PLR 202601003

IRS Blesses CRUT 'Divide and Donate' Strategy Involving Private Foundations

The IRS has given its blessing to a sophisticated charitable planning technique involving a "divide and donate" strategy with a Charitable Remainder Unitrust (CRUT) and private foundations. In Private Letter Ruling (PLR) 202601003, the IRS approved a transaction where a couple split their existing CRUT into two separate trusts. They then assigned their life interest in one of the newly created CRUTs to various charities, including their own private foundations, effectively terminating that portion of the trust early. The IRS ruled favorably on all counts, allowing income and gift tax deductions under Sections 170 and 2522, respectively. Furthermore, the IRS found that the transaction did not constitute self-dealing under Section 4941, provided expenditure responsibility requirements are met under Section 4945. This ruling provides a significant roadmap for donors seeking to accelerate charitable impact from CRUT assets that may otherwise be "stuck" until the end of the trust term.

Splitting the Pot: The Mechanics of the Division

To facilitate an early distribution to charitable beneficiaries, H and W, the settlors and trustees, proposed a "divide and donate" strategy. They funded a charitable remainder unitrust (CRUT) – described under Section 664 as a trust paying a fixed percentage of its assets annually to non-charitable beneficiaries, with the remainder passing to charity – with shares of a publicly traded corporation. One of the remainder beneficiaries, Foundation 1 (a private operating foundation they control), faced budget shortfalls. To address this, H and W sought to divide the original trust into two separate entities: Trust A, which would continue operating under the original terms, and Trust B, which would be terminated early.

The planned division was pro-rata, ensuring that each major asset class was represented in both trusts in proportion to its overall value. H and W then executed a written instrument designating Foundation 1, Foundation 2 (another private foundation), and Charity (a public charity described in Section 509(a)(2)) as beneficiaries of Trust B. Subsequently, H and W proposed to assign their unitrust interests in Trust B to Foundation 1, Foundation 2, and Charity, in proportion to their respective remainder interests. This assignment would effectively merge the income and remainder interests, allowing for the immediate distribution of Trust B's assets to the designated charities and the termination of that portion of the trust early.

Avoiding the Self-Dealing Trap

As detailed previously, H and W proposed to assign their unitrust interests in Trust B to Foundation 1, Foundation 2, and Charity, in proportion to their respective remainder interests. This assignment would effectively merge the income and remainder interests, allowing for the immediate distribution of Trust B's assets to the designated charities and the termination of that portion of the trust early. Because H and W are disqualified persons, the IRS carefully examined the transaction for potential self-dealing issues under Section 4941. Section 4941 prohibits "acts of self-dealing" between a private foundation (or a split-interest trust treated as a private foundation under Section 4947(a)(2)) and "disqualified persons" such as donors, trustees, and their family members.

The IRS focused on whether the proposed division and subsequent assignment constituted a sale or exchange of property, or a transfer of trust assets for the benefit of H and W, both of which are prohibited acts under Section 4941(d)(1). The IRS relied on Revenue Ruling 2008-41, which provides guidance on dividing a single charitable remainder trust (CRT) into two or more separate CRTs. The IRS noted that, similar to the scenarios described in Rev. Rul. 2008-41, neither H nor W would receive any additional interest in the trust assets as a result of the proposed division into Trusts A and B. The unitrust amount payable under the terms of the original trust, and then under the terms of Trusts A and B, remained unchanged.

Furthermore, the IRS emphasized that the assets allocated to Trust A and Trust B were to be fairly representative of the aggregate adjusted bases of the trust assets and that the division of the assets between Trust A and Trust B would be on a pro-rata basis with respect to each major class of investments held at the date of the division. Critically, the charitable remainder interest of the trust was to be preserved exclusively for charitable interests, with no increase in the unitrust amount at the expense of the charitable interest because of the proposed division.

The IRS concluded that because the proposed division of Trust into Trusts A and B was not a sale or exchange and did not result in the transfer of income or assets to disqualified persons, or the use of such assets by or for the benefit of disqualified persons, the proposed division and termination of Trust did not result in self-dealing within the meaning of Section 4941(d)(1) by either H or W with respect to Trust. The IRS also noted that H and W would not receive any money, property, or other benefit through the proposed transaction other than the incidental benefit of facilitating their charitable endeavors, which, citing Treasury Regulation Section 53.4941(d)-2(f)(2), does not give rise to an act of self-dealing under Section 4941.

Unlocking the Deduction: Income and Gift Tax Analysis

As previously established, the IRS determined that because H and W will not receive any money, property, or other benefit through the proposed transaction other than the incidental benefit of facilitating their charitable endeavors, the proposed division and termination of Trust did not result in self-dealing within the meaning of Section 4941(d)(1) by either H or W with respect to Trust.

The IRS then addressed whether H and W could claim an income tax deduction under Section 170 for the value of the Trust B unitrust interests transferred to the charitable remainder beneficiaries. Section 170(a)(1) allows an income tax deduction for any contribution or gift to organizations described in Section 170(c), which includes corporations, trusts, or foundations organized and operated exclusively for charitable purposes. However, Section 170(f)(3)(A) generally disallows a deduction for contributions of less than the taxpayer’s entire interest in property, unless the contribution would have been allowed had it been transferred in trust. An exception exists in Section 170(f)(3)(B)(ii) for a contribution of an undivided portion of the taxpayer’s entire interest in property.

Referencing Revenue Ruling 86-60, the IRS highlighted a similar situation where a taxpayer (A) donated their annuity interest in a charitable remainder trust (CRAT) to the remainder beneficiary. The IRS concluded that A's gift qualified for a charitable contribution deduction under Section 170 because A was donating their entire interest.

In the present case, H and W intend to divide Trust into two trusts (Trust A and Trust B) and then contribute their unitrust interests in Trust B to the Trust B Remainder Beneficiaries. The IRS determined that this is analogous to Situation 1 in Rev. Rul. 86-60. By dividing the trust first, and then giving away their entire interest in Trust B, the couple is giving an undivided portion of their entire interest in that specific property. Consequently, the IRS ruled that H and W are entitled to an income tax charitable deduction under Section 170, subject to any applicable limitations.

The IRS further addressed the gift tax implications under Section 2522, which allows a deduction for gifts made to charitable organizations. Section 2522(c)(2) disallows the gift tax charitable deduction where a donor transfers an interest in property (other than an interest described in section 170(f)(3)(B)) to a person, or for a use, described in section 2522(a), and an interest in the same property is retained by the donor.

Again referencing Rev. Rul. 86-60, the IRS noted that when A transferred their entire annuity interest to the charitable remainder beneficiary, the transfer qualified for a deduction under Section 2522(a).

In this case, the IRS determined that the transfer by H and W of their entire interest in Trust B is similar to the transfer described in Situation 1 of Rev. Rul. 86-60. Therefore, the IRS concluded that H and W are entitled to a gift tax charitable deduction under Section 2522(a) to the extent of the value of the unitrust interest transferred as of the date of transfer, and also a gift tax charitable deduction under Section 2522 to the extent of the present value of the Trust B remainder interest as of the date of transfer. The IRS determined that the gift is completed when the designation of the Trust B Remainder Beneficiaries becomes effective. Accordingly, H and W will each be entitled to a gift tax charitable deduction of 50% of the entire value of Trust B.

Compliance Corner: The Expenditure Responsibility Requirement

As H and W are entitled to income and gift tax charitable deductions under Sections 170 and 2522, respectively, for the donation of their unitrust interests, a key compliance caveat emerges. While the division of the original trust into Trust A and Trust B does not trigger "taxable expenditure" penalties under Section 4945, the termination of Trust B and subsequent distribution to the designated charities requires careful attention.

Section 4945 imposes an excise tax on "taxable expenditures" made by private foundations. This includes grants to organizations that are not public charities described in Section 509(a)(1) or (2), or certain types of supporting organizations. Because two of the intended recipient organizations, Foundation 1 and Foundation 2, are private foundations not effectively controlled by Trust B in the way described by Treasury Regulation Section 1.507-3(a)(9), Trust B must exercise "expenditure responsibility" under Section 4945(d)(4) and (h) with respect to the distributions to those two foundations.

"Expenditure responsibility," as defined in Section 4945(h), means that the trustee of Trust B must exert all reasonable efforts to ensure that the funds distributed to Foundation 1 and Foundation 2 are used solely for the charitable purposes for which they were granted. The trustee must also obtain full and complete annual reports from each foundation detailing how the funds were spent. Finally, the trustee must make full and detailed reports to the IRS regarding these expenditures, including the required information on its annual information return.

While the IRS acknowledged that H and W’s involvement in Foundation 1 and Foundation 2 warrants a less extensive pre-grant inquiry as per Treasury Regulation Section 53.4945-5(b)(2), the underlying responsibility to monitor and report on the use of funds remains. Practitioners should note that because these grants will be made as part of a final distribution and termination of Trust B, the information reporting requirements will be satisfied, provided that Trust B collects at least one report from each of Foundation 1 and Foundation 2 in the year of the transfer and provides the report required by Section 4945(h)(3) and Treasury Regulation Section 53.4945-5(d) on its final return. Beyond these final information reporting tasks, Trust B will not be required to exercise expenditure responsibility in later tax years when it holds no assets.

Implications: A Roadmap for Liquidity

The central point for estate planners is that this Private Letter Ruling (PLR) confirms the "divide and donate" strategy remains a viable option for grantors of Charitable Remainder Unitrusts (CRUTs), as defined by Section 664, who wish to accelerate liquidity for their charitable beneficiaries, including their own private foundations. Section 664 defines a CRUT as a trust that pays a fixed percentage of its assets to a non-charitable beneficiary, with the remainder going to charity. This strategy hinges on Revenue Ruling 2008-41, which allows for the division of a CRUT into multiple trusts, and Revenue Ruling 86-60, which addresses the tax implications of donating a CRUT interest to the charitable remainderman.

While this PLR offers reassurance, it's crucial to remember that a PLR is directed only to the taxpayer who requested it and cannot be used or cited as precedent. However, this ruling's reliance on established Revenue Rulings (2008-41 and 86-60) provides a degree of comfort that the IRS continues to view this strategy favorably when structured correctly.