Court Modification of CRT Due to Scrivener's Error Permitted

PLR 9822041

PGDC SUMMARY:

The IRS has ruled privately that a court modification to cure a drafting error in which the donor's counsel inadvertently included an "income only" provision in a charitable remainder unitrust will not disqualify the trust.

FACTS:

The donors created an "income only" CRUT and contributed low dividend paying stock to it. However, the donors had documentation to prove that a standard CRUT was intended. The donors propose to request a judicial reformation to cure this defect.

HOLDING:

(1) The proposed judicial modification of the CRUT will not violate Code Section 664 or the Regulations thereunder and will not disqualify the CRUT; and (2) the transfers to the CRUT will qualify for charitable gift tax purposes. These rulings are contingent on the issuance of a court order requiring the proposed modification.

POINTS TO PONDER:

Do the applicable reformation rules under Code Section 2055(e)(3) apply when a scrivener's error is involved?

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Date: March 2, 1998

LEGEND:

Taxpayers = * * *
CRUT = * * *
Charity = * * *
Stock = * * *
Date X = * * *
Dear * * *

This letter is in response to your letter dated October 14, 1997, and subsequent correspondence on behalf of taxpayers, requesting rulings under sections 664 and 2522 of the Internal Revenue Code. Specifically, rulings were requested that:

1. the proposed judicial modification of Trust, a charitable remainder unitrust (CRUT), will not violate any provisions under section 664 or sections 1.664-3(a)(3)(ii) and 1.664-3(a)(4) of the regulations or any other regulations under section 664;

2. the proposed judicial modification of Trust will not adversely affect Trust's qualification as a charitable remainder unitrust under section 664 and applicable regulations, and

3. transfers to Trust as modified will qualify under section 2522(a) as a charitable deduction in computing the taxable gifts made during each year.

FACTS:

The Taxpayers, spouses, wanted to contribute Stock to Charity and retain an income interest. Charity sent Taxpayers a letter and a copy of Rev. Proc. 90-30, 1990-1 C.B. 534. Both documents pertained to CRUTs with fixed annual payments to income beneficiaries as provided under section 664(d)(2). These documents described payments of 5 percent of the annual fair market value of the assets in the CRUT. Taxpayers' Stock was paying dividends equal to 3 to 4 percent of the fair market value of the stock.

Taxpayers took the letter and revenue procedure to their estate planning attorney and discussed the establishment of a CRUT with a fixed 7 percent payout. It was agreed that Taxpayers would also serve as trustees. The attorney drafted a trust agreement that he claimed provided a fixed 7 percent payout to Taxpayers.

On Date X, Taxpayers executed the agreement, transferred Stock to Trust, and, as trustees, began making quarterly 7 percent unitrust payments to themselves as beneficiaries. Shortly thereafter, in the process of having federal and state tax returns prepared, the Taxpayers were informed by their C.P.A. that paragraph 2(a) of the trust agreement provided for payment of the lesser of Trust income or 7 percent, under the section 664(d)(3) "income only" exception.

Paragraph 2(a) reads as follows:

a. In each taxable year of the Trust, the Trustee shall pay to[Taxpayers] (hereinafter referred to as "the Recipients"), in equal shares during their lifetimes, a unitrust amount equal to the lesser of:

1) The Trust income for such taxable year (as defined in section 643(b) of the Internal Revenue Code and the regulations thereunder) and

2) SEVEN PERCENT (7.0%) of the net fair market value of the assets of the Trust valued as of the first day of each taxable year of the Trust, hereinafter referred to as the "valuation date."

It is represented that Taxpayers had not heard of an "income only" CRUT before meeting with their C.P.A. and that the attorney who drafted Trust described Trust as having a fixed 7% payout. It is also represented that this attorney has admitted that he used the wrong form in his word processing system.

Taxpayers have submitted a document represented to be the husband's notes on their meetings with the scrivener. These notes clearly indicate Taxpayers' intent to establish a CRUT with a fixed 7 percent payout and their belief that the attorney was drafting the same.

Based on a claim of scrivener's error, Taxpayers propose to request a court modification of paragraph 2(a) of Trust to provide the intended fixed 7 percent payout.

LAW AND ANALYSIS:

Section 664 provides definitions, general rules governing the creation and administration of a charitable remainder trust, and rules governing the taxation of the trust and its beneficiaries.

Section 664(d)(2) defines a charitable remainder unitrust as: (A) a trust from which a fixed percentage (which is not more than 10 percent) of the net fair market value of its assets, valued annually, is to be paid, not less often than annually, to one or more persons (at least one of which is not an organization described in section 170(c) and, in the case of individuals, only to an individual who is living at the time of the creation of the trust) for a term of years (not in excess of 20 years) or for the life or lives of such individual or individuals;

(B) from which no amount other than the payments described in subparagraph (a) may be paid to or for the use of any person other than an organization described in section 170(c); and

(C) following the termination of the payments described in subparagraph (A), the remainder interest in the trust is to be transferred to, or for the use of, an organization described in section 170(c) or is to be retained by the trust for such a use.

Section 664(d)(3) contains an exception to the requirement that a fixed percentage of the net fair market value of CRUT assets, valued annually, be paid, annually to the income beneficiary. Section 664(d)(3) provides that the trust instrument may provide that the trustee shall pay the income beneficiary for any year:

(A) the amount of the trust income, if such amount is less than the amount required to be distributed under section 664(d)(2)(A), and

(B) any amount of the trust income which is in excess of the amount required to be distributed under section 664(d)(2)(A), to the extent that the aggregate of the amounts paid in prior years was less than the aggregate of such required amounts.

Under 1.664-3(a)(3)(ii) of the Income Tax Regulations, a trust is not a charitable remainder unitrust if any person has the power to alter the amount paid to any named person other than an organization described in section 170(c) if such power would cause any person to be treated as the owner of the trust, or any part thereof, if the grantor trust rules applied to the trust.

Section 1.664-3(a)(4) provides that the trust may not be subject to a power to invade, alter, amend, or revoke for the beneficial use of a person other than an organization described in section 170(c).

Section 2522(a) provides that in computing taxable gifts for the calendar year, there shall be allowed as a deduction the amount of all gifts made during such year to or for the use of a corporation, or trust, or community chest, fund, or foundation, organized and operated exclusively for religious, charitable, scientific, literary, or educational purposes, or to foster national or international amateur sports competition (but only if no part of its activities involve the provision of athletic facilities or equipment), including the encouragement of art and the prevention of cruelty to children or animals, no part of the net earnings of which inures to the benefit of any private shareholder or individual.

Section 2522(c)(2) disallows the gift tax charitable deduction where a donor transfers an interest in property (other than an interest described in section 170(f)(3)(B)) to a person, or for a use, described in section 2522(a), and an interest in the same property is retained by the donor, or is transferred or has been transferred (for less than an adequate and full consideration in money or money's worth) from the donor to a person, or for a use, not described in section 2522(a), unless --

(A) in the case of a remainder interest, such interest is in a trust which is a charitable remainder annuity trust or a charitable remainder unitrust (described in section 664) or a pooled income fund (described in section 642(c)(5)), or

(B) in the case of any other interest, such interest is in the form of a guaranteed annuity or is a fixed percentage distributed yearly of the fair market value of the property (to be determined yearly).

In Commissioner v. Estate of Bosch, 387 U.S. 456 (1967), the Court considered whether a state trial court's characterization of property rights conclusively binds a federal court or agency in a federal estate tax controversy. The Court concluded that the decision of a state trial court as to an underlying issue of state law should not be controlling when applied to a federal statute. Rather, the highest court of the state is the best authority on the underlying substantive rule of state law to be applied in the federal matter. If there is no decision by that court, then the federal authority must apply what it finds to be state law after giving "proper regard" to the state trial court's determination and to relevant rulings of other courts of the state. In this respect, the federal agency may be said, in effect, to be sitting as a state court. Provided that the state court determines that a scrivener's error was made in drafting Trust and modifies Trust to correct this error and provided that the court's modification is in accordance with state law properly applied, then we rule as follows:

1. Judicial modification of Trust, a charitable remainder unitrust (CRUT), will not violate any provisions under section 664 or sections 1.664-3(a)(3)(ii) and 1.664-3(a)(4) of the regulations or any other regulations under section 664.

2. Judicial modification of Trust will not adversely affect Trust's qualification as a charitable remainder unitrust under section 664 and applicable regulations.

3. The present value of the charitable interest with respect to transfers to Trust as modified will qualify under section 2522(a) as a charitable deduction in computing the taxable gifts made during each year. The rulings above are expressly contingent on the issuance of a court order requiring the proposed modification. Except as we have specifically ruled herein, we express no opinion on the federal tax consequences of the transaction under the cited provisions of the Code or under any other provisions of the Code.

This ruling letter is directed only to the taxpayer who requested it. Section 6110(j)(3) of the Code provides that it may not be used or cited as precedent.

A copy of this ruling should be attached to the first federal gift tax return filed with respect [to] any additional transfers to Trust. A copy is enclosed for that purpose.

Sincerely,

Assistant Chief Counsel
(Passthroughs and SpecialIndustries)
By: Frances Schafer
Senior Technician Reviewer, Branch 4

Enclosures
Copy for section 6110 purposes
Copy of letter