Apr 5, 2021 | Estate Planning Course Materials Journal


AM 2020-006

Estate Planning Updates: A Miscellany - By Kathleen R. Sherby & Larry Katzenstein - Presented by ALI CLE

There are so many defects in the plan examined in the Chief Counsel Memorandum released on June 26, 2020, that there is little to learn from it. But it is a fascinating read, for no other reason, than to marvel at how promoters of this plan could have gotten so deep into the promotion without understanding the basics of how a charitable remainder annuity trust (CRAT) works. The plan purported to be a way to avoid all tax on highly appreciated assets sold by the trust. The Memorandum noted that the same structure had been replicated numerous times by other promoters.

In brief, the plan envisioned a CRAT to be funded with interests in a closely held business or farmland, crops produced by the farmland, or both. The trust would provide for payment of the annuity by purchasing one or more single premium immediate annuities. In each taxable year of the trust, the trustee would pay to the beneficiary an annuity amount equal to the greater of 10 percent of the initial fair market value of the property transferred to the trust or the payments received by the trustee from one or more of the annuities. The plan seemed to assume that the capital gain generated from sale of the assets would sit forever untaxed in the trust as principal. Because part of the annuity payment would be tax-free return of investment in the contract under Internal Revenue Code section 72, only the tax-free income would ever be distributed to the beneficiary.

What’s wrong with this picture? First, a CRAT cannot pay the greater of 10 percent or payments received by the trustee from investments. A CRAT must pay an annuity, period. It can’t pay less than the annuity, and it cannot pay more than the annuity. But that is not the worst of it. The trust also provided that, in lieu of paying the remainder to charity, the trustee could at any time pay to the charitable organization a cash sum equal to 10 percent of the initial fair market value of the property, plus $100. At that point, the charity would have no further rights under the trust and would not receive the remainder at the end of the trust term. The promoters seemed to assume that this was permissible because section 664(d)(1)(D) mandates that the actuarial value of the remainder at inception be at least 10 percent of the initial fair market value of the trust. But clearly, this doesn’t work. Charitable remainder beneficiaries must receive the remainder. That seems pretty basic

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