Arizona Family Law Lawyer & Attorney : NRG - Nirenstein Ruotolo Group

During his marriage to B, A established a CRUT as described in Internal Revenue Code Section 664(d)(2). A and B reside in a community property state.

The charitable remainder interest in the CRUT belongs to a Section 509 private foundation (Charity). The CRUT provides annual payments to A during his lifetime equal to x percent of the annually determined net fair market value of its assets. After A dies, these unitrust payments will be made to B for her lifetime, if she survives A. A has reserved the power, exercisable in his will, to revoke B's interest in the CRUT.

The CRUT instrument provides that B's lifetime interest will become
effective on A's death only if B furnishes funds to pay the federal estate tax or state death taxes for which the trustee may be liable on A's death. On the death of the last to die of A and B (or after A's death if A revokes B's interest in the CRUT), Charity, acting as trustee, will be required to distribute all the principal and income of the CRUT to itself or to any other charities designated under the instrument.

Property Settlement

On the date of their divorce decree (Date 2), A and B entered into a written property settlement agreement. On Date 3, the property settlement agreement was modified. Under the property settlement agreement, A irrevocably renounced his retained power to revoke B's interest in the CRUT. The property settlement agreement also provided that the CRUT would be divided into two separate trusts (Trust A and Trust B). All components of principal, ordinary income, capital gain income, and other income of the CRUT will be divided equally between Trust A and Trust B. A will be the sole noncharitable beneficiary of Trust A and B will be the sole noncharitable beneficiary of Trust B. Charity will continue to serve as the trustee of both Trust A and Trust B. A and B will each receive a unitrust payment from the trust for that party's respective benefit.

The IRS ruled that the division of the CRUT into Trust A and Trust B will not cause either Trust A or Trust B to fail to qualify as a CRUT under Section 664(d).

Taxable Exchange

Applying the rationale of Cottage Savings Association v. Commissioner, 499 U.S. 554 (1991), the Internal Revenue Service found that the interests of A and B in the CRUT will change significantly as a result of the property settlement agreement. That is, A's interest will decrease significantly and B's interest will increase significantly. Accordingly, A and B will realize and recognize gain or loss under Section 1001 on the division of the CRUT unless another provision of the Internal Revenue Code provides otherwise. The IRS examined the portion of the legislative history of Section 1041 that deals with transfers of annuities and beneficial interests in trusts between divorcing spouses, and decided that Congress intended to have Section 1041 apply to this situation. Therefore, A will not recognize gain or loss on the transfer of half of his unitrust interest to B, and B will receive the interest with a carryover basis pursuant to Section 1041(b). In addition, the division of the CRUT as proposed will not result in recognition of gain or loss under Section 1001 by the CRUT, Trust A, or Trust B.

The IRS explained that the CRUT is a split-interest trust under Section 4947(a)(2) and so is subject to most of the private foundation excise taxes. In addition, Section 507(b)(2) applies to the division of the CRUT.

Relying on Rev. Rul. 2002-28, the IRS determined that Trust A and Trust B will meet the requirements for a significant disposition of assets under Treas. Reg. Section 1.507-3(c). Since the CRUT will transfer all of its assets to Trust A and Trust B, under Treas. Reg. Section 1.507-1(b)(6) the CRUT will not terminate its private foundation status under Section 507(a), and the transaction will not trigger the Section 507(c) termination tax.

Accordingly, under Treas. Reg. Section 1.507-3(a)(1), the two resulting unitrusts will not be treated as newly created private foundations. Trust A and Trust B will succeed to the aggregate tax benefit of the CRUT, under Treas. Reg. Section 1.507-3(a)(2)(i), on a pro rata basis in proportion to the fair market values of their assets. Under Treas. Reg. Section 1.507-3(a)(4), these assets will be subject to any liability that the Trust may have under Chapter 42.
No Self-Dealing. Although A and B are disqualified persons with respect to the CRUT under Section 4946, because A funded the CRUT when married to B, they are exchanging a unitrust payment for virtually the same interest payment due to the effect of community property law, and so under Section 4941 will not apply to the income interests of A and B, under Treas. Reg. Section 53.4947-1(c)(2).

Because A and B will not receive any additional interest in the CRUT's
principal, no self-dealing will occur under Section 4941(d). Pursuant to Rev. Rul. 2002-28, since the transferee foundations are treated as if they were the private foundation, they are not recipients of expenditure responsibility grants and need not exercise expenditure responsibility under Section 4945(d)(4) or Section 4945(h).
Legal and Accounting Expenses. The legal and other expenses incurred by the CRUT in connection with the request for the transaction, under Treas. Reg. Section 53.4945-6(b)(2), will not constitute Section 4945 taxable expenditures.

The IRS noted that Trust A and Trust B will be controlled by the same person (Charity) that controlled the CRUT within the meaning of Treas. Reg. Section 1.507-3(a)(9).

[Please remember that the IRS cautions that private letter rulings are directed to the taxpayers who request them, and that they may not be used or cited as precedent.]