PLR 202601002: CRUT Division and Early Termination

The 'Divide and Donate' Maneuver: Spouses Seek Early CRUT Termination

In a novel twist on charitable giving, a couple sought and received IRS approval to strategically dismantle their Charitable Remainder Unitrust (CRUT) to accelerate funding for their private foundations. H and W, the grantors and beneficiaries of the trust, aimed to access the capital locked within the CRUT early, rather than waiting for the trust to terminate upon their deaths. The IRS signed off on their plan, allowing them to split the existing trust into two, terminate one portion by donating their income interest, and claim associated tax deductions. Crucially, the IRS determined this maneuver would not trigger self-dealing excise taxes under Section 4941, which penalizes transactions between private foundations and "disqualified persons" (like the founders themselves). The core objective was to avoid those excise taxes while simultaneously expediting their philanthropic endeavors.

The Blueprint: Splitting the Trust to Fuel Private Foundations

As the IRS greenlit the 'divide and donate' maneuver, allowing them to split the existing trust into two, terminate one portion by donating their income interest, and claim associated tax deductions. Crucially, the IRS determined this maneuver would not trigger self-dealing excise taxes under Section 4941, which penalizes transactions between private foundations and "disqualified persons" (like the founders themselves). The core objective was to avoid those excise taxes while simultaneously expediting their philanthropic endeavors.

The taxpayers, a married couple ("H" and "W"), initially established a charitable remainder unitrust ("Trust") under Section 664, which defines the requirements for a trust to qualify as a charitable remainder trust. The terms stipulated that H and W would receive annual payments for their lifetimes, and then the survivor would receive payments for their lifetime. These payments were to be the lesser of 5% of the trust's net fair market value or the trust's net income, later changing to a fixed 5% of the net fair market value. Upon the death of the survivor, the trust property would be distributed to designated charitable organizations described in Sections 170(b)(1)(A), 170(c), 2055(a), and 2522(a), covering various types of qualifying charities for income, estate, and gift tax deduction purposes, respectively.

Years later, facing budget shortfalls at Foundation 1, a private operating foundation under Section 4942(j)(3) to which H was a founder, board member and substantial contributor, H and W explored ways to distribute assets to charitable remaindermen sooner. This led them to the "divide and donate" strategy.

To execute this plan, H and W, as trustees, petitioned a state court to modify the trust. Specifically, they sought clarification that their power to designate charitable beneficiaries could be exercised via an inter vivos (during life) instrument for the purpose of dividing and partially terminating the Trust. They also requested permission to divide the trust corpus into sub-trusts. The court approved the petition.

Following the court order, H and W planned to divide the original Trust into two separate trusts: Trust A and Trust B, with the same governing provisions as the original. They allocated a specific dollar amount ($X) to Trust B, with the remaining assets going to Trust A. The division was structured to ensure that assets allocated to each trust were fairly representative of the adjusted tax bases of the overall trust assets, and that the division occurred on a pro-rata basis across major investment classes, reflecting the overall appreciation or depreciation within each class. Finally, H and W assigned their unitrust interests in Trust B to Foundation 1, Foundation 2 (a private non-operating foundation under Section 509(a) and sections 170(b)(1)(A)(vii) and 170(b)(1)(F)(ii)), and a public charity, in proportion to their respective remainder interests in Trust B. This assignment was conditional upon the IRS approving the requested rulings. The goal was to terminate Trust B by distributing all its assets to these charities.

Navigating the Minefield: Self-Dealing and Foundation Rules

As detailed previously, H and W assigned their unitrust interests in Trust B to Foundation 1, Foundation 2 (a private non-operating foundation under Section 509(a) and sections 170(b)(1)(A)(vii) and 170(b)(1)(F)(ii)), and a public charity, in proportion to their respective remainder interests in Trust B. This assignment was conditional upon the IRS approving the requested rulings. The goal was to terminate Trust B by distributing all its assets to these charities.

The IRS addressed concerns about violating self-dealing rules under Section 4941, which imposes excise taxes on transactions between a "disqualified person" and a private foundation. Disqualified persons, as defined in Section 4946, include substantial contributors, foundation managers, and family members. Because H and W were settlors and trustees, they were considered disqualified persons. The IRS determined the proposed division and termination of Trust B did not constitute self-dealing (Rulings 1, 2, 5, 7, 8). This determination hinged on the principles established in Revenue Ruling 2008-41, which addressed the pro-rata division of a Charitable Remainder Trust (CRT). The IRS found that, similar to the scenarios in Rev. Rul. 2008-41, H and W did not receive any additional interest in the trust assets due to the division. Furthermore, the remainder interest was preserved for charitable purposes, and H and W paid all expenses related to the division. The IRS also noted that any incidental benefit to H and W in facilitating their charitable endeavors did not constitute self-dealing, citing Treasury Regulation § 53.4941(d)-2(f)(2).

However, the IRS highlighted the importance of "expenditure responsibility" under Section 4945. This section imposes an excise tax on taxable expenditures made by a private foundation. Because Trust B's assets were being distributed to private foundations (Foundation 1 and Foundation 2) that H and W controlled or were significantly involved with, Trust B had to exercise expenditure responsibility. This means Trust B was required to exert reasonable effort to ensure the funds were used solely for the intended charitable purposes, obtain full reports from the foundations on how the funds were spent, and make detailed reports to the IRS for the year of the transfer.

Finally, the IRS confirmed that the proposed transaction qualified as a transfer of assets under Section 507(b)(2). This section prevents the transfer of assets between private foundations, as part of a liquidation or reorganization, from being treated as a termination of foundation status under Section 507(a), which would trigger a termination tax under Section 507(c).

Double Benefit: Securing Income and Gift Tax Deductions

The IRS also confirmed that H and W would receive valuable tax benefits from the proposed transaction. Specifically, Ruling 3 addressed the income tax implications. Section 170(a)(1) allows a deduction for charitable contributions to qualified organizations described in Section 170(c). The IRS concluded that H and W were entitled to an income tax deduction under Section 170 for donating their unitrust interest in Trust B to the charitable remainder beneficiaries. This deduction is, of course, subject to the limitations outlined in Section 170(b) and other applicable Code sections.

Ruling 4 focused on gift tax benefits. Section 2501(a)(1) imposes a tax on the transfer of property by gift. However, Section 2522(a) allows a deduction for gifts made to qualified charities. The IRS determined that H and W were entitled to a gift tax deduction under Section 2522(a) for the actuarial value of the unitrust interest transferred to the charitable remainder beneficiaries. This essentially neutralizes any gift tax liability arising from the transfer. The IRS relied heavily on Rev. Rul. 86-60, which addressed a similar scenario where a taxpayer donated their annuity interest in a charitable remainder trust to the remainder beneficiary. The IRS reasoned that although H and W initially divided the trust, they were contributing their entire remaining interest in Trust B, thus qualifying for the deduction despite the "partial interest rules" of Section 170(f)(3)(A).

Strategic Implications: A Roadmap for Philanthropic Liquidity

For wealthy taxpayers, this Private Letter Ruling (PLR) confirms a viable, albeit complex, path to unlock assets held within a Charitable Remainder Unitrust (CRUT) earlier than initially anticipated. This strategy allows for immediate deployment of those assets to charitable endeavors, potentially addressing budget shortfalls within existing private foundations or enabling new philanthropic initiatives. The structure outlined in the PLR also allows the donors to secure a fresh income tax deduction under Section 170, which allows deductions for charitable contributions, and a gift tax deduction under Section 2522(a), which pertains to gift tax deductions for transfers to charitable organizations.

However, the path is not without its procedural hurdles. Strict adherence to specific requirements is crucial, including obtaining state court approval for the trust division, ensuring a strictly pro-rata division of the CRUT assets, and meticulously fulfilling expenditure responsibility reporting requirements under Section 4945(d)(4) and (h) – which dictates how private foundations must monitor grants to other private foundations to ensure the funds are used for charitable purposes.

While this PLR offers a potential roadmap for philanthropic liquidity, it's essential to remember that Private Letter Rulings, as per Section 6110(k)(3), cannot be used or cited as precedent by other taxpayers. Each situation is fact-specific, and taxpayers should seek qualified legal and tax advice before implementing a similar strategy.