Deduction Okayed on Termination of Non-Qualifying CRT
In Estate of Jackson, 1 the U.S. District Court for the Northern District of West Virginia held that an estate was entitled to an estate tax charitable deduction resulting from the termination of a non-qualifying charitable split-interest trust.
Mildred Jackson created a revocable trust that provided her with income and principal during her lifetime. The trustees of the trust were an individual and a trust company. The revocable trust provided that upon Mrs. Jackson's death, her residuary trust estate would be held in trust. The trust was to pay her nephew and three nieces each $150,000 outright and one-fourth of the trust's annual accounting income from the balance of the assets held in trust. The trust provided that upon the death of each of the nephew and three nieces, one-fourth of the trust corpus would be distributed to a specified church. The investment committee of the trust company included two individuals who were members of the church and were also members of two of the church's committees. The individual trustee was a member of the church and was married to one of the three nieces.
Upon Mrs. Jackson's death, the attorney administering the estate became concerned about potential conflicts of interest arising from the nieces' and nephew's dissatisfaction with the diminished income from the trust and the fact that the individual trustee was married to one of the nieces. To avoid possible disputes arising from such conflicts, the attorney suggested that the trustees and beneficiaries terminate the trust. The trustees, the nephew, the three nieces, and the church signed an agreement terminating the trust. A distribution was made to the nephew and the three nieces from the trust for their income interests based on life expectancy calculations derived from IRS actuarial tables. The church received the remaining trust property. Mrs. Jackson's estate filed an estate tax return and claimed a charitable deduction for the distribution to the church. The IRS denied the deduction on the ground that the trust was a charitable split-interest trust that did not comply with the requirements of Section 2055(e).
Section 2055(a)(2) permits a charitable estate tax deduction for bequests, legacies, devises, or transfers to charitable organizations. However, Section 2055(e)(2) provides that an estate tax charitable deduction is not allowed for property in which both a charitable and a non-charitable beneficiary have an interest unless—in the case of a charitable remainder interest—the property passes to either a charitable remainder trust (“CRT”) or a pooled income fund. Section 2055(e)(3) allows an estate tax charitable deduction with respect to a trust which does not initially satisfy the requirements of a CRT if such trust is timely reformed to comply with the requirements of a CRT.
The parties in Jackson agreed that the trust neither satisfied the requirements of a CRT nor was the trust reformed so as to qualify as a CRT. The issue before the court was whether the estate was nevertheless allowed an estate tax charitable deduction solely on account of the terminating distribution to the church.
The IRS argued that the denial of an estate tax charitable deduction can be avoided only if the non-qualifying CRT is terminated pursuant to settlement of litigation or to avoid an imminent breach of fiduciary duty. The court rejected the IRS's position as inconsistent with the history and purpose of Section 2055(e).
According to the court, the purpose of Section 2055(e) was to ensure that the amount claimed as an estate tax charitable deduction more closely corresponds to the amount that the charity actually receives. The Jackson court noted that in determining whether a terminating distribution from a non-qualifying split-interest trust qualifies for an estate tax charitable deduction, courts have generally focused on four factors: (1) whether property is directly transferred to the charitable beneficiary; (2) whether a non-charitable beneficiary maintains an interest in the property transferred to the charitable beneficiary; (3) whether the deduction claimed is for the actual amount received by the charitable beneficiary; and (4) whether the estate was concerned solely with obtaining a charitable deduction by avoiding the application of the split-interest rules of Section 2055(e).
The court determined that each of these four requirements was satisfied. First, the church received an outright distribution of money pursuant to the termination agreement. Second, the nephew and the three nieces had no interest in the property distributed to the church after the distribution. Third, the estate tax charitable deduction sought by the estate equaled the amount received by the church. Finally, the court found there was no evidence suggesting that either the trustees or the beneficiaries were aware of the requirements of Section 2055(e) before the execution of the termination agreement. Instead, the court found that the trustees believed in good faith that conflicts of interest threatened to compromise their ability to administer the trust impartially. Therefore, the court concluded that the terminating distribution rendered Section 2055(e) inapplicable, particularly in light of the trustees' good faith termination of the trust.
The holding of this case may be rather limited since the court's ruling relied heavily on the fact that the trustees and their advisors were not aware of the applicability of Section 2055(e) or its consequences to the estate. It would appear that this lack of knowledge ultimately saved the estate and the beneficiaries from potentially adverse tax consequences. The fact of the matter is, however, that the funds actually went to the charitable institution and the estate received a corresponding deduction. We will have to wait to see if the government appeals this decision.
1 96 AFTR 2d 2005-7279, 408 F Supp 2d 209 (DC W.Va., 2005).
Frank S. Baldino is an attorney at Lerch, Early & Brewer in Bethesda, Maryland who practices in the areas of estate planning and probate administration and who co-chairs the firm's Estate Planning and Probate Group. He has extensive experience in the areas of estate planning, charitable giving, estate planning for non-U.S. citizens, tax planning with respect to retirement plans and stock options, asset protection planning, business succession planning and estate and trust administration. Frank may be contacted at 301-657-0715 or firstname.lastname@example.org.