For Tax Professionals  
T.D. 8791 December 10, 1998

Guidance Regarding Charitable Remainder Trusts &
Special Valuation Rules for Transfers of Interests in Trusts

DEPARTMENT OF THE TREASURY
Internal Revenue Service 26 CFR Parts 1, 25, and 602 [TD 8791] RIN
1545-AU25

TITLE: Guidance Regarding Charitable Remainder Trusts and Special
Valuation Rules for Transfers of Interests in Trusts

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final regulations.

SUMMARY: This document contains final regulations relating to
charitable remainder trusts and to special valuation rules for
transfers of interests in trusts. The final regulations provide
additional guidance regarding charitable remainder trusts. The final
regulations affect charitable remainder trusts and their
beneficiaries.

DATES: Effective date: These regulations are effective December 10,
1998.

Applicability dates: For dates of applicability of these
regulations, see the explanations under SUPPLEMENTARY INFORMATION.

FOR FURTHER INFORMATION CONTACT: Mary Beth Collins or Jeff Erickson,
(202) 622-3080 (not a toll-free number).

SUPPLEMENTARY INFORMATION:

Paperwork Reduction Act

The collection of information contained in these final regulations
has been reviewed and approved by the Office of Management and
Budget in accordance with the Paperwork Reduction Act (44 U.S.C.
3507) under control number 1545-1536. Responses to this collection
of information are required to allow taxpayers alternative means of
valuing a charitable remainder trust's unmarketable assets.

An agency may not conduct or sponsor, and a person is not required
to respond to, a collection of information unless the collection of
information displays a valid control number.

The estimated annual burden per respondent varies from .25 to .75
hours, depending on individual circumstances, with an estimated
average of .5 hoU.S.
Comments concerning the accuracy of this burden estimate and
suggestions for reducing this burden should be sent to the Internal
Revenue Service, Attn: IRS Reports Clearance Officer, OP:FS:FP,
Washington, DC 20224, and to the Office of Management and Budget,
Attn: Desk Officer for the Department of the Treasury, Office of
Information and Regulatory Affairs, Washington, DC 20503.

Books or records relating to this collection of information must be
retained as long as their contents may become material in the
administration of any internal revenue law. Generally, tax returns
and tax return information are confidential, as required by 26
U.S.C. 6103.

Background

On April 18, 1997, the IRS published in the Federal Register (62 FR
19072) a notice of proposed rulemaking (REG-209823-96) regarding
sections 664 and 2702. Comments responding to the proposed
regulations were received, and a public hearing was held on November
18, 1997. After considering the comments received and the statements
made at the public hearing, the proposed regulations are adopted as
revised by this Treasury decision.

Explanation of Provisions

This document amends 26 CFR parts 1 and 25 to provide additional
rules under sections 664 and 2702. Section 664 contains the rules
for charitable remainder trusts (CRTs). In general, a CRT provides
for a specified periodic distribution to one or more beneficiaries
(at least one of whom is a noncharitable beneficiary) for life or
for a term of years with an irrevocable remainder interest held for
the benefit of charity.

There are two types of CRTs: a charitable remainder annuity trust
(CRAT) and a charitable remainder unitrust (CRUT). A CRAT pays a sum
certain at least annually to the beneficiaries (the annuity amount).
A CRUT pays a unitrust amount at least annually to the
beneficiaries. Generally, the unitrust amount is a fixed percentage
of the net fair market value of the CRUT's assets valued annually
(fixed percentage CRUT). The unitrust amount can instead be
calculated under one of two income exception methods (income
exception CRUT). Under the first method, the unitrust amount is the
lesser of the fixed percentage amount or the trust's annual net
income (net income method). Under the second method, the unitrust
amount is determined under the net income method plus any amount of
income that exceeds the current year's fixed percentage amount to
make up for any shortfall in payments from prior years when the
trust income was less than the fixed percentage amount (NIMCRUT
method). The shortfall in payments from prior years is commonly
referred to as the "make-up amount." The revisions to the proposed
regulations are discussed below.

I. Flip Unitrusts

A. Triggering Events

The proposed regulations provide specific rules for when a trust may
convert from one of the income exception methods of computing the
unitrust amount to the fixed percentage method (flip unitrust). The
proposed rule was designed for taxpayers who ultimately wanted the
unitrust amount to be computed on the fixed percentage method but
funded the trust with unmarketable assets that generate little
annual income. A number of commentators agreed with the policy
underlying the proposed rule.

Some commentators requested that we permit flip unitrusts for all
income exception CRUTs regardless of the marketability of the trust
assets. Other commentators suggested that the final regulations
clarify whether the proposed rule was a safe harbor or the exclusive
circumstance for which a flip unitrust would be permitted.

In response, the final regulations expand the availability of the
flip unitrust to certain other situations that the IRS and Treasury
believe are consistent with the legislative history indicating that
a trustee should not have discretion to change the method used to
calculate the unitrust amount. H.R. Conf.

Rep. No. 782, 91st Cong., 1st Sess. 296 (1969), 1969-3 C.B. 644,
655.

The final regulations allow the governing instrument of a CRUT to
provide that the CRUT will convert once from one of the income
exception methods to the fixed percentage method for calculating the
unitrust amount if the date or event triggering the conversion is
outside the control of the trustees or any other persons. The final
regulations include examples of permissible and impermissible
triggering events. For example, permissible triggering events with
respect to any individual include marriage, divorce, death, or birth
of a child. Also, the sale of an unmarketable asset such as real
estate is a permissible triggering event. Examples of impermissible
triggering events include the sale of marketable assets and a
request from the unitrust recipient or the unitrust recipient's
financial advisor that the trust convert to the fixed percentage
method.

The final regulations also provide that the conversion to the fixed
percentage method occurs at the beginning of the taxable year that
immediately follows the taxable year in which the triggering date or
event occurs. Any make-up amount described in section 664(d)(3)(B)
is forfeited when the trust converts to the fixed percentage
method..6 The proposed regulations define unmarketable assets as
assets other than cash, cash equivalents, or marketable securities
(within the meaning of section 731(c)). Commentators asked for
clarification of the term unmarketable assets and recommended
changing the scope of this class of assets.

In response, the final regulations define unmarketable assets as
assets other than cash, cash equivalents, or assets that can be
readily sold or exchanged for cash or cash equivalents. For example,
unmarketable assets include real property, closely-held stock, and
unregistered securities for which there is no available exemption
permitting public sale.

Commentators requested that the final regulations permit conversions
from the fixed percentage method to one of the income exception
methods and conversions from a CRAT to a CRUT. The flip unitrust
allowed in the final regulations is the only type of permissible
conversion. Thus, a CRAT cannot convert to a CRUT without losing its
status as a CRT. Similarly, a CRUT using the fixed percentage method
cannot convert to an income exception method without losing its
status as a CRT.

B. Effective Date and Transitional Rules

The rules for flip unitrusts are effective for CRUTs created on or
after December 10, 1998. The proposed regulations allowed
reformations in limited circumstances. In response to comments, the
final regulations expand the circumstances in which reformation is
available. The final regulations allow income exception CRUTs to be
reformed to add provisions allowing a conversion to the fixed
percentage method provided the triggering event does not occur in a
year prior to the year in which the court issues the order reforming
the trust. Adding the conversion provisions will not cause the CRUT
to fail to function exclusively as a CRT and will not be an act of
self-dealing under section 4941 if the trustee initiates legal
proceedings to reform the trust by June 8, 1999.

II. Time for Paying the Annuity Amount or the Unitrust Amount

The proposed regulations provide that the payment of the annuity
amount or the unitrust amount determined under the fixed percentage
method must be made by the close of the taxable year in which it is
due. The rules were proposed in response to abuses associated with
the use of accelerated CRTs described in Notice 94-78 (1994-2 C.B.
555). After receiving a significant number of comments on the
proposed rules, the IRS issued Notice 97-68 (1997-48 I.R.B. 11),
which provided guidance on complying with the proposed rules for the
1997 taxable year.

One commentator recommended applying the proposed rules only to
trusts created after the date the final regulations are published.
Another commentator suggested adopting the rules in Notice 97-68 for
all trusts created after a certain date.

Although recent legislative changes have reduced the potential tax
benefits of accelerated CRTs, the IRS and Treasury continue to be
concerned about the potential abuse of the post-year-end grace
period to produce a tax-free return of appreciation in the assets
contributed to a CRAT or a fixed percentage CRUT.

Therefore, the final regulations adopt rules similar to those in
Notice 97-68 with certain modifications. The rules are effective for
taxable years ending after April 18, 1997.

For CRATs and fixed percentage CRUTs, the annuity or unitrust amount
may be paid within a reasonable time after the close of the year for
which it is due if (a) the character of the annuity or unitrust
amount in the recipient's hands is income under section 664(b)(1),
(2), or (3); and/or (b) the trust distributes property (other than
cash) that it owned as of the close of the taxable year to pay the
annuity or unitrust amount and the trustee elects on Form 5227,
"Split-Interest Trust Information Return," to treat any income
generated by the distribution as occurring on the last day of the
taxable year for which the amount is due. In addition, for CRATs and
fixed percentage CRUTs that were created before December 10, 1998,
the annuity or unitrust amount may be paid within a reasonable time
after the close of the taxable year for which it is due if the
percentage used to calculate the annuity or unitrust amount is 15
percent or less.

III. Appraising Unmarketable Assets

Under section 664(d)(2)(A), a CRUT must value its assets annually.
The proposed regulations provide that, if a CRT holds unmarketable
assets and the only trustee is the grantor, a noncharitable
beneficiary, or a related or subordinate party to the grantor or the
noncharitable beneficiary within the meaning of section 672(c) and
the applicable regulations, the trustee must value those assets
using a current qualified appraisal, as defined in 1.170A-13(c)(3),
from a qualified appraiser, as defined in 1.170A-13(c)(5).

The final regulations follow the proposed regulations and provide
that the trust's unmarketable assets must be valued by an
independent trustee, or by a qualified appraisal from a qualified
appraiser. The proposed regulations define an independent trustee as
a person who is not the grantor, a noncharitable beneficiary or a
related or subordinate party to the grantor, or the noncharitable
beneficiary within the meaning of section 672(c) and the applicable
regulations. The final regulations add the grantor's spouse to the
list of persons to whom an independent trustee cannot be related or
subordinate. A co-trustee who is an independent trustee may value
the trust's unmarketable assets.

Finally, in response to comments, the final regulations define
unmarketable assets as assets other than cash, cash equivalents, or
assets that can be readily sold or exchanged for cash or cash
equivalents. For example, unmarketable assets include real property,
closely-held stock, and unregistered securities for which there is
no available exemption permitting public sale.

The rules for valuing unmarketable assets are effective for trusts
created on or after December 10, 1998.

IV. Application of Section 2702 to Certain CRUTs

Under the proposed regulations, unitrust interests in an income
exception CRUT that are retained by the donor or any applicable
family member will be valued at zero when a noncharitable
beneficiary of the trust is someone other than (1) the donor, (2)
the donor's U.S. citizen spouse, or (3) both the donor and the
donor's U.S. citizen spouse. Commentators stated that income
exception CRUTs without a make-up provision should be exempt from
section 2702. The IRS and Treasury believe that, in addition to the
NIMCRUT method, the net income method can be used to circumvent the
intent of section 2702. Therefore, the final regulations do not
exempt from section 2702 CRUTs that use only the net income method.

Commentators also stated that the proposed rule encompassed other
transfers that section 2702 was not intended to include. A
commentator noted that the proposed rule would value a transferor's
interest at zero even though the transferor merely retained a
secondary life estate. The final regulations clarify that section
2702 will not apply when there are only two consecutive
noncharitable beneficial interests and the transferor holds the
second of the two interests.

Commentators also asked whether section 2702 may apply to flip
unitrusts. The potential abuse associated with income exception
CRUTs also exists with flip unitrusts. Therefore, under the final
regulations, section 2702 applies to a flip unitrust if the CRUT
does not fall within one of the exemptions.

V. Prohibition on Allocating Precontribution Gain to Trust

Income and Make-up Amount as a Liability

The proposed regulations clarify that the proceeds from the sale of
an income exception CRUT's assets, at least to the extent of the
fair market value of the assets when contributed to the trust, must
be allocated to trust principal. Some commentators stated that the
rule is inconsistent with the rule concerning income under section
643(b). Other commentators questioned whether the make-up amount
under the NIMCRUT method should be treated as a liability when
valuing the trust's assets.

The final regulations maintain the prohibition on allocating
precontribution gain to trust income for an income exception CRUT.
However, the governing instrument, if permitted under applicable
local law, may allow the allocation of post-contribution capital
gains to trust income. Taxpayers do not have to treat the make-up
amount as a liability when valuing the assets of a NIMCRUT.

VI. Example Illustrating Rule for Characterizing Distributions from
CRUTs

The proposed regulations contain an example of how the ordering rule
under section 664(b) operates when the unitrust amount is computed
under an income exception method. No comments were received on this
example. Thus, the final regulations adopt the example without any
changes.

Effect on Other Documents

Notice 97-68 (1997-48 I.R.B. 11) is obsolete as of December 10,
1998.

Special Analyses

It has been determined that this Treasury decision is not a
significant regulatory action as defined in EO 12866. Therefore, a
regulatory assessment is not required. It also has been determined
that section 553(b) of the Administrative Procedure Act (5 U.S.C.
chapter 5) does not apply to these regulations, and because the
regulation does not impose a collection of information on small
entities, the Regulatory Flexibility Act (5 U.S.C. chapter 6) does
not apply. Therefore, a Regulatory Flexibility Analysis is not
required. Pursuant to section 7805(f), the notice of proposed
rulemaking preceding these regulations was submitted to the Chief
Counsel for Advocacy of the Small Business Administration for
comment on its impact on small business.

Drafting Information

The principal authors of these regulations are Mary Beth Collins and
Jeff Erickson, Office of the Assistant Chief Counsel (Passthroughs
and Special Industries), IRS. However, other personnel from offices
of the IRS and Treasury Department participated in their
development.

List of Subjects

26 CFR Part 1 Income taxes, Reporting and recordkeeping
requirements.

26 CFR Part 25 Gift taxes, Reporting and recordkeeping requirements.

26 CFR Part 602

Reporting and recordkeeping requirements.

Adoption of Amendments to the Regulations Accordingly, CFR parts 1,
25, and 602 are amended as follows:

PART 1--INCOME TAXES

Paragraph 1. The authority citation for part 1 continues to read in
part as follows:

Authority: 26 U.S.C. 7805 * * *

Par. 2. In 1.664-1, paragraphs (a)(7) and (d)(1)(iii) are added,
and paragraph (f)(4) is added following the concluding text of
paragraph (f)(3) to read as follows:

1.664-1 Charitable remainder trusts.

(a) * * *

(7) Valuation of unmarketable assets--(i) In general. If
unmarketable assets are transferred to or held by a trust, the trust
will not be a trust with respect to which a deduction is available
under section 170, 2055, 2106, or 2522, or will be treated as
failing to function exclusively as a charitable remainder trust
unless, whenever the trust is required to value such assets, the
valuation is--

(a) Performed exclusively by an independent trustee; or

(b) Determined by a current qualified appraisal, as defined in
1.170A-13(c)(3), from a qualified appraiser, as defined in
1.170A-13(c)(5).

(ii) Unmarketable assets. Unmarketable assets are assets that are
not cash, cash equivalents, or other assets that can be readily sold
or exchanged for cash or cash equivalents. For example, unmarketable
assets include real property, closely-held stock, and an
unregistered security for which there is no available exemption
permitting public sale.

(iii) Independent trustee. An independent trustee is a person who is
not the grantor of the trust, a noncharitable beneficiary, or a
related or subordinate party to the grantor, the grantor's spouse,
or a noncharitable beneficiary (within the meaning of section 672(c)
and the applicable regulations).

* * * * *

(d) * * * (1) * * *

(iii) Example. The following example illustrates the application of
this paragraph (d)(1):

Example. (i) X is a charitable remainder unitrust described in
section 664(d)(2) and (3). The annual unitrust amount is the lesser
of the amount of trust income, as defined in 1.664- 3(a)(1)(i)(b),
or six percent of the net fair market value of the trust assets
valued annually. The net fair market value of the trust assets on
the valuation date in 1996 is $150,000. During 1996, X has $7,500 of
income after allocating all expenses. All of X's income for 1996 is
tax-exempt income. At the end of 1996, X's ordinary income for the
current taxable year and undistributed ordinary income for prior
years are both zero; X's capital gain for the current taxable year
is zero and undistributed capital gain for prior years is $30,000;
and X's tax-exempt income for the current year is $7,500 and
undistributed tax-exempt income for prior years is $2,500.

(ii) Because the trust income of $7,500 is less than the fixed
percentage amount of $9,000, the unitrust amount for 1996 is $7,500.
The character of that amount in the hands of the recipient of the
unitrust amount is determined under section 664(b). Because the
unitrust amount is less than X's undistributed capital gain income,
the recipient of the unitrust amount treats the distribution of
$7,500 as capital gain. At the beginning of 1997, X's undistributed
capital gain for prior years is reduced to $22,500, and X's
undistributed tax-exempt income is increased to $10,000.

* * * * *

(f) * * *

(4) Valuation of unmarketable assets. The rules contained in
paragraph (a)(7) of this section are applicable for trusts created
on or after December 10, 1998. A trust in existence as of December
10, 1998, whose governing instrument requires that an independent
trustee value the trust's unmarketable assets may be amended or
reformed to permit a valuation method that satisfies the
requirements of paragraph (a)(7) of this section for taxable years
beginning on or after December 10, 1998.

* * * * *

Par. 3. In 1.664-2, paragraph (a)(1)(i) is revised to read as
follows:

1.664-2 Charitable remainder annuity trust.

(a) * * *

(1) * * * (i) Payment of sum certain at least annually. The
governing instrument provides that the trust will pay a sum certain
not less often than annually to a person or persons described in
paragraph (a)(3) of this section for each taxable year of the period
specified in paragraph (a)(5) of this section.

(a) General rule applicable to all trusts. A trust will not be
deemed to have engaged in an act of self-dealing (within the meaning
of section 4941), to have unrelated debt-financed income (within the
meaning of section 514), to have received an additional contribution
(within the meaning of paragraph (b) of this section), or to have
failed to function exclusively as a charitable remainder trust
(within the meaning of 1.664-1(a)(4)) merely because the annuity
amount is paid after the close of the taxable year if such payment
is made within a reasonable time after the close of such taxable
year and the entire annuity amount in the hands of the recipient is
characterized only as income from the categories described in
section 664(b)(1), (2), or (3), except to the extent it is
characterized as corpus described in section 664(b)(4) because--

(1) The trust distributes property (other than cash) that it owned
at the close of the taxable year to pay the annuity amount; and

(2) The trustee elects to treat any income generated by the
distribution as occurring on the last day of the taxable year in
which the annuity amount is due.

(b) Special rule for trusts created before December 10, 1998. In
addition, to the circumstances described in paragraph (a)(1)(i)(a)
of this section, a trust created before December 10, 1998, will not
be deemed to have engaged in an act of self-dealing (within the
meaning of section 4941), to have unrelated debt-financed income
(within the meaning of section 514), to have received an additional
contribution (within the meaning of paragraph (b) of this section),
or to have failed to function exclusively as a charitable remainder
trust (within the meaning of 1.664-1(a)(4)) merely because the
annuity amount is paid after the close of the taxable year if such
payment is made within a reasonable time after the close of such
taxable year and the sum certain to be paid each year as the annuity
amount is 15 percent or less of the initial net fair market value of
the property irrevocably passing in trust as determined for federal
tax purposes.

(c) Reasonable time. For this paragraph (a)(1)(i), a reasonable time
will not ordinarily extend beyond the date by which the trustee is
required to file Form 5227, A Split-Interest Trust Information
Return, @ (including extensions) for the taxable year.

(d) Example. The following example illustrates the rules in
paragraph (a)(1)(i)(a) of this section:

Example. X is a charitable remainder annuity trust described in
section 664(d)(1) that was created after December 10, 1998. The
prorated annuity amount payable from X for Year 1 is $100. The
trustee does not pay the annuity amount to the recipient by the
close of Year 1. At the end of Year 1, X has only $95 in the
ordinary income category under section 664(b)(1) and no income in
the capital gain or tax-exempt income categories under section
664(b)(2) or (3), respectively. By April 15 of Year 2, in addition
to $95 in cash, the trustee distributes to the recipient of the
annuity a capital asset with a $5 fair market value and a $2
adjusted basis to pay the $100 annuity amount due for Year 1. The
trust owned the asset at the end of Year 1. Under 1.664-1(d)(5),
the distribution is treated as a sale by X, resulting in X
recognizing a $3 capital gain. The trustee elects to treat the
capital gain as occurring on the last day of Year 1. Under
1.664-1(d)(1), the character of the annuity amount for Year 1 in
the recipient's hands is $95 of ordinary income, $3 of capital gain
income, and $2 of trust corpus. For Year 1, X satisfied paragraph
(a)(1)(i)(a) of this section.

(e) Effective date. This paragraph (a)(1)(i) is applicable for
taxable years ending after April 18, 1997.

* * * * *

Par. 4. Section 1.664-3 is amended as follows:

1. Paragraphs (a)(1)(i)(a), (a)(1)(i)(b)(1), and (a)(1)(i)(b)(2) are
revised.

2. Paragraphs (a)(1)(i)(b)(3), (a)(1)(i)(b)(4), (a)(1)(i)(b)(5), and
(a)(1)(i)(c) through (a)(1)(i)(l) are added.

3. The third sentence of paragraph (a)(1)(iv) is revised.

The added and revised provisions read as follows:

1.664-3 Charitable remainder unitrust.

(a) * * *

(1) * * * (i) * * * (a) General rule. The governing instrument
provides that the trust will pay not less often than annually a
fixed percentage of the net fair market value of the trust assets
determined annually to a person or persons described in paragraph
(a)(3) of this section for each taxable year of the period specified
in paragraph (a)(5) of this section. This paragraph (a)(1)(i)(a) is
applicable for taxable years ending after April 18, 1997.

(b) * * *

(1) The amount of trust income for a taxable year to the extent that
such amount is not more than the amount required to be distributed
under paragraph (a)(1)(i)(a) of this section.

(2) An amount of trust income for a taxable year that is in excess
of the amount required to be distributed under paragraph (a)(1)(i)
(a) of this section for such year to the extent that (by reason of
paragraph (a)(1)(i)(b)(1) of this section) the aggregate of the
amounts paid in prior years was less than the aggregate of such
required amounts.

(3) For this paragraph (a)(1)(i)(b), trust income means income as
defined under section 643(b) and the applicable regulations.

(4) For this paragraph (a)(1)(i)(b), proceeds from the sale or
exchange of any assets contributed to the trust by the donor must be
allocated to principal and not to trust income at least to the
extent of the fair market value of those assets on the date of
contribution.

(5) The rules in paragraphs (a)(1)(i)(b)(1), (2), and (3) of this
section are applicable for taxable years ending after April 18,
1997, and the rule in paragraph (a)(1)(i)(b)(4) of this section is
applicable for sales or exchanges that occur after April 18, 1997.

(c) Combination of methods. Instead of the amount described in
paragraph (a)(1)(i)(a) or (b) of this section, the governing
instrument may provide that the trust will pay not less often than
annually the amount described in paragraph (a)(1)(i)(b) of this
section for an initial period and then pay the amount described in
paragraph (a)(1)(i)(a) of this section (calculated using the same
fixed percentage) for the remaining years of the trust only if the
governing instrument provides that--

(1) The change from the method prescribed in paragraph (a)(1)(i)(b)
of this section to the method prescribed in paragraph (a)(1)(i)(a)
of this section is triggered on a specific date or by a single event
whose occurrence is not discretionary with, or within the control
of, the trustees or any other persons;

(2) The change from the method prescribed in paragraph (a)(1)(i)(b)
of this section to the method prescribed in paragraph (a)(1)(i)(a)
of this section occurs at the beginning of the taxable year that
immediately follows the taxable year during which the date or event
specified under paragraph (a)(1)(i)(c)(1) of this section occurs;
and

(3) Following the trust's conversion to the method described in
paragraph (a)(1)(i)(a) of this section, the trust will pay at least
annually to the permissible recipients the amount described only in
paragraph (a)(1)(i)(a) of this section and not any amount described
in paragraph (a)(1)(i)(b) of this section.

(d) Triggering event. For purposes of paragraph (a)(1)(i)(c)(1) of
this section, a triggering event based on the sale of unmarketable
assets as defined in 1.664-1(a)(7)(ii), or the marriage, divorce,
death, or birth of a child with respect to any individual will not
be considered discretionary with, or within the control of, the
trustees or any other persons.

(e) Examples. The following examples illustrate the rules in
paragraph (a)(1)(i)(c) of this section. For each example, assume
that the governing instrument of charitable remainder unitrust Y
provides that Y will initially pay not less often than annually the
amount described in paragraph (a)(1)(i)(b) of this section and then
pay the amount described in paragraph (a)(1)(i)(a) of this section
(calculated using the same fixed percentage) for the remaining years
of the trust and that the requirements of paragraphs (a)(1)(i)(c)(2)
and (3) of this section are satisfied. The examples are as follows:

Example 1. Y is funded with the donor's former personal residence.
The governing instrument of Y provides for the change in method for
computing the annual unitrust amount as of the first day of the year
following the year in which the trust sells the residence. Y
provides for a combination of methods that satisfies paragraph (a)
(1)(i)(c) of this section.

Example 2. Y is funded with cash and an unregistered security for
which there is no available exemption permitting public sale under
the Securities and Exchange Commission rules.

The governing instrument of Y provides that the change in method for
computing the annual unitrust amount is triggered on the earlier of
the date when the stock is sold or at the time the restrictions on
its public sale lapse or are otherwise lifted. Y provides for a
combination of methods that satisfies paragraph (a)(1)(i)(c) of this
section.

Example 3. Y is funded with cash and with a security that may be
publicly traded under the Securities and Exchange Commission rules.
The governing instrument of Y provides that the change in method for
computing the annual unitrust amount is triggered when the stock is
sold. Y does not provide for a combination of methods that satisfies
the requirements of paragraph (a)(1)(i)(c) of this section because
the sale of the publicly-traded stock is within the discretion of
the trustee.

Example 4. S establishes Y for her granddaughter, G, when G is 10
years old. The governing instrument of Y provides for the change in
method for computing the annual unitrust amount as of the first day
of the year following the year in which G turns 18 years old. Y
provides for a combination of methods that satisfies paragraph (a)
(1)(i)(c) of this section.

Example 5. The governing instrument of Y provides for the change in
method for computing the annual unitrust amount as of the first day
of the year following the year in which the donor is married. Y
provides for a combination of methods that satisfies paragraph (a)
(1)(i)(c) of this section.

Example 6. The governing instrument of Y provides that if the donor
divorces, the change in method for computing the annual unitrust
amount will occur as of the first day of the year following the year
of the divorce. Y provides for a combination of methods that
satisfies paragraph (a)(1)(i)(c) of this section.

Example 7. The governing instrument of Y provides for the change in
method for computing the annual unitrust amount as of the first day
of the year following the year in which the noncharitable
beneficiary's first child is born. Y provides for a combination of
methods that satisfies paragraph (a)(1)(i)(c) of this section.

Example 8. The governing instrument of Y provides for the change in
method for computing the annual unitrust amount as of the first day
of the year following the year in which the noncharitable
beneficiary's father dies. Y provides for a combination of methods
that satisfies paragraph (a)(1)(i)(c) of this section.

Example 9. The governing instrument of Y provides for the change in
method for computing the annual unitrust amount as of the first day
of the year following the year in which the noncharitable
beneficiary's financial advisor determines that the beneficiary
should begin receiving payments under the second prescribed payment
method. Because the change in methods for paying the unitrust amount
is triggered by an event that is within a person's control, Y does
not provide for a combination of methods that satisfies paragraph
(a)(1)(i)(c) of this section.

Example 10. The governing instrument of Y provides for the change in
method for computing the annual unitrust amount as of the first day
of the year following the year in which the noncharitable
beneficiary submits a request to the trustee that the trust convert
to the second prescribed payment method.

Because the change in methods for paying the unitrust amount is
triggered by an event that is within a person's control, Y does not
provide for a combination of methods that satisfies paragraph (a)(1)
(i)(c) of this section.

(f) Effective date--(1) General rule. Paragraphs (a)(1)(i)(c), (d),
and (e) of this section are applicable for charitable remainder
trusts created on or after December 10, 1998.

(2) General rule regarding reformations of combination of method
unitrusts. If a trust is created on or after December 10, 1998, and
contains a provision allowing a change in calculating the unitrust
amount that does not comply with the provisions of paragraph (a)(1)
(i)(c) of this section, the trust will qualify as a charitable
remainder unitrust only if it is amended or reformed to use the
initial method for computing the unitrust amount throughout the term
of the trust, or is reformed in accordance with paragraph (a)(1)(i)
(f)(3) of this section. If a trust was created before December 10,
1998, and contains a provision allowing a change in calculating the
unitrust amount that does not comply with the provisions of
paragraph (a)(1)(i)(c) of this section, the trust may be reformed to
use the initial method for computing the unitrust amount throughout
the term of the trust without causing the trust to fail to function
exclusively as a charitable remainder unitrust under 1.664-1(a)(4),
or may be reformed in accordance with paragraph (a)(1)(i)(f)(3) of
this section. Except as provided in paragraph (a)(1)(i)(f)(3) of
this section, a qualified charitable remainder unitrust will not
continue to qualify as a charitable remainder unitrust if it is
amended or reformed to add a provision allowing a change in the
method for calculating the unitrust amount.

(3) Special rule for reformations of trusts that begin by June 8,
1999. Notwithstanding paragraph (a)(1)(i)(f)(2) of this section, if
a trust either provides for payment of the unitrust amount under a
combination of methods that is not permitted under paragraph (a)(1)
(i)(c) of this section, or provides for payment of the unitrust
amount under only the method prescribed in paragraph (a)(1)(i)(b) of
this section, then the trust may be reformed to allow for a
combination of methods permitted under paragraph (a)(1)(i)(c) of
this section without causing the trust to fail to function
exclusively as a charitable remainder unitrust under 1.664-1(a)(4)
or to engage in an act of self- dealing under section 4941 if the
trustee begins legal proceedings to reform by June 8, 1999. The
triggering event under the reformed governing instrument may not
occur in a year prior to the year in which the court issues the
order reforming the trust, except for situations in which the
governing instrument prior to reformation already provided for
payment of the unitrust amount under a combination of methods that
is not permitted under paragraph (a)(1)(i)(c) of this section and
the triggering event occurred prior to the reformation.

(g) Payment under general rule for fixed percentage trusts.

When the unitrust amount is computed under paragraph (a)(1)(i)(a) of
this section, a trust will not be deemed to have engaged in an act
of self-dealing (within the meaning of section 4941), to have
unrelated debt-financed income (within the meaning of section 514),
to have received an additional contribution (within the meaning of
paragraph (b) of this section), or to have failed to function
exclusively as a charitable remainder trust (within the meaning of
1.664-1(a)(4)) merely because the unitrust amount is paid after the
close of the taxable year if such payment is made within a
reasonable time after the close of such taxable year and the entire
unitrust amount in the hands of the recipient is characterized only
as income from the categories described in section 664(b)(1), (2),
or (3), except to the extent it is characterized as corpus described
in section 664(b)(4) because--

(1) The trust distributes property (other than cash) that it owned
at the close of the taxable year to pay the unitrust amount; and

(2) The trustee elects to treat any income generated by the
distribution as occurring on the last day of the taxable year for
which the unitrust amount is due.

(h) Special rule for fixed percentage trusts created before December
10, 1998. When the unitrust amount is computed under paragraph (a)
(1)(i)(a) of this section, a trust created before December 10, 1998,
will not be deemed to have engaged in an act of self-dealing (within
the meaning of section 4941), to have unrelated debt-financed income
(within the meaning of section 514), to have received an additional
contribution (within the meaning of paragraph (b) of this section),
or to have failed to function exclusively as a charitable remainder
trust (within the meaning of 1.664-1(a)(4)) merely because the
unitrust amount is paid after the close of the taxable year if such
payment is made within a reasonable time after the close of such
taxable year and the fixed percentage to be paid each year as the
unitrust amount is 15 percent or less of the net fair market value
of the trust assets as determined under paragraph (a)(1)(iv) of this
section.

(i) Example. The following example illustrates the rules in
paragraph (a)(1)(i)(g) of this section:

Example. X is a charitable remainder unitrust that calculates the
unitrust amount under paragraph (a)(1)(i)(a) of this section. X was
created after December 10, 1998. The prorated unitrust amount
payable from X for Year 1 is $100. The trustee does not pay the
unitrust amount to the recipient by the end of the Year 1. At the
end of Year 1, X has only $95 in the ordinary income category under
section 664(b)(1) and no income in the capital gain or tax-exempt
income categories under section 664(b)(2) or (3), respectively. By
April 15 of Year 2, in addition to $95 in cash, the trustee
distributes to the unitrust recipient a capital asset with a $5 fair
market value and a $2 adjusted basis to pay the $100 unitrust amount
due for Year 1.

The trust owned the asset at the end of Year 1. Under 1.664-1(d)
(5), the distribution is treated as a sale by X, resulting in X
recognizing a $3 capital gain. The trustee elects to treat the
capital gain as occurring on the last day of Year 1.

Under 1.664-1(d)(1), the character of the unitrust amount for Year
1 in the recipient's hands is $95 of ordinary income, $3 of capital
gain income, and $2 of trust corpus. For Year 1, X satisfied
paragraph (a)(1)(i)(g) of this section.

(j) Payment under income exception. When the unitrust amount is
computed under paragraph (a)(1)(i)(b) of this section, a trust will
not be deemed to have engaged in an act of self-dealing (within the
meaning of section 4941), to have unrelated debt-financed income
(within the meaning of section 514), to have received an additional
contribution (within the meaning of paragraph (b) of this section),
or to have failed to function exclusively as a charitable remainder
trust (within the meaning of 1.664-1(a)(4)) merely because payment
of the unitrust amount is made after the close of the taxable year
if such payment is made within a reasonable time after the close of
such taxable year.

(k) Reasonable time. For paragraphs (a)(1)(i)(g), (h), and

(j) of this section, a reasonable time will not ordinarily extend
beyond the date by which the trustee is required to file Form 5227,
A Split-Interest Trust Information Return, @ (including extensions)
for the taxable year.

(l) Effective date. Paragraphs (a)(1)(i)(g), (h), (i), (j), and (k)
of this section are applicable for taxable years ending after April
18, 1997.

* * * * *

(iv) * * * If the governing instrument does not specify the
valuation date or dates, the trustee must select such date or dates
and indicate the selection on the first return on Form 5227, A
Split-Interest Trust Information Return, @ that the trust must file.
* * *

* * * * *

PART 25--GIFT TAX; GIFTS MADE AFTER DECEMBER 31, 1954 Par. 5. The
authority citation for part 25 continues to read in part as follows:

Authority: 26 U.S.C. 7805. * * *

Par. 6. In 25.2702-1, paragraph (c)(3) is revised to read as
follows:

25.2702-1 Special valuation rules in the case of transfers of
interests in trust.

* * * * *

(c) * * *

(3) Charitable remainder trust. (i) For transfers made on or after
May 19, 1997, a transfer to a pooled income fund described in
section 642(c)(5); a transfer to a charitable remainder annuity
trust described in section 664(d)(1); a transfer to a charitable
remainder unitrust described in section 664(d)(2) if under the terms
of the governing instrument the unitrust amount can be computed only
under section 664(d)(2)(A); and a transfer to a charitable remainder
unitrust if under the terms of the governing instrument the unitrust
amount can be computed under section 664(d)(2) and (3) and either
there are only two consecutive noncharitable beneficial interests
and the transferor holds the second of the two interests, or the
only permissible recipients of the unitrust amount are the
transferor, the transferor's U.S. citizen spouse, or both the
transferor and the transferor's U.S. citizen spouse.

(ii) For transfers made before May 19, 1997, a transfer in trust if
the remainder interest in the trust qualifies for a deduction under
section 2522.

* * * * *

PART 602--OMB CONTROL NUMBERS UNDER THE PAPERWORK REDUCTION ACT Par.
7. The authority citation for part 602 continues to read as follows:

Authority: 26 U.S.C. 7805.

Par. 8. In 602.101, paragraph (c) is amended by revising the entry
for 1.664-1 to read as follows:

602.101 OMB Control numbers.

* * * * *

(c) * * *
_____________________________________________________________

CFR part or section where Current OMB identified and described
control No.

* * * * *

1.664-1.........................................1545-1536

* * * * *

Robert E. Wenzel
Deputy Commissioner of Internal Revenue
Approved: December 1, 1998
Donald C. Lubick
Assistant Secretary of the Treasury
(Tax Policy)


SEARCH:

You can search the entire Tax Professionals section, or all of Uncle Fed's Tax*Board. For a more focused search, put your search word(s) in quotes.





1998 Regulations Main | IRS Regulations Main | Home