MLR

Value of charitable remainder trust interests at heart of case

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The IRS recently won a case concerning a charitable contribution deduction for two charitable remainder trusts. It came down to a decision of what distribution amount to use in calculating the values of the charitable remainder interests.

gavel with tax book

The U.S. Tax Court ruled that the value of the remainder interest in a NIMCRUT (net income with makeup charitable remainder unitrust) did not meet the historical requirement of being at least 10 percent of the net market value of the property in Estate of Schaefer v. Commissioner, 145 T.C. No 4 (July 28, 2015).

Arthur Schaefer established two charitable remainder unitrusts in 2006 for his sons Benjamin and Ronald. He transferred 49.5 percent of nonvoting stock in Schaefer Investment, LLC, to each son in separate trusts. During his lifetime, he was beneficiary of both trusts.

Upon Schaefer’s death in 2007, Ronald became the income beneficiary of Trust 1, and Benjamin became the beneficiary of Trust 2. The trusts were set up so that Schaefer’s sons would receive distributions during their lives with the remainder going to charity.

Trustees were to distribute the lesser of each trust’s annual income or a fixed percentage. If trust income exceeded the fixed percentage, the trustee was directed to make additional distributions to make up for previous years when the trust income did not yield enough to satisfy a distribution of the fixed percentage.

The estate claimed it was entitled to a charitable contribution deduction for the values of the charitable remainder interests of the two trusts. To be eligible for the deduction, the value of each remainder interest had to be at least 10 percent of the net fair market value of the property contributed to the trust at the time of contribution, according to Internal Revenue Code Section 664.

The IRS and the estate disagreed about the appropriate distribution amount to use in calculating the values of the charitable remainder interests.

The court held that if the trust payout is the lesser of the trust income or a fixed percentage, the parties must use an annual distribution amount equal to the fixed percentage stated in the trust instrument to determine whether the estate is eligible for the charitable contribution deduction.

The Tax Court ruled that Internal Revenue Code Section 664 is ambiguous in its description of how to value a remainder interest in a NIMCRUT where actual distributions will be the lesser of a fixed percentage or net income.

Because of the ambiguity of the statute, the court looked to legislative history as an aid to interpret the statute. The court concluded that the value of the remainder interest of a NIMCRUT must be calculated using the greater of 5 percent or the fixed percentage.

Because the estate did not meet the 10 percent test for each trust, the charitable contribution deduction was denied.