115 T.C. No. 3
UNITED STATES TAX COURT
ESTATE OF MELVINE B. ATKINSON, DECEASED, CHRISTOPHER J. MACQUARRIE, EXECUTOR, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 20968-97. Filed July 26, 2000.
R determined that the estate was not entitled to deduct the charitable remainder interest in a trust that was intended to be a charitable remainder annuity trust (CRAT). R challenged the validity of the CRAT on two bases: First, that the annual 5-percent minimum distributions were not made as required by sec. 664(d)(1)(A), I.R.C., and second, that sec. 664(d)(1)(B), I.R.C., will be violated because the trust corpus would have to be invaded to satisfy the estate’s obligation to pay one of the noncharitable secondary beneficiary’s apportioned part of the estate tax.
Held: No charitable deduction is allowable because: (1) Sec. 664(d), I.R.C., requires that minimum payments be distributed annually from the inception of the CRAT to certain designated persons, and these payments were not made, and (2) no portion of a purported CRAT may be paid to anyone other than designated noncharitable beneficiaries or statutorily - 2 -
acceptable charitable entities, and here the trust will be invaded to pay the estate tax attributable to a portion of the estate received by one of the noncharitable beneficiaries.
David D. Aughtry and Christopher J. MacQuarrie, for
petitioner.
Francis C. Mucciolo, for respondent.
GERBER, Judge: Respondent determined a deficiency in
petitioner’s Federal estate tax in the amount of $2,654,976. The
deficiency arose in connection with the operation of a charitable
remainder annuity trust (CRAT) created by decedent. The issue
for our consideration is whether the trust functioned exclusively
as a charitable remainder trust from its creation, thereby
remaining a valid trust, so as to qualify the estate for a
charitable deduction for the remainder interest.
FINDINGS OF FACT
The stipulation of facts and the exhibits attached thereto
are incorporated herein by this reference.
Melvine B. Atkinson (decedent), died on June 7, 1993, at the
age of 97, a resident of Miami Beach, Florida. The executor of
her estate, Christopher J. MacQuarrie (MacQuarrie), also resided
in Florida at the time the petition was filed.
On August 9, 1991, decedent placed stock worth $3,999,974 in
trust under a document entitled “Melvine B. Atkinson Charitable
Remainder Annuity Trust” (annuity trust) and named MacQuarrie as - 3 -
trustee. At that time, she also created the Melvine B. Atkinson
Irrevocable Trust (administrative trust) and placed stock worth
$953,012 in that trust. MacQuarrie was named trustee for this
second trust as well. On the same day, decedent signed her Last
Will and Testament (will), naming MacQuarrie as personal
representative.
The annuity trust provided that the trust would pay decedent
an annuity equal to 5 percent of the fair market value of the
assets of the trust as of the date of its creation, in equal
quarterly payments, until her death. At least seven quarterly
payments of $49,999.68 ($3,999,974 x 5% ÷ 4), totaling
$349,997.76, should have been made to decedent before her death.
No payments were actually made from the trust account during
decedent’s lifetime. The value of the trust was not diminished
by the 5-percent payments. MacQuarrie was aware that the trust
document and the statutes relating to CRAT’s required that a
minimum of 5 percent of the initial fair market value be paid out
each year, and he was aware that decedent was not withdrawing
money from the trust. No funds were ever transferred to decedent
from the trust. The amount of $366,334.92, representing the
amount due to decedent under the trust terms, was included as an
asset of decedent’s estate.
Upon decedent’s death, the trust document provided that the
same 5-percent annuity amount was to be distributed amongst - 4 -
various named individuals (secondary beneficiaries) but only if
those beneficiaries each furnished their share of the funds for
payment of Federal estate and State death taxes for which the
trustee might be liable upon Atkinson’s death. One of those
secondary beneficiaries was Mary Birchfield (Birchfield), who had
cared for decedent from 1984 until her death.
As trustee, MacQuarrie informed the secondary beneficiaries
of their right to receive an annuity under the trust and of the
condition that they must pay the related Federal estate and State
death taxes. After notifying the secondary beneficiaries of
their need to elect to receive, MacQuarrie moved to compel their
election. Ultimately, only Birchfield elected to take her share.
Birchfield agreed to take the money, but informed MacQuarrie that
the decedent had indicated that she would not be liable for her
share of the estate taxes and that she possessed a notarized
document from decedent to that effect. She informed MacQuarrie
that she expected to be given the money without paying any estate
tax. After increasingly hostile exchanges, MacQuarrie and a
second attorney (who was also evaluating the administration of
the estate) decided that it would be in the best interest of the
trust to settle Birchfield’s claim for the payment of any related
taxes. MacQuarrie filed a motion seeking the court’s approval of
payment out of the administrative trust for any estate taxes
related to the amount to be paid to Birchfield pursuant to the - 5 -
annuity trust. The probate judge signed a proposed order to that
effect. At that time $667,000, representing the annuity payments
due to Birchfield accrued from decedent’s death, was set aside
for Birchfield. MacQuarrie delayed paying the accrued amount to
Birchfield due to concern over a possible estate audit but
motioned the court for approval to distribute the funds before a
closing letter was obtained. The probate judge ordered that
those funds be distributed to Birchfield, and a payment of
$667,000 was made to Birchfield on December 31, 1996. Four
additional payments were made to Birchfield towards her 5-percent
annuity amount. No Federal estate or State death taxes were paid
by Birchfield on the amounts she received. It was subsequently
determined that funds from the administrative trust were
insufficient to pay both the estate tax attributable to
Birchfield’s interest and the administration expenses and
retirement of decedent’s debts. Accordingly, it will be
necessary to invade the CRAT to make up the shortfall.
Birchfield died of breast cancer on April 22, 1997. At the
time of the estate valuation calculation, MacQuarrie had asked
for and received an affidavit from Birchfield’s doctor stating
that Birchfield had a less than 5-year life expectancy. In
accordance with section 7520,1 the estate valued the charitable
1 Unless otherwise indicated, all section references are to the Internal Revenue Code in effect as of the date of decedent’s (continued...) - 6 -
remainder interest from the trust considering the annuity payment
to Birchfield based on her normal life expectancy. Petitioner
now asserts that this calculation had been done incorrectly and
that a shorter life expectancy should have been used resulting in
a greater charitable deduction for the remainder interest.
Respondent determined that the charitable remainder annuity
trust was not a valid CRAT and that no charitable deduction was
available to the estate. Respondent also determined that several
of the estate expenses were improperly deducted because they had
not been paid. Though respondent agrees that several of the
deductions are now allowable, respondent continues to maintain
that the charitable deduction taken by the estate should be
disallowed. Respondent determined that the trust did not
continue to function as a charitable remainder annuity trust for
two reasons: First, when it failed to pay the required annual
amount to decedent during her life and, second, when the trust
ostensibly agreed to pay money towards the tax liability on the
funds distributed to Mary Birchfield in accordance with the
settlement. Petitioner maintains that the estate qualifies for a
charitable deduction under section 2055 and that it is entitled
to a refund because a greater charitable deduction should have
1 (...continued) death, and all Rule references are to the Tax Court Rules of Practice and Procedure. - 7 -
been allowed in light of the revised actuarial values for
Birchfield’s annuity.
OPINION
The issue before us is whether, in its operation, decedent’s
charitable remainder annuity trust met the statutory requirements
so as to qualify for a charitable deduction. Specifically, we
consider whether the trust made the statutorily required payments
to decedent during her lifetime and the effect of the trust’s
obligation to make payments to the secondary beneficiary after
decedent’s death. If we decide that the trust was operationally
qualified, we must then decide the appropriate life expectancy of
Mary Birchfield to decide whether petitioner is entitled to a
larger charitable deduction. On brief and at trial,2 respondent
maintained that the trust failed to qualify as a CRAT for
purposes of sections 2055 and 664 because of actions of the
trustee and/or trustor. If the trust is so disqualified, section
2055 precludes the taking of a charitable deduction for the
charitable remainder interest.
Section 2055 provides for a deduction from the Federal gross
estate of an amount equal to the property passing from a decedent
to a charitable organization of the type described in subsection
2 At trial, respondent also raised the issue of whether certain expenses of the trust were reasonable. After reviewing the pertinent materials, we found that the reasonability of the fees was a new issue and therefore could not be raised for the first time at trial. Though respondent raises the issue again on brief, we adhere to our earlier ruling. - 8 -
(a) of the section. Subsection (a) includes organizations
pursuing religious, charitable, scientific, literary, or
educational purposes, or fostering amateur sports competition, or
preventing cruelty to children or animals, from which no net
earnings inure to a noncharitable private party and which do not
participate in political campaigning. See sec. 2055(a)(2).
However, no deduction shall be allowed if a charity receives a
remainder interest in property and if an interest in the same
property also passes to an individual or a noncharitable entity,
unless the charitable remainder interest is in a charitable
remainder annuity trust, a charitable remainder unitrust, or a
pooled income fund. See sec. 2055(e)(2)(A). The trust
established by decedent purports to be a CRAT, and if it were, a
gift of trust assets to charity would qualify for the charitable
deduction.
Section 664(d)(1) contains the definition of a charitable
remainder annuity trust. A trust only qualifies as a CRAT if:
(1) It pays out a sum certain, not less than 5 percent of the
initial fair market value of the trust assets, annually or more
frequently to one or more persons for either the lifetime of such
person or a term of years (not more than 20 years); (2) no other
payments, besides those described in (1), are paid to or for the
use of a person other than an organization described by section - 9 -
170(c);3 (3) once the payments described in (1) cease, the
remainder interest is transferred to or for the use of an
organization described in section 170(c) or is retained by the
trust for such a use; and (4) the value of that remainder
interest is at least 10 percent of the initial fair market value
of the trust assets. See sec. 664(d)(1). Furthermore, the terms
of the trust must meet the statutory requirements, and the trust
must operate within those terms from its creation. See sec.
1.664-1(a)(4), Income Tax Regs.
Five-Percent Distribution Requirement
Section 664 provides for a narrow exception to the general
disallowance of deductions for charitable remainder interests
under section 2055(e)(2)(A). In order to qualify, all section
664 requirements for CRAT’s must be met upon creation and must
continue to be met throughout the existence of the CRAT. See
sec. 1.664-1(a)(4), Income Tax Regs. One of those requirements
is that a minimum payment of 5 percent of the initial fair market
value of the trust’s assets be distributed each year to the
noncharitable beneficiary. Petitioner argues that this
distribution requirement should be set aside or ignored because
it only serves to decrease the charitable contribution and
because decedent had no need for the distribution. One of the
3 Sec. 170(c) describes organizations organized and operated exclusively for religious, charitable, scientific, literary, or educational purposes, or to foster amateur sports competition, or for the prevention of cruelty to children or animals. - 10 -
primary reasons for sections 2055 and 664 was to ensure that any
amount set aside for charity was not diminished by payments to
noncharitable beneficiaries.
The trust here, however, provides for four potential
secondary beneficiaries who could have survived decedent and
elected to receive payments that could have reduced the amount
due to charity. An expressed focus of Congress in enacting the
5-percent distribution requirement was to prevent a charitable
remainder trust from being used to circumvent the current income
distribution requirements imposed on private foundations. See S.
Rept. 91-552 (1969), 1969-3 C.B. 423, 481. If there were no such
requirement, a charitable remainder trust could be used to
accumulate trust income tax-free, while a private foundation
would remain limited in the amount of income it might accumulate.
See id.
Though the terms of the annuity trust met the letter of the
statutory requirement providing for distributions equal to 5
percent annually, the trust did not operate in accordance with
those terms. Petitioner bears the burden of proof in this
matter, including the burden of substantiation. See Rule 142(a).
Petitioner has presented no persuasive evidence that checks for
the 5 percent annuity ever existed or were ever sent to decedent.
Purportedly, MacQuarrie remitted checks to decedent that were not
cashed. However, there is no record of canceled or uncanceled - 11 -
checks, nor did petitioner present any evidence demonstrating a
gap in the check sequence. Though MacQuarrie testified that he
made copies of checks written on the trust account, no such
copies were presented to evidence these alleged payments. On the
other hand, we do have evidence that no payments were ever
actually consummated before decedent’s death. The trust was
never diminished by any payments during decedent’s life. Because
the trust value was undiminished and no transfer of funds
occurred, operationally the trust did not meet the express 5-
percent requirement of the statute and cannot qualify for
treatment as a charitable remainder trust. Accordingly, section
2055 applies, and the estate is not entitled to a deduction for
the bequest of a charitable split-interest.4
Petitioner alternatively argues that the trust should not be
disqualified as a CRAT for the lack of payments to decedent
because the failure of action took place during the trustor’s
lifetime. Petitioner argues that section 1.664-1(a)(5), Income
Tax Regs., allows for CRAT’s created inter vivos to ignore all of
the requirements established by section 664 until the moment of
4 The additional failure of the trust attributable to the payments to the secondary beneficiary, when coupled with the more technical “5 percent rule” makes respondent’s position that the trust failed operationally more compelling. See infra pp. 14-15. - 12 -
death.5 Petitioner argues that, under this provision of the
regulation, the trust did not come into being until the date of
decedent’s death, and therefore no prior violation of the CRAT
requirements could disqualify the trust. Petitioner’s position
overlooks that this provision of the regulation is inapplicable
to the trust involved here--an irrevocable trust established and
funded by decedent during her lifetime. The application of this
provision of the regulation, as reflected in its terms and
illustrated by the accompanying examples, see sec. 1.664-1(a)(6),
Income Tax Regs., is confined to testamentary trusts funded for
the first time after the grantor’s death. In the present case,
the trust is deemed created at the earliest time that neither the
grantor nor any other person is treated as the owner of the
entire trust. See sec. 1.664-1(a)(4), Income Tax Regs. Here,
5 Sec. 1.664-1(a)(5), Income Tax Regs., provides:
(5) Rules applicable to testamentary transfers-- (i) Deferral of annuity or unitrust amount. Notwithstanding subparagraph (4) of this paragraph and §§ 1.664-2 and 1.664-3, for purposes of sections 2055 and 2016 a charitable remainder trust shall be deemed created at the date of death of the decedent (even though the trust is not funded until the end of a reasonable period of administration or settlement) if the obligation to pay the annuity or unitrust amount with respect to the property passing in trust at the death of the decedent begins as of the date of death of the decedent, even though the requirement to pay such amount is deferred in accordance with the rules provided in this subparagraph. * * * - 13 -
decedent irrevocably relinquished ownership of the trust assets
during her lifetime when she signed the trust documents stating
that she was transferring the property to the trust on August 9,
1991. The CRAT was created on that date and was to function as a
CRAT from that day forward, as required in the regulations. See
id. The regulation providing for a deemed creation date upon the
death of a trustor does not apply to an operating inter vivos
trust that is to continue after the death of the grantor.
Though only mentioned in passing by petitioner, we also note
that reformation of the trust pursuant to section 2055(e)(3)
would not be an available remedy to petitioner. Section
2055(e)(3) provides that a trust or will may be reformed if it
was improperly created and yet conforms to the CRAT requirements.
The definition of “qualified reformation” demonstrates that the
reformation is meant to address only those problems arising in
the documentation of the trust. Section 2055(e)(3)(B) defines
qualified reformation as “a change of governing instrument by
reformation, amendment, construction, or otherwise”. The
legislative history indicates that reformation under section 2055
was created to address problems in trust creation as follows:
“The bill provides a permanent rule permitting reformation of
governing instruments of charitable split-interest trusts which
do not meet the requirements of the 1969 Act rules.” Staff of
the Senate Comm. on Finance, 98th Cong. 2d Sess., Explanation Of
Provisions Approved By The Committee On March 21, 1984, S. Prt. - 14 -
98-169, Vol. I at 732 (Comm. Print 1984). Here the trust was
validly formulated, and its terms were within the statutory
threshold requirements. Accordingly, reformation is not needed
to “rewrite” incorrect terms. The operational failure cannot be
corrected by reformation. Therefore, the concept of reformation
has no application here.
Payments to Birchfield
In addition to the failure in operation that occurred when
no payments were made to decedent in accordance with the trust
terms, the trust is disqualified from being a CRAT because it
will be necessary to invade the trust to satisfy the obligations
of the estate, which include the estate and death taxes
apportionable to Mary Birchfield’s beneficial interest in the
trust. The estate bears the responsibility for those tax
payments. As discussed earlier, the funds in the administrative
trust are not sufficient to pay decedent’s debts, the
administration expenses, and estate and death taxes. The
shortfall will have to come out of the trust corpus. Pursuant to
section 664(d)(1)(B), no amount of the trust, other than the
annuity, may be paid to or for the use of any person other than
an organization described in section 170(c). Because the trust
corpus will be invaded to pay expenses or debts of the estate,
including estate taxes, a substantial part of the trust funds may
be diverted from the charitable remainder. This is an additional - 15 -
reason for concluding that the trust failed to function
exclusively as a CRAT from the date of its creation. See sec.
1.664-1(a)(6), Example (3), Income Tax Regs. (reservation of
power to pay grantor’s debts precludes qualification as CRAT);
see also Rev. Rul. 82-128, 1982-2 C.B. 71 (ruling that “a trust
does not qualify as a charitable remainder trust and no deduction
is allowable under sections 170 and 2522 of the Code if it is
possible that federal estate and state death taxes may be payable
from the trust assets”).
We need not address the valuation of Birchfield’s life
interest and any correlated value of the remainder interest. At
the time the payments were made out of the trusts to and on
behalf of Birchfield, the estate did not qualify for the
exception to section 2055(e)(2)(A) and thus was not entitled to
any charitable deduction for the remainder interest in the trust.
On brief, respondent states that several deductions
previously disallowed will now be allowed, although the
deductions were not identified. At trial, respondent questioned
whether certain expenses were properly deducted due to
uncertainty about whether they had been actually paid. Testimony
about payment of the expense was received in evidence. On brief,
respondent did not address the issue of payment, and,
accordingly, we consider this issue to have been waived or - 16 -
conceded. See Stringer v. Commissioner, 84 T.C. 693, 708 (1985),
affd. without published opinion 798 F.2d 917 (4th Cir. 1986).
To reflect the foregoing,
Decision will be entered under Rule
155.