SECTION 5. ANNOTATIONS — Internal Revenue Bulletin 2008-30

LEAD UNITRUST

.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 CLUT 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.

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(3) Deduction under § 642(c)(1) available for amounts paid for a charitable purpose . Under § 642(c)(1), a nongrantor CLUT

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 CLUT 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 CLUT 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 CLUT are equal to the present value of the unitrust interest. Sections 20.2055–2(f)(1) and 25.2522(c)–3(d)(1). Section 7520 requires that a unitrust interest must be valued using tables published by the Service. The method for valuing a charitable lead unitrust 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. (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 Unitrust Amount, of the Sample Trust in Section 4 .

(1) Unitrust interest . To qualify for the applicable estate and gift tax charitable deductions, a nongrantor CLUT must provide

for the payment of a unitrust amount at least annually to a qualified charitable organization for each year during the unitrust period. See §§ 2055(e)(2)(B) and 2522(c)(2)(B). A unitrust interest is the right pursuant to the instrument of transfer to receive payment, not less often than annually, of a fixed percentage of the net fair market value, determined annually, of the property that funds the unitrust interest. Payments of a unitrust interest may be paid for a specified term or for the life or lives of certain individuals, each of whom must be living at the date of the transfer and can be ascertained as of such date. Sections 20.2055–2(e)(2)(vii)( a ) and 25.2522(c)–3(c)(2)(vii)( a ). See section 5.02(4) for a discussion of the permissible term of a nongrantor CLUT. An interest is a unitrust interest only if it is a unitrust interest in every respect. For example, if an interest is 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 net fair market value of the trust assets (determined annually), the interest is not a unitrust interest. Sections 20.2055–2(e)(2)(vii)( b ) and 25.2522(c)–3(c)(2)(vii)( b ). See Rev. Rul. 77–300, 1977–2 C.B. 352. In addition, an interest is not a unitrust interest if the trustee has the discretion to commute and prepay the interest prior to the termination of the unitrust period. Rev. Rul. 88–27, 1988–1 C.B. 331. If a charitable interest in the form of a unitrust 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 unitrust 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). Section 4947(b)(3) and § 53.4947–2(b)(1)(i). See §§ 20.2055–2(e)(2)(vii)( f ) and 25.2522(c)–3(c)(2)(vii)( f ). These prohibitions are contained in the sample trust in section 4. See section 5.06 for a further discussion of the 60 percent test. (2) Payment requirements . CLUTs are not subject to any minimum or maximum payout requirements. The governing instru ment of a CLUT must provide for the payment to a charitable organization, not less often than annually, of a fixed percentage of the net fair market value of the assets of the trust, valued annually. Alternatively, the governing instrument of a CLUT may provide for a unitrust amount that is initially stated as a fixed percentage amount but increases or decreases during the

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unitrust period, provided that the value of the unitrust interest is ascertainable at the time the trust is funded. The unitrust payments may be made in cash or in kind. If the trustee distributes appreciated property in satisfaction of the required unitrust payment, the trust will realize capital gain on the assets distributed to satisfy part or all of the unitrust 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 unitrust interest even if the gov erning 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 measuring lives who are selected to maximize, rather than limit, the term of the trust. Sections 20.2055–2(e)(2)(vii)( a ) and 25.2522(c)–3(c)(2)(vii)( a ). (4) Permissible term . Paragraph 2, Payment of Unitrust Amount, of the sample trust in section 4 provides for payment of the

unitrust amount for a specified term of years. Alternatively, the trust instrument may provide for payment of the unitrust 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 unitrust period must be living on the date assets are transferred to the trust. Sections 20.2055–2(e)(2)(vii)( a ) and 25.2522(c)–3(c)(2)(vii)( a ). See section 6.01 for an alternate provision that provides for a unitrust period based on the life of an individual. (5) Permissible recipients . A CLUT 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 unitrust interest to be incomplete for gift tax purposes and will 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. See section 6.03 for an alternate provision that provides the trustee with the power to apportion the unitrust amount among charitable beneficiaries. See section 6.04 for an alternate provision that provides for the designation of an alternate charitable beneficiary in the trust instrument. (6) Payment of unitrust amount in installments . Paragraph 2, Payment of Unitrust Amount, of the sample trust in section 4

specifies that the unitrust amount is to be paid in equal quarterly installments at the end of each calendar quarter. Alternatively, the trust instrument may specify that the unitrust amount is to be paid in annual or other equal or unequal installments throughout the year. See §§ 20.2055–2(e)(2)(vii)( a ) and 25.2522(c)–3(c)(2)(vii)( 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 unitrust amount 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)(vii)( d ) and 25.2522(c)–3(c)(2)(vii)( 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 unitrust for private purposes . In general, no part of a charitable lead unitrust interest may be payable for a

private purpose before the expiration of all charitable lead unitrust 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 unitrust interest and the trust’s governing instrument does not provide for any preference or priority in the payment of the private unitrust as opposed to the charitable unitrust. 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)(vii)( e ) and 25.2522(c)–3(c)(2)(vii)( e ). See section 5.06 for the private foundation rules applicable to charitable lead trusts. (9) Valuation date . Paragraph 2, Payment of Unitrust Amount, of the sample trust in section 4 specifies that the net fair market

value of trust assets is to be valued as of the first day of each taxable year of the trust. However, the value of the trust assets may be determined on any one date during the taxable year of the trust, or by taking the average of valuations made on

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more than one date during the taxable year of the trust, so long as the same valuation date or dates and the same valuation methods are used each year. If the governing instrument does not specify the valuation date or dates, the trustee must select the date or dates and indicate the selection on the first Form 1041, U.S. Income Tax Return for Estates and Trusts, that the trust must file. Sections 20.2055–2(e)(2)(vii)( a ) and 25.2522(c)–3(c)(2)(vii)( a ). Note that if the valuation date is a date other than the first day of each taxable year of the trust, it may be necessary to modify the provisions in the sample trust regarding: (i) the timing of the payment of the unitrust amount; (ii) the proration of the unitrust amount in a short taxable year and the last taxable year of the unitrust period; and (iii) additional contributions. (10) Ordering rules . A provision in the governing instrument of a charitable lead trust that provides for the payment to charity

to consist of different classes of income determined on a non pro rata basis will not be respected because such a provision does not have economic effect independent of the income tax consequences of the payment. See § 1.642(c)–3(b)(2) and (3).

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

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

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

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

(1) Generation-skipping transfer tax . The generation-skipping transfer (GST) tax may apply if a CLUT has or may have a

skip person, as defined in § 2613(a), as a remainder beneficiary. 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). Note that the rules set forth in § 2642(e) for determining the inclusion ratio of certain charitable lead trusts do not apply to CLUTs.

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

(1) Identity of additional contributors . For purposes of qualification under this revenue procedure, only a donor or a donor’s

estate may make an additional contribution to the trust. See section 5.01(8) of this revenue procedure for examples of who may be a donor of a CLUT. (2) Option to prohibit additional contributions . Paragraph 5, Additional Contributions, of the sample trust in section 4 provides

rules for determining the unitrust amount payable in a year during which an additional contribution is made to the trust. However, paragraph 5 of the trust instrument may instead be drafted to prohibit contributions to the trust after the initial contribution. (3) Proration of additional contributions . Paragraph 5, Additional Contributions, of the sample trust in section 4 provides a

formula for determining the unitrust amount in each year that an additional contribution is made to the CLUT. The formula incorporates a proration provision for additions made in a short taxable year. (4) Valuation date in year of additional contribution . Paragraph 2, Payment of Unitrust Amount, of the sample trust in section

4 specifies a January 1 valuation date for the trust. The formula contained in paragraph 5, Additional Contributions, of the sample trust may be used when January 1 or any other single date during the taxable year is selected as the valuation date for a CLUT. Note, however, that if a single date other than January 1 is selected as the valuation date for a CLUT, the formulas in both paragraphs 2 and 5 of the sample trust for computing the unitrust amount will be deficient unless the trust instrument addresses the possibility that the unitrust period may end before the valuation date, for instance, by providing that in a year in which the unitrust period ends before the valuation date, the valuation date for purposes of paragraph 2 and paragraph 5 shall be the last day of the unitrust period. In addition, if the trust instrument is drafted to provide for the valuation of trust assets by averaging the valuations as of multiple specified dates during the trust year, the additional contributions formula must be modified.

.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 does not provide for the payment of excess income to a noncharitable beneficiary, the references to §§ 4943 and 4944 may

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be removed from the trust instrument. Section 4947(b)(3) and § 53.4947–2(b)(1)(i). See §§ 20.2055–2(e)(2)(vii)( f ) and 25.2522(c)–3(c)(2)(vii)( f ). 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 unitrust 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 unitrust 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 CLUT.