A recent Chief Counsel Internal Revenue Service Memorandum (No. 202233014, July 12, 2022) signals the IRS’ view that including a provision for discretionary charitable remainder unitrust (CRUT) payments between charitable and noncharitable beneficiaries isn’t advisable if an estate wants to preserve its deductions under Internal Revenue Code Sections 2055 and 2056. The IRS denied an estate a charitable deduction for a CRUT that gave the trustee discretion to choose between distributing the income interest to a charity or surviving spouse. Here’s what happened:
Love Story With a Charitable Twist
An individual who passed away included an IRC Section 664 testamentary CRUT to be funded through their estate. The plan was for the trust to make annual 5% unitrust payments to take care of a loved surviving spouse and support a charitable cause important to the decedent. The CRUT directed the trustee to make 25% of the payments to the spouse but provided the trustee with discretion to split the remaining 75% of the unitrust amount between the charity and the spouse. Once the spouse had been taken care of and passed on, the trustee would distribute the trust remainder to the charity.
Love (and Tax Deduction) Lost
Section 2055 permits an estate to take an estate tax charitable deduction for a charitable interest created in a charitable remainder annuity trust or CRUT described in Section 664 or a pooled income fund described in IRC Section 642(c)(5). At first glance, an estate tax charitable deduction should have been permitted in this case. However, Section 2055 (e)(2) restricts this deduction when the interest passes from the decedent directly to a person or for a noncharitable purpose not included in Section 2055(a), which is what happened here.
Treasury Regulations Section 20.2055-2(a) contemplate that there can be both a charitable and noncharitable income beneficiary in a CRUT. However, the charitable beneficiary’s interest must be “ascertainable” and “severable” from the noncharitable interest. Here, the charitable and noncharitable interests in the 75% of the CRUT amount that was discretionary didn’t meet the standard. They weren’t separate or distinct. The Section 2055 deduction was lost.
The estate also lost its marital deduction under Section 2056, which is typically permitted for an interest passing to a surviving spouse. However, this loved spouse wasn’t the only beneficiary and under the terminable interest rule of Section 2056(b)(1), a marital deduction is lost if there’s an event or contingency that would mean the interest terminates or fails to pass to the spouse. The trustee’s discretion was the end of the romance at least for the 75% CRUT share. The decedent meant to do well by their loved one, but the contingency created in the CRUT meant the spouse might not share in any further income, and that was enough to defeat the marital deduction.
Bottom Line
The estate could claim an estate tax charitable deduction for the value of the remainder interest under Section 2055(a) passing to the charity because this was a valid Section 664 CRUT. However, there was no deduction permitted under Section 2055(a) for the value of any part of the unitrust when the trustee had discretion because the charity’s interest wasn’t a fixed unitrust amount nor was it ascertainable or severable from the spouse’s interest. The estate was permitted a marital deduction for the 25% CRUT interest of which the spouse was the only beneficiary.
Cautionary Tale
While the IRS states that the memorandum may not be used as precedent, it’s a cautionary tale for any practitioner drafting CRUT language. Discretion isn’t advised! Avoid including discretionary charitable/noncharitable beneficiary payments in testamentary CRUTs for a client with a taxable estate that could benefit from an estate tax charitable deduction.