SECTION 5. ANNOTATIONS REGARDING SAMPLE TESTAMENTARY CHARITABLE LEAD

UNITRUST

.01 Annotations for Introductory Paragraph of the Sample Trust .

(1) Income taxation of testamentary charitable lead trusts . A testamentary 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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(2) Deduction under § 642(c)(1) available for amounts paid for a charitable purpose . Under § 642(c)(1), a testamentary 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. 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 testamentary 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). (3) Charitable lead beneficiary requirements . A deduction is allowed under § 642(c)(1) for any amount of the gross income

of a testamentary 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). (4) Unrelated business taxable income . Under § 681, a testamentary charitable lead trust’s deduction under § 642(c)(1) is

disallowed 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). (5) Computation of estate tax charitable deduction . In general, the estate tax charitable deduction available under § 2055(e)(2)(B) with respect to contributions to a CLUT is equal to the present value of the unitrust interest. Section 20.2055–2(f)(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. If estate or other death taxes are paid from the assets used to fund a testamentary CLUT, the amount deductible under § 2055 is the amount that passes to charity, reduced by the amount of estate or death taxes paid. Section 2055(c). (6) 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.

.02 Annotations for Paragraph 1, Payment of Unitrust Amount, of the Sample Trust .

(1) Unitrust interest . To qualify for an estate tax charitable deduction, a 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). 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 decedent’s death and can be ascertained as of such date. Section 20.2055–2(e)(2)(vii)( a ). See section 5.02(4) for a discussion of the permissible term of a testamentary 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. Section 20.2055–2(e)(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 appropriate valuation date 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)(A) and § 53.4947–2(b)(1)(i). See § 20.2055–2(e)(2)(vii)( f ). These prohibitions are contained in the sample trust. See section 5.07 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 unitrust period, provided that the value of the unitrust interest is ascertainable at the time of the decedent’s death. 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. See

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section 5.03 for a discussion of the deferral of the requirement to pay the unitrust amount until the end of the taxable year in which the trust is completely funded. (3) Rule against perpetuities . An interest payable for a specified term of years may qualify as a unitrust 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 measuring lives who are selected to maximize, rather than limit, the term of the trust. Section 20.2055–2(e)(2)(vii)( a ). (4) Permissible term . Paragraph 1, Payment of Unitrust Amount, of the sample trust 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 decedent’s spouse and an individual who, with respect to all remainder beneficiaries (other than charitable organizations described in § 170 or 2055), 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 decedent’s date of death. Section 20.2055–2(e)(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 decedent’s estate from receiving a charitable deduction if the trust instrument provides for the selection by the trustee of a charitable beneficiary described in §§ 170(c) and 2055(a). Rev. Rul. 78–101, 1978–1 C.B. 301. See section 6.02 for an alternate provision that provides the trustee with the power to apportion the unitrust amount among charitable beneficiaries. See section 6.03 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 1, Payment of Unitrust Amount, of the sample trust 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 ). 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 § 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 provides for the retention of excess income by the trust. If, instead, the governing instrument provides for the payment of excess income to or for the use of the charitable beneficiary, no additional estate tax charitable deduction is available for the excess amounts of income distributed to the charitable beneficiary. See § 20.2055–2(e)(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 transfer tax consequences of the payment of excess income to a noncharitable beneficiary. See section 5.07 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. Section 20.2055–2(e)(2)(vii)( e ). See section 5.07 for the private foundation rules applicable to charitable lead trusts. (9) Valuation date . Paragraph 1, Payment of Unitrust Amount, of the sample trust 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 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. Section 20.2055–2(e)(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 and (ii) the proration of the unitrust amount in a short taxable year and the last taxable year of the unitrust period. (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).

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.03 Annotations for Paragraph 2, Deferral Provision, of the Sample Trust .

(1) Deferral of requirement to pay unitrust amount . The deferral provision in paragraph 2 of the sample trust authorizes the

trustee to defer the payment of the unitrust amount until the end of the taxable year of the trust in which the trust is completely funded. (2) Interest on unitrust payments . The deferral provision in paragraph 2 of the sample trust provides for the payment of interest,

compounded annually, with respect to any underpayment of the unitrust amount during the period of estate administration. The sample trust requires that interest be computed at the § 7520 rate in effect on the date of the decedent’s death. To the extent that interest payable under state law exceeds the applicable § 7520 rate, the payment of interest at the rate prescribed by state law will be deemed to satisfy the interest payment requirement set forth in the trust instrument.

.04 Annotation for Paragraph 3, Proration of Unitrust Amount, of the Sample Trust .

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

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

.05 Annotation for Paragraph 4, Distribution Upon Termination of Unitrust Period, of the Sample Trust .

(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 decedent/donor of 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.

.06 Annotation for Paragraph 5, Additional Contributions, of the Sample Trust .

(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 CLUT that permits additional contributions will not qualify for safe harbor treatment under this revenue procedure.

.07 Annotation for Paragraph 6, Prohibited Transactions, of the Sample Trust .

(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 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 be removed from the trust instrument. Section 4947(b)(3) and §§ 53.4947–2(b)(1)(i) and 20.2055–2(e)(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.

.08 Annotation for paragraph 7, Taxable Year, of the Sample Trust .

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

.09 Annotation for paragraph 10, Investment of Trust Assets, of the Sample Trust .

(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.

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