As noted in an earlier column, a charitable remainder trust (CRT) is a valuable tax-planning tool. However, Revenue Procedure 2005-24, issued on March 30, adds new rules to CRTs to address the problem of spouses “electing against the will,” which can arise in certain states.
A basic tenet of a CRT is that only the unitrust or annuity trust payment may be made to a non-charitable recipient.
For more information about CRUTS, see ”On the Record” from the November 2003 edition of FundRaising Success magazine.
If any other payment is made, the trust will not qualify as a CRT. An example of a potentially disqualifying payment is when a CRT has a primary beneficiary and a non-charitable beneficiary successor.
Upon the death of the primary beneficiary, there might be death taxes charged to the CRT — attributable to the successor beneficiary’s interest. This can occur if state law provides for the equitable apportionment of any federal estate or state death taxes imposed on his death, as well as the payment of taxes from the CRT assets.
The Internal Revenue Service’s Rev. Rul. 82-128 requires the CRT trust to condition the vesting of a beneficiary’s interest upon her payment of any death taxes attributable to her interest. On the flip side, the donor can stipulate that the funds come from another source, such as his estate.
Spousal right of election
There is another method in which a CRT could be paid to someone other than a charity: a spouse’s right of election permitted under many states’ laws.
According to law, a surviving spouse cannot be disinherited. These states permit a surviving spouse to take a statutory share of the deceased spouse’s estate rather than take whatever, if anything, the deceased spouse provided for him.
This right to “elect against the will” historically only applied to assets that passed under the deceased spouse’s will.
However, in many states this spousal right of election has been expanded to provide the surviving spouse a portion of an “augmented estate.” Under some state laws, the augmented estate might include property in which the deceased spouse retained an interest, which terminated at death, or property that the deceased spouse transferred during her lifetime. It’s possible, under these statutes, for the assets of a CRT to be included in the augmented estate.
“Invading” the CRT
If the spousal right of election does include the assets of a CRT, then it could be possible for the CRT to be “invaded” to satisfy the statute. This creates the possibility that all of the CRT wouldn’t pass to the charitable remainder beneficiary because the spouse is allowed to invade the CRT, thereby taking assets away from the charity.
To address this possibility, the IRS, in Rev. Proc. 2005-24, stated that the existence of a spousal right of election, even if it’s not exercised, causes a trust to fail CRT qualifications.
To avoid this, the Rev. Proc. requires that in the states where the spousal right of election can extend to CRT assets, the spouse must irrevocably waive the right of election as applied to CRT assets.
Thankfully, existing CRTs are grandfathered. All CRTs created before June 28, 2005, will not require a spousal waiver. However, those CRTs will be disqualified if, at the death of the donor spouse, the surviving spouse exercises a right of election and the CRT assets can be tapped under existing state law.
In such a situation, the CRT will lose its status from the date of its creation. If the CRT has been in existence for a number of years, it’s likely that the statute of limitations will have run out on the income and gift tax returns on which the donor claimed a charitable deduction. But, if the statute of limitations has not run out, the charitable deduction could be disallowed.
What you need to know
For CRTs created on or after June 28, failure of the donor’s spouse to waive the election right when the trust is created will disqualify the CRT.
The Rev. Proc. notes that no waiver is required if applicable state law doesn’t permit CRT assets to be invaded to satisfy the spousal right of election. It also states that events occurring after the CRT is created — including the donor’s move to a state that permits surviving spouses to reach CRT assets — may disqualify a CRT from the date of its creation.
Obviously, the marriage by the donor after the establishment of a CRT can implicate the need for a waiver.
According to Rev. Proc., the waiver must be executed by the donor’s spouse no later than six months after the due date — excluding extensions — of the trust’s tax return for the year in which the first of the following events occurs:
- the creation of the CRT;
- the date of the donor’s marriage to the spouse;
- the date on which the donor becomes “domiciled” in a state whose law provides a right of election that could be satisfied from the CRT assets; or
- the effective date of an applicable state law creating a right of election.
The waiver must be in writing, signed and dated by the spouse, waive the right of election against the assets of the CRT and be valid under state law. The trustee must keep a copy of the waiver with the trust records. If the waiver occurs as part of a prenuptial agreement, the trustee must have a copy of the agreement in his file.
Educating donors
Charitable beneficiaries of CRTs will still get the charitable remainder when the intervening non-charitable interests end. However, if the CRT loses its tax exempt status, the remainder interest passing to the charity may be eroded by income taxes paid during the trust term. And, when a marriage, remarriage, move to another state or a change in state law requires a waiver of a spousal right of election within a relatively short period of time, and when failure to obtain the waiver could cost the donor a desired charitable deduction, alerting the donor that a waiver will be needed will, perhaps, cement a relationship.
Kathleen A. Stephenson is of counsel with the Philadelphia office of Pepper Hamilton LLP. Lisa B. Petkun is a partner in the tax department of Pepper Hamilton. On the Record keeps readers up to date on the latest tax and planning issues pertaining to fundraising endeavors and charitable organizations.
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Lisa B. Petkun is a partner in the tax department at Pepper Hamilton LLP.