SCOTUS Reports

Tag: Charitable Remainder Unitrust

  • Estate of Schaefer v. Comm’r, 145 T.C. 134 (2015): Valuation of Charitable Remainder Interests in Net Income with Makeup Charitable Remainder Unitrusts

    Estate of Arthur E. Schaefer, Deceased, Kathleen J. Wells, Executor v. Commissioner of Internal Revenue, 145 T. C. 134 (U. S. Tax Court 2015)

    In a significant ruling, the U. S. Tax Court held in Estate of Schaefer v. Commissioner that the valuation of charitable remainder interests in net income with makeup charitable remainder unitrusts (NIMCRUTs) must use the fixed percentage specified in the trust instrument, not the actual net income distributed. This decision impacts how estates calculate charitable contribution deductions, potentially reducing the value of such deductions when the fixed percentage exceeds the trust’s income.

    Parties

    The petitioner, Estate of Arthur E. Schaefer, with Kathleen J. Wells as the executor, sought a charitable contribution deduction from the respondent, the Commissioner of Internal Revenue, regarding two irrevocable charitable remainder trusts established by the decedent.

    Facts

    Arthur E. Schaefer established two irrevocable charitable remainder unitrusts (CRUTs) in 2006, each designed to benefit one of his sons during their lifetimes or a term of years, with the remainder passing to a charitable organization. The trusts were structured as net income with makeup charitable remainder unitrusts (NIMCRUTs), where the trustees were required to distribute the lesser of each trust’s annual income or a fixed percentage (11% for Trust 1 and 10% for Trust 2) of the net fair market value of the trust assets. If trust income exceeded the fixed percentage, additional distributions could be made to cover prior years’ shortfalls. After Mr. Schaefer’s death in 2007, his estate sought a charitable contribution deduction for the value of the charitable remainder interests in these trusts.

    Procedural History

    The estate filed a Form 706, United States Estate (and Generation-Skipping Transfer) Tax Return, but did not initially claim a charitable contribution deduction for the trusts. Following an IRS audit, a notice of deficiency was issued on March 7, 2011, denying the estate’s claim for a charitable contribution deduction on the grounds that the trusts did not meet the statutory requirement that the charitable remainder interest be at least 10% of the net fair market value of the contributed property. The estate timely petitioned the U. S. Tax Court for review. The case was submitted fully stipulated under Tax Court Rule 122, and the court focused on the issue of the appropriate distribution amount for calculating the charitable remainder interest value.

    Issue(s)

    Whether the value of the charitable remainder interest in a net income with makeup charitable remainder unitrust (NIMCRUT) should be calculated using the fixed percentage stated in the trust instrument or the trust’s actual net income for determining the estate’s eligibility for a charitable contribution deduction under I. R. C. § 664(d)(2)(D)?

    Rule(s) of Law

    Under I. R. C. § 664(d)(2)(D), for an estate to claim a charitable contribution deduction for the remainder interest in a CRUT, the value of the remainder interest must be at least 10% of the net fair market value of the property contributed to the trust. I. R. C. § 664(e) provides that the remainder interest of a CRUT shall be computed on the basis that an amount equal to 5 percent of the net fair market value of its assets (or a greater amount, if required under the terms of the trust instrument) is to be distributed each year.

    Holding

    The U. S. Tax Court held that the value of the charitable remainder interest in a NIMCRUT must be calculated using the fixed percentage stated in the trust instrument (11% for Trust 1 and 10% for Trust 2) rather than the trust’s actual net income for determining the estate’s eligibility for a charitable contribution deduction under I. R. C. § 664(d)(2)(D).

    Reasoning

    The court found I. R. C. § 664(e) to be ambiguous in describing how to value the charitable remainder interest in a NIMCRUT, where actual distributions could be less than the fixed percentage. The court looked to legislative history and administrative guidance for interpretation. The Senate report accompanying the Tax Reform Act of 1969 indicated that the fixed percentage should be used for valuation purposes despite the net income limitation. The IRS’s consistent administrative guidance in Rev. Rul. 72-395 and Rev. Proc. 2005-54 further supported this interpretation. The court determined that this approach, although potentially undervaluing the remainder interest if the trust produced insufficient income, was consistent with the legislative intent to prevent manipulation of trust investments to favor income beneficiaries over charitable remainder beneficiaries. The court rejected the estate’s argument that the trust’s expected income based on the section 7520 rate should be used for valuation purposes, finding no statutory basis for this approach.

    Disposition

    The court sustained the Commissioner’s determination denying the estate’s claim for a charitable contribution deduction, as the stipulated facts indicated that the trusts did not meet the 10% requirement when valued using the fixed percentage method. The decision was to be entered under Tax Court Rule 155.

    Significance/Impact

    This decision clarifies the valuation methodology for charitable remainder interests in NIMCRUTs, requiring the use of the fixed percentage specified in the trust instrument rather than the actual net income distributed. This ruling has significant implications for estate planning involving charitable remainder trusts, potentially affecting the value of charitable contribution deductions. The court’s reliance on legislative history and administrative guidance underscores the importance of these sources in interpreting ambiguous statutory provisions. Subsequent courts and practitioners will need to consider this decision when structuring and valuing NIMCRUTs to ensure compliance with the statutory requirements for charitable contribution deductions.

  • Leila G. Newhall Unitrust v. Commissioner, 105 T.C. 406 (1995): Taxation of Charitable Remainder Unitrusts Receiving Unrelated Business Taxable Income

    Leila G. Newhall Unitrust v. Commissioner, 105 T. C. 406 (1995)

    A charitable remainder unitrust loses its tax-exempt status and is taxable on all its income if it receives any unrelated business taxable income (UBTI).

    Summary

    In Leila G. Newhall Unitrust v. Commissioner, the Tax Court ruled that the petitioner, a charitable remainder unitrust, was taxable on all its income for the years 1988 and 1989 because it received unrelated business taxable income (UBTI) from its interests in limited partnerships. The court determined that the trust’s passive ownership of partnership interests constituted being a “member” of the partnerships, and thus, the income was subject to UBTI rules. Furthermore, the court upheld the regulation that a charitable remainder unitrust loses its tax-exempt status for any year in which it has UBTI, necessitating taxation on its entire income. The decision also confirmed an addition to tax for substantial understatement of income for 1988.

    Facts

    The Leila G. Newhall Unitrust, a charitable remainder unitrust, received interests in Newhall Land & Farming Co. , Newhall Investment Properties, and Newhall Resources through a corporate liquidation in 1983 and 1985. These interests were publicly traded limited partnerships. For the tax years 1988 and 1989, the trust reported income from these partnerships and claimed it was not subject to unrelated business taxable income (UBTI). The Commissioner disagreed, asserting that the trust was liable for UBTI and, consequently, should be taxed on all its income as a result of losing its tax-exempt status under section 664(c).

    Procedural History

    The Commissioner determined deficiencies and additions to tax for the trust’s 1988 and 1989 tax returns. The trust challenged these determinations and also sought refunds for those years. The Tax Court reviewed the case, focusing on whether the trust received UBTI, the extent of its tax liability, and the applicability of an addition to tax under section 6661 for substantial understatement of income for 1988.

    Issue(s)

    1. Whether the trust received unrelated business taxable income (UBTI) under section 512(c) from its interests in limited partnerships.
    2. If the trust did receive UBTI, whether it is taxable under section 664(c) only to the extent of its UBTI or on its entire net income.
    3. Whether the trust is liable for the addition to tax under section 6661 for the taxable year 1988.

    Holding

    1. Yes, because the trust was a member of the partnerships and the partnerships’ income was considered UBTI under section 512(c).
    2. No, because the trust, having received UBTI, lost its tax-exempt status under section 664(c) and is taxable on its entire income.
    3. Yes, because the trust’s understatement of income tax for 1988 exceeded the threshold for a substantial underpayment under section 6661.

    Court’s Reasoning

    The court applied section 512(c) to determine that the trust’s passive ownership of limited partnership interests constituted being a “member” of the partnerships, making the income subject to UBTI rules. The court rejected the trust’s argument that it was not a member because it did not actively participate in the partnerships, citing Service Bolt & Nut Co. Profit-Sharing Trust v. Commissioner for the broad definition of “member. ” The court also upheld the regulation under section 664(c), which states that a charitable remainder unitrust is taxable on all its income if it has any UBTI in a given year. The court found this regulation to be a reasonable interpretation of the statute, supported by legislative history, and consistent with the principle that exemptions are matters of legislative grace. The court also found that the trust’s understatement of income for 1988 was substantial under section 6661, leading to an addition to tax.

    Practical Implications

    This decision underscores the importance for charitable remainder unitrusts to carefully consider the tax implications of investments that may generate unrelated business taxable income. Trusts must be aware that even passive investments in partnerships can lead to the loss of their tax-exempt status, subjecting them to taxation on all their income for the affected years. Legal practitioners advising such trusts should recommend thorough due diligence on potential investments to avoid UBTI and the consequent full taxation. This ruling may also influence future cases involving the tax treatment of charitable trusts and their investments, emphasizing the strict interpretation of the UBTI rules and the conditions for maintaining tax-exempt status.