News Briefings - Estate Planning
The following article was taken from the December 2008 issue of Estate
Planner's Alert.
12/1/08 -- Manipulation of charitable remainder trust identified as transaction of interest
IRS has identified a transaction and substantially similar ones as "transactions of interest" under Reg § 1.6011-4(b)(6). The transactions involve a sale of all interests in a charitable remainder trust (after the contribution of appreciated assets to, and their reinvestment by, the trust), that result in the grantor or other recipient receiving the value of their trust interest while claiming to recognize little or no taxable gain. (Notice 2008-99, 2008-47 IRB)
Background on sale of term interest in trusts. Under Code Sec. 1001(e)(1), in determining gain or loss from sales or other dispositions of term interests in property transfer in trust, that part of the adjusted basis of the interest determined under Code Sec. 1015 is disregarded to the extent that the adjusted basis is a portion of the entire adjusted basis of the property. Thus, if such an interest is sold, the full sales price is taxable, unreduced by any basis. However, under Code Sec. 1001(e)(3), there is no loss of basis on a sale or other disposition of a term interest in property as a part of a single transaction in which the entire interest in the property is transferred
Background on tax shelter rules. Under Code Sec. 6011 and its regs, taxpayers must disclose their participation in reportable, tax-shelter-type transactions by attaching an information statement to their income tax returns. Under Code Sec. 6111, material advisors must disclose reportable transactions (e.g., identify and describe them and the claimed tax benefits) and under Code Sec. 6112, material advisors must prepare and maintain lists for reportable transactions (e.g., identifying each person with respect to whom the advisor acted as a material advisor for the transactions). Regs provide that reportable transactions included listed transactions (i.e., transactions that have been specifically identified by IRS as tax avoidance transactions); transactions marketed under conditions of confidentiality and for which the taxpayer has paid an advisor a minimum fee; transactions with contractual protection; transactions generating a tax loss exceeding specified amounts; and transactions generating a tax credit when the underlying asset is held for a brief period of time.
In regs issued in August 2007, IRS added a new category of reportable transactions consisting of "transactions of interest," to be identified in published guidance. (Reg § 1.6011-4(b)(6)) These are transactions that IRS believes have potential for tax avoidance or evasion, but for which it lacks enough information to determine whether they should be identified specifically as tax avoidance transactions. (Preamble to TD 9350)
Facts. In one variation of the transaction, a grantor creates a charitable remainder trust (Trust) and contributes appreciated assets to it. He retains an annuity or unitrust interest--a term interest--in Trust and designates a charitable organization (charity) as the remainder beneficiary. Trust then sells or liquidates the appreciated assets and reinvests the net proceeds in new assets, such as money market funds or marketable securities. Because a charitable remainder trust is generally a tax-exempt entity under Code Sec. 664, Trust's sale of the appreciated assets is exempt from income tax, and its basis in the new assets is its purchase price.
In a transaction claimed to qualify under Code Sec. 1001(e)(3), the grantor and charity sell or otherwise dispose of their Trust interests to an unrelated third party in exchange for the fair market value (FMV) of Trust's assets (including the new assets). Trust terminates, and its assets (including the new assets) are distributed to the unrelated party. The grantor then claims a charitable deduction for the portion of the appreciated assets' FMV, as of the date of their contribution to Trust, that's attributable to the remainder interest. Grantor claims to recognize no gain from the Trust's sale or liquidation of the appreciated assets, taking the position that, as their entire interest in Trust has been sold, Code Sec. 1001(e)(3), rather than Code Sec. 1001(e)(1), applies. The grantor computes the gain on the sale of his term interest by taking into account the portion of uniform basis allocable to his term interest under Reg § 1.1014-5 and Reg § 1.1015-1(b), with this uniform basis being derived from the basis of the new assets, rather than the appreciated assets' basis.
Variation on the transaction. IRS notes that in some variations, a net income with make-up provision charitable remainder unitrust (NIMCRUT) may be used as Trust. Or Trust may have been in existence for some time before the sale of its interests, and appreciated assets may already be in Trust before the transaction begins. Or the recipient and seller of the term interest may be the grantor and/or another person, or the grantor may contribute the appreciated assets to a partnership or other passthrough entity and then contribute the interest in the entity to Trust. The common thread in these transactions is that the gain on the sale of the appreciated assets is never taxed, even though the grantor receives his share of the appreciated FMV of those assets.
Transaction targeted. In Notice 2008-89, IRS identifies the transaction at issue and substantially similar transactions as "transactions of interest." IRS is concerned about the manipulation of the uniform basis rules to avoid tax on gain from the sale or other disposition of appreciated assets. The type of transaction described Notice 2008-89, includes a coordinated sale or other coordinated disposition of the respective interests of the grantor or other noncharitable recipient and the charity in a charitable remainder trust in a transaction claimed to be described in Code Sec. 1001(e)(3), subsequent to the contribution of appreciated assets and the trust's reinvestment of those assets. In particular, IRS is concerned about the grantor's claim to an increased basis in the term interest coupled with the termination of the Trust in a single coordinated transaction under Code Sec. 1001(e) to avoid tax on gain from the sale or other disposition of the appreciated assets. IRS stresses that it isn't concerned about the mere creation and funding of a charitable remainder trust and/or the trust's reinvestment of the contributed appreciated property, and such events alone won't constitute the transaction subject to Notice 2008-89.
Consequences. Transactions that are the same as, or substantially similar to, the transactions described in the notice are identified as transactions of interest for purposes of Reg § 1.6011-4(b)(6), Code Sec. 6111, and Code Sec. 6112, effective August 14, 2007. Persons entering into these transactions on or after November 2, 2006, must disclose the transaction under the rules in Reg § 1.6011-4, and material advisors who make a tax statement on or after November 2, 2006, with respect to transactions entered into on or after that date have disclosure and list maintenance obligations under Code Sec. 6111 and Code Sec. 6112.
Notice 2008-89 cautions that independent of their classification as transactions of interest, transactions that are the same as, or substantially similar to, those described in the notices already may be subject to the tax shelter disclosure requirements. When IRS has enough information to make an informed decision as to whether the transaction described is a tax avoidance type transaction, it may take one or more actions, including removing the transaction from the transactions-of-interest category in published guidance, designating the transaction as a listed transaction, or providing a new category of reportable transaction.
Effective date. Under Reg § 1.6011-4(c)(3)(i)(E), each recipient of the term interest and Trust are participants in this transaction for each year in which their respective tax returns reflect tax consequences or a tax strategy described in this notice. The charity isn't a participant if it sold or otherwise disposed of its interest in Trust on or before October 31, 2008. For interests sold or otherwise disposed of after October 31, 2008, under Reg § 1.6011-4(c)(3)(i)(E), the charity is a participant for the first year for which its tax return reflects or is required to reflect the sale or other disposition of its interest in Trust. The charity is generally required to report the sale or other disposition of its interest in Trust on its return for the year of the sale or other disposition, and so it will be a participant for the year in which charity sells or otherwise disposes of its interest in Trust.
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