PLR 202601014: CRUT Division and Early Termination

IRS Blesses 'Divide and Donate' CRUT Strategy

In a victory for sophisticated charitable planning, the IRS has given its full approval to a complex "divide and donate" transaction involving a Charitable Remainder Unitrust (CRUT). The agency granted all eight requested rulings, confirming that splitting the trust and terminating one half to donate the unitrust interest to family foundations does not constitute self-dealing and qualifies for both income and gift tax deductions.

Budget Shortfalls Trigger Trust Restructuring

As a consequence of Foundation 1, one of the designated charitable remainder beneficiaries, facing budget shortfalls, H and W explored ways to distribute assets sooner than the trust's original termination date. They proposed a "divide and donate" transaction. This involved splitting the original CRUT into two separate trusts, Trust A and Trust B, on a pro-rata basis, a method the IRS has previously sanctioned in Revenue Ruling 2008-41 as not disqualifying the trust under Section 664. Trust B would then be terminated, and H and W would donate their unitrust interests in Trust B to three charities: Foundation 1, Foundation 2, and an unrelated public charity. H and W, as the settlors, trustees, and substantial contributors to the foundations, are considered "disqualified persons" under Section 4946 with respect to these private foundations. Section 4946 defines "disqualified persons" broadly to include substantial contributors, foundation managers, and their family members.

Navigating the Self-Dealing Minefield

The IRS also addressed concerns about self-dealing, a prohibited transaction under Section 4941 that can occur between a private foundation and "disqualified persons." Section 4946 defines "disqualified persons" broadly to include substantial contributors, foundation managers, and their family members. Because H and W were settlors, trustees, and substantial contributors to the foundations, they were considered disqualified persons.

The key question was whether the division and subsequent donation of the unitrust interests would constitute self-dealing. Section 4941(d)(1) defines self-dealing to include the sale or exchange of property and the transfer of income or assets of a private foundation to a disqualified person. The IRS, relying on Rev. Rul. 2008-41, concluded that the proposed transaction did not constitute self-dealing.

Rev. Rul. 2008-41 examined whether the pro-rata division of a charitable remainder trust (CRT) under Section 664(d) into two or more separate trusts constituted self-dealing. The IRS determined that it did not, provided that: (1) no disqualified person received any additional interest in the assets due to the division; (2) the charitable remainder interest remained preserved; (3) the division was not a sale or exchange; and (4) the recipients paid all legal and other expenses incident to the division.

In this case, the IRS found that H and W would receive no additional interest. The division of the trust assets would be pro-rata, and the remainder interest would still be exclusively for charitable purposes. Furthermore, H and W paid all legal costs. The IRS also noted that while the resulting Trusts A and B would have different charitable remainder beneficiaries, this was due to H and W's retained power to change the beneficiaries, not the division itself. Finally, the IRS acknowledged that H and W would receive an "incidental benefit" – the satisfaction of their charitable goals – but that this did not trigger self-dealing under Treasury Regulation Section 53.4941(d)-2(f)(2).

Double Deduction: Income and Gift Tax Wins

The IRS also granted favorable rulings regarding income and gift tax deductions stemming from the trust restructuring. Section 170(a)(1) allows an income tax deduction for any contribution to organizations described in Section 170(c), which includes charitable entities. However, Section 170(f)(3)(A) disallows a deduction for contributions of less than the taxpayer’s entire interest in property, unless it would have been allowed had the interest been transferred in trust. This is known as the "partial interest rule." An exception, outlined in Section 170(f)(3)(B)(ii), exists for contributions of an undivided portion of the taxpayer’s entire interest.

The IRS determined that H and W's donation of their unitrust interests in Trust B qualified for a charitable deduction under Section 170, even though the trust was divided before the donation. The IRS relied on Rev. Rul. 86-60, which held that a taxpayer who donates their entire retained annuity interest in a charitable remainder trust (CRAT) to the remainder beneficiary qualifies for a charitable contribution deduction. The key was that the original division of the trust wasn't to avoid the partial interest rules. Therefore, H and W secured an income tax deduction for the unitrust interest donated to the charitable beneficiaries.

Turning to gift tax implications, the IRS noted that 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 charitable organizations. Similar to the income tax rules, Section 2522(c)(2) disallows a gift tax deduction when a donor transfers an interest in property to a charity while retaining an interest in the same property, unless the transferred interest is a remainder interest in a qualifying trust (like a CRUT) or a unitrust interest. Following the precedent in Rev. Rul. 86-60, the IRS concluded that H and W were entitled to a gift tax charitable deduction under Section 2522(a) for the value of the unitrust interest transferred. Furthermore, they also qualified for a gift tax deduction for the present value of the Trust B remainder interest. The IRS specified that H and W were each entitled to a gift tax charitable deduction of 50% of the entire value of Trust B.

Administrative Hurdles: Expenditure Responsibility

Following the precedent in Rev. Rul. 86-60, the IRS concluded that H and W were entitled to a gift tax charitable deduction under Section 2522(a) for the value of the unitrust interest transferred. Furthermore, they also qualified for a gift tax deduction for the present value of the Trust B remainder interest. The IRS specified that H and W were each entitled to a gift tax charitable deduction of 50% of the entire value of Trust B.

The IRS then addressed the administrative requirements associated with Trust B's distributions. Because Trust B was a split-interest trust under Section 4947(a)(2), it was subject to the rules applicable to private foundations, including Section 4945, which imposes an excise tax on "taxable expenditures." One such expenditure, as defined in Section 4945(d)(4), is a grant to another organization unless that organization is a public charity under Section 509(a)(1) or (2), a supporting organization under Section 509(a)(3), or an exempt operating foundation under Section 4940(d)(2). If the recipient does not fall into one of those categories, the granting foundation must exercise "expenditure responsibility" under Section 4945(h). This means the foundation must exert reasonable efforts to ensure the grant is used solely for its intended purpose, obtain full reports from the grantee, and report the expenditures to the IRS.

In this case, Trust B was distributing its assets to Foundation 1, Foundation 2, and Charity. Because Charity was a public charity under Section 509(a)(2), Trust B did not need to exercise expenditure responsibility for that portion of the distribution. However, Foundation 1 was a private operating foundation but not an exempt operating foundation, and Foundation 2 was a private non-operating foundation. Furthermore, the IRS determined that H and W did not effectively control Foundation 1 and Foundation 2. Consequently, the IRS ruled that Trust B must exercise expenditure responsibility with respect to the assets distributed to Foundation 1 and Foundation 2 in order to avoid the excise tax under Section 4945.

The IRS noted that while Trust B had to exercise expenditure responsibility for the distributions to Foundation 1 and Foundation 2, because H and W were significantly involved with these foundations and the grants were required by the terms of Trust B, a less extensive pre-grant inquiry would suffice. Further, the IRS stated that the information reporting requirements under Treasury Regulations Section 53.4945-5(c) and (d) would be satisfied if Trust B collected at least one report from each foundation in the year of the transfer and provided the report required by Section 4945(h)(3) on its final return (Form 5227, Split-Interest Trust Information Return). While Trust B was required to file a final return, the IRS confirmed that the transaction did not trigger the termination tax under Section 507(c), because the distribution qualified as a transfer under Section 507(b)(2).

Green Light for Philanthropic Acceleration

Building on the confirmation that the division did not trigger termination tax under Section 507(c), this Private Letter Ruling (PLR) offers a roadmap for donors seeking to accelerate charitable giving through their Charitable Remainder Unitrusts (CRUTs). This involves the 'divide and donate' strategy, as supported by prior rulings like Revenue Ruling 2008-41 and Revenue Ruling 86-60. This strategy allows donors to separate a CRUT into two trusts and then donate their income interest in one of those trusts to the charitable beneficiary, thus triggering an early termination of that portion of the trust and an immediate influx of funds to the charity. The ruling confirms that this approach is viable and tax-efficient, provided it adheres strictly to pro-rata division rules, ensuring equal treatment of all beneficiaries, and avoids any element of the donors 'cashing out' their interests beyond the usual unitrust payments. The donors in this case received an income tax charitable deduction under Section 170, which allows deductions for contributions to certain charitable organizations, and a gift tax charitable deduction under Section 2522(a) for the value of the unitrust interest transferred.