In recent Private Letter Ruling 202432004 (August 8, 2024), the Internal Revenue Service concluded that early termination of a charitable annuity trust (CLAT) through an accelerated distribution of remaining annuity would be in two private foundations (PFs) shall not: (1) be considered a self-dealing act under Section 4941 of the Internal Revenue Code; (2) is treated as a taxable expense under IRC Section 4945; or (3) subject to tax under IRC Section 507.

Basics of CLAT

A CLAT is an irrevocable split-interest trust designed to make fixed payments over a period of time to one or more designated public charities or PFs exempt from income tax under IRC Section 501(c)( 3), with the potential to pass the remainder trust the assets to non-charitable beneficiaries, such as family members, free of gift or estate taxes. The charitable interest portion of the trust is fully deductible for gift and estate tax purposes, and the remaining noncharitable interest is fully taxable for gift or estate tax purposes. The value of the charitable interest is calculated as the present value of the stream of payments to the charity over the charitable period. The value of the taxable remainder interest is the difference between the original value of the trust and the value of the charitable interest.

If the trust is a grantor trust, the grantor also receives an immediate charitable income tax deduction for the present value of lump sum payments to be made to the tax-exempt entity, subject to applicable adjusted gross income limitations for charitable donations. If structured as a non-giving trust, a separate tax-paying trust is created, allowing an unlimited charitable income tax deduction for income paid to charity.

CLAT Treated as PF

On the facts of the decision, a CLAT was created to provide a guaranteed annuity that would qualify for a charitable gift tax deduction under IRC section 2522. As a split interest trust, the CLAT was treated as a PF for certain purposes. The CLAT trust agreement required the trustees to pay a 20-year fixed annuity to each of two PFs treated as tax-exempt organizations described in section 501(c)(3) and classified as PFs under Sec. 509(a). After the final pension payments were made, the CLAT agreement provided that half of the trust property should be paid to each of the two family trusts, subject to certain conditions being met.

The PFs requested the CLAT trustees to distribute the remaining two pension amounts before the completion of 20 years so that they could devote the funds to their respective charitable missions. CLAT represented that its trustees were willing to distribute the amounts if CLAT obtained a favorable ruling from the IRS and if the trustees of the family trust either executed a nonjudicial settlement agreement or accepted a court order approving the distribution, which the trustees of the family trusts agreed to do.

There is no self-treatment

The IRS concluded that CLAT's payment of accelerated annuity payments to PFs (without applying any present value deduction) would not constitute a self-dealing act under IRC Section 4941 because PFs were excluded from the definition of “disqualified persons”. ” as tax-exempt organizations described in section 501(c)(3) and classified as PFs under section 509(a). The self-dealing rules generally prohibit any direct or indirect financial transactions between a PF and almost all persons closely related to the PF (commonly referred to as “disqualified persons”).

There are no taxable expenses

The IRS also concluded that accelerated pension payments (again, without applying any present value deduction) by CLAT to PFs would not be treated as a taxable expense subject to an excise tax under section 4945(a). This was because the term “taxable expenditure” excludes amounts paid or incurred by a PF (for example, CLAT) for a purpose specified in section 170(c)(2)(B) (for example, religious, charitable, scientific, literary or educational purpose), and payments to PFs qualified for this exemption.

There is no termination fee

Relying on Treasury Regulation section 53.4947-1(e)(1), the IRS concluded that the CLAT would not be subject to the section 507 “termination tax” imposed on any PF that notifies the IRS of its intention to terminate its status as a PF. This regulation provides, in part, that the provisions of section 507 shall not apply to a split-interest trust because of any payment to a beneficiary that is governed by the terms of the trust's governing instrument and is not discretionary with the trustee. . This exception applied to the CLAT because the CLAT was, by its terms, required to make annuity payments to the PFs and the CLAT trustees had no discretion whether to pay the annuity amounts.

Win-Win?

This PLR can provide the trustees of a CLAT with substantial assets in excess of the amount required to satisfy the total charitable component with a level of certainty in making a large payment to the tax-exempt entity and terminating the trust before the expiry of pension. payment term. Accelerated payment of non-deductible annuity amounts can be beneficial both to the tax-exempt entity, who can apply the payment to fulfill its charitable purposes earlier than expected, and to the trust beneficiaries, who gain faster access to remaining trust principal. for their personal and financial use. Note that if CLAT had attempted to pay the current value of the charity's share to the PFs, the proposed transaction would have violated the principles of Revenue Ruling 88-27, which concluded that a CLAT agreement could not permit variation of the charitable portion based on present value calculations. Additionally, consider whether a state's attorney general should be consulted about the termination.