Guidance Under Section 664 Regarding the Effect of Unrelated Business Taxable Income on Charitable Remainder Trusts, 12313-12315 [E8-4576]

Agencies

• Internal Revenue Service
• DEPARTMENT OF THE TREASURY

[Federal Register Volume 73, Number 46 (Friday, March 7, 2008)]
[Proposed Rules]
[Pages 12313-12315]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: E8-4576]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[REG-127391-07]
RIN 1545-BH02


Guidance Under Section 664 Regarding the Effect of Unrelated 
Business Taxable Income on Charitable Remainder Trusts

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Notice of proposed rulemaking and notice of hearing.

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SUMMARY: This document contains proposed regulations that provide 
guidance under Internal Revenue Code (Code) section 664 on the tax 
effect of unrelated business taxable income (UBTI) on charitable 
remainder trusts. The proposed regulations reflect the changes made to 
section 664(c) by section 424(a) and (b) of the Tax Relief and Health 
Care Act of 2006. The proposed regulations affect charitable remainder 
trusts that have UBTI in taxable years beginning after December 31, 
2006. This document also provides notice of a public hearing on these 
proposed regulations.

DATES: Written or electronic comments must be received by May 6, 2008. 
Outlines of topics to be discussed at the public hearing scheduled for 
April 11, 2008, must be received by March 28, 2008.

ADDRESSES: Send submissions to: CC:PA:LPD:PR (REG-127391-07), Room 
5203, Internal Revenue Service, PO Box 7604, Ben Franklin Station, 
Washington, DC 20044. Submissions may be hand-delivered Monday through 
Friday between the hours of 8 a.m. and 4 p.m. to CC:PA:LPD:PR (REG-
127391-07), Courier's Desk, Internal Revenue Service, 1111 Constitution 
Avenue, NW., Washington, DC; or sent electronically via the Federal 
eRulemaking Portal at https://www.regulations.gov (IRS REG-127391-07).

FOR FURTHER INFORMATION CONTACT: Concerning the proposed regulations, 
Cynthia Morton at (202) 622-3060; concerning submissions of comments, 
the hearing, and/or access list to attend the hearing, contact Richard 
Hurst at (202) 622-7180 (not toll-free numbers) or e-mail at 
Richard.A.Hurst@irscounsel.treas.gov.

SUPPLEMENTARY INFORMATION: 

Paperwork Reduction Act

    The collections of information in this notice of proposed 
rulemaking have been submitted to the Office of Management and Budget 
for review in accordance with the Paperwork Reduction Act of 1995 (44 
U.S.C. 3507(d)). Comments on the collection of information should be 
sent to the Office of Management and Budget, Attn: Desk Officer for the 
Department of the Treasury, Office of Information and Regulatory 
Affairs, Washington, DC 20503, with copies to the Internal Revenue 
Service, Attn: IRS Reports Clearance Officer, SE:W:CAR:MP:T:T:SP; 
Washington, DC 20224. Comments on the collection of information should 
be received by May 6, 2008.
    Comments are specifically requested concerning:
    Whether the proposed collection of information is necessary for the 
proper performance of the functions of the Internal Revenue Service, 
including whether the information will have practical utility;
    The accuracy of the estimated burden associated with the proposed 
collection of information;
    How the quality, utility, and clarity of the information to be 
collected may be enhanced;
    How the burden of complying with the proposed collection of 
information may be minimized, including through the application of 
automated collection techniques or other forms of information 
technology; and
    Estimates of capital or start-up costs and costs of operation, 
maintenance, and purchase of service to provide information.
    The collection of information in the proposed regulation is in 
Sec.  1.664-1(c). This information is required to report the excise tax 
imposed by section 664(c) of the Code. The likely respondents are 
trustees of charitable remainder trusts.
    Estimated total annual reporting and/or recordkeeping burden: 50 
hours.
    Estimated average annual burden per respondent and/or recordkeeper: 
.5 hours.
    Estimated number of respondents and/or recordkeepers: 100.
    Estimated annual frequency of responses: Once.
    An agency may not conduct or sponsor, and a person is not required 
to respond to, a collection of information unless it displays a valid 
control number assigned by the Office of Management and Budget.
    Books and records relating to a collection of information must be 
retained as long as their contents may

[[Page 12314]]

become material in the administration of any internal revenue law. 
Generally, tax returns and tax return information are confidential, as 
required by 26 U.S.C. 6103.

Background

    For taxable years beginning before January 1, 2007, section 664(c) 
provided that a charitable remainder trust (whether a charitable 
remainder annuity trust or a charitable remainder unitrust) would not 
be exempt from income tax for any year in which the trust had any UBTI 
(within the meaning of section 512). Instead, such trust was taxed for 
each such year under subchapter J as though it were a nonexempt, 
complex trust. The proposed regulations reflect the changes to section 
664(c) made by section 424 of the Tax Relief and Health Care Act of 
2006 (Act) Public Law 109-432, 120 Stat. 2922. Section 424(a) of the 
Act, which applies to taxable years beginning after December 31, 2006, 
provides that charitable remainder trusts that have UBTI remain exempt 
from Federal income tax, but imposes a 100-percent excise tax on their 
UBTI. Pursuant to section 664(c)(2)(A), the amount of UBTI is 
determined pursuant to section 512. Under section 512, UBTI is computed 
with the modifications in section 512(b) including the $1,000 deduction 
in section 512(b)(12). The excise tax imposed under section 
664(c)(2)(A) is treated as imposed under the excise tax rules that 
apply to private foundations and other tax-exempt organizations, other 
than the rules for abatement of first and second-tier taxes (chapter 
42, other than subchapter E of chapter 42).
    Pursuant to section 664(b), distributions from a charitable 
remainder trust for the year that the annuity or unitrust amount is 
required to be distributed are treated in the following order as: (1) 
Ordinary income to the extent of the trust's ordinary income for that 
year and undistributed ordinary income for all prior years; (2) Capital 
gains to the extent of the trust's capital gain for that year and 
undistributed capital gain for all prior years; (3) Other income (for 
example, tax-exempt income) to the extent of the trust's other income 
for that year and undistributed other income for all prior years; and 
(4) Corpus.
    For purposes of determining the character of the distribution made 
to the beneficiary, the charitable remainder trust income that is UBTI 
is considered income of the trust. Specifically, income of the 
charitable remainder trust is allocated among the trust income 
categories in Treasury Regulation Sec.  1.664-1(d)(1) without regard to 
whether any part of that income constitutes UBTI under section 512. 
Section 1.664-1(d)(1) assigns charitable remainder trust income to one 
of three categories (ordinary income, capital gains, or other income) 
in the year in which it is required to be taken into account by the 
trust.

Explanation of Provisions

    The proposed regulations amend the regulations under section 664(c) 
to provide that charitable remainder trusts with UBTI in taxable years 
beginning after December 31, 2006, are exempt from Federal income tax, 
but are subject to a 100-percent excise tax on the UBTI of the 
charitable remainder trust. The proposed regulations provide that the 
excise tax is reported and payable in accordance with the appropriate 
forms and instructions. Currently, the appropriate form to report and 
pay the excise tax on charitable remainder trusts with UBTI is Form 
4720, ``Return of Certain Excise Taxes Under Chapters 41 and 42 of the 
Internal Revenue Code.'' The rules that apply with respect to 
charitable remainder trusts that have UBTI in taxable years beginning 
before January 1, 2007, are contained in Sec.  1.664-1(c) as in effect 
for taxable years beginning before January 1, 2007. (See 26 CFR part 1 
Sec.  1.664-1(c) revised as of April 2, 2007).
    The proposed regulations clarify that, consistent with Sec.  1.664-
1(d)(2), the excise tax imposed upon a charitable remainder trust with 
UBTI is treated as paid from corpus and the trust income that is UBTI 
is income of the trust for purposes of determining the character of the 
distribution made to the beneficiary. The proposed regulations provide 
examples illustrating the tax effects of UBTI on a charitable remainder 
trust for taxable years beginning after December 31, 2006. Finally, the 
proposed regulations amend Sec.  1.664-1(d)(2) to conform with section 
424 of the Act.

Proposed Effective Date

    The proposed regulations are proposed to be effective for taxable 
years beginning after December 31, 2006.

Special Analyses

    It has been determined that this notice of proposed rulemaking is 
not a significant regulatory action as defined in Executive Order 
12866. Therefore, a regulatory assessment is not required. It has also 
been determined that section 553(b) of the Administrative Procedure Act 
(5 U.S.C. chapter 5) does not apply to the regulations. It is hereby 
certified that the collection of information in these regulations will 
not have a significant economic impact on a substantial number of small 
entities. This certification is based upon the fact that any burden on 
taxpayers is minimal. Accordingly, a regulatory flexibility analysis 
under the Regulatory Flexibility Act (5 U.S.C. 601) (RFA) is not 
required. Pursuant to section 7805(f) of the Code, this notice of 
proposed rulemaking will be submitted to the Chief Counsel for Advocacy 
of the Small Business Administration for comment on its impact on small 
business.

Comments and Public Hearing

    Before these proposed regulations are adopted as final regulations, 
consideration will be given to any written (a signed original and eight 
(8) copies) or electronic comments that are submitted timely to the 
IRS. The IRS and the Treasury Department request comments on the 
clarity of the proposed rules and how they can be made easier to 
understand. All comments will be available for public inspection and 
copying.
    A public hearing has been scheduled for April 11, 2007, at 10 a.m., 
in the IRS Auditorium, Internal Revenue Service, 1111 Constitution 
Avenue, NW., Washington, DC. Due to building security procedures 
visitors must enter at the Constitution Avenue entrance. In addition, 
all visitors must present photo identification to enter the building. 
Because of access restrictions, visitors will not be admitted beyond 
the immediate entrance area more than 30 minutes before the hearing 
starts. For information about having your name placed on the building 
access list to attend the hearing, see the FOR FURTHER INFORMATION 
CONTACT section of this preamble.
    The rules of 26 CFR 601.601(a)(3) apply to the hearing. Persons who 
wish to present oral comments at the hearing must submit electronic or 
written comments and an outline of the topics to be discussed and the 
time to be devoted to each topic (signed original and eight (8) copies) 
by March 28, 2007. A period of 10 minutes will be allotted to each 
person for making comments. An agenda showing the scheduling of the 
speakers will be prepared after the deadline for receiving outlines has 
passed. Copies of the agenda will be available free of charge at the 
hearing.

Drafting Information

    The principal author of the proposed regulations is Cynthia Morton, 
Office of the Associate Chief Counsel (Passthroughs and Special 
Industries).

[[Page 12315]]

List of Subjects in 26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

Proposed Amendments to the Regulations

    Accordingly, 26 CFR part 1 is proposed to be amended as follows:

PART 1--INCOME TAXES

    Paragraph 1. The authority citation for part 1 continues to read in 
part as follows:

    Authority: 26 U.S.C. 7805. * * *

    Par. 2. Section 1.664-1 is amended as follows:
    1. In paragraph (a)(1)(i), the last sentence is revised and a 
sentence is added to the end of the paragraph.
    2. Paragraph (c) is revised.
    3. In paragraph (d)(2), the fourth sentence is revised.
    The revisions and addition read as follows:


Sec.  1.664-1  Charitable remainder trusts.

    (a) * * * (1) * * * (i) * * * A trust created after July 31, 1969, 
which is a charitable remainder trust, is exempt from all of the taxes 
imposed by subtitle A of the Code for any taxable year of the trust, 
except a taxable year beginning before January 1, 2007, in which it has 
unrelated business taxable income. For taxable years beginning after 
December 31, 2006, an excise tax, treated as imposed by chapter 42, is 
imposed on charitable remainder trusts that have unrelated business 
taxable income. See paragraph (c) of this section.
* * * * *
    (c) Excise Tax on Charitable Remainder Trusts--(1) In general. For 
each taxable year beginning after December 31, 2006, in which a 
charitable remainder annuity trust or a charitable remainder unitrust 
has any unrelated business taxable income, an excise tax is imposed on 
that trust in an amount equal to the amount of such unrelated business 
taxable income. For this purpose, unrelated business taxable income is 
as defined in section 512, determined as if part III, subchapter F, 
chapter 1 subtitle A of the Internal Revenue Code applied to such 
trust. Such excise tax is treated as imposed by chapter 42 (other than 
subchapter E) and is reported and payable in accordance with the 
appropriate forms and instructions. Such excise tax shall be allocated 
to corpus and, therefore, is not deductible in determining taxable 
income distributed to a beneficiary. (See paragraph (d)(2) of this 
section.) The charitable remainder trust income that is unrelated 
business taxable income constitutes income of the trust for purposes of 
determining the character of the distribution made to the beneficiary. 
Income of the charitable remainder trust is allocated among the 
charitable remainder trust income categories in paragraph (d)(1) of 
this section without regard to whether any part of that income 
constitutes unrelated business taxable income under section 512.
    (2) Examples. The application of the rules in this paragraph (c) 
may be illustrated by the following examples:

    Example 1. For 2007, a charitable remainder annuity trust with a 
taxable year beginning on January 1, 2007, has $60,000 of ordinary 
income, including $10,000 of gross income from a partnership that 
constitutes unrelated business taxable income to the trust. The 
trust has no deductions that are directly connected with that 
income. For that same year, the trust has administration expenses 
(deductible in computing taxable income) of $16,000, resulting in 
net ordinary income of $44,000. The amount of unrelated business 
taxable income is computed by taking gross income from an unrelated 
trade or business and deducting expenses directly connected with 
carrying on the trade or business, both computed with modifications 
under section 512(b). Section 512(b)(12) provides a specific 
deduction of $1,000 in computing the amount of unrelated business 
taxable income. Under the facts presented in this example, there are 
no other modifications under section 512(b). The trust, therefore, 
has unrelated business taxable income of $9,000 ($10,000 minus the 
$1,000 deduction under section 512(b)(12)). Undistributed ordinary 
income from prior years is $12,000 and undistributed capital gains 
from prior years are $50,000. Under the terms of the trust 
agreement, the trust is required to pay an annuity of $100,000 for 
year 2007 to the noncharitable beneficiary. Because the trust has 
unrelated business taxable income of $9,000, the excise tax imposed 
under section 664(c) is equal to the amount of such unrelated 
business taxable income, $9,000. The character of the $100,000 
distribution to the noncharitable beneficiary is as follows: $56,000 
of ordinary income ($44,000 from current year plus $12,000 from 
prior years), and $44,000 of capital gains. The $9,000 excise tax is 
allocated to corpus, and does not reduce the amount in any of the 
categories of income under paragraph (d)(1) of this section. At the 
beginning of year 2008, the amount of undistributed capital gains is 
$6,000, and there is no undistributed ordinary income.
    Example 2. During 2007, a charitable remainder annuity trust 
with a taxable year beginning on January 1, 2007, sells real estate 
generating gain of $40,000. Because the trust had obtained a loan to 
finance part of the purchase price of the asset, some of the income 
from the sale is treated as debt-financed income under section 514 
and thus constitutes unrelated business taxable income under section 
512. The unrelated debt-financed income computed under section 514 
is $30,000. Assuming the trust receives no other income in 2007, the 
trust will have unrelated business taxable income under section 512 
of $29,000 ($30,000 minus the $1,000 deduction under section 
512(b)(12)). Except for section 512(b)(12), no other exceptions or 
modifications under sections 512-514 apply when calculating 
unrelated business taxable income based on the facts presented in 
this example. Because the trust has unrelated business taxable 
income of $29,000, the excise tax imposed under section 664(c) is 
equal to the amount of such unrelated business taxable income, 
$29,000. The $29,000 excise tax is allocated to corpus, and does not 
reduce the amount in any of the categories of income under paragraph 
(d)(1) of this section. Regardless of how the trust's income might 
be treated under sections 511-514, the entire $40,000 is capital 
gain for purposes of section 664 and is allocated accordingly to and 
within the second of the categories of income under paragraph (d)(1) 
of this section.

    (3) Effective/Applicability date. Paragraph (c) is effective for 
taxable years beginning after December 31, 2006. The rules that apply 
with respect to taxable years beginning before January 1, 2007, are 
contained in 1.664-1(c) in effect prior to the date these regulations 
are published as final regulations in the Federal Register. (See 26 CFR 
part 1, Sec.  1.664-1(c)(1) revised as of April 2, 2007).
    (d) * * *
    (2) * * * All taxes imposed by chapter 42 of the Code (including 
without limitation taxes treated under section 664(c)(2) as imposed by 
chapter 42) and, for taxable years beginning prior to January 1, 2007, 
all taxes imposed by subtitle A of the Code for which the trust is 
liable because it has unrelated business taxable income, shall be 
allocated to corpus. * * *
* * * * *

Linda E. Stiff,
Deputy Commissioner for Services and Enforcement.
 [FR Doc. E8-4576 Filed 3-6-08; 8:45 am]
BILLING CODE 4830-01-P