4.76.5  Non-Exempt Charitable And Split Interest Trusts  (04-01-2003)

  1. Trusts not exempt under IRC § 501 can obtain many of the tax benefits held by organizations that are exempt under IRC Section 501(c)(3). IRC §4947 prevents use of trusts not exempt under IRC § 501 to escape the foundation tax provisions. There are several types of entities that a taxpayer may establish that do not seek tax exempt status, yet may still offer attractive tax advantages. The rules regarding these entities are quite complex and are frequently misapplied or deliberately abused. The examiner should review IRM 4.76.4, " Private Foundations" , setting forth the guidelines of IRC 4947 Trusts. Basically, the private foundation provisions apply to nonexempt charitable trusts and charitable remainder trusts in the same manner as they apply to exempt private foundations.  (04-01-2003)
Examination Objectives

  1. The examination of an IRC § 4947 trust will be initiated for the following objectives:

    1. For 4947(a)(1) trusts: to determine whether the organization is operating in accordance with the rules under IRC § 4947(a)(1).

    2. For 4947(a)(2) trusts: to determine whether the organization is operating in accordance with the rules under IRC §664.

    3. To determine whether the unexpired interests (for 4947(a)(1) trusts) or remainder interest (for 4947(a)(2) trusts) are devoted to a qualified charitable purpose.

    4. To determine if any of the excise taxes or provisions described in IRC §4940 - 4948 apply.

    5. To determine if a referral should be made to the examination division to consider income tax issues.  (04-01-2003)
Charitable Remainder Trusts (CRT)

  1. IRC Section 4947(a)(1) defines a type of trust known as a nonexempt charitable trust (NECT), which does not qualify for tax exempt status. It is required to have exclusively charitable interests (beneficiaries) and must be an entity for which a charitable deduction was allowed under IRC section 170, 545(b)(2), 556(b)(2), 642(c), 2055, 2106(a)(2), or 2522. IRC section 509 determines whether or not it is a private foundation. The private foundation provisions apply to a nonexempt charitable trust in generally the same manner as to exempt private foundations. See IRM 4.76.4 for general trust audit guidelines.

  2. IRC Section 4947(a)(2) - Describes split-interest trusts. As the name implies, a split-interest trust can have both charitable and non-charitable beneficiaries. It cannot be exempt under IRC section 501(a), and its interests (beneficiaries) must be devoted in part (but not exclusively) to charitable purposes described in IRC section 170(c)(2)(B). A charitable deduction must have been allowed under IRC section 170, 545(b)(2), 556(b)(2), 642(c), 2055, 2106(a)(2) or 2522.

    1. The three basic types of split-interest trusts are pooled income fund, charitable remainder trust, and charitable lead trust. The charitable remainder and lead trusts can take two forms: a unitrust (CRUT) or annuity trust (CRAT), distinguished by the method of payment to the non-charitable beneficiary.

    2. Split-interest trusts are usually subject to private foundation taxes if created after May 26, 1969. For those to which such taxes apply, it is necessary to consider each provision under Chapter 42, particularly IRC sections 4943 and 4944. IRC section 4947(a)(2)(A) segregates amounts as if they were separate trusts and has the effect of limiting foundation excise taxes so they do not apply to beneficiary payments unless a charitable deduction was allowed under the sections cited above. See IRM 4.76.5 for general audit guidelines.  (04-01-2003)

  1. The unitrust is funded by a donor who provides the assets, as the trust corpus, to the unitrust.The Trustee, whose appointment is provided for in the trust instrument, administers the unitrust, and is required to make payments from the unitrust to one or more non-charitable beneficiaries for their life or a fixed period of years.

  2. The amount of the payments is determined by the percentage of the net fair market value of the unitrust's assets, and cannot be lower than 5 percent. When the non-charitable beneficiaries pass away or the fixed period of years ends, the assets in the unitrust are paid over to or are held for the benefit of a charitable organization or organizations described in IRC § 170(c).


    The 60 year old creator of a unitrust donates $500,000 cash, as trust corpus, to that unitrust on January 1, 19x1. the trust instrument provides that: 1) The sole income beneficiary is the creator, 2) The unitrust will pay 5 percent of the net fair market value of the unitrust assets as valued annually, 3) The unitrust must make an annual payment to the income beneficiary for 15 years, and 4) The remainder beneficiary is an IRC 501(c)(3) organization.

  3. The creator in the previous example, receives a federal income tax deduction for the charitable contribution and the trustee distributes the required payment to the contributor each year for 15 years. At the end of the 15th year, the trustee make the final payment to the contributor, dissolves the unitrust, and transferred the corpus to the IRC § 501(c)(3) organization.  (04-01-2003)
Annuity Trust

  1. The other type of charitable remainder trust is the annuity trust. Annuity trusts are very similar to unitrusts, for they also make payments to one or more non-charitable beneficiaries.

  2. The major difference is the method of determining payments. the annuity trust payment is a set dollar mount, which is at least 5 percent of the net fair market value of the trust assets valued as of the date of transfer. For transfers after June 18, 1997, the annuity may not be greater than 50 percent of the fair market value of trust assets as of the date of the transfer of assets to the trust. See IRC § 664(D)(1).  (04-01-2003)
IRC 4947(a)(1) Charitable Trust - Examination Guidelines

  1. A nonexempt charitable trust (NECT) defined by IRC § 4947(a)(1) is a trust that does not qualify for tax exempt status and therefore is required to file a Form 1041 and pay tax on its taxable income. It is also required to file either a Form 990-PF or 990, depending upon whether it is more properly described as a private foundation or public charity, respectively. Accordingly, the examiner must verify it has exclusively charitable interests or beneficiaries, and must be an entity for which a charitable deduction was allowed under IRC §§170, 545(b)(2), 556(b)(2), 642(c), 2055, 2106(a)(2), or 2522.

  2. The examiner should review possible applicability of the trust meeting the organizational and operational tests of IRC § 509(a)(3). See IRM 4.76.3, Public Charities.

  3. The examiner should be aware of the different tax application of the excise tax on net investment tax imposed by IRC §4940. Refer to the section on Private Foundations, IRM 4.76.4, IRC § 4940(b), and Treas. Regs. 53.4947-1(b)(1)(i).

  4. The examiner must be aware that some promoters of abusive tax schemes are promoting the use of NECTs to shelter business income or to otherwise circumvent the income tax provisions, with very little actually going to charity. These schemes frequently involve the use of multiple entities, or using offshore entities located in tax haven countries, or the use of phony charitable organizations.  (04-01-2003)
IRC 4947(a)(2) Trusts - Examination Guidelines

  1. IRC Section 4947(a)(2) trusts are more commonly referred to as split- interest trusts, as they have both charitable and non-charitable beneficiaries. There are 2 basic types: a charitable remainder unitrust (CRUT) and a charitable remainder annuity trust (CRAT).

  2. A CRT must hold amounts for which a charitable deduction is allowed. It must have an irrevocable remainder interest that is held for the benefit of a qualified charitable organization (as described in IRC 170(c)).

  3. Examiners should be aware that split interest trusts must file Form 5227 annually. They are also required to file Form 1041-A annually, unless all net income is distributed to beneficiaries. A Form 1041 is required only if the entity has unrelated business income, in which case the tax liability should be reflected on the Form 1041. (Refer to IRM 4.75.30)

  4. It is essential for the examiner to obtain the trust document and review it to determine if the trust meets all of the qualifications of IRC §664. The Service has produced the following Revenue Procedures that contain sample required wording for trust documents for CRTs:

    1. For Charitable Remainder Annuity Trusts: Rev. Proc. 89-21, 1989-1 C.B. 842; Rev. Proc. 90-32, 1990-1, C.B. 546.

    2. For Charitable Remainder Unitrusts: Rev. Proc. 89-20, 1989-1 C.B. 841; Rev. Proc. 90-30, 1990-1 C.B. 534.

    3. For Charitable Remainder Unitrusts (Net Income) : Rev. Proc. 90-31, 1990-1 C.B. 539; Rev. Proc. 90-31, 1990-1 C.B. 539.

    4. For Pooled Income Funds: Rev. Proc. 88-53, 1988-2 C.B. 712

  5. The examiner should review records concerning the nature of property transferred to the trust and the date that legal transfer was made. A CRT is not created until an actual transfer of property is made, regardless of other events, such as when the trust document is signed.

  6. Examiners should review IRM 4.76.4 to familiarize themselves with Charitable Remainder Annuity Trusts (CRAT), Charitable Remainder Unitrusts (CRUT), and pooled income funds. Certain Chapter 42 excise tax sanction apply to all split interest trusts. (Refer to the 2001 CPE section "Trust Primer " for an in-depth treatment of such trusts.)

  7. Examiners need to be aware that there may be many issues associated with CRTs that effect income tax examinations, mostly concerning the allowance of a deduction for the contribution made to the CRT. It is recommended that TEGE examiners coordinate the examination of a CRT with an SBSE examiner whenever feasible, especially if it is suspected that there are material issues concerning the charitable deduction.  (04-01-2003)
Abusive Trusts - Examination Guidelines

  1. Examiners must pay special attention to trusts utilizing " Promoters" who market potential abusive tax schemes. Documents relative to the marketing scheme should be reviewed to determine the scheme is not a "harm to the federal government" . Consideration should be given to contacting the SBSE Abusive Tax Promoters Group. Also, in many of these types of cases, the examination should be coordinated with either SBSE or LMSB, (depending on the dollar amounts involved)

  2. Special interest should be paid to trusts operating in a " multi-tier" system organized and operated to avoid tax. It is recommended that an examiner perform IDRS and/or other database research to determine what other entities the taxpayer is involved with and how the other entities may be interrelated with the CRT. Check to see if distributions are being made to other trusts or entities in which the donor-creator receives the ultimate benefit.

  3. The examiner must check to see if the creator of a NECT assigns or "re-directs" earned income to the trust, never giving up "control" of the income or assets. The examiner may determine this to be a sham or grantor trust, alternatively, resulting in employment tax issues.

  4. The examiner should verify that NECTs are not paying the personal expenses of the creator or trustee and labeling these expenses as "management service fees" or deducting them as some other expense.

  5. For NECTs, if there is an entry on line 13 of form 1041, the examiner should check to see if the taxpayer filed Form 1041-A (these forms are filed through the Ogden Campus). If the taxpayer was required to, but did not file Form 1041-A, consider assessing penalties per IRC Section 6652(c)(2). The Form 1041-A is used to provide information about the charitable deduction and the identity of the charitable organization(s) which received the contribution. When examining CRTs, beware of pre-arranged sales of highly appreciated property (such as real estate or capital stock) that are purposefully structured merely to avoid capital gain taxes. If there is no other economic purpose, and the grantor effectively retains control over the assets, consider treating it as a sham transaction or as a grantor trust.

  6. In the case of CRTs, the examiner will always check to see what was donated to the trust as well as whether or not the present value actuarial amount was properly computed and deducted by the donor. Also, check to determine if a reasonable and accurate valuation was placed on the assets transferred. If not, a referral should be made to a valuation specialist.

  7. It is essential for the examiner to trace the flow of cash in any examination of a charitable trust to determine if there are any self-dealing or taxable expenditure issues and to determine if proper payments are made to qualified charities.

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