Charitable Lead Trust's Termination Ruled to Not Trigger Termination Tax

• Published date: 01 October 2019
• Date: 01 October 2019
• DOI: http://doi.org/10.1002/npc.30646

Bruce R. Hopkins’ NONPROFIT COUNSEL

October 2019 5

THE LAW OF TAX-EXEMP T ORGANIZATIONS MONTHLY

Bruce R. Hopkins’ Nonpr ofit Counsel DOI:10.10 02/n pc

Law and Analysis

The IRS had three reasons for denying recognition of

tax exemption to this entity. One reason was violation of

the operational test, in that the operation of a coffee-

house is not a charitable activity. The second reason was

that the operation of the coffeehouse is an unrelated

business.

The third reason for the unfavorable ruling was that

the organization will be operating in a commercial man-

ner—violation of the commerciality doctrine. The cof-

feehouse will be open to the public. It will be in direct

competition with other coffeehouses. Its pricing is essen-

tially the same as that of other coffeehouses. Its hours

of operation are likewise the same. The organization has

a paid staff. Most of the organization’s expenses will be

met by funds generated from sales. Indeed, the organi-

zation “will primarily be funded by coffeehouse profits.”

The organization “will use advertising tools common to

for-profit businesses such as radio advertisement and

the internet.”

The IRS quite correctly observed that this organiza-

tion satisfies nearly all of the factors of commerciality set

forth in Living Faith, Inc. v. Commissioner (7th Cir. 1991)

and Airlie Foundation v. Commissioner (D.D.C. 2003).

[4.9(a), (f)] ◆

Commentary: It may be conceded that operation of a

coffeehouse for the benefit of the public, as a stand-

alone enterprise, is not a charitable, educational, or

like activity. This conclusion may be reached by simple

application of the operational test or by a finding that

the organization’s primary function is the conduct of an

unrelated business. (See the discussion of these topics in

last month’s issue.)

The problem in this regard stems from applica-

tion of the commerciality doctrine—or, perhaps more

accurately, with the doctrine itself. This ruling illus-

trates how exquisitely ridiculous the commerciality

doctrine is. The IRS cannot be faulted for applying

the doctrine, because the doctrine is supported by

case law. The IRS can be faulted, however, for blindly

adhering to elements of the doctrine to the extent

that the agency is making absurd statements, such

as, for example, holding that radio advertising and/or

having employees is evidence of improper features of

an exempt charity.

CHARITABLE LEAD TRUST’S

TERMINATION RULED TO NOT

TRIGGER TERMINATION TAX

The IRS ruled that a charitable lead annuity trust will

terminate on the designated termination date, with the

termination not giving rise to the private foundation

termination tax (Priv. Ltr. Rul. 201930017).

Facts

A charitable lead annuity trust was established, with

Charity C granted the annuity interest. On expiration of

the term of this income interest, the trustee is to distrib-

ute the trust principal to the grantor’s children. This term

is set to be just sufficient to make the income interest

in the trust, for which an estate tax charitable deduc-

tion (IRC § 2055) would be allowed, have an aggregate

value of X percent of the total fair market value of all

amounts in the trust as of its commencement. The annu-

ity amount is to be paid in equal quarterly installments.

By court order, Charity C was divided into two pri-

vate foundations, Charity A and Charity B. A and B each

received one-half of C’s annuity interest in the trust.

Law and Analysis

A ruling was requested as to whether the trust will

terminate on a particular date (termination date). The

IRS noted that to determine whether the trust will termi-

nate in accordance with the grantor’s will, a termination

date must be calculated (under IRC § 7520) so that the

present value of the charities’ annuity interest equals X

percent of the trust’s initial value. The IRS wrote that it

“performed calculations based upon our understanding

of the trust mechanics … and basic actuarial and finan-

cial principles associated with the time value of money

and the theory of interest.” It was stated that the IRS’s

“goal was to determine a termination date that would

render the total present value of the charitable annuity

to equal [X] percent of the initial trust value.” In order

to effect this, the IRS stated, the “final payment may

need to be a partial payment that occurs between two

otherwise scheduled payment dates.”

The IRS determined that, in fact, the “theoretical par-

tial quarterly payment” would need to occur between

the payment scheduled for a date (date 3) and the

payment scheduled for a subsequent date (date 4). The

IRS further calculated that a partial payment a certain

number of days into the quarter, discounted back to the

grantor’s date of death, will result in the total present

value of the charitable annuity equaling X percent of the

initial trust value, as required. This number of days after

date 3 is the termination date. (Do you believe in coin-

cidences?) Thus, the IRS was able to conclude that the

trust will terminate on the prescribed termination date.

The second issue was whether termination of the

trust on the termination date will result in imposition of

a termination tax (IRC § 507(c)). The IRS noted that the

trust is terminating by reason of a payment to a ben-

eficiary that is directed by the terms of the governing

instrument of the trust, rather than being discretionary

with the trustee (Reg. § 53.4947-1(e)(1)). The agency

stated that, when the trust terminates (on the termina-

tion date), the law treating the trust as a private founda-

tion (IRC § 4947(a)(2)) will cease to apply because the

trust will no longer retain any amounts for which the