The Tax Court held that the remainder interest for a net income with makeup charitable remainder unitrust (NIMCRUT) must be computed using an annual distribution amount equal to the greater of 5% of the net fair market value (FMV) of the trust assets or the fixed percentage defined in the trust instrument. The court relied on legislative history and administrative guidance to resolve textual ambiguity of Sec. 664(e).
Facts: In 2006, Arthur Schaefer created two charitable remainder unitrusts (CRUTs). Upon Schaefer's death in 2007, one of his sons became income beneficiary of CRUT 1, and another son became income beneficiary of CRUT 2. Distributions to the income beneficiaries equaled the lesser of annual trust income or a percentage (11% for CRUT 1; 10% for CRUT 2) of the net FMV of trust assets. The remainder of principal and income in each trust was to go to a charity.
Schaefer's estate reported a charitable contribution deduction on Form 706, United States Estate (and Generation-Skipping Transfer) Tax Return. The IRS issued a notice of deficiency, asserting that no deduction was allowed because the value of the charitable remainder interest did not equal at least 10% of the net FMV of the property contributed.
Issues: Under Sec. 2055(e)(2)(A), an estate is allowed a deduction for a charity's remainder interest if the charity's interest is in any of certain designated charitable trusts, including a CRUT as defined under Sec. 664, or a pooled income fund. An income beneficiary may receive CRUT distributions of a fixed percentage of the net FMV of the trust's assets for a term of years or for the beneficiary's lifetime. Then, the remainder charitable beneficiary receives what remains. Sec. 664(d)(2)(D) requires that for each property contribution to the CRUT, the value of the remainder interest in the property as determined by valuation tables under Sec. 7520 must be at least 10% of the property's net FMV on the date of contribution.
Sec. 664(d)(3)(B) defines NIMCRUTs. The income beneficiary receives distributions of the current trust income in excess of the fixed percentage if the aggregate amounts distributed in prior years are less than the aggregate of the fixed percentage amounts for those prior years. CRUT 1 and CRUT 2 were NIMCRUTs.
Sec. 664(e) provides that the valuation of a charitable remainder interest must be computed on "the basis that an amount equal to 5 percent of the net fair market value of its assets (or a greater amount, if required under the terms of the trust instrument) is to be distributed each year."
The estate argued that annual distributions should be calculated using the expected net income according to the applicable Sec. 7520 rate, so long as the rate is above 5%. The IRS argued that annual distributions should be calculated using the fixed percentage.
Holding: The court held that the value of the remainder interest of a NIMCRUT must be calculated using an annual distribution equal to the greater of 5% or the fixed percentage stated in the trust instrument. Consequently, Schaefer's estate was required to use an annual distribution amount of 11% (for CRUT 1) or 10% (for CRUT 2) of the net FMV of the trust assets when valuing the remainder interests. Because the estate and the IRS had stipulated that the estate would not be entitled to the deduction if the remainder interests were valued with this method, the court sustained the IRS's denial of the deduction.
The court found that the text of Sec. 664(e) was ambiguous in describing how to value a remainder interest in a NIMCRUT where distributions are the lesser of a fixed percentage or net income. Therefore, to determine which valuation method should be used, the court considered the legislative history of the statute, the regulations under it, and administrative guidance.
The court concluded that the legislative history supported the IRS position based on the Senate report (S. Rep't No. 91-552, 91st Cong., 1st Sess. 89 (1969)) for the Tax Relief Act of 1969, which enacted Sec. 664(e). That report stated that with a NIMCRUT, the distribution amount in the trust instrument should be used for valuation purposes even if distributions are limited by trust income. On the other hand, the court found that the regulations, like the statute, were ambiguous and did not shed any additional light on the correct interpretation of the statute.
However, the court determined that IRS administrative guidance, specifically Rev. Rul. 72-395 and Rev. Proc. 2005-54, was consistent with the legislative history, instructing taxpayers that a remainder interest in a NIMCRUT should be valued by using the fixed percentage stated in the trust instrument, regardless of whether distributions are limited to trust income. Although the court noted that it was not bound by revenue rulings or revenue procedures, it found that both Rev. Rul. 72-395 and Rev. Proc. 2005-54 were persuasive under the test set out in Skidmore v. Swift & Co., 323 U.S. 134 (1944), because they were thoroughly reasoned, they have proved valid in withstanding the test of time, and they remain consistent with the IRS's position.
- Estate of Schaefer, 145 T.C. No. 4 (2015)
—By Matthew Schippers, CPA, CGMA, J.D. candidate, University of Kansas School of Law.