As you know, dividing assets in divorce can be complicated. But, typically, charitable remainder trusts (also known as CRTs) are divided 50-50 into two separate trusts, in accordance with IRS Revenue Ruling 2008-41. But tax issues can make these divisions trickier than they might first appear.
How do you Spell Relief from Excise Tax?
There are two types of CRTs: 1) charitable remainder annuity trusts (CRATs) and 2) charitable remainder unitrusts (CRUTs). They are considered “split-interest trusts,” which means they generally are subject to Internal Revenue Code (IRC) Section 507(a) just as if they were private foundations. The provision levies a termination or excise tax when a private foundation’s tax status is terminated. But the question remains: Does transferring assets from a private foundation (or CRT) to another private foundation (or CRT) — as when divorce assets are split — trigger that tax?
According to Revenue Ruling 2008-41, if a transfer is pursuant to an “adjustment, organization or reorganization” that includes a significant disposition of assets, the transferee foundation isn’t treated as a newly created organization. Thus, the excise tax doesn’t apply. Significant disposition of assets encompasses the transfer of a total of 25% or more of the fair market value (FMV) of the net assets of the original private foundation to one or more private foundations. In the above scenario, 100% of a CRT’s FMV would be transferred. Therefore, no excise tax applies.
Defining Disqualified Persons
CRATs and CRUTs also are subject to IRC Sec. 4941(a)(1). It imposes an excise tax on each act of self-dealing between a private foundation and a disqualified person. Self-dealing may include any direct or indirect transfer of the assets or income of a private foundation to a disqualified person. It also includes use of such assets or income by — or for the benefit of — a disqualified person. Disqualified persons encompass (among other substantial contributors to the foundation) foundation managers, and members of the family of a substantial contributor or foundation manager.
Revenue Ruling 2008-41 states that divorcing spouses can be disqualified persons with respect to their original trust, which creates the potential for self-dealing. But it also concluded that spouse recipients are protected from self-dealing with respect to their interests upon the trust’s division. Because distributions are made pro rata, neither spouse will receive any additional interest in the original trust’s assets, the original trust’s remainder interest is preserved for charitable interests and no self-dealing transaction occurs.
Typically, trusts which are properly divided during divorce will still qualify as CRTs — avoiding certain excise taxes. Make sure you and your clients work with experienced financial professionals when it’s time to handle these types of assets.