Tax Court: Valuing charitable remainder trusts

Tax Court: Valuing charitable remainder trusts

The U.S. Tax Court today issued an opinion in a case involving an estate seeking a charitable contribution deduction for the values of remainder interests in two charitable remainder trusts created during the decedent’s life. The Tax Court held that when the trust payout is the lesser of the trust income or a fixed percentage, an annual distribution amount equal to the fixed percentage stated in the trust instrument must be used to determine whether the estate is eligible for the charitable contribution deduction.

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The case is: Estate of Schaefer v. Commissioner, 145 T.C. No. 4 (July 28, 2015)

Read the Tax Court opinion [PDF 75 KB]

Background

During his lifetime, the decedent established two irrevocable charitable remainder trusts. Each trust was designed so that one of the decedent’s sons would receive distributions during his life or a term of years, with the remainder going to a charity.

The trust instruments directed the trustees to distribute the lesser of: (1) each trust’s annual income; or (2) a fixed percentage to one of the sons. If trust income exceeded the fixed percentage, the trustee was directed to make additional distributions to make up for previous years when the trust income did not yield enough to satisfy a distribution of the fixed percentage. This type of trust is referred to as a “net income with makeup charitable remainder unitrust” (NIMCRUT).

The estate claimed it was entitled to a charitable contribution deduction for the values of the charitable remainder interests of the two irrevocable trusts. To be eligible for the charitable deduction, the value of each remainder interest had to be at least 10% of the net fair market value of the property contributed to the trust at the time of contribution.

The IRS determined that the estate was not entitled to the deduction because the value of the remainder interest for each trust did not equal 10% of the net fair market value of the property contributed to the trust at the time of contribution (based on calculating the charitable deduction assuming distributions would equal the fixed percentage of the NIMCRUT’s assets).

The estate disagreed, and countered that the distributions were to be determined using the expected net income according to the applicable section 7520 rate so long as the rate is above 5%.

Tax Court’s opinion

The Tax Court—noting that although section 664(e) is ambiguous in describing how to value a remainder interest in a NIMCRUT—concluded that based on legislative history, the IRS’s guidance instructing a taxpayer to value the remainder interest in a NIMCRUT based on the fixed percentage stated in the trust instrument was persuasive. Accordingly, the court held that the NIMCRUTs failed the 10% test.

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