Sunday, November 22, 2015

Is the Charitable Deduction for Trusts Limited to Adjusted Basis?

No, says a U.S District Court.

An irrevocable trust received distributions from a partnership in one year and purchased property. In a later year it contributed the property to a qualified charity, after the property had appreciated in value. It took an income tax charitable deduction for the fair market value of the property.

Code Section 642(c)(1) allows for an income tax charitable for trusts. It reads:

[T]here  shall  be  allowed  as  a  deduction  in  computing  its  taxable
income  (in  lieu  of  the  deduction  allowed  by  section  170(a),  relating  to
deduction for charitable, etc., contributions and gifts) any amount of the gross
,  without  limitation,  which  pursuant  to  the  terms  of  the  governing
instrument is, during the taxable year, paid for a purpose specified in section
170(c)  (determined  without  regard  to  section  170(c)(2)(A))… (emphasis added)

The IRS argued that the “gross income” language (1) limits a trust’s deduction to the amount of gross income it contributed to charity; (2) gross income does not include unrealized appreciation; and (3) a liberal construction of the  statute  allowing  fair  market  valuation  would  negate  the  gross  income  derivative requirement. Thus, it sought to limit the deduction to the trust’s adjusted basis in the contributed property.

The District Court began its analysis by noting that the policy behind the charitable contribution is to encourage charitable deductions. This was not a good start for the IRS.

Another policy issue was that the IRS sought to apply the rule that an income tax deduction is a
matter of legislative grace and that the burden of clearly showing the right to the claimed deduction is on the taxpayer. While there is such a rule, the court noted statutes regarding charitable deductions are not matters of legislative grace, but rather “expression[s] of public policy.” As such, provisions regarding charitable deductions should be liberally construed in favor of the taxpayer.

The Court also noted a distinction between Section 642, and Section 170 (relating to charitable deductions for individuals). Unlike Section 170, Section 642 has no limiting language on the amount of the deduction, including limits relating to appreciation in contributed property. The Court perceived the IRS as seeking to impose limitations where Congress clearly declined to do so.

One of the IRS’ arguments was that the contribution had to be traced to gross income. While this is true, there is no requirement that the payment had to be traced to income from the same tax year as the contribution. So the fact that the property was purchased in a prior tax year with income from that year was not a problem. That the contribution was paid out of trust principal and not income was also not an issue – the Court found that such an argument conflated fiduciary accounting principles with the federal tax concept of gross income.

Since the case is not an appellate court case but only an interpretation of a District Court, the precedential value of the decision is limited. Given the substantial amounts at issue, the IRS may appeal.

Green v. U.S., U.S. District Court for the Western District of Oklahoma, Case No. CIV-13-1237-D (11-4-2015)

Thursday, November 19, 2015

Can Correction of a Scrivener’s Error Retroactively Fix a Tax Problem with a Trust?

Yes, in a recently released Private Letter Ruling in regard to an irrevocable trust.

There were actually two problems with the trust. First, the settlors retained powers to change the beneficial interests of the trust, creating an incomplete gift. Second, those retained powers also created a problem under Code Section 2036.

The trust was reformed in state court to create both a completed gift and to take away the retained powers that were problematic under Code Section 2036. The IRS allowed the reformation to implement the revised tax consequences, retroactive to the creation of the trust.

Does this mean that such corrections will always be respected retroactively by the IRS? A key requirement here was that the changes were made to effectuate the settlors’ original intent. This was evidenced by the other provisions of the trust agreement, and an affidavit by the attorney who drafted the trust. Absent those facts, it is unlikely that the IRS would have allowed such retroactive treatment – scrivener’s error or otherwise.

PLR 201544005

Sunday, November 15, 2015

Article Abstract - The New Estate Planning Lexicon: SUGRITs and Other Grantor-Retained Interest Step-Up Trusts


The New Estate Planning Lexicon: SUGRITs and Other Grantor-Retained Interest Step-Up Trusts




Journal of Taxation, November 2015



ABSTRACT (Key Points & Discussions)

    • Discusses alternative lifetime trusts for married couples that seek to allow for a basis-step up in trust property at death of first spouse, regardless of order of death, so as to achieve basis step-up parity at death of first spouse to spouses in community property jurisdictions. Referred to as GRISUTs - grantor retained interest step up trusts.
    • SUPRT - step up QPRT. A standard QPRT, but with one spouse (or his or her estate) as remainderman, and funding settlor spouse retaining an interest that continues until death of first spouse to die. Nonsettlor spouse provides for return of trust property to settlor in his or her own estate planning documents if nonsettlor spouse dies first. Allows for gift tax marital deduction to match remainder gift on formation, basis step-up regardless of order of death, and the marital deduction for estate tax purposes. It does not achieve any estate tax savings, unlike a regular QPRT.
    • SUGRIT - step up grantor retained income. This is a retained income trust set up by one spouse with the other spouse as remainderman, that does not meet the requirements for avoiding Section 2702(a) 100% gift treatment (i.e., unlike a QPRT). This leads to a partial taxable gift on formation and use of unified credit of settlor spouse, while again achieving full basis step up regardless of order of death. For couples who will likely not use up their full unified credit. But may also be of use to wealthier couples due to reasonable likelihood that use of unified credit on formation of the trust will be undone at death of the spouses.
    • Tangible personal property SUGRIT. This is similar to a QPRT such that unlike the SUGRIT discussed above there is no taxable gift or use of unified credit on formation per qualification as a remainder only gift under Section 2702. Only nondepreciable personal property can be used.
    • SUGRUT and SUGRAT. Uses qualified GRATs and GRATs to avoid an upfront gift by also qualifying as a remainder only gift under Section 2702. Useful for properties other than residences and qualified tangible personal property. One negative is that there may not be 100% estate inclusion and basis step-up if settlor spouse dies first.
    • The death of the remainderman spouse within one year of formation may not allow for a basis step-up under Section 1014(e).
    • The benefits and risks of each spouse creating a GRISUT for the other are discussed, including the application (and possible nonapplication) of the reciprocal trust doctrine.



Basis step up


An excellent overview of the key tax issues in using these trusts to achieve a favorable income tax benefit (in lieu of an estate tax benefit). Such trusts provide an alternative to similar "estate trusts" whereunder one spouse creates an inter vivos trust for the other spouse so as to achieve a basis step-up in trust property regardless of order of death - such estate trusts are different than those discussed in the article because the settlor spouse does not retain a direct interest in the trust. Note that both such trust arrangements need to go beyond tax issues and address divorce aspects, including who ends up with trust property upon divorce or subsequent death of a spouse, and how estate taxes will be paid if there is no marital deduction at the death of the first spouse.


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