UIL Number(s) 2055.12‑07, 0642.00‑00, 4941.00‑00, 4943.00‑00, 4944.00‑00, 4945.00‑00, 4947.00‑00
Date: January 21, 1997
Refer Reply to: CC:DOM:P&SI:4/PLR‑68091‑96
LEGEND:
Taxpayer = * * *
Spouse = * * *
Children = * * *
Family Trust = * * *
Survivor's Trust = * * *
Lead Trust = * * *
Limited Partnership = * * *
General Partnership = * * *
Foundation = * * *
Dear * * *
This is in response to your May 10, 1996 letter requesting rulings on behalf Taxpayer concerning Family Trust and Lead Trust.
Family Trust, created by Taxpayer and Spouse in 1976, was amended and restated in full on November 29, 1988. Spouse died in 1990. On Spouse's death, Survivor's Trust was created pursuant to the terms of Family Trust. Survivor's Trust may be revoked or amended by Taxpayer. Under the terms of the Survivor's Trust, the trustee shall pay to or apply for the benefit of Taxpayer the net income of the Survivor's Trust in quarterly installments or more frequently unless Taxpayer notifies the trustee to withhold any portion of the net income. If the trustee considers the net income insufficient, the trustee shall pay to or for the benefit of Taxpayer as much of the principal of the trust estate as (i) is necessary in trustee's discretion for the proper health, education, support, maintenance, comfort and welfare of Taxpayer, in accordance with Taxpayer's accustomed manner of living.
Upon Taxpayer's death, the trust balance is to be distributed to one or more of those persons and entities, including Taxpayer's estate as Taxpayer shall appoint by will specifically referring to this power of appointment. However, Article 4.02 provides for the distribution of the trust corpus not effectively appointed by Taxpayer. Under Article 4.02.1(d)(i) Taxpayer's interest in Limited Partnership is to be distributed to Lead Trust.
Article 2, section 2.02 of Lead Trust provides that an "Annuity Amount" equal to 8 percent of the value of the Trust, as determined for Federal estate tax purposes, is to be paid in equal installments at the end of each quarter for a term of 5 years (the "Charitable Term"). Section 2.03 provides that the annuity amount is to be paid first from ordinary taxable income (including short‑term capital gains) which is not unrelated business income and then from fifty percent of the unrelated business income, then from long‑term capital gains, then from the balance of the unrelated business income, then from the tax‑exempt income, then from any accumulated income, and finally from the principal in that order. Any net income for a taxable year in excess of the Annuity Amount, may, in the discretion of the Trustee be added to principal. Section 2.04 provides that the Annuity Amount shall be prorated on a daily basis for short taxable years and for the taxable year in which the Charitable Term terminates. Section 2.05 provides that the Annuity Amount is to be distributed to Foundation. In the event that Foundation is not a organization formed and qualified under section 501(c)(3) on Taxpayer's date of death, then the Annuity Amount shall, in the sole discretion of the trustee, be distributed to one or more organizations described in sections 170(c) and 2055(a). Lead Trust will terminate 5 years after the date of Taxpayer s death, at which time the trustee will distribute the remaining accrued income to Foundation and the principal will be distributed to a series of trusts, one share shall be allocated for each of the then living children of Taxpayer and one for each group composed of the then living descendants of a deceased child of Taxpayer.
Article 6 of Lead Trust provides that in accordance with sections 508(e) and 4947(a)(2), regardless of any other provision of the trust, the trustee is prohibited from engaging in any act of self‑dealing as defined in section 4941(d), from retaining any excess business holdings (except to the extent allowed by section 4947(b)(3)) as defined in section 4943(c) which would subject the trust to tax under section 4944, and from making any taxable expenditures as defined in section 4945(d). In addition, the trustee must make distributions at such time and in such manner as not to subject the trust to tax under section 4942.
As noted above, the assets to be allocated to Lead Trust include a 55.55‑percent limited partnership interest and a 1.146‑ percent general partnership interest in Limited Partnership. Limited Partnership holds a 36‑percent interest in General Partnership which acquired a shopping center (hereinafter "Real Property") for the sum of $7,120,000. The partnership entered into leases with various tenants at rents stipulated in each lease. At some time in the future, there is a possibility that rents based on a percentage of gross profits may be paid by various tenants. However, no rent is currently being paid based on income or profits.
The Real Property is subject to three deeds of trust (three loans), each securing a promissory note. The firsts two loans ("First Loan" and "Second Loan") were incurred in 1978 and 1988, respectively, during the period that the property was held by the prior owner. Third Loan ("Third Loan") in the amount of $400,000 was entered into as a part of the sale of the property to the general partnership (September 13, 1995). The loan was made to the seller, the prior owner of the property. The obligees on the loans described above are not disqualified persons within the meaning of section 4946.
You have requested the following rulings discussed below.
RULINGS 1 AND 2:
1. The Annuity amount paid from Lead Trust will qualify under section 2055(e)(2)(B) of the Internal Revenue Code as a "guaranteed annuity" and Lead Trust does not contain any provision that would negate that qualification as a guaranteed annuity.
2. Taxpayer's taxable estate will be entitled to an estate tax charitable deduction under section 2055(a) for the value of the Annuity Amount (determined under sections 2031 and 7520) to be paid to the Charitable Organization during the Charitable Term.
Section 2055(a) allows a deduction from the value of a decedent's gross estate for the amount of bequests to or for the use of any organization organized and operated exclusively for religious, charitable, scientific, literary, or educational purposes.
Section 2055(e)(2)(B) provides that no deduction is allowed where an interest in property is transferred for both charitable and noncharitable purposes unless, in the case of an interest other than a remainder interest in property, the charitable interest is in the form of a guaranteed annuity or a fixed percentage distributed yearly of the fair market value of the property (to be determined yearly).
Section 20.2055‑2(e)(2)(vi) of the Estate Tax Regulations defines a guaranteed annuity as an arrangement under which a determinable amount is paid periodically, but not less often than annually, for a specified term or for the life or lives of an individual or individuals living at the decedent's death. A charitable interest is a guaranteed annuity interest only if it is a guaranteed annuity interest in every respect. Where a charitable interest in the form of a guaranteed annuity is in trust and the present value, on the appropriate valuation date, of all the income interests for a charitable purpose exceeds 60 percent of the aggregate fair market value of all amounts in such trust (after payment of estate taxes and all other liabilities), the charitable interest will not be considered a guaranteed annuity interest unless the governing instrument of the trust prohibits both the acquisition and the retention of assets which would give rise to a tax under section 4944 if the trustee had acquired such assets. Section 20.2055‑2(e)(2)(vi)(e).
Lead Trust will annually distribute an annuity amount each year to Foundation, or if Foundation is not a qualifying organization under sections 170(c) and 2055(a), such other charities as the trustee shall select that are described in those sections. Each annual distribution will equal 8 percent of the initial net fair market value of the assets transferred to Lead Trust. The distributions will continue throughout the 5 year term of Lead Trust.
We conclude that the annuity amount payable from Lead Trust will be a guaranteed annuity interest described in section 2055(e)(2)(B) and section 20.2055‑2(e)(2)(vi). Accordingly, Taxpayer's estate will be entitled to an estate tax charitable deduction under section 2055(a) for the present value, on the date of Taxpayer's death, of the guaranteed annuity that will be paid to Foundation or other qualified charitable organizations.
RULINGS 3 THROUGH 5:
3. The Annuity Amount paid by Lead Trust to Foundation or other charitable organizations will be paid for a purpose specified in section 170(c).
4. The Annuity Amount paid by Lead Trust to Foundation or other charitable organizations will be allowed as an income tax charitable deduction in computing Lead Trust's taxable income under section 642(c) to the extent paid from gross income.
5. Section 681 will not apply to the deduction to which Lead Trust will be entitled under section 642(c) for amounts paid to Foundation or other charitable organizations with respect to rents received by Lead Trust from the Limited Partnership due to either (i) Lead Trust conducting a trade or business or (ii) there being debt‑financed property with respect to the Limited Partnership.
Section 170(a) provides, subject to certain limitations, a deduction for charitable contributions as defined in section 170(c), payment of which is made in the taxable year.
Section 170(c) provides that, for purposes of section 170, the term "charitable contribution" means a contribution or gift to or for the use of 1) federal or other government entities for exclusively public purposes; 2) a corporation or trust operated exclusively for religious, charitable, scientific, literary, or educational purposes; or 3) certain transfers to fraternal or veterans organizations. Section 170(c)(2)(A) restricts charitable contributions to corporations or trusts created in the United States.
Section 642(c)(1) provides that, in computing its taxable income, a trust is allowed a deduction for any amount of gross income that, pursuant to the terms of the governing instrument, is paid during the tax year for a purpose specified in section 170(c) (determined without regard to section 170(c)(2)(A)). Section 642(c)(4) provides that the deduction allowed for a trust is subject to section 681 (regarding unrelated business income).
Section 681(a) provides that no charitable deduction is allowable to a trust under section 642(c) for any amounts allocable to the trust's unrelated business income for the tax year. The term "unrelated business income" means any amount that would be computed as the trust's unrelated business taxable income under section 512 if the trust were exempt from tax under section 501(a) by reason of section 501(c)(3).
In this case, section 2.02 of Lead Trust provides that the trustee will pay an annuity amount to Foundation and that the trustee may not exercise any power to invade principal or income for any persons other than Foundation. In addition, section 2.05 of Lead Trust provides that in the event that Foundation is not during the "charitable term" an organization of the type described in sections 170(c) and 2055(a), the amount which would have been paid to Foundation will instead be paid to one or more organizations described in sections 170(c) and 2055(a), in the sole discretion of the trustee.
These two sections of Lead Trust require that Lead Trust will make payments to Foundation only if it is described in section 170(c). Also, if Foundation does not qualify as a section 170(c) organization, the payment will instead be made to an organization that is described in section 170(c). Accordingly, the Annuity Amount paid by Lead Trust to Foundation will be paid for purposes specified in section 170(c). In addition, as the Annuity Amount is to be paid first from income, except to the extent that Lead Trust has unrelated business income within the meaning of section 681(a), Lead Trust will be entitled to a deduction under section 642(c)(1) for the amount of the trust's gross income paid to the charitable organization during the tax year.
Finally, in view of the conclusions in Ruling Requests Nos. 6 and 7 below, section 681 will not apply to the deduction to which Lead Trust will be entitled under section 642(c) for amounts paid to Foundation or other charitable organization with respect to rents received by Lead Trust from the Limited Partnership due to either (i) Lead Trust conducting a trade or business or (ii) there being debt‑financed property with respect to the Limited Partnership.
RULING 6:
6. The rents, including any percentage rents based on gross receipts received by Lead Trust, will be excluded from unrelated business taxable income" under section 512(a) due to the application of section 512(b)(3)(A).
Section 512(b) lists modifications to unrelated business taxable income defined under section 512(a). Section 512(b)(3)(A) provides that in the case of rents, except as provided in subparagraph (B), there shall be excluded: (i) all rents from real property (including property described in section 1245(a)(3)(C); and (ii) all rents from personal property leased with such real property, if the rents attributable to such personal property are an incidental amount of the total rents received or accrued under the lease, determined at the time the personal property is placed in service. Section 512(b)(3)(B)(ii) provides that subparagraph (A) shall not apply: (ii) if the determination of such rent depends in whole or in part on the income or profits derived by any person from the property leased (other than an amount based on a fixed percentage or percentages of receipts or sales).
Based on the facts and representations set forth above, and (1) assuming the rent received is not based on income or profits derived by Lead Trust's partnership interest from the property leased (other than an amount based on a FIXED percentage or percentages of receipts or sales); (2) assuming Lead Trust, through Limited Partnership and General Partnership, is not engaged in a trade or business with respect to the real estate activity associated with the Real Property, by virtue of the provision of impermissible services or for any other reason; and (3) further assuming that there is no rental of personal property leased with the real property that is more than incidental to the leasing of the real property, we conclude that: the rents, including any fixed percentage rents based on gross receipts, received by Lead Trust will be excluded from "unrelated business taxable income" under section 512(a) due to the application of section 512(b)(3)(A).
RULING 7:
7. With respect to the Real Property, pursuant to section 514(c)(2)(B), First Loan, Second Loan, and Third Loan secured by the Real Property shall not be considered "acquisition indebtedness", and, therefore, the Real Property shall not be classified as "debt‑financed property" of Lead Trust during the Charitable Term;
Section 514(a) includes in the computation of unrelated business taxable income certain unrelated debt‑financed income.
Section 514(c)(1) describes acquisition indebtedness to include debt that is incurred to acquire the property. Section 514(c)(2)(A) describes acquisition indebtedness to include, as a general rule, the following:
Where property (no matter how acquired) is acquired subject to a mortgage or other similar lien, the amount of the indebtedness secured by such mortgage or lien shall be considered as an indebtedness of the organization in acquiring such property even though the organization did not assume or agree to pay such indebtedness.
Section 514(c)(2)(B) provides an exception as follows:
Where property subject to a mortgage is acquired by an organization by bequest or devise, the indebtedness secured by the mortgage shall not be treated as acquisition indebtedness during a period of 10 years following the date of the acquisition.
Section 1.514(c)‑1(b)(3)(iii) of the Income Tax Regulations provides, in effect, that the exception provided by section 514(c)(2)(B) SHALL NOT APPLY if the organization assumes and agrees to pay all or any part of the indebtedness secured by the mortgage or the organization makes any payment for the equity owned by the decedent or the donor in the property. Whether an organization has assumed and agreed to pay all or any part of an indebtedness in order to acquire the property shall be determined by the facts and circumstances of each situation.
Assuming that Lead Trust does not assume and agree to pay any part of the indebtedness secured by the Deeds of Trust on the Real Property, we conclude that with respect to the Real Property, pursuant to section 514(c)(2)(B), the loans secured by the Real Property shall not be considered "acquisition indebtedness," and therefore, the real property shall not be classified as "debt‑ financed property" of Lead Trust for a period of ten years from the date of the acquisition of the property by Lead Trust by virtue of a bequest or devise.
RULING 8:
8. Under section 4947(a)(2), the excise taxes of section 4941 and sections 4943 through 4945 will cease to be applicable after both (a) the charitable term expires and (b) the last Annuity Amount is paid to Foundation or an other charitable organization.
Section 4947(a)(2) provides, in part, that in the case of a trust which is not exempt from tax under section 501(a), not all of the unexpired interests in which are devoted to one or more of the purposes described in section 170(c)(2)(B), and which has amounts in trust for which a deduction was allowed under sections 170, 545(b)(2), 556(b)(2), 642(c), 2055, 2106(a)(2), or 2522, section 4941 (relating to taxes on self‑dealing, section 4943 (relating to taxes on excess business holdings) except as provided in subsection (b)(3), section 4944 (relating to investments which jeopardize charitable purpose) except as provided in subsection (b)(3), and section 4945 (relating to taxes on taxable expenditures) shall apply as if such trust were a private foundation.
Depending on the facts, Lead Trust may or may not be excepted from sections 4943 and 4944 by virtue of section 4947(b)(3).
Example 2 of section 53.4947‑1(e)(2) of the Private Foundation Regulations describes how section 4947(a)(2) ceases to apply to a charitable lead trust at the time of the final income payment to the charitable income beneficiary under the terms of the trust agreement.
Accordingly, we conclude that under section 4947(a)(2), the excise taxes of section 4941 and sections 4943 through 4945 will cease to apply to Lead Trust after both (a) the charitable term expires and (b) the last annuity amount has been paid.
RULINGS 9, 10, AND 11:
9. Funding Lead Trust pursuant to Article 4.02.1(d)(i) ofSurvivor's Trust will not be a "transaction" which would be m classified as an act of self‑dealing under section 4941 and section 53.4941(d)‑1.
10. With respect to First Loan and Second Loan, funding Lead Trust pursuant to Article 4.02.1(d)(i) of Survivor's Trust will not be deemed a transaction which would be an act of self‑ dealing under section 4941(d)(2)(A).
11. With respect to Third Loan, funding Lead Trust pursuant to Article 4.02.1(d)(i) of Survivor's Trust will not be deemed a transaction which would be an act of self‑dealing under section 4941(d)(2)(A).
Section 4941(d)(1)(A) defines the term "self‑dealing" to include any direct or indirect sale or exchange, or leasing, of property between a private foundation and a disqualified person.
Section 4941(d)(2)(A) provides that the transfer of real or personal property by a disqualified person to a private foundation shall be treated as a sale or exchange if the property is subject to a mortgage or similar lien which the foundation assumes or if it is subject to a mortgage or similar lien which a disqualified person placed on the property within the 10‑year period ending on the date of transfer.
Section 53.4941(d)‑2(a)(1) provides a general rule that, in part, follows the rule provided by section 4941(d)(1)(A).
Section 53.4941(d)‑2(a)(2) provides, in part, that for purposes of subparagraph (1) of this paragraph, the transfer of real or personal property by a disqualified person to a private foundation shall be treated as a sale or exchange if the foundation assumes a mortgage or similar lien which was placed on the property prior to the transfer, or takes subject to a mortgage or similar lien which a disqualified person placed on the property within the 10 year period ending on the date of transfer.
Section 53.4941(d)‑1(a) provides in part that the term "self‑dealing" does not, however, include a transaction between a private foundation and a disqualified person where the disqualified person status arises only as a result of such transaction. For example, the bargain sale of property to a private foundation is not a direct act of self‑dealing if the seller becomes a disqualified person only by reason of his becoming a substantial contributor as a result of the bargain element of the sale.
First, we note that none of the three liabilities (First Loan, Second Loan and Third Loan) described above are obligations owing to disqualified persons. As to each of the notes, the obligee is an unrelated third party. Secondly, we specifically express no opinion as to whether the transfer of ownership of the partnership property along with the underlying obligations on the real estate is a "transfer" within the meaning of section 4941(d)(2)(A) and the corresponding regulations, occurring either by virtue of the death of Taxpayer or as a result of the funding of Lead Trust under the terms of Survivor's Trust. However, the distribution of the partnership interest to Lead Trust, subject to the liabilities, does not constitute an act of self‑dealing under the authority provided by section 53.4941(d)‑1(a). The disqualified person status of the transferor of the property arises only as a result of the distribution of the property to Lead Trust.
Further, the extension of credit relationship that will follow the transaction would also not constitute an act of self‑ dealing under section 4941(d)(1)(B) since the obligees would not be disqualified persons. Compare this situation to the extension of credit example described in section 53.4941(d)‑3(d)(2). In the latter, the stock redemption through a debenture issuance by the disqualified person was not an act of self‑dealing ab initio because of the section 4941(d)(2)(F) exception, but became one each and every year thereafter while there was an uncorrected extension of credit. Under the circumstances, the transfer of the partnership property to Lead Trust does not constitute an act of self‑dealing.
Accordingly, we conclude that funding Lead Trust pursuant to Article 4.02.1(d)(i) of Survivor's Trust will not be a transaction which would be classified as an act of self‑dealing under section 4941 and section 53.4941(d)‑1. With respect to First Loan and Second Loan, funding Lead Trust pursuant to Article 4.02.1(d)(i) of Survivor's Trust will not be deemed a transaction which would be an act of self‑dealing under section 4941(d)(2)(A). With respect to Third Loan, funding Lead Trust pursuant to Article 4.02.1(d)(i) of Survivor's Trust will not be deemed a transaction which would be an act of self‑dealing under section 4941(d)(2)(A).
RULING 12:
12. Because of the application of section 4943(c)(6), Lead Trust will not be subject to the tax on excess business holdings under section 4943 during the five‑year charitable term after Taxpayer dies.
Section 4943 imposes a tax on excess business holdings. Such tax applies to excess business holdings in corporations and partnerships as defined by section 4943.
Section 4943(c)(6), in effect, provides that if a private foundations obtains holdings in a business enterprise other than by purchase, that is, by gift or bequest, the private foundation has five years to dispose of the excess business holdings.
Assuming that section 4943 is applicable to Lead Trust after considering the exception provided by section 4947(b)(3)(A), and further assuming the interest in the general partnership will constitute an excess business holding in a business enterprise and not an interest in a business that receives income from passive sources as assumed in Ruling Request No. 13 (below), we conclude that due to the application of section 4943(c)(6), Lead Trust will not be subject to the excise tax on excess business holdings under section 4943 during the five year charitable term of Lead Trust.
RULING 13:
13.Because of the application of section 4943(d)(3)(B) during the charitable term, Lead Trust will not be subject tothe tax on excess business holdings under section 4943 provided the sources of gross income throughout the charitable term are derived 9570 or more from sources listed in section 4943(d)(3)(B).
Section 4943(d)(3) defines the term "business enterprise" to exclude (B) a trade or business at least 95 percent of the gross income of which is derived from passive sources. For purposes of subparagraph (B), the gross income from passive sources includes the items excluded by section 512(b)(1), (2), (3), and (5).
Assuming Lead Trust will receive income only in the form of interest, dividends, real property rents, and proceeds from the sale of property (as defined in section 512(b)(5)), Lead Trust will have gross income derived 100 percent from passive sources. Accordingly, assuming that section 4943 is applicable to Lead Trust after considering the exception provided by section 4947(b)(3)(A), we conclude that because of the application of section 4943(d)(3)(B), Lead Trust will not be subject to the tax on excess business holdings under section 4943 provided the sources of gross income are derived 95 percent or more from sources listed in section 4943(d)(3)(B).
This ruling is based on the facts and applicable law in effect on the date of this letter. If there is a change in material fact or law (local or Federal) before the transaction considered in the ruling takes effect, the ruling will have no force or effect. If Taxpayer is in doubt whether there has been a change in material fact or law, a request for reconsideration of this ruling should be submitted to this office.
Except as specifically ruled above, no opinion is expressed as to the federal tax consequences of the transaction described under any other provisions of the Internal Revenue Code.
This ruling is directed to the taxpayer who requested it. Section 6110(j)(3) provides that it may not be used or cited as precedent.
Sincerely,
Assistant Chief Counsel
(Passthroughs andSpecial Industries)
By: George L. Masnik
Chief, Branch 4
Enclosure
Copy for 6110 purposes