On December 10, 1998 the U.S. Treasury issued final Regulations affecting charitable remainder unitrusts (CRUT's). The rules are effective for CRUT's created on or after December 10, 1998. CRUT's already in existence at that date can now be reformed until June 30, 2000, as discussed below.
Background
Generally, a CRUT provides for the payment to the non-charitable beneficiary of an amount (called the "unitrust amount") equal to a fixed percentage of the net fair market value of the CRUT's assets, revalued annually. Two variations of the fixed percentage method are widely used. Under the first (NI-CRUT) method, the unitrust amount is the lesser of the fixed percentage amount or the trust's annual net income. Under the second (NIM-CRUT) method, the unitrust amount has the same net income limitation as the NI-CRUT; but in any year in which the amount of net income exceeds the current year's fixed percentage, the excess can be distributed to the extent necessary to make up for the amount by which the income limitation caused prior years' payments to fall short of the fixed percentage amount. The shortfall in payments from prior years is commonly referred to as the "make-up amount." In the case of transfers of unmarketable assets to a CRUT, the IRS recognized the difficulty of the CRUT's meeting a steady stream of unitrust payments if the assets produced little or no income until they were sold. Consequently, the 1998 Regulations allow the governing instrument of a CRUT to provide that it will "flip" irrevocably, one time only, from one of the income exception methods (described above) to the fixed percentage, non-income limited method for calculating the unitrust amount under the following conditions:
a) The date or event triggering the conversion has to be outside the unilateral control of the trustees or any other person. The sale of unmarketable assets is a permissible triggering event. (Other permissible triggering events with respect to any individual include marriage, divorce, death, birth of a child or a person attaining a stated age.) The Regulations clarify that the term "unmarketable assets" applies to assets that are not "cash, cash equivalents, or other assets that can be readily sold or exchanged for cash or cash equivalents." Regs. Section 1.664-1(a)(7)(ii). Examples include real property, closely-held stock or unregistered securities for which there is no available exemption permitting public sale.
b) The change of methods has to occur at the beginning of the taxable year that immediately follows the taxable year during which the triggering event occurs. Any make-up amount is forfeited upon the conversion.
Reforming existing CRUT's
The Regulations, coupled with recently issued Notice 99-31, allow existing NI-CRUT's and NIM-CRUT's to add a flip provision as described above. In order to do so, a formal proceeding is required. Legal proceedings to reform the trust have to be initiated in the appropriate jurisdiction by June 30, 2000. Non-judicial reformation procedures valid under state law must be completed by June 30, 2000. In addition, the triggering event (for example, the sale of unmarketable assets) must not have already occurred before the court issues the order reforming the trust.
This change may be quite advantageous for CRUT's that contain low income yielding, unmarketable assets. With the addition of a flip provision, once the assets are sold, the entire proceeds can be reinvested for total return, without regard to the income yield and without discrimination of the corpus by less of the make-up amount.
If you have any questions or comments about this new Regulation, or if you would like to know what its impact will be upon you, please contact your attorney at Rosenman & Colin LLP or any of the following members of the Trusts & Estates Department:
- Rosenman & Colin LLP
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