Helpful Testamentary Charitable Lead Annuity Trust Private Letter Ruling

KEY WORDS: Charitable Lead Trusts

EXECUTIVE SUMMARY: In this private letter ruling, the IRS held that a zeroed out testamentary charitable lead annuity trust (“T-CLAT”) that used an ascending (i.e., back-loaded) charitable payout was a qualified charitable lead annuity trust.

FACTS: The decedent set up a ten year testamentary charitable lead annuity trust in his revocable living trust in which a private foundation was the charitable beneficiary.  The T-CLAT payout was variable, but it was tied to zeroing out the value of the non-charitable interest in the T-CLAT.  The T-CLAT trustee filed a petition with the local probate court to construe a proposed ascending charitable payout as being consistent with the decedent’s intent and provided notice to the state attorney general.  The proposed T-CLAT payout would increase by 20% each year for the entire ten year T-CLAT term.

The trustee of the T-CLAT averred that a straight-line annuity payout risked not being able to honor the decedent’s testamentary intent that the T-CLAT would probably not be able to make the charitable payouts for all of the ten years.  The T-CLAT trustee attached illustrations to its petition showing both ways to set up the T-CLAT charitable payout.  The probate court agreed with the proposal, but the court conditioned its ruling upon the T-CLAT trustee obtaining a favorable private letter ruling from the IRS, hence the ruling request.

The IRS gave a favorable ruling on the ascending T-CLAT payouts, concluding:

The state court’s construction, an event that occurred after the date of Decedent’s death, does not affect the charitable qualification of the trust or the estate’s eligibility for a charitable deduction for that interest. Accordingly, based on the information submitted and the representations made, we conclude, on the date of Decedent’s death, the trust satisfied the requirements under § 2055(e)(2). Therefore, pursuant to § 2055(a), Decedent’s estate is entitled to the charitable deduction claimed on Decedent’s original Form 706 for the present value of the charitable interest established under the trust on the date of Decedent’s death. [Emphasis added]

COMMENTS: This ruling is welcome news and shows how flexible that T-CLATs can be made to be.  It is good to know that the IRS believes that setting up the T-CLAT payout in a writing other than the trust instrument doesn’t harm the qualification of the T-CLAT under IRC Sec. 2055(e)(2), which permits qualified reformations of a trust instrument.

The ruling is as interesting for what the IRS did not say because it wasn’t asked: what is the level of flexibility that the IRS will permit in having unequal T-CLAT payouts?  In the ruling, the T-CLAT trustee expressly asked for qualification of ascending payouts that increased by 20% each year, similar to the 20% increases that are expressly permitted in GRATs by Treas. Reg. Sec. 25.2702-3(b)(1)(ii)(A).  I don’t think that there is any restriction on the size of the increases that are possible in a T-CLAT.   In fact, I even think that a descending (i.e. front-loaded) charitable payout is possible to qualify a T-CLAT, but I doubt that such would find much utility as a practical matter.

From a drafting standpoint, the ruling may stand for the proposition that perhaps it is better to not be more specific in confecting the charitable annuity payout than to simply provide, like the T-CLAT in this ruling, for a payout that would “zero out” the non-charitable interest.  I say that because one of the hardest things to do in putting together a T-CLAT is dealing with the unknown AFR that will be in effect at the time of death.

There have been a number of private letter rulings in which the IRS has blessed various T-CLAT formulae, but each of those rulings involved a specific formula in the trust instrument.  Of course, the proposed payout would have to be consistent with the testator’s intent, and a court would have to go along with the strategy.  However, from a practical standpoint, the back-loaded ascending payout will almost always be better for preserving the non-charitable share than a straight-line payout.

CITES: PLR 201216045; IRC Sec. 2055; Treas. Reg. Sec. 20.2055-2(e)(2)(vi); PLRs 8946022, 9118040, 9128051, 9840036, 199947022 and 199927031; and Hood, “A Panacea or Potential Problem: T-CLATs-Beyond the Basics,” The Ultimate Estate Planner, Inc. (Nov. 17, 2011).


About lpaulhoodjr

I am an inactive lawyer who practiced almost 20 years as a tax and estate planning lawyer. Today, I am a speaker, author and consultant on tax and estate planning. In the recent past, I was the Director of Planned Giving for The University of Toledo Foundation. I am the co-author of six books, the sole author of another book and a frequent speaker and writer on estate planning, planned giving and business valuation.
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