7.26.15 IRC 4947 Trusts


  1. Under subchapter J, trusts not exempt under IRC 501 can obtain many of the tax benefits held by organizations which are exempt under IRC 501(c)(3). The principal benefits are as follows:

    1. use of IRC 642(c) — the practical equivalent of income tax exemption, and

    2. deductibility of charitable contributions.

  2. IRC 4947 prevents the use of trusts not exempt under IRC 501 to escape the foundation excise tax provisions. IRC 4947 is a "loophole closer" by applying private foundation rules:

    1. to charitable trusts that intentionally or inadvertently fail to file for exemption under IRC 501(a) (See IRC 4947(a) (1)) and

    2. to "split interest" trusts having a portion of the contribution deductible (See IRC 4947(a)(2)).

  3. IRC 4947 echoes a theme that is found throughout the foundation provisions: being subject to them is the "price" one pays for deductibility of contributions.

Nonexempt Charitable Trusts

  1. A trust is described in IRC 4947(a)(1) if it:

    1. has exclusively charitable interests, and

    2. is a trust for which a charitable deduction is allowed.

    3. is an estate in unduly prolonged administration or a trust, discussed below in IRM

  2. If a trust is described in IRC 4947(a)(1), private foundation rules will apply unless the trust qualifies for public charity status.

Estates and Certain Trusts Performing Administrative Functions

  1. An estate is not considered to be an IRC 4947(a)(1) trust during any reasonable period for administration or winding up of its affairs. Once it is terminated for federal income tax purposes or if it is considered unduly prolonged, the provisions of IRC 4947(a)(1) will apply.

  2. Similarly, in the winding up of an IRC 4947(a)(2) trust, there are transitional rules that apply before the trust is considered described in IRC 4947(a)(1).

  3. Examples of trusts or estates not subject to IRC 4947(a)(1) during a period of administration or settlement include the following:

    1. A split-interest trust for which a final distribution of all assets is required because its private interests have expired would not be subject to the provisions of IRC 4947(a)(1) until expiration of any reasonable period for settlement. Regs. 53.4947–1(b)(2)(iii).

    2. Another variation of the preceding example is a split interest trust where all private interests have expired and where the charitable beneficiaries are not entitled to a distribution will continue to be treated as a split-interest trust during a period of settlement. This trust is unlike the preceding trust because some or all of the charitable remainder interests remain in the trust rather than being distributed. Regs. 53.4947–1(b)(2)(iv).

    3. A revocable trust that becomes irrevocable at the creator’s death and is required to make a final distribution of all its assets is not subject to IRC 4947(a)(1) during any reasonable period of settlement. Regs. 53.4947–1(b)(2)(v).

Exclusively Charitable Interests

  1. IRC 4947(a)(1) only describes trusts having exclusively charitable interests. An interest in a trust is the beneficiaries right to the trust’s income or assets.

  2. An interest is created by the trust’s governing instrument subject to local law. All of the interests must be charitable as described in IRC 170, and at least a portion of the interests in the trust must be charitable as described in IRC 170(c)(2)(B). Regs. 53.4947–1(b)(2)(vii). See IRC 170(c) for definitions.

Trust for Which a Deduction Was Allowed

  1. In order for a trust to be described in IRC 4947(a)(1) , a charitable deduction must have been allowed under IRC 170, 545(b)(2), 556(b)(2) , 642(c), 2055, 2106(a)(2) , or 2522. Deductions allowed under IRC 642(c) include deductions allowed a trust with respect to its own income as well as deductions allowed for a payment to another trust. Each trust would be subject to IRC 4947(a). If a charitable deduction was allowable, it will be presumed to have been taken and allowed in the absence of proof to the contrary. Regs. 53.4947–1(a).

Private Foundation Classification

  1. Just as with IRC 501(c)(3) organizations, IRC 4947(a)(1) trusts are either public charities or private foundations. If it is a public charity, IRC 509(a)(3) is the most likely subsection that it qualifies under.

  2. An IRC 4947(a)(1) trust may request a determination from the Service under IRC 509(a)(3) even though it has neither obtained nor seeks exemption under IRC 501(c)(3). Rev. Proc. 72–50, 1972–2 C.B. 830, as superseded in minor part by Rev. Proc. 76–34, 1976–2 C.B. 657.

  3. The requirements of IRC 509 are not modified for IRC 4947(a)(1) trusts except for the organizational test of IRC 509(a)(3). A trust is considered organized at the time the trust becomes subject to the provisions of IRC 4947(a)(1). Regs. 53.4947–1(b)(3). Thus, an expired private interest of a former split-interest trust does not prevent the trust from meeting the IRC 509(a)(3) organizational test.

Application of Private Foundation Provisions

  1. Generally, IRC 4947(a)(1) provides that the private foundation provisions apply to trusts in the same manner as they apply to exempt private foundations.

  2. One important exception, however, is that IRC 4947(a)(1) trusts do not have to notify the Service in order to be described in IRC 4947(a)(1). See Regs. 53.4947–1(b)(1)(i).

  3. The excise tax on net investment income is imposed under IRC 4940(b) instead of IRC 4940(a). Regs. 53.4947–1(b)(1)(i). The amount of IRC 4940 tax is the difference between any income tax paid and the amount of unrelated business tax which would have been paid if the trust had been subject to IRC 511. Regs. 53.4940–1(b).

  4. Modifications are made for those trusts that are private foundations and have IRC 170(c)(3) or IRC 170(c)(5) interests. Payments under the terms of the trust’s governing instrument in satisfaction of such interests do not violate any provision of Chapter 42 and constitute qualifying distributions for purposes of IRC 4942. Regs. 53.4947–1(b)(2)(vii).

IRC 4947(a)(2) Split-Interest Trust

  1. The applicability of excise taxes imposed by Chapter 42 to split interest trusts is governed by IRC 4947(a)(2). Not all provisions of Chapter 42 are applicable.

  2. A trust is described in IRC 4947(a)(2) if it is:

    1. not exempt under IRC 501(a);

    2. its income and assets are not completely devoted to charitable purposes described in IRC 170(c)(2)(B) ; and

    3. it has amounts in trust for which a charitable deduction was allowed.

Common Types of Split-Interest Trusts

  1. Because of statutory changes effective in 1969 (IRC 170(f)(2), IRC 2055(e)(2) and IRC 2522(c)(2)), there are three common types of split-interest trust;

    1. pooled income funds described in IRC 642(c)(5),

    2. charitable remainder trusts described in IRC 664, and

    3. charitable lead trusts.

  2. Charitable remainder trusts, and charitable lead trusts, make annuity or unitrust income payments. Annuity payments involve payment of a specific amount per year under the terms of the trust’s governing instrument. Unitrust payments involve payment of a specific percentage of the fair market value of a trust’s assets determined each year.

Pooled Income Funds
  1. Pooled income funds are created and maintained by organizations described in IRC 509(a)(1). Income is paid to an individual for life with the remainder to the organization maintaining the fund. Income paid to income beneficiaries is computed under normal trust accounting rules. Trusts tend to pay out net ordinary income and to retain capital gains. Income payments to beneficiaries is based on a pro rate portion of overall trust income rather than tracing to specific assets.

  2. There are other specific technical income tax requirements for qualifying as a pooled income fund. See IRC 642(c)(5) and Regs. 1.642(c)–5(b).

Charitable Remainder Trusts Described in IRC 664
  1. Charitable remainder trusts described in IRC 664 also involve trusts where noncharitable beneficiaries have an income interest and all remainder interests are devoted to charitable purposes. There are two varieties, charitable remainder annuity trusts and charitable remainder unitrusts.

  2. Charitable remainder annuity trusts "CRATS" must make annuity payments to individuals of at least 5% of the value of the corpus when the trust is established. Annuity payments for charitable purposes are permitted but not required. If actual trust income exceeds the exact annuity amount, the excess is permitted to be paid for charitable purposes. However, payments to private beneficiaries are required to be the exact annuity amount. See IRC 664 and Regs. 1.664–1 and 1.664–2.

  3. Charitable remainder unitrusts "CRUTS" must make unitrust payments of at least 5% of the fair market value of the assets, valued annually, to noncharitable interests. Unitrust payments for charitable purposes are permitted but not required. CRUTS normally pay the unitrust amount even if corpus must be invaded.

  4. CRUTS may be created that solve this problem. IRC 664 permits the formation of trusts that pay the lesser of trust income and the unitrust amount. These are called NIMCRUTs.

  5. If a NIMCRUT makes an annual payment that is less than the unitrust amount (because the trust income is less than the unitrust amount), the trust may make-up the payment in a subsequent year. It does so, however, only to the extent that trust income exceeds the unitrust amount.

Charitable Lead Trusts
  1. Charitable lead trusts must have at least a portion of its income devoted to charitable purposes. There are two types of charitable lead trusts, one type makes annuity payments while the other type makes unitrust payments.

  2. Either trust can be set up to make payments for private purposes in addition to the required payments for charitable purposes.

  3. If the creator desires an income tax deduction under IRC 170 for the gift creating the trust, the income of the trust must be taxed to the grantor under Subpart E of Subchapter J of the Code.

Trusts, Estates Exceeding a Reasonable Period of Settlement

  1. Under the Code, all estates and trusts are allowed a reasonable period of settlement to wind up and to distribute assets. When estate and trust administration is unduly prolonged, tax law treats them as terminated. If settlement is prolonged;

    1. an estate,

    2. a revocable trust becoming irrevocable on the death of the decedent-grantor, and

    3. certain revocable and testamentary trusts;

    all having both charitable and noncharitable beneficiaries is subject to IRC 4947(a)(2) for the period after it is treated as terminated or unreasonably prolonged. See Regs. 53.4947–1(c)(6)(ii) through (iv). See Regs. 4947–1(b)(2)(iv) for a discussion of the term "reasonable period of settlement." Note that this provision is only applicable to trusts or estates having both charitable and noncharitable beneficiaries.

Trusts Not Exceeding a Reasonable Period of Settlement
  1. As discussed earlier, a split interest trust having only charitable beneficiaries at the expiration of the private interests (and where some of the charitable interests will continue in trust) will have a reasonable period of settlement to wind up its affairs during which period the trust will remain subject to IRC 4947(a)(2) before it is treated as an IRC 4947(a)(1) trust subject to all of the private foundation provisions. Regs. 53.4947–1(b)(2)(iv).

Trust Partially Devoted to IRC 170(c)(2)(B) Charitable Purposes

  1. A trust must have some interests devoted to IRC 170(c)(2)(B) charitable purposes to be described in IRC 4947(a)(2).

  2. IRC 170(c)(2)(B) defines the term "charitable" . Gifts to governmental units, described in IRC 170(c)(1) are considered described in IRC 170(c)(2)(B). Regs. 53.4947–1(a). For purposes of IRC 4947 a similar result is not reached for gifts to war veterans posts described in IRC 170(c)(3) and cemeteries described in IRC 170(c)(5). Thus, a trust having a mixture of private interests and interests described in IRC 170(c)(3) or IRC 170(c)(5) is never subject to IRC 4947(a)(2) . Trusts having no private interests and a mixture of IRC 170(c)(2)(B) and IRC 170(c)(3) or IRC 170(c)(5) interests are described in IRC 4947(a)(1).

Charitable Deduction Allowance

  1. In order to be subject to IRC 4947(a)(2), a charitable deduction must have been allowed for an amount in trust. All types of charitable deductions (IRC 170, 545(b)(2), 556(b)(2), 642(c), 2055, 2106(a)(2), 2522) taken by others or by trust set-asides, result in the split-interest trust having amounts in trust for which a deduction was allowed. Reg. 53.4947–1(c)(1)(i).

Application of Foundation Rules to Split-Interest Trusts Under IRC 4947(a)(2)

  1. Not all private foundation provisions of Chapter 42 do apply to split interest trusts. Those that apply may apply differently to split interest trust then to private foundations. IRC 4947(a)(2) lists the provisions that apply to split-interest trusts. IRC 4943 and IRC 4944 are only applicable to some of the types of split-interest trusts.

  2. IRC 4947(a)(2)(C) excludes amounts transferred in trust prior to May 27, 1969, from application of the private foundation provisions.

Exceptions and Limitations

  1. IRC 4947(a)(2)(A) limits application of the foundation excise tax provisions to amounts paid to beneficiaries where a charitable deduction was allowed under specific provisions (IRC 170(f)(2)(B), IRC 2055(e)(2)(B), and IRC 2522(c)(2)(B)). This prevents payments to the noncharitable beneficiaries attributable to amounts for which a deduction was not allowed from being considered acts of self dealing under IRC 4941 or taxable expenditures under IRC 4945.

  2. A single trust document may create separate trusts not all trusts being subject to 4947(a)(2). Assume one asset, Building A, is used to fund a trust for completely private interests. Building B is used to fund a split interest trust. Under IRC 4947(a)(2)(B) and Regs. 53.4947–1(c)(3), Building A trust may be treated as a separate trust not subject to IRC 4947.

  3. Building A and B trusts are treated as two trusts because a different trust is imposed on each asset. If the same trust was imposed on both assets and if that trust were described in IRC 4947(a)(2), it would be subject to IRC 4947(a)(2).

  4. If more that one trust is created, separate accounting is required by any reasonable method regularly employed by the trust or by a method which the Commissioner finds reasonable. Regs. 53.4947–1(c)(4)(ii).

Provisions Never Applicable to Split-Interest Trusts

  1. Since IRC 4940 and IRC 4942 are not listed in IRC 4947(a)(2), those sections never apply to split-interest trusts.

Termination of Private Foundation Status—IRC 507

  1. IRC 507 is listed in IRC 4947(a)(2) but the effect is limited because of the payments to private interests. Payments in satisfaction of private interests do not result in termination of private foundation status under IRC 507(a). Regs. 53.4947–1(e)(1). Payments to private interests would prevent transfer of all assets to a public charity as required for termination of private foundation status under IRC 507(b)(1)(A).

  2. Also, the existence of private interests make it impossible for a split-interest trust to use the provisions of IRC 507(b)(1)(B) to terminate private foundation status by operation as an organization described in IRC 509(a)(3).

IRC 508(e)

  1. The governing instrument requirements of IRC 508(e) apply to split-interest trusts but only those foundation excise tax provisions which apply to split-interest trusts are required to be included. Regs. 53.4947–1(c)(1)(ii). IRC 508(e) does not apply to governing provisions concerning gifts to cemeteries (IRC 170(c)(5)), war veterans posts (IRC 170(c)(3)), and private interests.

  2. Because IRC 4947(a)(2) trusts are not exempt under IRC 501(a), the effect of violation of any of the provisions of IRC 508(e) is limited to disqualification of any charitable deductions. This would then cause the split-interest trust not to be described in IRC 4947(a)(2) because no deduction was allowed.

Self-Dealing—IRC 4941

  1. The self-dealing provisions of IRC 4941 apply without modification to all split-interest trusts subject to IRC 4947(a)(2). The only exception is for the treatment of beneficial interests. IRC 4947(a)(2)(A) provides that payments to private, war veterans posts, and cemetery interests are not acts of self dealing. Thus, payment of the annuity or unitrust amount by a charitable remainder trust is not an act of self dealing.

  2. Also, IRC 4941 does not apply to a charitable lead trust where the remainder interest is paid to private parties because after the remainder is paid the trust no longer has amounts in trust for which a charitable deduction was allowed. Regs. 53.4947–1(e)(2), example 2.

Examples of Self-Dealing Specific to IRC 4947(a)(2) Trusts

  1. Termination of the trust by the creator/income beneficiary for the purpose of reacquiring trust assets is usually an act of self dealing. Unless there some unusual circumstance such as fraud perpetrated on the income beneficiary or a clear case of scrivener’s error, and only then under court supervision the termination or the trust is problematical.

  2. Special rules under IRC 664 are being developed under which trusts can "flip" that is modify their formats from standard CRUT form to NIMCRUT.

  3. Other examples of self-dealing that may be applied in the context of IRC 4947(a)(2) trusts include the following:

    1. Notice 94–78, 1994–2 C.B. 555, addressed the problem of the charitable remainder trust being used as a vehicle to convert appreciated assets into cash while avoiding a substantial portion of the tax on the gain.

Taxable Expenditures—IRC 4945

  1. The taxable expenditure provisions of IRC 4945 apply to split-interest trust which are treated as if they were private foundations. IRC 4947(a)(2) provides that the taxable expenditure provisions do not apply to income payments in satisfaction of private interests, cemetery interests, and war veterans post interests. A charitable lead trust makes payments to private remaindermen. IRC 4947(a)(2) no longer applies because the charitable interests have expired. Thus, there would be no taxable expenditure.

IRC 4943 and IRC 4944

  1. IRC 4947(b)(3) governs application of IRC 4943 and IRC 4944 to split-interest trusts. There are two separate rules which, if applicable, result in neither IRC 4943 nor IRC 4944 applying to a split-interest trust.

  2. One rule, set forth in IRC 4947(b)(3)(A), applies only to certain charitable lead trusts. The rule applies to trusts which have income interests exclusively devoted to charitable purposes (as describe in IRC 170(c)(2)(B)), remainder interests exclusively devoted to private interests and charitable interests, for which a charitable deduction was allowed, having an aggregate value of not more than 60% of the value of all amounts in such trusts. In these circumstances, neither IRC 4943 nor IRC 4944 applies to the split-interest trust. The determination is made at the time for which the charitable deduction was allowed. Regs. 53.4947–2(b)(1).

  3. The second rule, set forth in IRC 4947(b)(3)(B), applies to pooled income funds and charitable remainder trusts where a charitable deduction was allowed for amounts payable under the terms of such trust to every remainder beneficiary but not to any income beneficiary. If this rule applies, neither IRC 4943 nor IRC 4944 applies.

  4. If IRC 4943 or IRC 4944 applies to a trust, the sections apply in the same manner as they apply to a private foundation which is exempt under IRC 501(c)(3).