Life and Death Planning for Retirement Benefits

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Life and Death Planning for Retirement Benefits

In Rev. Rul. 71-285, 1971-2 CB 248, a trust was required to make an annual annuity payment to charity. On termination, the trust would pass to daughter. The trust was silent regarding the source of the charitable annuity payments. Applicable local law indicated that, absent a contrary provision in the trust, payments would be made first from the trust’s income. Accordingly, the IRS allowed the charitable deduction for the charitable annuity payments in this case, unlike in Rev. Rul. 68-667. E. Out of gross income, Part III: Governing instrument provision. If the governing instrument (or applicable state law, in the absence of a governing instrument provision) specifies that the payment to charity shall be made first from income, that provision will be honored for purposes of § 642(c) , regardless of whether it has any economic effect independent of its income tax consequences. Rev. Rul. 71-285, op. cit. Nongrantor charitable lead trusts, for example, are allowed an income tax charitable deduction for charitable annuity payments paid out of gross income, even though there is no “economic effect” of designating income as the first source for such payments—the charity is entitled to the same annuity amount regardless of whether the trust even has any income. Rev. Proc. 2007-45, 2007-28 I.R.B. 87, Section 5.01(3); see PLRs 2003-39018, 2005-16005, 2005- 36013. This conclusion is consistent with the rules for the allocation of DNI, where a governing instrument provision that a particular beneficiary’s “separate share” is to be funded “first” with retirement benefit proceeds will be respected for purposes of allocation of DNI among beneficiaries’ shares even though the provision has no economic effect independent of income taxes. Reg. § 1.663(c)-5 , Example 9. Ivan Example: Ivan dies, leaving his $1 million IRA (all distributions from which are includible in the trust’s gross income) and $2 million of other assets to his revocable trust. The trust instrument directs the trustee to pay a flat fixed-dollar amount of $100,000 to each of three charities and two aunts immediately upon Ivan’s death, and to fund these $500,000 total gifts from the IRA proceeds. To carry out this provision, the trustee withdraws $500,000 from the IRA and distributes $100,000 to each of these five beneficiaries. There is no DNI deduction for the distributions to the aunts (because there is generally no DNI deduction for a pecuniary bequest; see § 663(a)(1) , Reg. § 1.663(a)-1 , and ¶ 6.5.02 (C)), or for the distributions to the charities (see ¶ 7.4.02 ). However, the distributions to the charities are deductible under § 642(c) since the trust instrument mandates that these charitable gifts be paid out of the 401(k) proceeds, i.e., out of gross income. A pecuniary gift is eligible for the income tax charitable deduction to the extent it is paid out of gross income pursuant to the governing instrument; see Reg. § 1.642(c)-(3)(c) , Example 2. F. Out of WHICH income? The charitable deduction under § 642(c) is limited to amounts paid out of gross income other than tax-exempt income and unrelated business taxable income (UBTI). § 681(a) ; Reg. § 1.642(c)-3(b)(1) , (d) .