Credibility: The Legal View
Initially, there were questions regarding the concept of utilizing deferred annuities as an investment for "wealth accumulation" within a Net Income with Makeup Charitable Remainder Unitrust (NIMCRUT), particularly since no laws existed on the issue. Most knowledgeable sources now agree with Renaissance's long held position on the use of deferred annuities to defer income within a NIMCRUT. As of the date of this publication, there appears to have been no reported rulings or cases where a NIMCRUT failed to qualify under IRC 664 because its definition of distributable "income" included Renaissance's recommended annuity language.
Historical Overview
Since the Internal Revenue Service had not issued an official position on annuities in NIMCRUTs, an attempt to clarify the most critical issues took place in 1990 with a request for a private letter ruling (PLR) from the IRS for a NIMCRUT governed by North Carolina law.
The request resulted in PLR 9009047, which indicated that:
- The mere investment by a NIMCRUT in deferred annuities does not threaten the qualification of the trust under IRC 664
- Such annuities are to be valued at their "account value"
- Because a NIMCRUT is not an "agent for a natural person," any annual contract appreciation will be considered income includable in Tier 1 and taxable to the trust if the trust should ever lose its tax-exempt status
- Because no definitive North Carolina law existed at the time of the ruling, the IRS declined to rule whether and/or when any accretion in the surrender value of the contract is distributable to NIMCRUT income beneficiaries.
The state law issue should not be a problem in any state adopting some version of the Uniform Principal and Income Act, the Revised Uniform Principal and Income Act, or the Uniform Principal and Income Act (1997).All adopted versions of these acts permit settlors to write their own principal and income definitions and allocation rules even if they conflict with the default statutory rules. In examining a NIMCRUT for initial compliance with IRC 664 qualification requirements, the IRS will look to the trust document as written. Under 3.04 of Rev. Rul. 72-395, a NIMCRUT may contain provisions in addition to those that are intended to satisfy the qualification requirements if they are not in conflict with the regulations. In states that either have not enacted a principal and income act or have a version with altered language, trustors typically can look to case and common law for the grant of discretion to include special trust provisions.
A more permanent solution would be to seek to have the law of each state specifically amended to address these issues. For example, Indiana has expressly addressed the issue in Indiana Code 30-2-14-18(e) by providing that any increase in the value of a deferred annuity contract before it is "annuitized" is considered "distributable income," but only when such increase is received by the trustee. The statute also provides that the contract appreciation is to be distributed before the investment in the contract.
Self Dealing
In 1997, the IRS reviewed whether the use of a deferred annuity could constitute an act of self-dealing. One avenue of analysis considered whether a property right was created and transferred to a disqualified person who received a current benefit. Another avenue of analysis examined whether there could be a collusive manipulation of trust investments solely to further the income, retirement and tax planning goals of disqualified persons.
On June 19, 1998, the IRS released a Technical Advice Memorandum (TAM 9825001) that addressed the above self-dealing theories in a manner favorable to the continued use of deferred annuities.
To address the first theory, the TAM indicated that although a property right was created and transferred to a disqualified person, there could be no self-dealing because the mere purchase of a deferred annuity did not confer any current vested benefits on disqualified persons. Any rights held by the disqualified persons were clearly contingent because of the chance that an annuitant might die or the annuity might be surrendered before payments commenced.
The second theory of investment manipulation was based on the trustee's failure to make partial withdrawals of distributable income with the intention of making up unitrust payments at a future time.
The TAM dismissed this on three counts:
- the payment of the unitrust amount to a disqualified person is never an act of self-dealing;
- IRC 664 expressly permits income deferral by a NIMCRUT; and
- a NIMCRUT's split-interest nature renders any investment decision a potential use of trust assets for the benefit of an income recipient who is a disqualified person.
However, the practice of intentional income deferral is protected from self-dealing implications only if a disqualified person, such as the donor or income beneficiary, does not control the investment decisions and does not use this control to unreasonably affect the charitable remainder beneficiary's interest. For this reason, Renaissance strongly recommends the use of an Independent Special Trustee (IST) to apply for and make withdrawals from an annuity contract.
The TAM went further by also addressing a IRC 664 qualification issue and a trust accounting income issue. It indicated that the purchase of deferred annuities does not adversely affect the trust's qualification as a CRT. It also concluded that the mere right of the trust to receive either the cash value or the surrender value of an annuity does not create trust accounting income under IRC 664 and 643(b).
- Thanks to many state laws and the above-mentioned TAM, planners can be much more confident when utilizing deferred annuities within a NIMCRUT. Anyone interested in this investment method should consult with legal counsel and reach their own conclusions about its risks and rewards.
