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Sunday, May 21, 2006

KEEP THOSE CHARITABLE TRUSTS SEGREGATED

If an individual leaves property to a qualified charity at their death, this will generally qualify for the estate tax charitable deduction (and thus the property so transferred will not be subject to federal estate tax). This applies even if the property is to be held in trust for the charity instead of an outright transfer. However, if persons or entities who are not charities are also beneficiaries of the trust, a "split-interest" trust will be created. For transfers to the trust to qualify for the estate tax charitable deduction (in whole or in part), the split-interest trust must have special provisions that do not apply to nonsplit-interest trusts established for charity.

In Galloway, Edmond C. v. U.S., 97 AFTR 2d 2006-XXXX, (DC PA 5/9/06), the decedent left a portion of his assets in a residuary trust. The residuary trust was divided into four shares - two for individuals and two for charitable entities. Distributions made to the individuals would not be made from the charitable shares, and thus could not reduce the amounts passing to charity. The estate took a charitable deduction (presumably limited to the amounts funded into the two charitable portions). The IRS disallowed the deduction, asserting that the trust was a classic split interest, where an interest in the same property passes to both charitable and noncharitable beneficiaries.”

The estate argued first that while there was technically only one trust, the division into four shares really created four trusts and thus the individuals had no interests in the charitable trusts. The District Court rejected this argument, citing similar prior cases when the form of creating separate trusts was not followed and thus resulted in the application of the split-interest trust rules.

The estate then argued that the split-interest trust rules should not apply since the policy of those rules was not implicated under the current facts. The District Court rejected this, noting that there was no ambiguity in the statute that would open the door to a policy/intent of the statute analysis.

In the end, the District Court applied the split-interest rules and denied the charitable deduction. The lesson for draftsman is simple - make sure that when trusts are being created in an estate plan for both individuals and charities, that true separate trusts are created for the charities (separate and apart from any interests held for noncharitable beneficiaries).
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