8093 / What are FLIP unitrusts?

A CRUT that is funded with assets that are illiquid may require special care. Under the conditions described below, the grantor may employ a net income with makeup provision until the assets are sold, thus preventing an ill-timed sale or an invasion of the trust corpus, then switch (i.e., “flip”) to a fixed percentage payout once the assets have been sold. A trust that provides first for the use of a net income with makeup payout, followed by a fixed percentage payout is referred to as a flip unitrust.

Regulations allow the use of flip unitrusts provided all the following conditions are satisfied:

(a)  The trust instrument must provide that the one-time change in payout methods (i.e., the flip) 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.¹ Permissible triggering events include marriage, divorce, death, the birth of a child, or the sale of “unmarketable assets” (i.e., assets other than cash, cash equivalents, or assets that can be readily sold or changed for cash equivalents). For example, unmarketable assets would include real property, closely held stock, and unregistered securities for which there is no available exemption permitting public sale.²

(b)  Following the “flip,” only fixed percentage payouts (i.e., no net income makeup amounts) may be provided under the terms of the trust.³ Any makeup amounts remaining due at the time of the change in payout methods are forfeited when the trust converts to the fixed percentage method.⁴

(c)  The “flip” may be made only from the net income method to the fixed percentage method.⁵ A CRUT cannot convert from a fixed percentage method to a net income method without losing its status as a CRT.⁶

(d)  The change from the net income with makeup amount method to the fixed percentage payout method must occur at the beginning of the taxable year that immediately follows the taxable year during which the triggering date or event occurs.⁷

The regulations for flip unitrusts are effective for CRUTs created after December 9, 1998. Generally, a trust may not be amended or reformed to add a flip provision.⁸