Life and Death Planning for Retirement Benefits

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Life and Death Planning for Retirement Benefits

by court order, after the participant’s death, to provide for (among other changes) immediate distributions to the charities, so that the ongoing trust would be solely for the benefit of individuals and qualify as a see-through trust. The IRS Chief Counsel advised that the immediate payments made to the charities under the reformed trust were not made “pursuant to the governing instrument,” because the trust reformation was done to achieve a tax goal (acquire see-through trust status) rather than to compromise a dispute, and accordingly were not income tax-deductible! Compare PLR 2006-52028 (discussed at ¶ 7.4.05 ). For our purposes, suffice it to say that “pursuant to the governing instrument” means that the trustee is explicitly authorized or required by the trust instrument to make the payment to the charity. If there is more than one instrument involved, or if there is any other ambiguity regarding whether this requirement is met, please refer to the treatises cited in the Bibliography , not this Chapter . Janet Example: Janet dies in Year 1, leaving her $1 million IRA to her living trust, which already holds $3 million of other assets at her death. The entire trust is to be paid to three charities in equal shares, as soon as Janet’s estate is settled. In the meantime, the governing instrument gives the trustee discretion to pay income and/or principal to the three charities in equal shares. In Year 1, the trustee cashes out the $1 million IRA and distributes the cash to the three charities equally. This is a payment to the charities made from the gross income of the trust pursuant to the governing instrument, and accordingly is deductible under § 642(c) . See PLR 2003-36020. C. Out of gross income, Part I: Tracing. The Code requires that the payment to charity must come from the trust’s gross income in order to be deductible. This requires tracing the origin of the item that is distributed to the charity. Rev. Rul. 2003-123, 2003-50 I.R.B. 1200. Note that this is in contrast to the “DNI” system for deducting distributions to noncharitable beneficiaries ( ¶ 7.4.01 ), which was explicitly designed to eliminate the need for tracing, according to Ferguson/Freeman/Ascher , § 6.09, Note 1.1. Lou Example: Lou dies leaving his $1 million bank account to his trust. The trust authorizes the trustee to pay income and/or principal to charity and/or to Lou’s daughter. The day after Lou dies, the trustee distributes $10,000 to the charity and $30,000 to Lou’s daughter, reducing the bank account to $960,000. Over the remaining months of the trust’s taxable year, $40,000 of interest is credited to the bank account. Because the trust received $40,000 of gross income and distributed $40,000 in the same year, one might think the trust’s income tax return for the year would show $40,000 of gross income, with a charitable deduction of $10,000 and a $30,000 DNI deduction, producing taxable income of zero. However, the trust is not entitled to deduct the $10,000 payment to the charity because it was not paid out of “gross income”; the payment to the charity was made before the trust had even received any income, so it could not have been paid out of income. The payment to Lou’s daughter is deductible because the DNI deduction does not require a showing that the funds actually came out of the trust’s gross income.

“Income in respect of a decedent” (IRD; see ¶ 7.1.02 (B)) that is includible in the gross income of a trust is “gross income” for purposes of the charitable deduction. Reg. § 1.642(c)-3(a) .