SECTION 5. ANNOTATIONS — Internal Revenue Bulletin 2007-29

LEAD ANNUITY TRUST

.01 Annotations for Introductory Paragraph and Paragraph 1, Funding of Trust, of the Sample Trust in Section 4 .

(1) Types of charitable lead trusts . An inter vivos charitable lead trust may be established as either a grantor charitable lead

trust or a nongrantor charitable lead trust. The sample trust in section 4 is an example of a nongrantor charitable lead trust. The sample trust in section 7 is an example of a grantor charitable lead trust. (2) Income taxation of nongrantor charitable lead trusts . A nongrantor CLAT is a complex trust that is taxable as a separate

entity under the provisions of subchapter J of the Code. The trustee of the trust must apply for a tax identification number for the trust. (3) Deduction under § 642(c)(1) available for amounts paid for a charitable purpose . Under § 642(c)(1), a nongrantor CLAT

is allowed a deduction in computing its taxable income for any amount of gross income, without limitation, that under the terms of the trust instrument is paid for a purpose specified in § 170(c) (determined without regard to § 170(c)(2)(A)) during the taxable year. This deduction is in lieu of the charitable deduction allowed by § 170. Section 642(c)(1) and § 1.642(c)–1(a). An amount paid to a corporation, trust, or community chest, fund, or foundation otherwise described in § 170(c)(2) shall be considered paid for a purpose described in § 170(c) even though the corporation, trust, or community chest, fund, or foundation is not created or organized in the United States, any state, the District of Columbia, or any possession of the United States. Section 1.642(c)–1(a)(2). With regard to amounts of income paid to the charitable beneficiary after the close of the taxable year in which the income was received (but on or before the last day of the next succeeding taxable year), the trustee of a nongrantor CLAT may elect to take the charitable deduction for that payment for the year in which the income was received, rather than for the year in which the payment was made. Section 642(c)(1). The election is made by filing a statement with the income tax return for the taxable year in which the charitable contribution is treated as paid. See § 1.642(c)–1(b). (4) Charitable lead beneficiary requirements . A deduction is allowed under § 642(c)(1) for any amount of the gross income of a

nongrantor CLAT that is paid for a purpose specified in § 170(c). Note that the class of permissible charitable recipients for obtaining a deduction under § 642(c)(1) differs from the class of permissible charitable recipients for obtaining a deduction under § 170(a). Compare § 170(c) and § 1.642(c)–1(a)(2). (5) Unrelated business taxable income . Under § 681, a nongrantor charitable lead trust’s deduction under § 642(c)(1) is disal lowed in any year to the extent that the deduction is allocable to the trust’s unrelated business taxable income, as defined in § 512, for that taxable year. See § 1.681(a)–2. However, a partial deduction is allowed under § 512(b)(11) for amounts allocable to unrelated business taxable income. Section 512(b)(11). See § 512(b)(12) and § 1.681(a)–2(a). (6) Computation of estate and gift tax charitable deductions . In general, the estate and gift tax charitable deductions available

under §§ 2055(e)(2)(B) and 2522(c)(2)(B) with respect to contributions to a CLAT are equal to the present value of the annuity interest. Section 7520 requires that an annuity interest must be valued using tables published by the Service. The method for valuing a charitable lead annuity interest is set forth in the regulations. See §§ 20.7520–2 and 25.7520–2. (7) Trustee provisions . The trust instrument may name alternate or successor trustees and/or may include a process for the

appointment of unnamed alternate or successor trustees. In addition, the trust instrument may contain certain administrative provisions relating to the trustee’s duties and powers.

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(8) Identity of donor . For purposes of qualification under this revenue procedure, the donor may be an individual or a husband

and wife. Appropriate adjustments should be made to the introductory paragraph if a husband and wife are the donors. Terms such as “grantor” or “settlor” may be substituted for “donor.”

.02 Annotations for Paragraph 2, Payment of Annuity Amount, of the Sample Trust in Section 4 .

(1) Guaranteed annuity . To qualify for the applicable estate and gift tax charitable deductions, a nongrantor CLAT must pro vide for the payment of a guaranteed annuity amount at least annually to a qualified charitable organization for each year during the annuity period. See §§ 2055(e)(2)(B) and 2522(c)(2)(B). A guaranteed annuity is an arrangement under which a determinable amount is paid periodically, but not less often than annually, for a specified term of years or for one or more measuring lives. See section 5.02(4) for a discussion of the permissible term of a nongrantor CLAT. An amount is determinable if the exact amount that must be paid under the conditions specified in the instrument of transfer may be ascertained at the time of the transfer to the trust. Sections 20.2055–2(e)(2)(vi)( a ) and 25.2522(c)–3(c)(2)(vi)( a ). A charitable interest expressed as the right to receive an annual payment from a trust equal to the lesser of a sum certain or a fixed percentage of the trust assets (determined annually) is not a guaranteed annuity interest. See §§ 20.2055–2(e)(2)(vi)( b ) and 25.2522(c)–3(c)(2)(vi)( b ). In addition, a charitable lead annuity interest is not a guaranteed annuity interest if the trustee has the discretion to commute and prepay the charitable interest prior to the termination of the annuity period. Rev. Rul. 88–27, 1988–1 C.B. 331. If a charitable interest in the form of a guaranteed annuity interest is in trust and the present value of the charitable interest on the date of gift exceeds 60 percent of the aggregate value of all amounts in the trust, the charitable interest will not be considered a guaranteed annuity interest unless the governing instrument of the trust prohibits the acquisition and retention of assets that would give rise to a tax under § 4943 or 4944, as modified by §§ 4947(a)(2) and 4947(b)(3). Sections 20.2055–2(e)(2)(vi)( e ) and 25.2522(c)–3(c)(2)(vi)( e ). These prohibitions are contained in the sample trust in section 4. See section 5.06 for a further discussion of the 60 percent test. See section 6.04 for an alternate provision that provides for an annuity amount stated as a specific dollar amount. (2) Payment requirements . CLATs are not subject to any minimum or maximum payout requirements. The governing instru ment of a CLAT must provide for the payment to a charitable organization of a fixed dollar amount or a fixed percentage of the initial net fair market value of the assets transferred to the trust. Alternatively, the governing instrument of a CLAT may provide for an annuity amount that is initially stated as a fixed dollar or fixed percentage amount but increases during the annuity period, provided that the value of the annuity amount is ascertainable at the time the trust is funded. The annuity payments may be made in cash or in kind. If the trustee distributes appreciated property in satisfaction of the required annuity payment, the trust will realize capital gain on the assets distributed to satisfy part or all of the annuity payment and the trust will be allowed a § 642(c)(1) deduction for the realized capital gains. Rev. Rul. 83–75, 1983–1 C.B. 114. (3) Rule against perpetuities . An interest payable for a specified term of years may qualify as a guaranteed annuity interest

even if the governing instrument contains a savings clause intended to ensure compliance with a rule against perpetuities. However, any such savings clause must utilize a period of vesting of not more than 21 years after the deaths of the measuring lives who are selected to maximize, rather than limit, the term of the trust. Sections 20.2055–2(e)(2)(vi)( a ) and 25.2522(c)–3(c)(2)(vi)( a ). (4) Permissible term . Paragraph 2, Payment of Annuity Amount, of the sample trust in section 4 provides for payment of the

annuity amount for a specified term of years. Alternatively, the trust instrument may provide for payment of the annuity amount for the life or lives of one or more measuring lives or for the life or lives of one or more measuring lives plus a term of years. Rev. Rul. 85–49, 1985–1 C.B. 330. Only one or more of the following individuals may be used as measuring lives: the donor, the donor’s spouse, and an individual who, with respect to all remainder beneficiaries (other than charitable organizations described in § 170, 2055, or 2522), is either a lineal ancestor or the spouse of a lineal ancestor of those beneficiaries. Each person used as a measuring life for the annuity period must be living on the date assets are transferred to the trust. Sections 20.2055–2(e)(2)(vi)( a ) and 25.2522(c)–3(c)(2)(vi)( a ). See section 6.01 for an alternate provision that provides for an annuity period based on the life of an individual. (5) Permissible recipients . A CLAT must have one or more charitable lead beneficiaries. The failure to designate a specific

charitable beneficiary will not preclude the donor from receiving a charitable deduction if the trust instrument provides for the selection by the trustee of a charitable beneficiary described in §§ 170(c), 2055(a), and 2522(a). Rev. Rul. 78–101, 1978–1 C.B. 301. If it is determined that a deduction under § 2055(a) will not be necessary in any event, all references to § 2055(a) in the trust instrument may be deleted. Note, that if the donor is serving as trustee of the trust, the trustee’s power to select the charitable beneficiaries will cause the gift of the annuity interest to be incomplete for gift tax purposes and may cause some or all of the trust property (depending on the date of the donor’s death) to be included in the donor’s gross estate. See §§ 2035(a), 2036(a)(2), and 2038(a)(1) and § 25.2511–2(c). Further note that if the charitable beneficiary is a private foundation and the donor is an officer or director of the private foundation or possesses certain decision making authority in the private foundation, some or all of the trust property may be included in the donor’s gross estate. See § 2036(a)(2). See section 6.02 for an alternate provision that provides for a donor’s retained right to substitute the charitable beneficiary.

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See section 6.03 for an alternate provision that provides the trustee with the power to apportion the annuity amount among charitable beneficiaries. (6) Payment of annuity amount in installments . Paragraph 2, Payment of Annuity Amount, of the sample trust in section 4

specifies that the annuity amount is to be paid in equal quarterly installments at the end of each calendar quarter. Alternatively, the trust instrument may specify that the annuity amount is to be paid in annual or other equal or unequal installments throughout the year. See §§ 20.2055–2(e)(2)(vi)( a ) and 25.2522(c)–3(c)(2)(vi)( a ). The amount of the charitable deduction will be affected by the frequency of the payment, by whether the installments are equal or unequal, and by whether each installment is payable at the beginning or end of the period. See §§ 25.2512–5 and 20.2031–7. (7) Excess income . Trust income in excess of the amount required to pay the annuity may be retained by the trust or distributed

currently to the charitable beneficiary. The sample trust in section 4 provides for the retention of excess income by the trust. If, instead, the governing instrument of a nongrantor charitable lead trust provides for the payment of excess income to or for the use of the charitable beneficiary, no additional estate or gift tax charitable deductions are available for the excess amounts of income distributed to the charitable beneficiary. See §§ 20.2055–2(e)(2)(vi)( d ) and 25.2522(c)–3(c)(2)(vi)( d ). However, the trust is entitled to a charitable income tax deduction under § 642(c)(1) for any amounts of excess income paid to the charitable beneficiary. See Situation 2 of Rev. Rul. 88–82, 1988–2 C.B. 336, for the gift tax consequences of the payment of excess income to a noncharitable beneficiary. See section 5.06 for the private foundation rules applicable to charitable lead trusts. (8) Payment of part of annuity for private purposes . In general, no part of a charitable lead annuity interest may be payable

for a private purpose before the expiration of all charitable lead annuity interests. However, there are two exceptions to this rule. The first exception arises when the amount payable for a private purpose is in the form of a guaranteed annuity interest and the trust’s governing instrument does not provide for any preference or priority in the payment of the private annuity as opposed to the charitable annuity. The second exception arises when, under the trust’s governing instrument, the amount that may be paid for a private purpose is payable only from a group of assets that is devoted exclusively to private purposes and to which § 4947(a)(2) is inapplicable by reason of § 4947(a)(2)(B). Note that an amount is not deemed to have been paid for a private purpose if it was paid for full and adequate consideration in money or money’s worth. Sections 20.2055–2(e)(2)(vi)( f ) and 25.2522(c)–3(c)(2)(vi)( f ). See section 5.06 for the private foundation rules applicable to charitable lead trusts.

.03 Annotation for Paragraph 3, Proration of Annuity Amount, of the Sample Trust in Section 4 .

(1) Prorating the annuity amount . Paragraph 3, Proration of Annuity Amount, of the sample trust in section 4 provides for the

proration of the annuity amount in any short taxable year, including the last year of the annuity period.

.04 Annotation for Paragraph 4, Distribution Upon Termination of Annuity Period, of the Sample Trust in Section 4 .

(1) Generation-skipping transfer tax . If a CLAT has or may have a skip person, as defined in § 2613(a), as a remainder benefi ciary, the transfer to the trust will be subject to the generation-skipping transfer (GST) tax. Under § 2651(f)(3), a charitable organization is deemed to be in the same generation as the donor to a charitable lead trust. Therefore, the GST potential of a charitable lead trust is dependent upon whether any noncharitable beneficiary is a skip person. GST tax liability is determined by multiplying the taxable amount by the applicable rate. The applicable rate is the inclusion ratio multiplied by the maximum federal estate tax rate. Section 2641(a). The rules for determining the inclusion ratio for a CLAT are set forth in § 2642(e), and confirm that the inclusion ratio is determined at the termination of the annuity period, rather than on the funding of the trust.

.05 Annotation for Paragraph 5, Additional Contributions, of the Sample Trust in Section 4 .

(1) Additions to the trust . For purposes of qualification under this revenue procedure, the trust instrument must contain a

provision that prohibits additional contributions. A CLAT that permits additional contributions will not qualify for safe harbor treatment under this revenue procedure.

.06 Annotation for Paragraph 6, Prohibited Transactions, of the Sample Trust in Section 4 .

(1) Prohibitions against certain investments and excess business holdings . Prohibitions against retaining any excess business

holdings within the meaning of § 4943, as modified by §§ 4947(a)(2) and 4947(b)(3), and against investments that jeopardize the exempt purpose of the trust within the meaning of § 4944, as modified by §§ 4947(a)(2) and 4947(b)(3), are generally required. The sample trust in section 4 contains prohibitions against §§ 4943 and 4944 transactions. If the present value of the charitable interest does not exceed 60 percent of the aggregate value of all amounts in the trust, the trust instrument does not provide for the payment of any of the income interest to a noncharitable beneficiary, and the trust instrument

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does not provide for the payment of excess income to a noncharitable beneficiary, the references to §§ 4943 and 4944 may be removed from the trust instrument. Section 4947(b)(3) and §§ 53.4947–2(b)(1)(i), 20.2055–2(e)(2)(vi)( e ), and 25.2522(c)–3(c)(2)(vi)( e ). See section 5.02(7) for a discussion of the payment of excess trust income to a noncharitable beneficiary. See section 5.02(8) for a discussion of the payment of part of the annuity for a private purpose.

.07 Annotation for paragraph 7, Taxable Year, of the Sample Trust in Section 4 .

(1) Calendar year . The taxable year of a charitable lead trust must be a calendar year. Section 644(a).

.08 Annotation for paragraph 10, Investment of Trust Assets, of the Sample Trust in Section 4 .

(1) Capital gains . Gains from the sale or exchange of capital assets may be allocated to the income or the principal of the trust.

If the governing instrument is silent, capital gains are allocated in accordance with local law. Even if gains are allocated to principal, they will be deductible under § 642(c)(1) if they are paid to the charitable beneficiary as part of a charitable annuity payment. Rev. Rul. 83–75, 1983–1 C.B. 114.

.09 Annotation for paragraph 11, Retained Powers and Interests, of the Sample Trust in Section 4 .

(1) Trust not a grantor trust . Paragraph 11, Retained Powers and Interests, of the sample trust in section 4 prohibits any person

from holding any power or possessing any interest that would cause the donor to be treated as the owner of the trust under subpart E, part I, subchapter J, chapter 1, subtitle A of the Code. This prohibition should be included only in nongrantor charitable lead trusts. See section 7 for a sample grantor charitable lead annuity trust.