Guidance Under Section 664 Regarding the Effect of Unrelated Business Taxable Income on Charitable Remainder Trusts, 35583-35585 [08-1380]

Agencies

• Internal Revenue Service
• DEPARTMENT OF THE TREASURY

[Federal Register Volume 73, Number 122 (Tuesday, June 24, 2008)]
[Rules and Regulations]
[Pages 35583-35585]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 08-1380]


-----------------------------------------------------------------------

DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Parts 1 and 602

[TD 9403]
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: Final regulations.

-----------------------------------------------------------------------

SUMMARY: This document contains final 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 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 regulations affect charitable remainder trusts that have UBTI in 
taxable years beginning after December 31, 2006.

DATES: Effective Date: The regulations are effective on June 24, 2008.
    Applicability Date: For dates of applicability, see Sec.  1.664-
1(c)(3).

FOR FURTHER INFORMATION CONTACT: Cynthia Morton at (202) 622-3060 (not 
a toll-free number).

SUPPLEMENTARY INFORMATION:

Paperwork Reduction Act

    The collections of information contained in these final regulations 
have been reviewed and approved by the Office of Management and Budget 
in accordance with the Paperwork Reduction Act of 1995 (44 U.S.C. 
3507(d)) under control number 1545-2101. The collection of information 
in these final regulations is in Sec.  1.664-1(c)(1). This information 
is required to enable a charitable remainder trust to report and pay 
the excise tax due on any UBTI of the trust.
    An agency may not conduct or sponsor, and a person is not required 
to respond to, a collection of information unless the collection 
information displays a valid control number.
    Books or records relating to a collection of information must be 
retained as long as their contents might become material in the 
administration of any internal revenue law. Generally, tax returns and 
tax information are confidential, as required by 26 U.S.C. 6103.

[[Page 35584]]

Background and Explanation of Provisions

    This document contains amendments to 26 CFR part 1 under section 
664 of the Code. On March 7, 2008, proposed regulations (REG-127391-07) 
relating to the tax effect of UBTI on charitable remainder trusts were 
published in the Federal Register (73 FR 12313). Although two comments 
were received in response to the proposed regulations, no request to 
speak was submitted, so no public hearing was held (see 73 FR 18729). 
After consideration of the comments, the proposed regulations are 
adopted by this Treasury decision without substantive change.
    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 final 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.
    The regulations confirm that, 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. The regulations also confirm 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.

Summary of Comments

Comments Relating to Transitional Relief

    The two commentators requested transitional relief to allow time 
for charitable remainder trusts with investments producing significant 
UBTI to restructure these investments. The commentators noted that the 
Tax Relief and Health Care Act of 2006 revising section 664(c) was 
signed into law on December 20, 2006, and became effective for tax 
years beginning after December 31, 2006. Consequently, charitable 
remainder trusts had 11 days to make changes in their investments in 
response to the legislation.
    The Treasury Department and the IRS have carefully considered the 
concerns of the commentators and the request for transitional relief, 
but have not adopted this comment. The primary objective of adopting 
the tax on UBTI was to eliminate a source of unfair competition by 
placing the unrelated business activities of certain exempt 
organizations on the same tax basis as the nonexempt businesses with 
which they compete. See Sec.  1.513-1(b). The provision denying the 
income tax exemption for charitable remainder trusts in years in which 
the trust has UBTI was enacted because Congress did ``not believe that 
it is appropriate to allow the unrelated business income tax to be 
avoided by the use of a charitable remainder trust rather than a tax-
exempt organization''. See Public Law 91-172, Senate Report 91-552 
(H.R. 13270), CB 1969-3, P. 481-2. The sanction imposed under prior law 
on a charitable remainder trust investing in UBTI-producing asset(s), 
specifically the loss of tax-exempt status, was generally viewed as 
particularly onerous. Section 424 of the Act changed the sanction to 
alleviate its severity, but did not reflect any change in the long-
standing policy to sanction and thus to discourage such investment by 
charitable remainder trusts.

Special Analyses

    It has been determined that this Treasury decision 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 these 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 reporting burden flows directly from the statute 
implemented by these regulations. Accordingly, a regulatory flexibility 
analysis under the Regulatory Flexibility Act (5 U.S.C. chapter 6) 
(RFA) is not required. Pursuant to section 7805(f) of the Code, the 
notice of proposed rulemaking preceding these regulations was submitted 
to the Chief Counsel for Advocacy of the Small Business Administration 
for comment on its impact on small business.

Drafting Information

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

List of Subjects

26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

26 CFR Part 602

    Reporting and recordkeeping requirements.

Adoption of Amendments to the Regulations

0
Accordingly, 26 CFR parts 1 and 602 are amended as follows:

PART 1--INCOME TAXES

0
Paragraph 1. The authority citation for part 1 continues to read in 
part as follows:

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


0
Par. 2. Section 1.664-1 is amended as follows:
0
1. In paragraph (a)(1)(i), the last sentence is revised and two 
sentences are added to the end of the paragraph.
0
2. Paragraph (c) is revised.
0
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 for 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

[[Page 35585]]

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. This paragraph (c) is applicable 
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 Sec.  1.664-1(c) as in effect prior to June 24, 2008. 
(See 26 CFR part 1, Sec.  1.664-1(c)(1) revised as of April 1, 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. * * *
* * * * *

PART 602--OMB CONTROL NUMBERS UNDER THE PAPERWORK REDUCTION ACT

0
Par. 3. The authority citation for part 602 continues to read as 
follows:

    Authority: 26 U.S.C. 7805.


0
Par. 4. In Sec.  602.101, paragraph (b) is amended by adding the 
following entry in numerical order to the table as follows:


Sec.  602.101  OMB Control numbers.

* * * * *
    (b) * * *

------------------------------------------------------------------------
  CFR part of section where identified and
                 described                     Current OMB control No.
------------------------------------------------------------------------
 
                                * * * * *
1.664-1(c).................................  1545-2101
 
                                * * * * *
------------------------------------------------------------------------


Linda E. Stiff,
Deputy Commissioner for Services and Enforcement.
    Approved: June 18, 2008.
Eric Solomon,
Assistant Secretary of the Treasury (Tax Policy).
[FR Doc. 08-1380 Filed 6-19-08; 1:29 pm]
BILLING CODE 4830-01-P