This post was originally published on Forbes Aug 5, 2015
The decision in the case of the Estate of Arthur Schaefer made me realize that I had left something out of Reilly's Laws of Tax Planning. It was a caution about being too aggressive that we used to use at Joseph B Cohan and Associates, back in the day - "Pig's get fed. Hogs get slaughtered." (That brings the count to a nice prime eleven. Maybe I will stop). For some clients our managing partner, Herb Cohan, would say "Don't be a chazzer".
Each approach is arguably flawed. Although the estate's approach yields a remainder interest value that is possibly closer to what the charitable beneficiary will ultimately receive, there is no basis for this approach in the statute. Respondent's approach potentially undervalues the remainder interest that will pass to the charitable beneficiary because it assumes the maximum distribution by using the fixed percentage, even though that amount can be distributed only if the trust produces sufficient income. And a 5% distribution rate potentially overvalues the remainder interest that will pass to the charitable beneficiary because if the trust produces income leading to distributions higher than 5%, the charitable beneficiary receives less than projected. Nevertheless, our task is not to look to the varying results and choose the best answer. Instead, we interpret the statute to the best of our ability, looking beyond it if necessary.
Conclusion Section 664(e) is ambiguous in its description of how to value a remainder interest in a NIMCRUT where actual distributions will be the lesser of a fixed percentage or net income. Where the statute is ambiguous, we can look to legislative history as an aid in the interpretation of the statute. And where a statute is ambiguous, the administrative agency can fill gaps with administrative guidance to which we owe the level of deference appropriate under the circumstances. With regard to the statute before us, the legislative history and the administrative guidance point us to only one conclusion—that the value of the remainder interest of a NIMCRUT must be calculated using the greater of 5% or the fixed percentage stated in the trust instrument. Accordingly, the estate must use an annual distribution amount of 11% or 10% of the net fair market value of the trust assets when valuing the remainder interests of Trust 1 and Trust 2, respectively. Because the parties have previously stipulated that the estate would not be entitled to a charitable contribution deduction if the remainder interests are valued using this method, respondent's determination denying the charitable contribution deduction is sustained.
IRS issued Rev.Ruls. and Rev. Procs following that lead, although the regs aren’t clear, and the Code is not much better. So IRS’s guidance gets Skidmore deference.
Clear? Thought not.
A question not expressly raised in Schaefer is whether a CRUT or CRAT established during lifetime must re-qualify as such on death. Yet, this court and, presumably, the litigants, acted as if that is so.
The opinion doesn’t mention collateral income tax consequences of its holdings. Because the CRUTs didn’t qualify as such, the general rules regarding taxation of trusts and trust beneficiaries apply.