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

Published date01 October 2019
Date01 October 2019
October 2019 5
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
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.
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).
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

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