A pillar of the conventional wisdom of planning with charitable remainder trusts (CRTs) is that these very flexible split-interest trusts are subject to the private foundation excise tax on self-dealing transactions. But a recent IRS ruling has shaken that pillar and questioned the conventional wisdom.
Some (but not all) of the private foundation excise taxes apply to CRTs pursuant to Internal Revenue Code section 4947(a)(2), which provides that in the case of a trust which is not exempt under Code section 501(a) (i.e. a tax-exempt organization), not all of the unexpired interests which are devoted to one or more charitable purposes (i.e. a split-interest trust like a CRT) and which has amounts in trust for which a charitable deduction was allowed, Code section 4941 (excise tax on self-dealing) shall apply as if such trust were a private foundation.
In Private Letter Ruling 201713003, the grantor established a charitable remainder unitrust, but did not claim a charitable income tax deduction under section 170. The IRS ruled that because no charitable deduction was allowed, section 4947(a)(2) does not apply and the CRT is therefore not subject to any private foundation excise taxes, including self-dealing.
Many gift planners will find this surprising, since they may have erroneously remembered that section 4947(a)(2) applies to split interest trusts for which a charitable deduction was allowed or allowable, or maybe just accepted the conventional wisdom that CRTs are subject to the self-dealing rules. But this is one of those situations in which one shouldn’t rely on exegesis when one can consult the scripture, in this case the Internal Revenue Code. Here, a close reading of the statute supports the result of the ruling.
Speaking of exegesis, the ruling tells us that the basic purpose of section 4947 is to prevent split-interest trusts from being used to avoid the restrictions applicable to private foundations. The provision achieves its objective if the principal tax planning objective of the CRT to claim a charitable deduction for the present value of charitable remainder interest in the trust. But the second tax benefit of the CRT – frequently more valuable than the first – is the tax exemption of the trust, allowing the deferral of tax arising from the sale of appreciated assets. The grantor of the CRT in the ruling remained able to take advantage of this tax benefit, while freeing himself from the prohibition on self-dealing.
The ruling requires the taxpayer who might otherwise be subject to the excise tax on self-dealing transactions as a disqualified person with respect to the CRT maintain proof that no charitable deduction of any kind — income, estate or gift — has ever been taken (such as maintaining copies of tax returns for each year in which contributions were made to the trust).