Saving an Estate Charitable Deduction through Qualified Reformation

On Dec. 12, 2014 the Internal Revenue Service issued Private Letter Ruling 201450003, in which it considered whether an estate is entitled to a charitable deduction under the federal tax code Section 2055(a) if a portion of a defective charitable remainder trust (CRT) was reformed to satisfy the statutory requirements for a charitable remainder unitrust (CRUT).

IRS Determination

The IRS concluded in its Private Letter Ruling that the proposed reformation would be a “qualified reformation” within the meaning of Section 2055(e)(3) as long as the reformation is effective under local law and the CRUT, as reformed, meets the requirements under Section 664 of the code. The definitions of the CRUT are detailed in that section of the code in addition to in relevant regulations. As a result, as long as the reformation is a qualified one, an estate is entitled to a federal estate tax charitable deduction under Section 2055(a) equal to the present value of the charitable remainder interest and charitable income interest of the CRUT.

An estate is entitled to claim a charitable deduction pursuant to Section 2055(a) when the decedent transfers property to a CRT, as long as the remainder is in the form of a CRUT, an annuity trust, or a pooled income fund. Section 2055(e)(3) provides a mechanism where a fiduciary can make a qualified reformation, including an after-death reformation for an estate, of an otherwise defective CRT. If a qualified reformation of a defective CRT occurs, an estate is entitled to a charitable deduction under Section 2055(a).

Requirements for Qualified Reformation

The reformation of the portion of the CRT into the CRUT must be considered qualified within Section 2055(e)(3) in order to claim a charitable deduction under Section 2055(a) for any portion of the CRT. In order to be qualified, the following must be true:

· The CRT is a reformable interest within the meaning of Section 2055(e)(3)(C)
· The CRUT is a qualified interest within the meaning of Section 2055(e)(3)(D)
· The actuarial value of the remainder interest of the CRUT as of the date of death of the estate doesn’t deviate by more than five percent from the actuarial value of the remainder interest of the CRT as of the date of death · The non-charitable interests in the CRT and CRUT both terminate at the same time · The reformation of the CRT into the CRUT was retroactive to the date of the decedent’s death
IRS Tests

The IRS ran their ruling through a series of tests to check the viability of the Private Letter ruling. The four tests include the following:

Actuarial Test
The IRS determined that the actuarial test was satisfied because the actuarial value of the remainder interest of the CRUT as of the date of death of the decedent for the estate didn’t deviate by more than five percent from the actuarial value of the remainder interest of the CRT as of the date of death.

Equal Duration Test
The IRS determined that the equal duration test was satisfied because the non-charitable interests in the CRT and the CRUT both terminate upon the date of the decedent’s death of the estate.

Effective Date Test
The IRS concluded that the effective date test was satisfied because the reformation of the CRT was retroactive to the date of the decedent’s death.

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