IRS Blesses “Sprinkling Powers” for CRT’s

by Prof. Robert Bloink and Prof. William H. Byrnes

Charitable remainder unitrusts (CRUTs) can provide a valuable estate planning strategy for clients who wish to provide for favorite charities on a tax-preferred basis while still continuing to receive income from the trust during life. CRUTs can also help clients split assets to provide for a charity while also providing for a non-charitable beneficiary during life. To receive favorable tax treatment, however, the CRUT has to satisfy certain detailed IRS requirements—including the requirement that a “more than de minimis” portion of the CRUT be distributed to non-charitable beneficiaries. A recent IRS ruling provides a degree of guidance for clients interested in potential structures to allow flexibility in their giving decisions going forward. The IRS allowed a power to “sprinkle” CRUT distributions among charities and non-charities each year without jeopardizing qualification—potentially adding flexibility for CRUTs in the future.

New IRS Ruling on CRUTs: The Facts

Applicable tax rules, however, generally provide that the client must give up a degree of control over the assets in order to avoid being treated as the owner of those assets for tax purposes—and thus receive the favorable tax treatment that makes CRUTs attractive. With respect to CRUTs, at least one beneficiary must be noncharitable and receive a more than de minimis amount. Further, under IRC Section 674, trust grantors are generally treated as the owner of any trust portion over which the grantor or a “non-adverse party” has a power of disposition without requiring approval of an adverse party.

The IRS ruling in this case involved a grantor who created two CRUTs with substantially similar terms. The first CRUT required payments of the unitrust interest to be made for the life of the grantor. The second CRUT required payments of the unitrust interest for the life of the grantor and the grantor’s spouse, except that the grantor had the right to revoke the spouse’s interest.

The first CRUT required the trustee to distribute a fixed percentage of the unitrust interest to the grantor each year. However, it also required the trustee to distribute an additional portion of the unitrust amount (if any) necessary to make sure that the unitrust amount received by the grantor in each year was not de minimis, based upon all relevant facts and circumstances. The second CRUT contained a similar provision, except that the spouse would receive the amounts after the grantor’s death.

After distributing these amounts, the CRUT would distribute the remaining unitrust interest to the grantor and one or more charitable organizations in the charitable class. Those charitable organizations were essentially any charity that the grantor identified or, if he failed to identify one or more charities, a charity that the independent trustee chose. The independent trustee also had discretion to determine the portion of the remaining interest that would be allocated to each chosen charity.

The primary issue under these circumstances was whether the independent trustee’s power to allocate distributions between noncharitable and charitable beneficiaries, as well as the grantor’s power to choose the charitable beneficiaries, would result in disqualification as a CRUT.

IRS Finds the Trust Qualifies as a CRUT

The IRS found that the provisions in these CRUT agreements fell under exceptions to the general rule of IRC Section 674. Under IRC Section 674(c), the general rule of IRC Section 674 does not apply when the power in question is solely exercisable (without approval or consent of any other person) by a trustee or trustees who are not the grantor, if no more than half of the trustees are related or subordinate parties to the wishes of the grantor.

This exception applies to a trustee with the power to (1) to distribute, apportion, or accumulate income to or for a beneficiary, or to, for, or within a class of beneficiaries; or (2) to pay out the trust corpus to or for a beneficiary, beneficiaries, or class of beneficiaries.

The grantor’s power to designate a class of charitable organizations also fell within an exception so that the trust could continue to qualify as a CRUT— the exception that the general rule of Section 674 does not apply to a power to determine the beneficial enjoyment of the corpus or its income if the amounts are irrevocably payable for a charitable purpose specified in IRC Section 170(c)

Conclusion

Although the IRS has never specified exactly what “not de minimis” means for CRUT purposes, this ruling indicates that a flexible approach to making this determination is acceptable. Of course, private letter rulings can only be relied upon by the person or entity receiving the ruling—but these rulings can give an indication of how the IRS will enforce a given issue.