Rev. Rul. 89-31

1989-1 C.B. 277, 1989-9 I.R.B. 32.

                       Internal Revenue Service

                                 Revenue Ruling

     CHARITABLE DEDUCTION; INTEREST PASSING DIRECTLY TO CHARITY; SETTLEMENT

                                   AGREEMENT

                          Published: February 27, 1989

Section 2055. - Transfers for Public, Charitable and Religious Uses, 26 CFR 20.2055-2: Transfers not exclusively for charitable purposes.

  Charitable deduction; interest passing directly to charity; settlement agreement. An estate is entitled to a charitable deduction under section 2055(a) of the Code for a remainder interest in a split interest trust passing directly to a named charity pursuant to a settlement of a will contest, where the split interest trust did not meet the requirements of section 2055(e)(2). Rev. Rul. 77-491 revoked and Rev. Rul. 78-152 modified.

  An individual died testate in 1987. Under the will, which was executed in 1986, the decedent bequeathed the residue of the estate to a trust under which the trust income was payable to the decedent's child for life with the remainder payable to a charity described in Code sections 170(c) and 2055(a). However, the charitable bequest did not comply with the requirements of section 2055(e)(2)(A) in that the trust was not either a charitable remainder annuity trust or a charitable remainder unitrust or a pooled income fund. Thus, the estate would not be entitled to a charitable deduction for the split interest remainder bequest. The decedent's child in good faith contested the validity of the will. As the result of a bona fide settlement of the child's challenge, the estate made an immediate payment of money to the child and distributed the balance of the residuary estate to the charity.

  ISSUE. At issue is whether the estate is entitled to a charitable deduction under section 2055 where, in settlement of a bona fide will contest, the estate makes an immediate payment to a qualifying charity in satisfaction of the charity's claim to a split interest remainder that would not have been deductible under section 2055(e)(2)(A).

  HOLDING. The estate is entitled to a charitable deduction under section 2055(a) for a remainder interest in a split interest trust passing directly to a named charity pursuant to a settlement of a bona fide will contest, even though the split interest trust did not meet the charitable deduction requirements of section 2055(e)(2). The Service revoked Rev. Rul. 77-491 and modified Rev. Rul. 78-152.

  ANALYSIS. In Rev. Rul. 77-491, 1977-2 C.B. 332, the Service concluded that a charitable deduction was not allowable when an accelerated outright payment was made to the charity in lieu of a nondeductible remainder interest. The Service reasoned that the accelerated payment to the charity was in effect a postmortem modification of the will that did not satisfy the requirement of section 2055(e)(3). In Rev. Rul. 78-152, 1978-1 C.B. 296, the Service found that a payment to a charity in settlement of a will contest was not deductible because the interest passing to a charity pursuant to a compromise of a will contest is deductible to no greater extent than the interest that would have passed had the charity prevailed in the will contest.

  However, courts have reached an opposite result in Flanagan v. U.S., 810 F.2d 930 (10th Cir. 1987); Estate of Strock v. U.S., 655 F. Supp. 1334 (W.D. Pa. 1987); and Northern Trust Co. v. U.S., 78-1 USTC para 13,229, 41 AFTR 2d 78-1523 (N.D. Ill. 1977). In each of these cases, a charity received an outright accelerated payment in lieu of a nondeductible remainder interest as the result of the settlement of a bona fide will contest. In each case, the court held that a deduction was allowable under section 2055(a) and that section 2055(e)(2)(A) did not apply, because the settlement did not create split interests.

  The Service has reconsidered the position taken in Rev. Rul 77-191, and the portion of Rev. Rul. 78-152 in support thereof, and concluded that it will no longer adhere to that position in view of these adverse court decisions. Accordingly, in situations involving settlements of bona fide will contests, the Service will no longer challenge the deductibility of immediate payments to charities solely on the ground that they were made in lieu of a split interest that would not constitute an allowable deduction under Code section 2055(e)(2). However, the Service cautioned that it will continue to scrutinize settlements of will contests to assure that the settlement in question is not an attempt to circumvent section 2055(e)(2) by instituting and settling a collusive contest.

ISSUE

  If, in settlement of a bona fide will contest, a decedent's estate makes an immediate payment to a qualifying charity in satisfaction of the charity's claim to a split interest remainder that would not be deductible under section 2055(e)(2)(A) of the Code, is the estate entitled to a charitable deduction under section 2055?

FACTS

  The decedent died testate in 1987. Under the will, which was executed in 1986, the decedent bequeathed the residue of the estate to a trust under which the trust income was payable to A for life with the remainder payable to B charity, an organization described in sections 170(c) and 2055(a) of the Code. A was the decedent's child.

  The bequest to B did not comply with the requirements of section 2055(e)(2)(A) of the Code. That section allows a deduction for a bequest of a remainder interest to a charity only if the remainder interest is in a trust that is a charitable remainder annuity trust or a charitable remainder unitrust (described in section 664) or a pooled income Fund (described in section 642(c)(5)).

  A in good faith contested the validity of the will. As the result of a bona fide settlement of A's challenge, the estate made an immediate payment of 100x dollars to A and distributed the balance of the residuary estate to B.

LAW AND ANALYSIS

  Section 2055(a) of the Code allows a deduction from the gross estate for the amount of all bequests, legacies, devises, or transfers to specified beneficiaries, including certain charitable institutions.

  Prior to the Tax Reform Act of 1969, a deduction generally was allowable for a charitable remainder if the value of the remainder interest was ascertainable and the possibility that the charitable transfer would not become effective was so remote as to be negligible. See section 20.2055-2(a) and (b) of the Estate Tax Regulations. Congress perceived that there was often no correlation between the allowable estate tax deduction and the amount ultimately received by the charity because the trustee might favor the income beneficiary over the charitable remainderman by methods such as the exercise of a power of invasion or by manipulating the trust's investments to maximize the income interest. Congress concluded that to correct these abusive situations the annual payment to the income beneficiary must be stated in terms of either of fixed dollar amount or as a fixed percentage of the value of the trust property each year. Section 2055(e)(2)(A) of the Code was enacted by the 1969 Act to achieve this result. See H.R. Rep. No. 413 (Part I), 91st Cong., 1st sees. (1969), 1969-3 C.B. 200, 237, and Estate of Gillespie v. Commissioner, 75 T.c. 374, 376-78 (1980). As amended, section 2055(e)(2)(A) provides, in part, that where a remainder interest in property passes or has passed from the decedent for a charitable purpose, and an interest in the same property passes or his passed from the decedent for a noncharitable use, no deduction is allowed under section 2055(a) unless the charitable remainder interest is in a trust that is a charitable remainder annuity trust or a charitable remainder unitrust (described in section 664) or a pooled income fund (described in section 642(c)(5)).

  Section 2055(e)(3) was added to the Code n 1974 and amended several time thereafter to establish relief procedures that allow governing instruments to be amended or reformed to comply with the requirements of section 2055(e)(2).

  Rev. Rul 77-491, 1977-2 C.B. 332, deals with a situation in which the decedent had executed two wills. Under each will a charity was to receive a remainder interest that would not have been deductible because the interest did not comply with the requirements of section 2055(e)(2)(A). As the result of the settlement of a will contest, the later will was probated, and the charitable remainderman received an accelerated outright payment in lieu of the remainder interest. The ruling concludes that a charitable deduction was not allowable under section 2055(a) of the code because the accelerated payment to the charity pursuant to the settlement was in effect a postmortem modification of the will that did not satisfy the requirement of section 2055(e)(3) of the Code that the charitable interest created be placed in a charitable remainder annuity trust, a charitable remainder unitrust, or a pooled income fund.

  Rev. Rul. 78-152, 1978-1 C.B. 296, discusses an additional reason for denying the deduction at issue in Rev. Rul. 77-491. Under Lyeth v. Hoey, 305 U.S. 188 (1938), a settlement payment is traceable to the rights that are the source of the compromise, and hence the interest passing to charity pursuant to a compromise of a will contest is deductible to no greater extent than the interest that would have passed had the contest proceeded to judgment and the charity prevailed in its maintenance or defense of the action. Therefore, a charitable deduction was not allowable with respect to the payment to the charity in Rev. Rul. 77-491 since it was in settlement of rights under one or the other of the two wills, and neither will provided for a charitable interest that was deductible under section 2055(e)(2)(a) of the Code.

  The Service has reconsidered the position taken in Rev. Rul. 77-491 and the portion of Rev. Rul. 78-152 in support thereof and has concluded that it will no longer adhere to that position in view of adverse decisions in Flanagan v. U.S., 810 F.2d 930 (10th Cir. 1987); Estate of Strock v. U.S. 655 F.Supp. 1334 (W.D. Pa. 1987); Northern Trust Co. v. U.S., 78-1 USTC para. 13,229, 41 AFTR 2d 78-1523 (N.D. Ill. 1977). In each of these cases a charity received an outright accelerated payment in lieu of a nondeductible remainder interest as the result of the settlement of a bona fide will contest. In each case it was held that a deduction was allowable under section 2055(a) of the Code, and that section 2055(e)(2)(A) of the Code did not apply because the settlement did not create split interests. In other words, section 2055(e)(2)(A) did not operate to disallow the deductions because the interests passing to the charitable and non-charitable beneficiaries were not interests in the same property. Once it has been determined that section 2055(e)(2) of the Code does not apply to a given case, it follows that section 2055(e)(3) of the Code is also inapplicable because the only purpose of the latter section is to allow remedial action to be taken when a deduction would other wise be disallowed by reason of the former section.

  In situations involving settlements of bona fide will contests the Service will no longer challenge the deductibility of immediate payments to charities solely on the ground that they were made in lieu of a split interest that would not constitute an allowable deduction under section 2055(e)(2) of the Code. However, settlements of will contests will continue to be scrutinized in order to assure that the settlement in question is not an attempt to circumvent section 2055(e)(2) by instituting and settling a collusive contest.

HOLDING

  If, in settlement of a bona fide will contest, a decedent's estate makes an immediate payment to a qualifying charity in satisfaction of the charity's claim to a split interest remainder that would not be deductible under section 2055(e)(2)(A) of the Code, the estate is entitled to a charitable deduction under section 2055.

DRAFTING INFORMATION

  The principal author of the revenue ruling is Laura Howell of the Office of Assistant Chief Counsel (Passthroughs and Special Industries). For further information regarding this revenue ruling contact Ms. Howell on (202) 566-9317 (not a toll-free call).

EFFECT ON OTHER REVENUE RULINGS

  Rev. Rul. 77-491 is revoked.

  Rev. Rul. 78-152 is modified.

Rev. Rul. 89-31, 1989-1 C.B. 277, 1989-9 I.R.B. 32.