Private Letter Rulings - Judicially Reformation of CRT Not Self-Dealing
GiftLaw Note:
B and C created a charitable remainder unitrust (CRUT) to benefit Organization. Attorney for Organization assisted B and C in the drafting of the trust. Due to a miscommunication regarding the liquidity of the assets used to fund the trust, Attorney drafted the trust as a net income plus makeup charitable remainder trust. B and C believed they were funding a fixed percentage CRUT and instructed their financial advisor, CPA and insurance advisor to administer the trust as a fixed percentage CRUT. Upon discovery that the trust was drafted incorrectly, B and C petitioned the state court for authorization to amend the trust due to the scrivener's error. B and C presented the court with affidavits from Attorney, Organization, as well as their professional advisors. All parties acknowledged the mistake and gave consent to amend the trust document. The state court agreed to order the amendment retroactive to the trust's inception, subject to a Private Letter Ruling from the Service stating that the proposed reformation would not violate the self-dealing rules of Sec. 4941.
Sec. 4941(a)(1) imposes an excise tax on acts of self-dealing between private foundations and disqualified persons. Sec. 4941(d)(1)(E) defines self-dealing as any direct or indirect transfer to, or the use by or for the benefit of, a disqualified person of the income or assets of a private foundation. Sec. 4946(a) of the Code defines the term "disqualified person" with respect to a private foundation as including a substantial contributor to the foundation (including the creator of a trust). However, under Sec. 4947(a)(2) of the Code, the self-dealing rules of Sec. 4941 do not apply to any amounts payable from a split-interest trust to income beneficiaries as long as no deduction was allowed for such income interest under Secs. 170(f)(2)(B), 2055(e)(2)(B), or 2522(e)(2)(B). The Service ruled that while B and C are disqualified persons as they are substantial contributors, they did not benefit from a larger charitable deduction that they otherwise would have with a fixed percentage CRUT. Furthermore, the Service was satisfied that the drafting of the net income plus makeup provisions was the result of a scrivener's error and did not benefit B and C to the detriment of Organization or the IRS. Therefore, no act or acts of self-dealing were found.
Sec. 4941(a)(1) imposes an excise tax on acts of self-dealing between private foundations and disqualified persons. Sec. 4941(d)(1)(E) defines self-dealing as any direct or indirect transfer to, or the use by or for the benefit of, a disqualified person of the income or assets of a private foundation. Sec. 4946(a) of the Code defines the term "disqualified person" with respect to a private foundation as including a substantial contributor to the foundation (including the creator of a trust). However, under Sec. 4947(a)(2) of the Code, the self-dealing rules of Sec. 4941 do not apply to any amounts payable from a split-interest trust to income beneficiaries as long as no deduction was allowed for such income interest under Secs. 170(f)(2)(B), 2055(e)(2)(B), or 2522(e)(2)(B). The Service ruled that while B and C are disqualified persons as they are substantial contributors, they did not benefit from a larger charitable deduction that they otherwise would have with a fixed percentage CRUT. Furthermore, the Service was satisfied that the drafting of the net income plus makeup provisions was the result of a scrivener's error and did not benefit B and C to the detriment of Organization or the IRS. Therefore, no act or acts of self-dealing were found.
This is in response to Trust's request dated September 27, 2007, and as supplemented in its February 11, 2009 letter, for a ruling that the proposed judicial reformation will not constitute an act of self-dealing as defined in section 4941 of the Internal Revenue Code (the "Code").
FACTS
The Trust was established by B and C, who are husband and wife, with the intention that it qualify as a fixed percentage charitable remainder unitrust ("FPCRUT"). The Trust was created with the assistance of an attorney. However, due to a drafting error, the Trust was drafted inadvertently as a net income makeup charitable remainder trust ("NIMCRUT") rather than as a FPCRUT. With the NIMCRUT, the Trust was drafted to limit payments from it to the income beneficiaries to the lesser of the Trust's net income or eight percent of the net fair market value of the Trust's assets, but allowed the trustee to distribute more than eight percent of the Trust's value in order to make up for distributions in prior years when the Trust's net income fell below that amount. However, B and C had desired that the Trust be and operate as a FPCRUT that would pay out a fixed percentage, in this case eight percent, of the value of the Trust's assets without regard to Trust's net income in any given year.
B and C submitted an affidavit from the manager of the operational department of the organization whose attorney that assisted in the Trust's creation which states that a misunderstanding as to the liquidity of the Trust's underlying assets lead to the drafting error. B and C also submitted affidavits regarding the error, as well as affidavits from their certified public accountant, financial advisor, and insurance advisor stating that the Trust was administered as an FPCRUT in accordance with their understanding of B and C's intent.
The Trust represents that no benefit has been received by B and C as a result of the mistaken administration of the Trust as a FPCRUT, and no tax benefit will be received by the requested reformation. The Trust also represents that B and C took no deductions under any provision of the Code for amounts payable to them pursuant to the terms of the Trust. In fact, the charitable contribution deduction taken by B and C upon the formation of and contribution of assets to the Trust was calculated based upon the administration of the Trust as a FPCRUT, which deduction is the same as the deduction that they would have claimed if the Trust was to be administered as a NIMCRUT. Also, if the Trust was administered as a NIMCURT, it would have paid out to the income beneficiaries approximately $600,000 less that it actually has. Therefore, if the Trust had been administered as a NIMCRUT rather than a FPCRUT, it would be worth approximately $600,000 more today.
All parties to the Trust, including the charitable beneficiaries, have consented in writing to the reformation of the Trust. Additionally, in order to correct the scrivener's error, and because the Trust is irrevocable, the trustee sought a state court order authorizing an amendment of the trust document. No parties objected to the proposed reformation. The court issued an order reforming the Trust to a FPCRUT, retroactively to your inception, subject to the Internal Revenue Service issuing a private letter ruling that the Trust's reformation will not disqualify it as a charitable remainder unitrust.
RULING REQUESTED
That the reformation of the Trust will not disqualify the Trust as a charitable remainder unitrust and will not constitute an act of self-dealing.
LAW
Section 4941(a)(1) of the Code imposes an excise tax on each act of self-dealing between a disqualified person and a private foundation.
Section 4941(d)(1)(E) of the Code defines the term "self-dealing" as any direct or indirect transfer to, or the use by or for the benefit of, a disqualified person of the income or assets of a private foundation.
Section 4946(a) of the Code defines the term "disqualified person" with respect to a private foundation as including a substantial contributor to the foundation (including the creator of a trust).
Section 4947(a)(2) of the Code provides, in pertinent part, that in the case of a trust which is not exempt from tax under section 501(a), not all of the unexpired interests of which are devoted to charitable purposes, and which has amounts in trust for which a charitable deduction was allowed, section 4941 and other provisions apply as if such trust were a private foundation.
Sections 53.4947-1 (c)(2) and 53.4947-1(c)(2)(ii), Example (1), of the Estate and Similar Excise Tax Regulations ("regulations") indicate, in pertinent part, that the payments of income under the term of the trust by a charitable remainder unitrust to its individual income beneficiaries do not result in any tax on self-dealing under section 4941 of the Code.
ANALYSIS
The analysis is two-fold in that we must first delve into whether the self-dealing rules of Chapter 42 of the Code apply to B and C in their roles as income beneficiaries. We must also determine if there are any self-dealing issues regarding whether B or C, as substantial contributors, are involved in any self-dealing transactions with regard to the Trust.
First, as a charitable remainder unitrust under section 664(d)(2) of the Code, the Trust is considered to be a split-interest trust as described in section 4947(a)(2). By virtue of being described in section 4947(a)(2), the Trust is subject to the provisions of section 4941, which impose an excise tax on acts of self-dealing. The involvement of disqualified persons in certain transactions with the Trust constitutes self-dealing under section 4941. Since B and C are substantial contributors to the Trust under section 4946, they are considered to be disqualified persons with respect to the Trust. Therefore, because the proposed judicial reformation of the Trust based on a drafting error may have the effect of increasing the annual amount payable to B and C, any such increase could be considered to be a transfer to, or use by, or for the benefit of, disqualified persons of income or assets of a private foundation and may be considered to be an act of self-dealing under section 4941.
However, under section 4947(a)(2) of the Code, the self-dealing rules of section 4941 do not apply to any amounts payable under the terms of a split-interest trust to income beneficiaries as long as no deduction was allowed for such income interest under section 170(f)(2)(B), 2055(e)(2)(B), or 2522(e)(2)(B) with respect to the income interest of any such beneficiary. The Trust represents that no deduction, under the above Code sections, was taken by B or C with respect to any amounts of income payable to them by the Trust. As a result, the self-dealing rules of section 4941 do not apply to B and C as income beneficiaries.
Regarding whether B and C as substantial contributors are subject to the self-dealing rules of section 4941 of the Code, the circumstances presented above indicate that there is no act of self-dealing, since we are satisfied that the signatory parties to the Trust never intended to create a NIMCRUT. Certain facts are indicative of this intent such as the fact that the signatory parties of the Trust submitted affidavits indicating that this was a drafting error as well as an affidavit from the organization whose attorney drafted the Trust. The Trust also submitted affidavits from B and C's certified public accountant, financial advisor, and insurance advisor stating that the Trust was administered as an FPCRUT in accordance with their understanding of B and C's intent. Furthermore, there is a lack of evidence that B and C are reducing their own taxes, or using the benefit of hindsight in making the change to FPCRUT. Moreover, if the Trust had been administered as a NIMCRUT rather than a FPCRUT, it would be worth approximately $600,000 more today.
RULING
The proposed judicial reformation of the Trust will not be an act of self-dealing under section 4941 of the Code.
Based solely on the information submitted and representations made, we conclude that your judicial reformation in accordance with the state court order does not constitute an act of self-dealing under section 4941 of the Code.
This ruling will be made available for public inspection under section 6110 of the Code after certain deletions of identifying information are made. For details, see enclosed Notice 437, Notice of Intention to Disclose. A copy of this ruling with deletions that we intend to make available for public inspection is attached to Notice 437. If you disagree with our proposed deletions, you should follow the instructions in Notice 437.
This ruling is directed only to the organization that requested it. Section 6110(k)(3) of the Code provides that it may not be used or cited by others as precedent.
This ruling is based on the facts as they were presented and on the understanding that there will be no material changes in these facts. This ruling does not address the applicability of any section of the Code or regulations to the facts submitted other than with respect to the sections described. Because it could help resolved questions concerning your federal income tax status, this ruling should be kept in your permanent records.
If you have any questions about this ruling, please contact the person whose name and telephone number are shown in the heading of this letter.
In accordance with the Power of Attorney currently on file with the Internal Revenue Service, we are sending a copy of this letter to your authorized representative.
Sincerely,
Manager
Exempt Organizations
Technical Group 3