Charitable remainder trusts are a valuable method to create a charitable gift. They usually provide the donor with an income stream, for life or a term of up to 20 years, while giving the qualified charity a remainder interest gift.
Because a CRT has tax-exempt status under the Internal Revenue Code, the donor receives an income tax deduction for the present value of the remainder interest projected to pass to the qualified charity. There is, however, a new danger that could cause the CRT to lose its tax-exempt status, thereby decreasing its attractiveness for current and potential clients.
A spouse who elects rights in the estate of a deceased grantor of a CRT may disqualify the CRT. To avoid this adverse result, the IRS issued a revenue procedure stating that CRTs created on or after June 28, 2005, will not be disqualified if the surviving spouse waives the right of election.
CRTs are created under applicable state trust law and some states allow a spouse to make an election of his or her statutory share against the estate. This statutory share election may require that a portion of the share come from the assets of the CRT.
Therefore, all or part of the remainder interest that the charity should receive may pass to the spouse, not to the charity. This was not the donor’s intent and it clearly disadvantages the charity. Also to consider is what happens to the income tax deduction the donor received when the trust was created.
The IRS Solution
Effective June 28, 2005, the trustee of a CRT must retain a copy of a waiver by the spouse of his or her elective share or right in the CRT, if permitted by state law. Revenue Procedure 2005-24 provides a safe harbor under which a right of election may be disregarded.
The revenue procedure states that for trusts created on or after June 28, 2005, the failure of the donor’s spouse to waive the right of election in accordance with the revenue procedure will cause the CRT to lose its tax-exempt status, regardless of whether the spouse exercises the right of election.
The revenue procedure requires that the waiver be obtained on or before the date that is six months after the due date (not including extensions) of IRS Form 5227, the Split-Interest Trust Information Return, for the year in which the latest date of the following events occurs:
==at the creation of the trust;
==at the donor’s marriage to a spouse;
==when the donor first becomes domiciled in a jurisdiction whose law provides a right of election that could be satisfied from assets of the trust; or
==when the state enacts a new law creating a right of election.
CRTs created before June 28, 2005, are generally grandfathered under the old procedures. That is, Revenue Procedure 2005-24 states that the IRS will not require a spousal waiver of right of election in existing trusts. The danger, however, is that CRTs could still lose their tax-exempt status if the surviving spouse actually elects his or her statutory share and it is paid from the CRT assets.
There are many concerns about Revenue Procedure 2005-24 and how it affects the future of CRTs. Among them: whether CRTs not yet in existence but in the drafting process are appropriately including the waiver. This is an important issue because when the IRS released the sample documents for CRTs, after Revenue Procedure 2005-24, (i.e., Revenue Procedures 2005-52 through 2005-59) it did not include any sample language on the required waiver.
Another concern is whether advisors that created CRTs for their clients should now have to follow their clients from state to state, and possibly marriage to marriage, to ensure that all the applicable laws are followed and waivers are signed.
The IRS is aware of the issues that practitioners and charitable associations have raised. They have sent comments to the IRS respecting this procedure, particularly regarding the procedure’s undue burden on taxpayers and its possible chilling effect on the charitable market.
The American College of Trust and Estate Counsel and the American Bar Association have established task forces to address these concerns. Each organization may make recommendations to the IRS on the revenue procedure.
To avoid the burden, a few practitioners have suggested signing a waiver when the CRT is formed, regardless if there is a spousal election issue. Additional commentary has suggested this waiver may not be valid, however, because the requirements for a valid waiver will be unknown prior to the enacted law.
There are other ways to exercise care to ensure the requirements of the revenue procedure are met for CRTs created on or after June 28, 2005.
First, when suggesting a CRT as a planning technique in the interest of full disclosure, one should be certain to discuss the revenue procedure. This will prevent the client from being blindsided by having to create another legal document in the future. Also, if the client is aware of the problem, he or she may be more diligent to ensure the CRT retains its tax-exempt status.
Second, an annual review of the CRT may be prudent. Because the waiver is required on or before six months after the trust’s Form 5227 due date, a change in status, such as a marriage or a move, may be easier to recognize.
At the time the annual 5227 is completed, a practitioner can ask the relevant questions to monitor status changes that may adversely affect the CRT. However, this approach may be problematic if the questions are asked after the extension of the 5227 is filed. A trustee, tax advisor or legal advisor would generally file the 5227.
Finally, if there is a change in your state law that makes the spousal election applicable, such as the enactment of Uniform Trust Code, a notice to clients that have established a CRT may be appropriate to alert them to this change in law.
Although it may seem that CRT planning has become less clearly defined, it is still a viable option as long as the advisors and their clients exercise due diligence in ensuring that the charitable planning remains current.
Elizabeth Lindsay-Ochoa, JD, is case design specialist at Paramount Planning Group, a division of AXA Advisors, LLC, Denver, Colo. You may e-mail her at Elizabeth.Ochoa@axa-financial.com.
‘There is…a new danger that could cause the CRT to lose its tax-exempt status, thereby decreasing its attractiveness for current and potential clients’