of sections 4943 and 4944.

                                     ISSUES

  (1) If a guaranteed annuity charitable lead trust with noncharitable remaindermen adds to corpus any income earned in any year in excess of the amount needed for that year's annuity payment, is a gift tax charitable deduction allowable under section 2522 of the Internal Revenue Code even though the trust instrument does not contain restrictions relating to the requirements of sections 4943 and 4944?

  (2) Would the deduction be allowable if any income earned in excess of the amount needed for the annuity payment was paid currently to the noncharitable remaindermen?

                                     FACTS

  SITUATION 1. In 1988 A created an irrevocable inter vivos trust that provided for the payment of a guaranteed annuity of ten and one- half percent of the initial net fair market value of the trust's assets in equal installments to named initial and successor charitable organizations that are required to be ones described in sections 170(c)(2)(B), 2055(a)(2), and 2522(a)(2) of the Code at the time the guarantee annuity amount is distributed to them. Payment of the annuity amount will commence on the first anniversary of the date of funding of the trust and will continue for the first eight years following funding of the trust. The annuity payments are to be made from income and, if necessary, from corpus. Any income earned in any year in excess of the amount needed for that year's annuity payment is to be accumulated and added to corpus. The trust instrument contains provisions prohibiting the trust from engaging in acts that would give rise to tax under sections 4941, 4942, and 4945 of chapter 42. However, the trust instrument does not contain any restrictions relating to the requirements of sections 4943 and 4944. Further, the state where the trust was created has no statutes that would make sections 4943 and 4944 a part of the trust instrument. The trust will terminate upon expiration of the period during which the charitable annuity payments are to be made, and the balance of the trust estate will be distributed in equal shares to the settlor's children per stirpes. The trust was funded with shares of stock of a closely held family business.

  SITUATION 2. The facts in SITUATION 2 are the same as described in SITUATION 1, except that any income earned by the trust in any year in excess of the amount needed for the annuity payment is to be paid currently to the individuals named as the trust remaindermen.

                                LAW AND ANALYSIS

  Section 2522 of the Code provides for a deduction in computing gifts taxable under section 2501 for the value of property transferred to charitable organizations and for purposes described in section 2522(a). Under section 2522(c)(2)(B), if a donor transfers a term-for-years interest in property to a charitable organization and a remainder interest in the same property to a noncharitable beneficiary, no deduction is allowed for the interest passing to charity unless it is in the form of a guaranteed annuity or is a fixed percentage distributed annually of the fair market value of the property (to be determined annually).

  The Internal Revenue Code and regulations thereunder provide additional requirements that must be met before a deduction under section 2522 is allowable. Under section 25.2522(c)-3(c)(2)(vi)(f) of the Gift Tax Regulations, if a charitable interest in the form of a guaranteed annuity is in trust, the value of the charitable interest will be nondeductible if an amount such as excess income may be paid by the trustee for a private purpose before the expiration of the guaranteed annuity interest payable to charity.

  Section 4947(a)(2) of the Code provides generally that a non- exempt split- interest trust will be subject to sections 507, 508(e), 4941, 4943, 4944, and 4945 if a charitable income, estate, or gift tax deduction was allowed for any portion of the trust and if any of the unexpired interests in the trust are devoted to noncharitable purposes.

  Section 4947(b)(3)(A) of the Code provides, however, that sections 4943 and 4944 shall not apply to a trust if (i) all the income interest (and none of the remainder interest) of such trust is devoted solely to one or more purposes described in section 170(c)(2)(B), and (ii) the aggregate value of all amounts in such trust for which the deduction was allowed, under section 170, 545(b)(2), 556(b)(2), 642(c), 2055, 2106(a)(2), or 2522, does not exceed 60 percent of the aggregate fair market value of all amounts in such trust.

  Section 25.2522(c)-3(c)(2)(vi)(e) of the regulations requires in effect that either (1) the guaranteed annuity interest payable to charity not exceed 60 percent of the aggregate fair market value of all amounts in the trust, or (2) the trust instrument contain provisions that prohibit both the acquisition and the retention of assets that would give rise to a tax under section 4944 if the trustee had acquired such assets.

  In SITUATION 1, although trust income in excess of the guaranteed annuity payable to charity is to be added to trust corpus for distribution to noncharitable remaindermen upon expiration of the guaranteed annuity period, all of that excess income, along with any other property held by the trust, may be applied, if necessary, to pay the guaranteed annuity during the annuity's term and is not available for any private purpose during that term. Under these circumstances, none of the trust income is considered payable for a private purpose before expiration of the charitable income interest for purposes of section 25.2522(c)-3(c)(2)(vi)(f) of the regulations, and the amount payable to charity constitutes a guaranteed annuity under section 2522(c)(2)(B) of the Code.

  Further, under Table B of section 25.2512-5(f) of the regulations, which is to be used to compute the present value of a guaranteed annuity interest, the value of the interest at issue here is 56.02 percent of the trust corpus. This figure is computed as follows: ten and one-half percent (guaranteed annuity amount) x 5.3349 (8 year factor) x 1.00 (annual payment factor) equals 56.02 percent. Because this percentage does not exceed 60 and because the income interest of the trust is devoted solely for charitable purposes, the value of the guaranteed annuity payable to charity in SITUATION 1 is deductible under section 2522(a) even though the trust instrument contains no references to sections 4943 and 4944.

  In SITUATION 2, however, the amount payable to charity does not constitute a guarantee annuity interest under section 2522(c)(2)(B) of the Code. It fails to constitute such an interest because the trust income in excess of that required to pay the guaranteed annuity is payable to the individuals named as trust remaindermen prior to expiration of the guaranteed annuity interest. See section 25.2522(c)-3(c)(2)(vi)(f) of the regulations. Thus, even though the value of the charitable interest is less than 60 percent of the trust corpus, the value of the amount payable to charity in SITUATION 2 is not deductible under section 2522(a) for two reasons: (1) the income interest of the trust is not devoted solely to charitable purposes, and (2) the trust

instrument does not contain any restrictions relating to the requirements of sections 4943 and 4944.

                                    HOLDINGS

  In SITUATION 1, the settlor is entitled to a charitable gift tax deduction under section 2522 for the value of the guaranteed annuity interest passing to charity.

  The settlor is not entitled to a charitable gift tax deduction for assets used to fund the charitable annuity trust under the facts described in SITUATION 2.

                              DRAFTING INFORMATION

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

Rev. Rul. 88-82, 1988-2 C.B. 336, 1988-39 I.R.B. 37.