Bills / Cases / IRS

Question: In the event the beneficiary of an IRA dies and leaves the entire estate to charity so the IRA goes to the estate, what can be done to minimize the income tax hit, which diminishes the charitable bequests?

Answer: To prevent the income tax hit, every will and revocable living trust that provides for a bequest to charity should contain language such as:

"I instruct that all charitable gifts, bequests and devises shall be made, to the extent possible, from property that constitutes "income in respect of a decedent" as that term is defined in the Internal Revenue Code."

If the documents did not contain this language, then if either the will or state law gives an executor discretion to make non-pro rata cash or in kind distributions, then there may be no taxable income when the executor distributes the IRA to charity.


Question: IRA owner decedent names spouse as beneficiary, spouse predeceases; estate becomes residual beneficiary; estate is directed by pourover will into a Revocable Living Trust now irrevocable which gives 100% of the estate to charity. IRAs are directed by executor and trustee to be paid directly to charity. Any estate or income tax?

Answer: If a transfer is not a pecuniary interest, it should be possible to make distribution without payment of income tax. Thus, in this case, there should not be either estate (100% charitable estate tax deduction) nor income tax on the IRA account.


Question: Lump sum distribution of employer stock from qualified plan. Discuss subsequent transfer to CRT.

Answer: Under current IRS law, most withdrawals from qualified plans are subject to ordinary income tax in the year of withdrawal. However, the IRS makes an exception for certain in-kind distributions of employer securities held in a qualified workplace savings plan, such as a 401(k). (With an in-kind distribution, the employee receives unsold stock certificates directly from the employer.) Under the IRS exception, if the employee takes the company stock in an in-kind, lump-sum distribution, he/she will owe only the income tax on the original cost of the stock. In other words, the IRS allows the employee to postpone paying tax on the net unrealized appreciation - that is, the difference between the stock price when the initial investment was made and its appreciated value today - until the stock is sold. At the time of the sale, the employee will owe capital gains tax (at a maximum Federal rate of 20%) as opposed to the ordinary income tax rate of 39.6%.

The stock subject to the capital gains or unrealized appreciation can subsequently be transferred into a charitable remainder trust and sold without capital gains taxation.


Question: Donor with a $6 million estate has made a $400,000 pledge to charity. New will provides all of estate to a family foundation first using marital (spousal) trust and personal trust until second to die (of donor's spouse). What risk is there to charity since spouse has authority to redesignate trust distribution?

Answer: If spouse has the authority to designate, there is always the risk that the $400,000 pledge will not be made to that particular charity. Of course, if this is a valid enforceable pledge, charity could file suit to collect if the pledge was not honored. However, in probably 90% of these cases, the surviving spouse will honor the wishes of the decedent spouse.


Question: How will Roth IRAs change unitrust thoughts described?

Answer: A Roth IRA is a specialized IRA. Any "qualified distribution" from a Roth IRA is not includible in gross income unlike a traditional IRA wherein distributions are taxed at ordinary income rates. Therefore, any withdrawals from a Roth IRA are not taxable to the IRA owner and the designated beneficiaries. However, if the IRA owner passes away with a Roth IRA, it will be subject to estate taxes.

Because of the tax free income, we would suggest that a Roth IRA be transferred to family members. Any traditional IRAs owned at death should be transferred to charity to fulfill bequests or to a charitable trust as described in the teleconference.

Since Roth IRAs were just created by Tax Reform Act of 1997, we estimate that only about 10-15% of all IRAs will be Roth IRAs by the year 2010. Therefore, most planning will need to be done with traditional IRAs for many years to come.


Question: What effect does 10% residual to charity limitation have on setting up a testamentary unitrust?

Answer: The 10% minimum deduction test for charitable remainder trusts does apply to testamentary transfers. Therefore, one must be careful in creating a testamentary trust for young beneficiaries or multiple beneficiaries. A typical solution is to create one life unitrusts for each of the children, rather than a multiple life trust for all children. The testamentary trusts illustrated in the teleconference were primarily for older beneficiaries which passed the 10% test.



Question: Do you anticipate any problems with the Service in regards to the "Stretch Unitrust?

Answer: According to Private Letter Ruling 9852001, the trustee of a unitrust used trust assets to purchase two commercial deferred annuity agreements. The Service held that the purchase by a charitable remainder unitrust of variable annuity contracts 1) would not adversely affect the unitrust's status under Code Section 664 and the current regulations thereunder, and 2) is not an act of self-dealing. Therefore, the idea of using a unitrust as a retirement or deferral of income type of trust seems to find favor with the IRS since the Service did not rule adversely on the use of commercial annuity contracts as an investment of a unitrust.

The concept of a retirement unitrust now seems to be widely accepted and the provision of discretion on the part of the trustee to distribute capital gains is now drafted into many net income with makeup unitrusts. This allows for the investment of trust assets on a total return basis and the ability to pay out income when needed by the beneficiary(ies).



Question: Who gets the benefit of the 691(c) deduction if the testamentary CRUT is the beneficiary of a qualified plan? Is the CRUT or the noncharitable income beneficiary/beneficiaries of the CRUT that get the deduction?

Answer: Private Letter Ruling 199901023 basically prevents the income beneficiary of a CRUT from claiming the 691(c) deduction. However, the deduction is allocated to first tier ordinary income of the trust and thereby decreases the amount of ordinary income allocable to the trust. Therefore, if the trust is invested aggressively for growth, it will be able to transition to payouts of capital gain more rapidly because there is less tier-one ordinary income.


Question: Can you satisfy required minimum distributions in kind? If so, what is the income tax basis to the participant in the distributed assets?

Answer: Distributions from IRAs need to be made in the form of cash. Therefore, the actual investments held inside an IRA cannot be utilized to make the required distributions.


Question: Can you transfer an IRA at death in exchange for a gift annuity? Can a ommercial deferred annuities be used to fund a CRT or gift annuity?

Answer: A transfer of an IRA directly to charity as a bequest or to a charitable trust can be accomplished without payment of income taxes. However, since a gift annuity is part sale, part gift, it would appear that the transfer of an IRA in exchange for a charitable gift annuity would result in a "sale" of the IRA requiring recognition of income and payment of tax by the estate.

A commercial annuity could be used to fund a testamentary charitable trust with the same tax advantages of an IRA. A commercial annuity is an IRD asset and would be an ideal funding vehicle for a charitable bequest or testamentary trust. The same problem would exist, however, if the commercial annuity is used to fund a testamentary gift annuity as income would be required to be recognized by the estate.


Question: Funding decedent's B Trust with additional A-B Trust assets so as to avoid losing/wasting exemption from federal estate tax on death of first spouse. Example: $900,000 trust assets funding B Trust up to $650,000; A Trust wit h$250,000.

Has the IRS formally ruled that a postnuptial property agreement can be used to allow the B Trust to receive more than one-half of the community property trust estate in consideration of the surviving spouse receiving the decedent's souse's community property in the IRA?

Answer: In PLR 199912040 the IRS state that if the Trust document and applicable law authorize a Trustee to make a non-pro rata distribution of property, then the Bypass Trust and the Survivor's Trust are not required to receive pro rata distributions of each asset and any such distribution will not be treated as a pro rata distribution followed by an exchange of assets between the Bypass Trust and the Survivor's Trust. It must be pointed, however, that a Private Letter Ruling cannot be cited as precedent for any particular issue. It does, however, give and indication of the IRS' viewpoint on the issue.

Question: On page 78, Credit Shelter Trust #2 Use of Disclaimers, it says, ". . . if the trustee of the marital deduction trust disclaims the right to the benefits, the benefit could then be payable to a credit shelter trust."

I thought only a person with a beneficial interest in a transfer (gift or bequest) can disclaim, hence a trustee cannot disclaim. Is my understanding correct?

Answer: Yes. It would have been better if the sentence were written as follows:

"On the other hand, the benefits could initially be payable to the credit shelter trust with the provision that if the benefits were disclaimed by all of the beneficiaries of that trust, the benefits would be payable to a marital deduction trust and, if disclaimed by all the beneficiaries of that trust, the benefits would be payable to the spouse."

However, Keydel and Wallace, the authors of the paper cited in Footnote 37, stress the point that the trustee of these trusts must be given certain discretion to "disclaim" IRD assets. Perhaps the authors should have made a distinction between authorizing a trustee to allocate IRD assets when such assets are disclaimed by the beneficiaries of the trusts rather than disclaiming them.


Question: What are the limitations on transfer of assets - both personal, joint and retirement assets - without QDOTs?

Answer: If the decedent's spouse is an alien, whether resident or not, the decedent's estate will not be allowed a marital deduction for property passing to the spouse unless the requirements of IRC Section 2056(d)(4) and the regulations thereunder are satisfied. In all cases a marital deduction will be allowed only if the executor makes a timely QDOT election. Accordingly, if the value of the assets is less than the decedent's remaining lifetime exclusionary amount, then there would be no restrictions on the transfer. If the value of the assets exceeds the remaining lifetime exclusionary amount, then the QDOT requirements must be met or the decedent-spouse's estate will have to pay an estate tax if the failure to qualify for the marital deduction results in an estate tax being due and payable.


Question: Plan participant dies at age 68. Surviving spouse is beneficiary and the children are contingent beneficiaries. Spouse elects to disclaim interest in the IRA. Can the children take withdrawals over their life expectancy and which Code section is applicable?

Answer: IRC Section 401(1)(9)(B) generally requires that retirement benefits payable on account of a participant's death prior to age 70.5 be entirely distributed within five years after the date of death. If the benefits are payable th a "designated beneficiary" ("DB"), however, the benfits may be distributed over the life expectancy of the DB. The IRS'proposed regulations provide detailed requirements for determining whether a participant has a "DB" and who that DB is. Where a primary beneficiary disclaims in favor of a contingent beneficiary, the primary beneficiary is merely "deemed," for gift tax purposes, to have predeceased the participant, but is actually still alive, will the change of identity of the DB be recognized under IRC Section 401(a)(9)? The proposed minimum distribution regulations do not address this issue. The proposed regulations say only that the DB will be dtermined as of the participant's date of death. Several private letter rulings, while not precisely on point, do not support the conclusion that a qulified disclaimer by a beneficiary is treated the same as the death of that beneficiary for purposes of determining who is the DB under IRC Section 401(a)(9). On the other hand, the rulings are fact specific and there is no indication that the Service might not rule favorably in the right situation. It is hoped that the IRS will give full effect to qualified disclaimers, retroactive to the date of death, for the purposes of Section 401(a)(9). The point is, however, is that the IRS has not yet announced that it will do so, and planners must deal with the possibility the IRS will not do so. Accordingly, it is not clear that the children can take withdrawals over their life expectancy.


Question: The client dies at age 72 and has been receiving minimum distributions. The beneficiary designation form specified single life, fixed distribution, and lump sum distribution (among options including monthly, quarterly and to be specified by beneficiary). The beneficiary is a child. The person dies in 1998. Does the lump-sum amount need to be paid out in 1999 or over five years? Any other options?

Answer: Where distributions to a participant had begun prior to death and the participant dies after the RBD, the death benefits must be distributed to the designated beneficiary at least as fast as the method of distribution in force prior to death (IRC § 401(a)(9)(B)(i); Prop. Treas. Regs. § l.401(a)(9)-l, Q&A F-3A). In this situation, the five year rule does not apply. Accordingly, if distribution had been elected over the joint lives of the client and the child, post mortem distributions will in turn be dependent on the recalculation method elected.


Question: Under what circumstances is it important to establish a trust IRA rather than a custodial IRA? Should accounts that might be candidates for QTIP trust beneficiaries with delayed distributions to children be established as trust IRAs? Or are the same options available if the IRA is custodial?

Answer: Trust departments typically prefer to use a trust IRA form for larger accounts that can provide for more investment opportunities. Typically, the minimum size may run from $500,000 to $1,000,000. On the other hand, bank departments prefer the shorter custodian form of IRA that a client who walks in the door can simply sign to open a small IRA account. Approximately 98% of all IRA accounts use the custodian form of IRA account. Either form could be used to distribute funds to a QTIP trust.


Question: Charity is one of several residual beneficiaries of a decedent's estate. The decedent was single and her estate after some small bequests distributes to charitable beneficiaries. One of the assets is an IRA payable to her estate. A probate of the estate has been commenced. The question is, how can the charity get the IRA now?

Answer: Although charitable income tax deductions are normally not allowed for gifts of principal by estates or trusts, IRD items are considered gross income rather that principal for tax purposes. Accordingly, if the IRD item is distributed to the charities before it is collected and realized by the estate, the item will be includable in the gross income of the charities under IRC Section 691(a)(1)(C), and no income will usually result. If the estate collects the IRD item, it should be able to claim a deduction under the set-aside rules of IRC Section 642(c)(2) to offset the gross income. In this situation, it would be better to have the estate collect the item and then distribute it to the charities. This action, however, may require an appropriate probate petition or notice of distribution depending on the applicable state law.