Form over substance: district court denies split-interest charitable deduction.

• Author: Barton, Peter

In Galloway, DC PA, 5/9/06, a district court ruled that no charitable deduction was allowed on an estate tax return for a mast specifying distributions to charitable and noncharitable beneficiaries, because the mast did not meet the requirements of Sec. 2055(e)(2). The court barred the deduction even though the charity received all of the income and principal for 50% of the trust assets. This and other similar cases illustrate situations to avoid in obtaining the deduction. With the high number of aging American millionaires and the billions donated to charity, every year, this topic is an important one.

Background

Sec. 2055(a) allows a deduction from the gross estate for transfers to qualified charities. However, under Sec. 2055(e)(2), no deduction is permitted for a trust specifying a split interest in property held for the benefit of charitable and noncharitable beneficiaries. Secs. 2055(e)(2)(A) and (B) and 170(f)(3)(B) provide exceptions to this disallowance rule; the charitable portion of the split interest is deductible if any of these exceptions is met.

Under Sec. 2055(e)(2)(A), a deductible charitable remainder interest must be in a trust that is a charitable remainder annuity trust (CRAT), a charitable remainder unitrust (CRUT) or a pooled income fund (PIF). Sec. 664(d) defines CRATs and CRUTs; for them, payments must be made at least annually of either a fixed amount or a fixed percentage of the trust's assets respectively (determined annually), to at least one noncharitable beneficiary. A PIF is managed by the charity and its payment requirements are based on the PIF's rate of return. Under Sec. 2055(e)(2)(B), for other interests (such as when a charity has only an income interest (i.e., a charitable lead trust)), the charitable interest must be a guaranteed annuity or a fixed percentage of the property's fair market value, determined and distributed annually. Sec. 170(f)(3)(B) includes a contribution not in trust of (1) a remainder interest in a personal residence or farm, (2) an undivided portion of the taxpayer's entire interest in property or (3) a qualified conservation contribution.

The purpose of Sec. 2055(e), enacted in 1969, is to provide a closer connection between the charitable deduction and the amounts the charity ultimately receives. For example, for a charitable remainder trust, the CRAT, CRUT and PIF requirements reduce the incentive and opportunity for the trustee to invest the trust assets in risky securities...