Internal Revenue Service
Revenue Ruling
Rev. Rul. 77-374
1977-2 C.B. 329
Section 2055 -- Estate Tax Charitable Deduction
IRS Headnote
Charitable transfer; trust remainder; reformed to protect corpus. No
deduction is allowable under section 2055 of the Code for a charitable
remainder trust that, pursuant to the provisions of section 2055(e)(3), was
amended and reformed to meet the conditions of section 20.2055-2(b)(1) of
the regulations requiring that only a negligible chance exist that the
charitable transfer will not become effective.
Full Text
Rev. Rul. 77-374
Advice has been requested whether a charitable deduction is allowable under
section 2055 of the Internal Revenue Code of 1954 with respect to a
remainder interest in a trust that was amended, pursuant to the order of a
local court, under the circumstances described below.
The decedent died testate on June 15, 1973. Under the terms of the will,
executed on September 15, 1972, the decedent bequeathed the residue of the
probate estate, valued at $400,000, in trust. The trustee was directed to
pay to W, a female aged 61 years, $40,000 each year during W's lifetime.
The trust was to have terminated upon the death of W, at which time the
principal and any accumulated income would be paid to an organization
considered charitable under sections 170(c), 2055(a), and 2522(a) of the
Code.
On March 15, 1974, the executor of the decedent's estate filed the Federal
estate tax return in which a charitable deduction was claimed in respect of
the trust. Six months thereafter, the Internal Revenue Service disallowed
the charitable deduction because, in view of W's age and the size of W's
annuity, a distinct possibility existed that no trust assets would remain
available to charity at W's death. The possibility that W's annuity might
entirely consume the trust assets was not so remote as to be a negligible
possibility.
Section 2055(e)(3) of the Code was enacted on October 26, 1974, to provide
for amendment of certain governing instruments in order to qualify
charitable remainder interests passing thereunder for a charitable
deduction for Federal estate tax purposes. Shortly thereafter, on December
5, 1974, the executor of the estate, the trustee of the trust, and W
obtained from the local probate court an order amending and reforming the
trust to provide that W shall receive a reduced annuity of only $28,000
each year during W's lifetime. After the trust was amended, W repaid to the
trustee the excess of the amount of the annuity that W had received during
the prior year over the amount receivable under the amended trust.
Section 2055(a) of the Code provides that for purposes of the estate tax,
the value of the taxable estate shall be determined by deducting from the
value of the gross estate the amount of all bequests, devises, or transfers
to or for the use of charity. Any property interest which increases a
charitable bequest as the result of an irrevocable disclaimer of a
noncharitable bequest, legacy, devise, transfer, or power will qualify for
the charitable deduction "if the disclaimer is made before the date
prescribed for the filing of the estate tax return."
Section 2055(e) of the Code provides, with certain exceptions, that where
interests in the same property pass from the decedent to charity and to
persons or for uses not qualified as charitable, the charitable deduction
is disallowed unless, in the case of a charitable remainder interest, that
interest is in a charitable remainder annuity trust or charitable remainder
unitrust (described in section 664), or in a pooled income fund (described
in section 642(c)(5)). The above requirement with respect to charitable
remainder interests is set forth in section 2055(e)(2)(A). If however, a
deduction is not allowable because of the requirements of section
2055(e)(2)(A), a deduction may nevertheless be allowable in certain cases
pursuant to section 2055(e)(3).
Section 2055(e)(3) of the Code provides, in pertinent part, as follows:
In the case of a will executed before December 31, 1977, or a trust created
before such date, if a deduction is not allowable at the time of the
decedent's death because of the failure * * * to meet the requirements of
subparagraph (A) of paragraph (2) of this subsection, and if the governing
instrument is amended or conformed on or before December 31, 1977, or, if
later, on or before the 30th day after the date on which judicial
proceedings begun on or before December 31, 1977 * * * become final, so
that the interest is in a trust which is a charitable remainder annuity
trust * * * a deduction shall nevertheless be allowed. * * *.
Section 20.2055-2(a) of the Estate Tax Regulations provides that if a trust
is created or property is transferred for both a charitable and a private
purpose, deduction may be taken of the value of the charitable beneficial
interest only insofar as that interest is presently ascertainable, and
hence severable from the noncharitable interest. Section 20.2055-2(b) of
the regulations provides that in the case of a charitable transfer subject
to a condition, no deduction is allowable "unless the possibility that the
charitable transfer will not become effective is so remote as to be
negligible."
Section 24.1(c) of the Temporary Estate Tax Regulations describes those
situations where a charitable deduction may be obtained by amending a
governing instrument pursuant to section 2055(c)(3) of the Code. Section
24.1(c) states, however, that "a governing instrument may not be amended
pursuant to this section unless, at the time of the decedent's death, the
interest is an irrevocable remainder interest for which a deduction, but
for section 2055(e)(2)(A), would be allowable under section 2055(a) and the
regulations thereunder."
Under section 2031 of the Code and section 20.2031-10 of the regulations,
an interest rate of six percent per annum is used for valuation purposes
with respect to decedents dying after December 31, 1970. See also section
1.664-4(a)(1)(ii) of the Income Tax Regulations. A fund of $400,000,
invested at 6 percent per annum, yields $24,000 each year. Therefore, the
trustee of the charitable remainder annuity trust would have been required
to invade trust principal each year in order to provide W with the $40,000
annual payment originally provided in the decedent's will. The principal of
the trust must also be invaded, but to a lesser extent, to provide W with
the reduced annuity of $28,000 that she is now entitled to receive under
the amended trust.
The mathematical formula used to determine the number of years it will take
to completely exhaust a fund with an initial value of $400,000, invested at
6 percent per annum, that is subject to fixed annual payments of $40,000
out of both income and principal is: 1.06 X $400,000 (initial value of
corpus) - $40,000 (fixed annual payment) = $384,00 (value of corpus at end
of year after first invasion). By a series of similar successive
computations (that is: 1.06 X $384,000 (value of corpus at end of first
year) - $40,000 (fixed annual payment) = $367,040 (value of corpus after
second invasion), it was determined that the original fund of $400,000
would be completely exhausted in less than sixteen years. Based on Table
LN, which is found in section 20.2031-10(e) of the regulations, the
probability that a female aged 61 will be alive sixteen years hence--or
stated otherwise, the probability that a female aged 61 will survive to age
77, is greater than 63 percent. See example 12 contained in I.R.S.
Publication 723A (12-70), "Actuarial Values II: Factors at 6 Percent
Involving One and Two Lives."
As set forth in Rev. Rul. 70-452, 1970-2 C.B. 199, the charitable deduction
is not allowable where the probability exceeds 5 percent that a
noncharitable beneficiary will survive the exhaustion of a fund in which
charity has a remainder interest. Any possibility in excess of 5 percent
that the contingency will occur and defeat charity's interest is not
considered so remote as to be negligible within the meaning of section
20.2055-2(b) of the regulations. In this connection, see sections 2037 and
2042 of the Code which specify that 5 percent is the value at which a
reversionary interest will be considered significant. The charitable
deduction was disallowed in Moffett v. Commissioner, 269 F. 2d 738 (4th
Cir. 1959), where the probability that the fund would be exhausted was 19
percent, and United States v. Dean, 224 F.2d 26 (1st Cir. 1955), where the
probability was 9 percent.
Section 2055(e)(3) of the Code states only that a trust instrument can be
amended if no deduction is allowed because the instrument fails to meet the
requirements of section 2055(e)(2)(A), which states that a charitable
remainder trust must be in the form of an annuity trust, a unitrust or a
pooled income fund. In neither an annuity trust, a unitrust nor a pooled
income fund must the noncharitable beneficiary receive an amount less than
the amount that would deplete the trust prior to the death of the
noncharitable beneficiary. Sections 1.664-2, 1.664-3, and 1.642(c)-5 of the
Income Tax Regulations. Thus, an amendment of a trust to meet the
requirement of section 20.2055-2(b)(1) of the Estate Tax Regulations
requirement that only a negligible chance exist that the charity will
receive nothing is not a change within the purview of section 2055(e)(3)
since the purpose of such a change is not compliance with the section
2055(e)(2)(A) requirements.
Additionally, the Senate Finance Committee Report states that the purpose
of section 2055(e)(3) of the Code was merely to extend the cut-off date of
the Treasury Regulation transitional rules that allow trusts to be amended
to comply with the new requirements added by the Tax Reform Act of 1969. S.
Rep. No. 93-1063, 93d Cong., 2d Sess. 3 (1974). The Conference Committee
report contains a similar statement. H.R. Rep. No. 73-1405, 93 Cong., 2d
Sess. 3 (1974). Therefore, to interpret section 2055(e)(3) as affording
trusts an opportunity to achieve compliance with the long-standing
requirement of section 20.2055-2(b)(1) of the regulations would be
inconsistent with its legislative history.
Accordingly, no deduction is allowable under section 2055 of the Code for
the amended charitable remainder annuity trust in this case.
