After the September/October 1997 issue of Probate & Property went to press, action by Congress and the IRS changed some of the applicable rules discussed in two articles. This column provides updates to those articles to reflect the current state of the law.

Giving IRAs to Charity

By Stephen P. Magowan

The Taxpayer Relief Act of 1997 (TRA 97) affects the various IRA-to-charity techniques described in Doing Right by Doing Good: Giving IRAs to Charity, 10 Prob. & Prop. 16 (Sept./Oct. 1997).

Repeal of Code 4980A

Effective January 1, 1997, TRA 97 (1) permanently extended the previously enacted three year moratorium on the 15% tax on "excess retirement distributions," and (2) repealed the 15% excise tax on "excess retirement accumulations." The latter repeal is especially important for an IRA-to-charity technique because a significant drawback to the technique had been the fact that the gift to charity could not mitigate this tax.

With the repeal, lawyers should keep the following points in mind:

  • A client should not automati-cally designate the spouse as the IRA beneficiary because one of the primary nonfinancial, nonfamily reasons for doing so (i.e., avoiding the excess accumulations tax) no longer exists.
  • Clients who have reached their required beginning date or whose designated beneficiary has died can now use a charitable remainder trust (CRT) without incurring the 15% excise tax. This makes "rescuing" an improper or lapsed beneficiary designation less costly.
  • Disclaimer planning is even more important because spouses can disclaim without fear of the 15% excise tax.

    Charitable Remainder Trust Changes

    TRA 97 makes two important changes to the CRT rules. Under these rules, contained in amendments to Code 664(d), a trust will not qualify as a CRT if it has a unitrust or annuity payout that exceeds, respectively, 50% of the annual net fair market value of the trust assets or 50% of the initial fair market value of the trust assets.

    In addition, under the new law, a charitable remainder annuity trust will fail to qualify if the value of the remainder interest is less than 10% of the initial net fair market value of all property placed in the trust. A charitable remainder unitrust will not qualify each contribution of property to the trust if the value of the remainder interest is less than 10% of the net fair market value of the contributed property as of the date of the contribution.

    An amendment to Code 2055 should eliminate problems that might be encountered with the new 10% rule because of changing interest rates. This amendment states that a trust otherwise failing the 10% test will be treated as passing if the trust is altered through a reformation proceeding, an amendment or otherwise to pass the test. The reformation proceeding must begin no later than 90 days after the last day to file an estate tax return or, if no estate tax return is filed, by the last date (including extensions) for filing the first income tax return of the CRT.

    The 10% rule does not apply (1) to a CRT created by a will or other testamentary instrument so long as it is not modified and the decedent dies before January 1, 1999; or (2) to an existing instrument that the decedent could not modify after July 28, 1997 because of his or her mental disability.

    Stephen P. Magowan is an associate with Gravel and Shea in Burlington, Vermont.

    Electing Small Business Trusts

    By Nancy C. Hughes

    Since the publication of Electing Small Business Trust: The Good, the Bad and the Ugly, 10 Prob. & Prop. 50 (Sept./Oct. 1997), the IRS clarified some uncertainties surrounding the Electing Small Business Trust (ESBT) in Notice 97-49, 1997-36 I.R.B. 1 (Notice) and Congress made a statutory change regarding ESBTs in TRA 97.

    First, if a trust agreement provides that a trust may be the beneficiary of trust property (a distributee trust), the trust may still qualify as an ESBT even though a literal reading of Code 1361(e)(1)(A) would preclude such a trust from qualification. The Notice explains that a distributee trust is not considered a beneficiary for purposes of determining the eligible beneficiaries of an ESBT. Rather, the persons having beneficial interests in the distributee trust are the beneficiaries who must be eligible ESBT beneficiaries for the trust to qualify as an ESBT.

    For example, if the beneficiaries of the distributee trust are qualified ESBT beneficiaries and the other requirements of 1361(e) are met, the ESBT would be a qualified S corporation shareholder. This clarification will enable a client to include a contingent trust as a beneficiary of an ESBT for beneficiaries under a certain age without worrying that the S election would terminate because of an ineligible shareholder.

    The Notice also gives guidance on the treatment of distributions from an ESBT when the ESBT has fiduciary accounting income in both the S portion and the non-S portion of the trust. Because the trustee must disregard the S portion of the trust in calculating the distributable net income (DNI) of the non-S portion of the trust under Code 641(d)(3), it was unclear how distributions from the S portion would be treated for purposes of determining the distribution deduction in connection with the non-S portion of the trust. The Notice provides that distributions from the S portion of the trust are treated the same as distributions of any other item excluded from DNI. Accordingly, distributions from the S portion would be considered in calculating the distribution deduction for the non-S portion of the trust.

    Finally, TRA 97 makes it clear that charitable remainder annuity trusts and charitable remainder unitrusts may not be ESBTs. Code 1361(e)(1)(B)(iii).

    Nancy C. Hughes is a share- holder with Berkowitz, Lefkowitz, Isom & Kushner, P.C. in Birmingham, Alabama and is chair of the Probate Division's Post-Mortem Income Tax Planning (I-2) Committee.

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