November 2, 08

NEWS / Transaction of Interest - Potential for Avoidance of Tax Through Sale of Charitable Remainder Trust

Notice 2008-99
The Internal Revenue Service and the Treasury Department are aware of a type
of transaction, described below, in which a sale or other disposition of all interests in a
charitable remainder trust (subsequent to the contribution of appreciated assets to and
their reinvestment by the trust), results in the grantor or other noncharitable recipient
receiving the value of that person’s trust interest while claiming to recognize little or no
taxable gain. The IRS and Treasury Department believe this transaction has the
potential for tax avoidance or evasion, but lack enough information to determine
whether the transaction should be identified specifically as a tax avoidance transaction.
This notice identifies this transaction and substantially similar transactions as
transactions of interest for purposes of § 1.6011-4(b)(6) of the Income Tax Regulations
and §§ 6111 and 6112 of the Internal Revenue Code. This notice also alerts persons
involved in these transactions to certain responsibilities that may arise from their
involvement.
2
FACTS
In one variation of the transaction, Grantor creates a charitable remainder trust
(Trust) and contributes appreciated assets (Appreciated Assets) to Trust. Grantor
retains an annuity or unitrust interest (term interest) in Trust and designates an
organization described in §§ 170(c), 2055(a) and 2522(a) (Charity) as the remainder
beneficiary. Charity may, but need not, be controlled by Grantor; Grantor may, but need
not, reserve the right to change the Charity designated as the remainder beneficiary.
Next, Trust sells or liquidates the Appreciated Assets and reinvests the net proceeds in
other assets (New Assets) such as money market funds, marketable securities, and/or
other assets, often to acquire a diversified portfolio. Because a charitable remainder
trust generally is a tax-exempt entity under § 664, Trust’s sale of the Appreciated Assets
is exempt from income tax, and Trust’s basis in the New Assets is the price Trust pays
for those New Assets. Some portion of Trust’s ordinary income and capital gains may
become taxable to Grantor as the periodic annuity or unitrust payments are made by
Trust in accordance with the rules of § 664 and the regulations thereunder. Next,
Grantor and Charity, in a transaction they claim is described in § 1001(e)(3), sell or
otherwise dispose of their respective interests in Trust to X, an unrelated third party, for
an amount that approximates the fair market value of the assets of the trust, including
the New Assets. Trust then terminates, and the assets of Trust, including the New
Assets, are distributed to X.
Grantor takes the following positions regarding the tax consequences of this
transaction. Grantor claims a charitable deduction for the portion of the fair market
value of the Appreciated Assets as of the date of their contribution to Trust that is
3
attributable to the remainder interest. Grantor claims to recognize no gain from the
Trust’s sale or liquidation of the Appreciated Assets. When Grantor and Charity sell
their respective interests in Trust to X, Grantor and Charity take the position that they
have sold the entire interest in Trust within the meaning of § 1001(e)(3). Because the
entire interest in Trust is sold, Grantor claims that § 1001(e)(1), which disregards basis
in the case of a sale of a term interest, does not apply to the transaction. Grantor also
takes the position that, under § 1001(a) and related provisions, the gain on the sale of
Grantor’s term interest is computed by taking into account the portion of uniform basis
allocable to Grantor’s term interest under §1.1014-5 and § 1.1015-1(b), and that this
uniform basis is derived from the basis of the New Assets rather than the basis of the
Appreciated Assets.
The transaction may use trusts with circumstances that vary from the situation
described in the facts of this notice. In some variations, a net income with make-up
provision charitable remainder unitrust (NIMCRUT) may be used as Trust, Trust may
have been in existence for some time prior to the sale of Trust interests, the
Appreciated Assets already may be in Trust prior to the commencement of the
transaction, the recipient and seller of the term interest may be the Grantor and/or
another person, or Grantor may contribute the Appreciated Assets to a partnership or
other passthrough entity and then contribute the interest in the entity to Trust.
A result of the claimed tax treatment of the transaction is that the gain on the sale
of the Appreciated Assets is never taxed, even though the Grantor receives the
Grantor’s share of the appreciated fair market value of those assets. The IRS and
Treasury Department are not concerned about the mere creation and funding of a
4
charitable remainder trust and/or the trust’s reinvestment of the contributed appreciated
property, and such events alone do not constitute the transaction subject to this notice.
However, the IRS and Treasury Department are concerned about the
manipulation of the uniform basis rules to avoid tax on gain from the sale or other
disposition of appreciated assets. Accordingly, the type of transaction described in this
notice includes a coordinated sale or other coordinated disposition of the respective
interests of the Grantor or other noncharitable recipient and the Charity in a charitable
remainder trust in a transaction claimed to be described in § 1001(e)(3), subsequent to
the contribution of appreciated assets and the trust’s reinvestment of those assets. In
particular, the IRS and Treasury Department are concerned about Grantor’s claim to an
increased basis in the term interest coupled with the termination of the Trust in a single
coordinated transaction under § 1001(e) to avoid tax on gain from the sale or other
disposition of the Appreciated Assets.
TRANSACTION OF INTEREST
Effective Date
Transactions that are the same as, or substantially similar to, the transaction
described in this notice are identified as transactions of interest for purposes of
§ 1.6011-4(b)(6) and §§ 6111 and 6112 effective October 31, 2008, the date this notice
was released to the public. Persons entering into these transactions on or after
November 2, 2006, must disclose the transaction as described in § 1.6011-4. Material
advisors who make a tax statement on or after November 2, 2006, with respect to
transactions entered into on or after November 2, 2006, have disclosure and list
maintenance obligations under §§ 6111 and 6112. See § 1.6011-4(h) and §§ 301.6111-
5
3(i) and 301.6112-1(g) of the Procedure and Administration Regulations.
Independent of their classification as transactions of interest, transactions that
are the same as, or substantially similar to, the transaction described in this notice
already may be subject to the requirements of §§ 6011, 6111, or 6112, or the
regulations thereunder. When the IRS and Treasury Department have gathered
enough information to make an informed decision as to whether this transaction is a tax
avoidance type of transaction, the IRS and Treasury Department may take one or more
actions, including removing the transaction from the transactions of interest category in
published guidance, designating the transaction as a listed transaction, or providing a
new category of reportable transaction.
Participation
Under § 1.6011-4(c)(3)(i)(E), each recipient of the term interest and Trust are
participants in this transaction for each year in which their respective tax returns reflect
tax consequences or a tax strategy described in this notice. Charity is not a participant
if it sold or otherwise disposed of its interest in Trust on or prior to October 31, 2008.
For interests sold or otherwise disposed of after October 31, 2008, under § 1.6011-
4(c)(3)(i)(E), Charity is a participant for the first year for which Charity’s tax return
reflects or is required to reflect the sale or other disposition of Charity’s interest in Trust.
In general, Charity is required to report the sale or other disposition of its interest in
Trust on its return for the year of the sale or other disposition. See § 6033 and
§ 1.6033-2(a)(ii). Therefore, in general, Charity will be a participant for the year in which
charity sells or otherwise disposes of its interest in Trust.
Time for Disclosure
6
See §1.6011-4(e) and § 301.6111-3(e).
Material Advisor Threshold Amount
The threshold amounts in § 301.6111-3(b)(3)(i)(B) are reduced to $5,000.
Penalties
Persons required to disclose these transactions under § 1.6011-4 who fail to do
so may be subject to the penalty under § 6707A. Persons required to disclose these
transactions under § 6111 who fail to do so may be subject to the penalty under
§ 6707(a). Persons required to maintain lists of advisees under § 6112 who fail to do so
(or who fail to provide such lists when requested by the IRS) may be subject to the
penalty under § 6708(a). In addition, the IRS may impose other penalties on parties
involved in these transactions or substantially similar transactions, including the
accuracy-related penalty under § 6662 or § 6662A.
REQUESTING COMMENTS
The IRS and Treasury Department are aware of concerns expressed by
commentators regarding this transaction of interest. The IRS and Treasury Department
share these concerns and are requesting written comments on how the transaction
might be addressed in published guidance. One approach might involve issuing
regulations under the authority of § 643(a)(7) to address the uniform basis rules under
§§ 1014 and 1015 and the regulations thereunder.
Comments should be submitted by January 31, 2009, to: Internal Revenue
Service, CC:PA:LPD:PR (Notice 2008-99), Room 5203, P.O. Box 7604, Ben Franklin
Station, Washington, DC 20224. Alternatively, comments may be hand delivered
Monday through Friday between the hours of 8:00 a.m. to 4:00 p.m. to: CC:PA:LPD:PR
7
(Notice 2008-99), Courier’s Desk, Internal Revenue Service, 1111 Constitution Avenue,
N.W., Washington, DC. Comments also may be submitted electronically via the
following email address: Notice.Comments@irscounsel.treas.gov. Please include
“Notice 2008-99” in the subject line of any electronic submissions. All comments
received will be open to public inspection and copying.
DRAFTING INFORMATION
The principal author of this notice is Allison Carmody of the Office of Associate
Chief Counsel (Passthroughs and Special Industries). For further information regarding
this notice, contact Ms. Carmody at (202) 622-3070 (not a toll-free call).
http://www.irs.gov/pub/irs-drop/n-08-99.pdf