I am not sure what to call this one. Read this story about a situation I worked on today – for fun and for learning purposes.
In helping a client work with a donor with an existing CRUT (drafted to allow the donor to adjust the remainder charities), I went back to one of my old tricks – why not have the donor sign a statement irrevocably waiving his right to change the charities? Usually, I required this if a donor was requesting that my charity take over as trustee (an old New York rule about only being trustee if you have an irrevocable interest).
In recent years, this switching from revocable to irrevocable (on the choice of charitable beneficiaries) has been a nice way to close a new gift or count it in a campaign or for a naming opportunity.
Of course, no one knows exactly how to do this since none of the usual planned giving resources provide a sample form. So, years back, I created a form based on one of the standard forms for changing CRT trustees or something like that. Basically, it looks like an addendum to the CRT and states the facts clearly and has the donor and trustee sign. Hopefully this addendum stays with the CRT document itself (with the trustee) or it is pretty worthless. (contact me directly if you are in desperate need of one)
So, I advised a client on this technique a few months ago, gave him the form for the donor’s attorney to use and forgot about it until today when they announced the closing a decent sized CRUT gift. And, then they emailed me for help calculating the present value for counting purposes.
Great, I said. Just give me the Unitrust rate. I already had the current market value and the birthdate of the donor. Turns out, I had a copy of the CRUT on my hard drive so I started looking for the Unitrust rate.
Mind you, this is a 17 page document (about 10-12 more pages than I would have drafted it). I would venture to say it was beautifully drafted. All the bells and whistles.
Except one. Perhaps the most important bell/whistle: THE UNITRUST RATE! I searched and searched – no rate. The definition section towards the end of the trust said that the Unitrust Amount shall mean the amount described in Paragraph XYZ.2 of Article II – very lawyerly-like. But when I went back to the referenced paragraph, it said
“The Unitrust Amount shall be the Net Income for each taxable year of this trust.”
Ok folks, never-mind what the value of the new gift is, this is technically not a qualified CRT!
There are a bunch of rules regarding what is needed in a CRT document, very specific, listed in Sec. 664 of the IRS Code. One of them is just this – you must specify the payout in terms of a percentage (for Unitrusts). Here is the specific language in 664 defining a CRUT:
“(2) CHARITABLE REMAINDER UNITRUST
For purposes of this section, a charitable remainder unitrust is a trust–
(A) from which a fixed percentage (which is not less than 5 percent nor more than 50 percent) of the net fair market value of its assets, valued annually, is to be paid, not less often than annually, to one or more persons (at least one of which is not an organization described in section 170(c) and, in the case of individuals, only to an individual who is living at the time of the creation of the trust) for a term of years (not in excess of 20 years) or for the life or lives of such individual or individuals,”
What threw this drafting attorney off, besides the fact that he clearly missed one of the most basic requirements of a CRT?
This was supposed to be a Net Income Unitrust (i.e. paying the lesser of net income or the Unitrust percentage). From the facts (most of which I can’t disclose, of course), it was clear that the net income from the chosen investments was going to be less than a chosen Unitrust percentage. Not a bad plan. I am guessing that the drafting attorney thought that since they would only be taking Net Income, there was no need to specify a Unitrust rate.
Of course, that was wrong.
Consequences? None at this point. This trust was already over 5 years old. That means that more than 3 years had passed since the filing date of the initial tax return and disclosure of this trust (and when you give a copy of the trust to the IRS). I am guessing no one read this trust because the first thing you look for is a payout rate, when reviewing CRTs. The statute of limitations on this type of stuff is 3 years – so they are in the clear on that.
What about subsequent tax returns? Well, if the net income was less than 5% a year, presumably it was, then the K-1 was showing the correct income to the donor. No harm, no foul.
But, we are still left with a defective trust and I am wondering what they based the initial tax deduction on – that for sure required a Unitrust rate. Maybe the donor never took a deduction? Maybe the donor’s accountant presumed that the Unitrust rate was the 5% minimum, in absence of a rate stated in the trust? Nice logic but with no basis in the law.
I think this was a classic scriveners error and possibly fixable – in a state court which inevitably would go along with it (regardless of the IRS issues on this one).
The whole story makes me wonder how lax or uneducated IRS agents who review these things are.
Also, reminds me how uneducated most attorneys are in this area. Actually, as I took one last look at this 17 page monstrosity, what a botch up it was. It says that any Net Income in excess of the Unitrust Amount shall be added to principal, but never actually states a Unitrust Amount outside of saying it is the Net Income. In other words, it is saying any Net Income in excess of the Net Income shall be added to principal – get that one.