CRTs–Using a Trust Beneficiary

The IRS recently amplified an earlier decision that annuity or unitrust amounts paid to a trust by a charitable remainder trust (CRT) for the life of a "financially disabled" individual will not disqualify the CRT. According to Rev. Rul. 2002-20, superseding Rev. Rul. 76-270, a trust will qualify as a CRT if:

1 The separate trust's sole function is to receive and administer the annuity or unitrust amounts for the disabled beneficiary's benefit; and

2. On the beneficiary's death, the separate trust's remaining assets will be distributed to the beneficiary's estate or, after reimbursing the state for any Medicaid benefits provided to the beneficiary, will be subject to the beneficiary's general power of appointment.

By meeting these requirements, the trust mirrors the beneficiary's actions (i.e., its assets are controlled by the beneficiary). Thus, the IRS position is that the annuity or unitrust amounts are deemed to go directly to the beneficiary for Sec. 664(d)(2)(A) purposes, because the trust's only function is to receive and administer the payments received from the CRT for the beneficiary's benefit. The Service also concluded that the CRT's term under these circumstances "can be for the life of the beneficiary and is not limited to a term of years."

Under Regs. Sec. 1.664-3(a)(5)(i), a beneficiary of annuity or unitrust amounts must be either an individual or a charity. To qualify as a CRT with other types of beneficiaries under Rev. Rul. 2002-20, the beneficiary who receives the annuity or unitrust amount must qualify as a "financially disabled" individual under Sec. 6511(h)(2)(A). This requires the individual to be unable to manage his or her financial affairs due to a "medically determinable physical or mental impairment" that will result in his or her death or which has lasted or is expected to last for at least one year. If the individual has a person acting on his or her behalf for financial matters, he or she is not financially disabled for Sec. 6511(h)(2)(A) purposes.

According to Regs. Sec. 1.664-2(a)(5)(i), the annuity or unitrust amount must continue either for the life or lives of a named individual(s) or for a term not to exceed 20 years. However, under Rev. Rul. 2002-20, a CRT's term can be for the life of the financially disabled individual and not limited to a term of years.

Rev. Rul. 2002-20 also describes a situation in which an individual creates a CRT and Trust B to benefit individual C. The CRT will pay annual unitrust amounts to Trust B for the life of C, who is financially disabled. Trust B is to pay a portion of the unitrust amount to C each month. If this amount is insufficient to provide C's proper care, maintenance, support and general welfare, Trust B's trustee could authorize additional payments to C. On C's death, the balances remaining in the CRT and Trust B will be distributed subject to C's general power of apportionment.

The ruling provides an excellent tax planning strategy for high-net-worth individuals who care for an incompetent individual. By using the ruling, wealthy individuals can reduce their estates, avoid gift taxes, benefit an incompetent individual and produce a charitable contribution.

From Jennifer S. Spillman, CPA, Frazier & Deeter, LLC, Atlanta, GA