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Blank Rome Attorney Paper Leads to IRS Revenue Procedure

On August 8, 2016, the Internal Revenue Service adopted the recommendation of Blank Rome LLP Partner William Finestone and Associate Dustin Lauermann, together with Faegre Baker Daniels LLP Partner Charles (Chip) Parks, Jr. and Covington & Burling Of Counsel Susan Leahy, contained in their paper, Charitable Remainder Trusts and The Probability of Exhaustion Test, when it issued Revenue Procedure 2016-42.

Rev. Proc. 2016-42 provides a sample provision that may be included in a Charitable Remainder Annuity Trust (“CRAT”), which would be treated as a qualified contingency under Section 664(f) of the Internal Revenue Code (the “Code”), and expands the universe of both potential income beneficiaries and the number of charities that can benefit from CRATs, which have long been used as an important mechanism for charitable contributions.

Among other requirements, a CRAT is required to annually pay out a minimum of five percent of the initial fair market value of all property placed in the trust to one or more beneficiaries for a term not to exceed 20 years or for the life of one or more beneficiaries. At the end of the term or life of the beneficiaries, the remainder is donated to an organization described in section 170(c) of the Code (the “remainder beneficiary”). The value of the remainder interest at the time the CRAT is funded must be at least 10 percent of the initial fair market value of all the property placed in the trust. Additionally, the CRAT must meet the “probability of exhaustion” test, which requires that the probability be no more than five percent that the remainder beneficiary will not receive any property. These requirements, coupled with historically low interest rates over the past nine years, have greatly limited the use of CRATs as charitable vehicles.

The paper proposed that a qualified contingency provision could be included in the CRAT that would terminate the trust immediately before any payment to the income beneficiary that would cause the value of the CRAT to fall below five percent or its initial value. Thus, whether or not the probability of exhaustion test would be satisfied, would be determined using a wait-and-see approach with the probability of exhaustion test conducted prior to each payment rather than at the time the CRAT is funded.

Revenue Procedure 2016-42 adopts the authors’ wait-and-see proposal and provides that if the sample provision is included in a CRAT, such provision would be treated as a qualified contingency and the probability of exhaustion would be satisfied if the value of the trust, when multiplied by a specified discount factor, was not less than 10 percent of the trust’s initial fair market value.

“Charitable Remainder Trusts and the Probability of Exhaustion Test,” by Charles T. Parks Jr., William Finestone, Susan Leahy, and Dustin Lauermann was published in Tax Notes (Volume 148, Number 10) on September 7, 2015. Reprinted with permission.