reg

68188

Federal Register/Vol. 63, No. 237/Thursday, December 10, 199B/Rules and Regulations

policyholder to be offered the right to
coverage under an individual contract
policyholder (or certificate holder), the
increase dollar limits for inflation every three
follOWing an individual's ineligibility
insured, or the insurance company;
years (without the policyholder being
(B) A substitution of the insured
for continued coverage under the group
reqUired to pass a physical or satisfy any
under an individual contract; or
contract; and
(C) A change (other than an
(1<) The substitution of one insurer for other underwriting requirements). During
2002, C elects to increase the amount of
immaterial change) in the contractual
another insurer in an assumption
insurance coverage (with a resulting
terms, or in the plan under which the
reinsurance transaction.
premium increase) pursuant to the inflation
(5) Examples. The following examples provision.

contract was issued. relating to
illustrate the principles of this
eligibility for membership in the group
(Ii) Under paragraph (b)(4)(ii)(A) of this

paragraph (b):
section, an increase in the amount of

covered under a group contract.
(ii) Exceptions. For purposes of this
Example 1. (i) On December 3, 1996, A, an insurance coverage at the election of the
policyholder (without the insurance
paragraph (b) (4). the following changes
indiVidual, submits a signed application to
are not treated as the issuance of a new
an insurance company to purchase a nursing company's consent and without underwriting
or other limitations on the policyholder's
home contract that meets the long-term care
contract­
insurance requirements of the State in which rights) pursuant to a pre-1997 inflation
(A) A policyholder's exercise of any
provision is not treated as the issuance of a
the contract is sitused. The insurance
right provided under the terms of the
new contract. Thus, C's contract continues to
company
decides
on
December
20,
1996,
that
contract as in effect on December 31,
be a pre-I 997 long-term care insurance
it will issue the contract, and assigns
1996. or a right required by applicable
contract that is treated as a qualified long­
December 20. 1996, as the issue date for the
State law to be proVided to the
contract. Under the terms of the contract, A's
term care insurance contract.
policyholder;
insurance coverage becomes effective on

(c) Effective date. This section is
(B) A change in the mode of premium January I. 1997. The company delivers the
applicable January I, 1999.
payment (for example. a change from
contract to A on January 3, 1997. A has the
David A. Mader,
right to return the contract within 15 days

monthly to quarterly premiums);
Acting Deputy Commissioner ofInternal

follOWing delivery for a refund of all
(C) In the case of a policy that is
Revenue.

premiums paid.
guaranteed renewable or
(ii) Under paragraph (b)(3)(i) of this
ApprOVed: November 24. 1998.
noncancellable, a classwide increase or
section, the issue date of the contract is
decrease in premiums;
Donald
C. Lubick.
December 20, 1996. Thus, the contract Is a

(D) A reduction in premiums due to
Assistant Secretary of the Treasury.

pre-I 997 long-term care insurance contract
the purchase of a long-term care
that is treated as a qualified long-term care
IFR Doc. 98-32759 Filed 12-9-98; 8:45 amI

insurance contract by a family member
insurance contract.

BilliNG CODE 483D-Ol-tJ
of the policyholder;
Example 2. (i) The facts are the same as in

(E) A reduction in coverage (With a
Example I, except that the insurance

coverage under the contract does not become
DEPARTMENT OF THE TREASURY
corresponding reduction in premiums)
effective until March I. 1997. Under the

made at the request of a policyholder;
insurance company's usual business practice,
Internal Revenue Service
(F) A reduction in premiums as a
the period between the date of the

result of extending to an individual
application and the date the contract

26 CFR Parts 1,25, and 602
policyholder a discount applicable to
becomes effective Is 30 days or less.
similar categories of individuals
(i1) Under paragraph (b)(3)(i) of this
[TO 8791]
'-~
• ,c;.
pursuant to a premium rate structure
section, the issue date of the contract is
RIN 1545-AU25 (,? ~ ( .....- ,) 0, (
that was in effect on December 31,1996, March I. 1997. Thus, the contract is not a

pre-I 997 long-term care insurance contract,

for the issuer's pre-l 997 long-term care
and, accordingly, the contract must meet the
Guidance Regarding Charitable
insurance contracts of the same type;
Remainder Trusts and Special

requirements of section 7702B(b) and any
(G) The addition. without an increase
regulations issued thereunder to be a
Valuation Rules for Transfers of

in premiums, of alternative fonns of
qualified long-term care insurance contract.
Interests In Trusts

benefits that may be selected by the
Example 3. (I) B. an individual. is the
policyholder;
AGENCY: Internal Revenue Service (IRS),

policyholder under a long-term care
(H) The addition of a rider (including
Treasury.

insurance contract purchased in 1995. On
any similarly identifiable amendment)
June 15,2000. the insurance coverage and

ACTION: Final regulations.
to a pre-1997 long-tenn care insurance
premiums under the contract are increased

contract in any case in which the rider,
by agreement between B and the insurance

SUMMARY: This document contains final
company.
if issued as a separate contract of
regulations relating to charitable
(i1) Under paragraph (b)(4)(i)(A) of this
insurance. would itself be a qualified
remainder trusts and to special
long-term care insurance contract under section, a change in the terms of a contract
valuation rules for transfers of interests
that alters the amount or timing of an item

section 7702B and any regulations
payable by the policyholder or the insurance
in trusts. The final regulations proVide

issued thereunder (including the
additional guidance regarding charitable

company is treated as the issuance of a new
consumer protection provisions in
remainder trusts. The final regulations

contract. Thus, B's coverage is treated as
section 7702B(g) to the extent applicable coverage under a contract issued on June 15,
affect charitable remainder trusts and

2000, and. accordingly, the contract must

to the addition of a rider);
their beneficiaries.
(I) The deletion of a rider or provision meet the requirements of section 7702B(b)
DATES: Effective date: These regulations
and any regulations issued thereunder in
of a contract that prohibited
are effective December 10, 1998.
order to be a qualified long-term care
coordination of benefits with Medicare
Applicability dates: For dates of
(often referred to as an HHS (Health and insurance contract.

applicability of these regulations. see

Example 4. (i) C. an individual, is the
Human Services) rider);
the explanations under SUPPLeMENTARY
policyholder under a long-term care
U) The effectuation of a continuation
insurance contract purchased in 1994. At that INFORMAllON.
or conversion of coverage right that is
time and through December 31. 1996, the
FOR FURTHER INFORMAllON CONTACT:
proVided under a pre-1997 group
contract met the long-term care insurance
Mary Beth Collins or Jeff Erickson, (202)
contract and that, in accordance with
requirements of the State in which the
the terms of the contract as in effect on
contract was sitused. In 1996, the policy was
622-3080 (not a toll-free number).
SUPPLEMENTARY INFORMATION:

amended to add a provision reqUiring the
December 31, 1996, provides for

.
!

Federal Register/Vol. 63. No. 237/Thursday. December 10. 1998/Rules and Regulations

68189

provide that the CRUT will convert once
(CRA1') and a charitable remainder
from one of the income exception
unitrust (CRUll A CRAT pays a sum
methods to the fixed percentage method
certain at least annually to the
for calculating the unitrust amount if
beneficiaries (the annuity amount). A
the date or event triggering the
CRlff pays a unitrust amount at least
annually to the beneficiaries. Generally, conversion is outside the control of the
trustees or any other persons. The final
the unitrust amount is a fixed
regulations include examples of
percentage of the net fair market value
permissible and impermissible
of the CRUT's assets valued annually
triggering events. For example.
(fixed percentage CRUT). The unitrust
amount can instead be calculated under permissible triggering events with
respect to any individual include
one of two income exception methods
marriage, divorce, death, or birth of a
(income exception CRUT). Under the
child. Also, the sale of an unmarketable
first method, the unitrust amount is the
lesser of the fixed percentage amount or asset such as real estate is a permiSSible
triggering event. Examples of
the trust's annual net income (net
impermissible triggering events include
income method). Under the second
the sale of marketable assets and a
method, the unitrust amount is
request from the unitrust recipient or
determined under the net income
method plus any amount of income that the unitrust recipient's financial adVisor
that the trust convert to the fixed
exceeds the current year's fixed
percentage method.
percentage amount to make up for any
The final regulations also prOVide that
shortfall in payments from prior years
when the trust income was less than the the conversion to the fixed percentage
method occurs at the beginning of the
fixed percentage amount (NIMCRUT
method). The shortfall in payments from taxable year that immediately follows
the taxable year in which the triggering
prior years is commonly referred to as
date or event occurs. Any make-up
the "make-up amount."
amount described in section
The revisions to the proposed

664(d)(3)(B) is forfeited when the trust
regulations are discussed below.

converts to the fixed percentage method.
l. Flip Unitrusts
The proposed regulations def"me
unmarketable assets as assets other than
A. Triggering Events
cash. cash equivalents. or marketable
The proposed regulations proVide
securities (within the meaning of
specific rules for when a trust may
section 731 (c». Commentators asked for
convert from one of the income
clarification of the term unmarketable
exception methods of computing the
assets and recommended changing the
unitrust amount to the fixed percentage scope of this class of assets. In response,
method (flip unitrust). The proposed
the final regulations define
rule was designed for taxpayers who
unmarketable assets as assets other than
Background

ultimately wanted the unitrust amount
cash. cash equivalents, or assets that can
be readily sold or exchanged for cash or
On April 18, 1997. the IRS published
to be computed on the fixed percentage
cash eqUivalents. For example,
in the Federal Register (62 FR 19072) a
method but funded the trust with
unmarketable assets that generate little
unmarketable assets include real
notice of proposed rulemaking (REG­

annual income. A number of
property, closely-held stock, and
209823-96) regarding sections 664 and

commentators agreed with the policy
unregistered securities for which there
2702. Comments responding to the

is no available exemption permitting
proposed regulations were received, and
underlying the proposed rule. Some
a public hearing was held on November
commentators requested that we permit public sale.
flip unitrusts for all income exception
Commentators requested that the final
18. 1997. After considering the

CRUTs regardless of the marketability of regulations permit conversions from the
comments received and the statements

the trust assets. Other commentators
fixed percentage method to one of the
made at the public hearing, the

suggested that the final regulations
income exception methods and
proposed regulations are adopted as

clarify whether the proposed rule was a conversions from a CRAT to a CRUT.
revised by this Treasury decision.

safe harbor or the exclUSive
The flip unitrust allowed in the final
Explanation of Provisions
circumstance for which a flip unitrust
regulations is the only type of
would be permitted.
permissible conversion. Thus. a CRAT
This document amends 26 CFR parts
In response, the final regulations
cannot convert to a CRUT without
I and 25 to provide additional rules
expand the availability ofthe flip
losing its status as a CRT. Similarly, a
under sections 664 and 2702. Section
unitrust to certain other situations that
664 contains the rules for charitable
CRUT using the fixed percentage
the IRS and Treasury believe are
method cannot convert to an income
remainder trusts (CRTs). In general, a
consistent with the legislative history
exception method without losing its
CRT provides for a specified periodic
distribution to one or more beneficiaries indicating that a trustee should not have status as a CRT.
(at least one of whom is a noncharitable discretion to change the method used to
B. Effective Date and Transitional Rules
beneficiary) for life or for a term of years calculate the unitrust amount. H.R.
The rules for flip unitrusts are
Conf. Rep. No. 782. 91st Cong.. 1st Sess.
with an irrevocable remainder interest
effective
for CRUTs created on or after
1969-3
C.B.
644,
655.
296
(1969),
held for the benefit of charity.
December 10, 1998. The proposed
The final regulations allow the
There are two types of CRTs; a
regulations allowed reformations in
governing instrument of a CRUT to
charitable remainder annuity trust
Paperwork Reduction Act
The collection of information
contained in these final regulations has
been reviewed and approved by the
Office of Management and Budget in
accordance with the Paperwork
Reduction Act (44 U.S.C. 3507) under
control number 1545-1536. Responses
to this collection of information are
required to allow taxpayers alternative
means of valuing a charitable remainder
trust's unmarketable assets.
An agency may not conduct or
sponsor. and a person is not reqUired to
respond to. a collection of information
unless the collection of information
displays a valid control number.
The estimated annual burden per
respondent varies from .25 to .75 hours,
depending on individual circumstances,
with an estimated average of .5 hours.
Comments concerning the accuracy of
this burden estimate and suggestions for
reducing this burden should be sent to
the Internal Revenue Service. Attn: IRS
Reports Clearance Officer. OP:FS:FP,
Washington, DC 20224, and to the
Office of Management and Budget. Attn:
Desk Officer for the Department of the
Treasury. Office of Information and
Regulatory Affairs. Washington, DC
20503.
Books or records relating to this
collection of information must be
retained as long as their contents may
become material In the administration
of any internal revenue law. Generally.
tax returns and tax return information
are confidential, as required by 26
U.S.C. 6103.

68190

Federal Register/Vol. 63, No. 237/Thursday, December 10, 1998/Rules and Regulations

the donor's U.S. citizen spouse, or (3)
both the donor and the donor's U.S.
citizen spouse. Commentators stated
that income exception CRUTs without a
make-up provision should be exempt
from section 2702. The IRS and
Treasury believe that, in addition to the
NIMCRUT method. the net income
method can be used to circumvent the
intent of section 2702. Therefore. the
final regulations do not exempt from
III. Appraising Unmarketable Assets
section 2702 CRUTs that use only the
Under section 664(d)(2)(A). a CRUT
net income method.
must value its assets annually. The

Commentators also stated that the
proposed regulations provide that. if a
proposed rule encompassed other
CRT holds unmarketable assets and the
transfers that section 2702 was not
only trustee is the grantor. a

intended to include. A commentator
II. Time for Paying the Annuity Amount noncharitable beneficiary, or a related or noted that the proposed rule would
or the Unitrust Amount
subordinate party to the grantor or the
value a transferor's interest at zero even
The proposed regulations provide that noncharitable beneficiary within the
though the transferor merely retained a
meaning of section 672(c) and the
the payment of the annUity amount or
secondary life estate. The final
the unitrust amount detennined under
applicable regulations. the trustee must
regulations clarify that section 2702 will
value those assets using a current
the fixed percentage method must be
not apply when there are only two
qualifled appraisal, as defined in
made by the close of the taxable year in
consecutive noncharitable beneficial
§ 1.1 70A-I3 (c) (3). from a qualified
which it is due. The rules were
interests and the transferor holds the
appraiser, as defined in § I.I70A­
proposed in response to abuses
second of the two interests.
associated with the use of accelerated
13 (c)(5).
Commentators also asked whether
The final regulations follow the
CRTs described in Notice 94-78 (1994­
section 2702 may apply to flip unitrusts.
2 C.B. 555). After receiving a significant proposed regulations and prOVide that
The potential abuse associated with
the trust's unmarketable assets must be
number of comments on the proposed
income exception CRUTs also exists
valued by an independent trustee, or by with flip unitrusts. Therefore. under the
rules. the IRS issued Notice 97-68
(1997-481.R.B. 11). which prOVided
a qualified appraisal from a qualified
final regulations. section 2702 applies to
appraiser. The proposed regulations

gUidance on complying with the
a flip unitrust if the CRUT does not fall
proposed rules for the 1997 taxable year. define an independent trustee as a

within one of the exemptions.
One commentator recommended
person who is not the grantor. a
applying the proposed rules only to
noncharitable beneficiary or a related or V. Prohibition on Allocating

Precontribution Gain to Trust Income

trusts created after the date the final
subordinate party to the grantor, or the
and
Make-up Amount as a Liability

regulations are published. Another
noncharitable beneficiary within the
commentator suggested adopting the
The proposed regulations clarify that
meaning of section 672{c) and the
rules in Notice 97-68 for all trusts
the proceeds from the sale of an income
applicable regulations. The final
created after a certain date. Although
exception CRUT's assets. at least to the
regulations add the grantor's spouse to
recent legislative changes have reduced
extent of the fair market value of the
the list of persons to whom an
the potential tax benefits of accelerated
independent trustee cannot be related or assets when contributed to the trust.
CRTs. the IRS and Treasury continue to subordinate. A co-trustee who is an
must be allocated to trust principal.
be concerned about the potential abuse
Some commentators stated that the rule
independent trustee may value the
of the post-year-end grace period to
is inconsistent with the rule concerning
trust's unmarketable assets.
produce a tax-free return of appreciation
Finally, in response to comments, the income under section 643(b). Other
in the assets contributed to a CRAT or
final regulations define unmarketable
commentators questioned whether the
a fixed percentage CRUT. Therefore. the assets as assets other than cash. cash
make-up amount under the NIMCRUT
final regulations adopt rules similar to
eqUivalents, or assets that can be readily method should be treated as a liability
those in Notice 97-68 with certain
when valUing the trust's assets.
sold or exchanged for cash or cash
modifications. The rules are effective for equivalents. For example, unmarketable

The final regulations maintain the
taxable years ending after April 18,
prohibition on allocating
assets include real property, closely­

precontribution gain to trust income for
1997.
held stock. and unregistered securities

For CRATs and fixed percentage

an income exception CRUT. However,
for which there is no available

CRUTs, the annuity or unitrust amount
exemption pennitting public sale.
the governing instrument, if permitted
may be paid within a reasonable time
The rules for valUing unmarketable
under applicable local law, may allow
after the close of the year for which it
assets are effective for trusts created on
the allocation of post-contribution
is due if (a) the character of the annuity
capital gains to trust income. Taxpayers
or after December 10, 1998.
or unitrust amount in the recipient's
do not have to treat the make·up amount
IV. Application of Section 2702 to
hands is income under section
as a liability when valUing the assets of
Certain CRUTs
664(b)(I). (2). or (3); and/or (b) the trust
aNIMCRUT.
Under the proposed regulations.
distributes property (other than cash)
VI. Example Illustrating Rule for
unitrust interests in an income
that it owned as of the close of the
Characterizing
Distributions From
exception CRUT that are retained by the
taxable year to pay the annuity or
CRUTs
donor or any applicable family member
unitrust amount and the trustee elects
will be valued at zero when a
The proposed regulations contain an
on Form 5227, "Split-lnterest Trust
noncharitable beneficiary of the trust is
example of how the ordering rule under
Information Return," to treat any
section 664 (b) operates when the
someone other than (1) the donor, (2)
income generated by the distribution as
limited circumstances. In response to
comments, the final regulations expand
the circumstances in which reformation
is available. The final regulations allow
income exception CRUTs to be reformed
to add provisions alloWing a conversion
to the fixed percentage method prOVided
the triggering event does not occur in a
year prior to the year in which the court
issues the order reforming the trust.
Adding the conversion provisions will
not cause the CRUT to fail to function
exclusively as a CRT and will not be an
act of self-dealing under section 4941 if
the trustee initiates legal proceedings to

reform the trust by June S, 1999.

occurring on the last day of the taxable
year for which the amount is due. In
addition, for CRATs and fixed
percentage CRUTs that were created
before December 10, 1998. the annuity
or unitrust amount may be paid within
a reasonable time after the close of the
taxable year for which it is due if the
percentage used to calculate the annUity
or unitrust amount is 15 percent or less.

Federal Register/Vol. 63, No. 237/Thursday, December la, 199B/Rules and Regulations
text of paragraph (0(3) to read as

follows:

unitrust amount is computed under an
income exception method. No
comments were received on this
example. Thus, the final regulations
adopt the example without any changes.

§ 1.664-1 Charitable remainder trusts.
(a) * * *

(7) Valuation of unmarketable
assets-(i) In general. If unmarketable

Effect on Other Documents

Notice 97-68 (I997-481.R.B. 11) is

obsolete as of December 10, 1998.

assets are transferred to or held by a
trust, the trust will not be a trust with
respect to which a deduction is
Special Analyses

available under section 170, 2055,2106,
It has been determined that this

or 2522, or will be treated as failing to
function exclusively as a charitable
Treasury decision is not a significant

remainder trust unless, whenever the
regulatory action as defined in EO

trust is required to value such assetS, the
12866. Therefore, a regulatory

valuation is­
assessment is not required. It also has

(a) Performed exclusively by an

been determined that section 553(b) of

independent trustee; or

the Administrative Procedure Act (5

(b) Determined by a current qUalified
U.s.C. chapter 5) does not apply to these
appraisal. as defined in § 1.170A­
regulations. and because the regulation
13(c) (3), from a qualified appraiser. as
does not impose a collection of
defined in § 1.170A-13(c)(5).
information on small entities, the
(il) Unmarketable assets.

Regulatory Flexibility Act (5 U.S.C.
Unmarketable assets are assets that are

chapter 6) does not apply_ Therefore, a
not cash, cash equivalents, or other

Regulatory Flexibility Analysis is not
assets that can be readily sold or

required. Pursuant to section 7805(0,
exchanged for cash or cash equivalents.

the notice of proposed rulemaking
For example, unmarketable assets

preceding these regulations was
include real property, closely-held

submitted to the Chief Counsel for
stock. and an unregistered security for

Advocacy of the Small Business
which there is no available exemption

Administration for comment on its
pennitting public sale.

impact on small business.
(iii) Independent trustee. An
Drafting Information. The prinCipal
independent trustee is a person who is
authors of these regulations are Mary
Beth Collins and Jeff Erickson, Office of not the grantor of the trust, a
noncharitable beneficiary, or a reI ated or
the Assistant Chief Counsel
subordinate
party to the grantor. the
(Passthroughs and Special Industries),
grantor's spouse. or a noncharitable
IRS. However, other personnel from
beneficiary (within the meaning of
offices of the IRS and Treasury
section 672(c) and the applicable
Department participated in their
regulations).
development.
List of Subjects

26CFR Part J
Income taxes, Reporting and

recordkeeping requirements.

26 CFR Part 25
Gift taxes, Reporting and

recordkeeping requirements.

26 CFR Part 602
Reporting and record keeping

requirements.

Adoption of Amendments to the
Regulations
Accordingly, CFR parts 1, 25, and 602
are amended as follows:
PART 1-INCOME TAXES

Paragraph 1. The authority citation
for part 1 continues to read in part as
follows:
Authority: 26 U.S.C. 7805 • • *
Par. 2. In § 1.664-1, paragraphs (a)(7)
and (d)(l)(iii) are added and paragraph
(0(4) is added following the concluding

*

•

*

*
***

*

68191

is determined under section 664(b). Because
the unltrust amount is less than Xs
undistributed capital gain Income, the
recipient of the unitrust amount treats the
distribution of $7,500 as capital gain. At the
beginning of 1997. X's undistributed capital
gain for prior years is reduced to $22,500.
and X's undistributed tax-exempt income is
increased to SIO.OOO.

*

*

(0.

* *

*

*

*

(4) Valuation of unmarketable assets.
The rules contained in paragraph (a) (7)
of this section are applicable for trusts
created on or after December 10, 1998.
A trust in existence as of December 10
.
1998 whose governing instrwnent
requires that an independent trustee
value the trust's unmarketable assets
may be amended or reformed to permit
a valuation method that satisfies the
requirements of paragraph (a) (7) of this
section for taxable years beginning on or
after December 10, 1998.

*

•

*

*

Par. 3. In § 1.664-2, paragraph (a)(l)(i)
is revised to read as follows:
§ 1.664-2
trust.

(a)

(l)

Charitable remainder annuity

* * *
* * * (i) Payment ofsum certain

at least annually. The governing

instrument prOVides that the trust will

pay a sum certain not less often than

annually to a person or persons

described in paragraph (a)(3) of thiS

section for each taxable year of the

period specified in paragraph (a) (5) of

this section.

(a) General rule applicable to all
trusts. A trust will not be deemed to

have engaged in an act of self-dealing
(d) • • * (1)
(within the meaning ofsection 4941), to
(iii) Example. The following example
have unrelated debt-financed income
illustrates the application of thiS
(within the meaning of section 514), to
paragraph (d)(I):
have
received an additional
Example. (J) X Is a charitable remainder
contribution
(within the meaning of
unltrust described in section 664(d)(2) and
paragraph (b) of this section). or to have
(3). The annual unitrust amount is the lesser
failed to function exclusively as a
of the amount of trust income, as defined in
§ 1.664-3(a)(l)(i)(b), or six percent of the net
charitable remainder trust (within the
fair market value of the trust assets valued
meaning of § 1.664-1 (a)(4» merely
annually. The net fair market value of the
because the annuity amount is paid after
trust assets on the valuation date in 1996 is
the close of the taxable year If such
SI50,OOO. During 1996. Xhas S7.500 of
payment is made within a reasonable
income after allocating all expenses. All of
time
after the close of such taxable year
Xs income for 1996 Is tax-exempt Income. At
and the entire annuity amount in the
the end of 1996, Xs ordinary income for the
hands of the recipient is characterized
current taxable year and undistributed
ordinal)' income for prior years are both zero; only as income from the categories
X's capital gain for the current taxable year
described in section 664(b)(lJ, (2), or (3),
is zero and undistributed capital gain for
except to the extent it is characterized
prior years is $30,000; and Xs tax-exempt
as corpus described in section 664(b)(4)
income for the current year is S7 ,500 and
because­
undistributed tax-exempt income for prior
(I) The trust distributes property
years Is S2.500.
(other
than cash) that it owned at the
(ii) Because the trust income of S7,500 is
close of the taxable year to pay the
less than the fIXed percentage amount of
annUity arnoWlt; and
$9,000, the unitrust amount for 1996 is
(2) The trustee elects to treat any
S7,500. The character of that amount in the
hands of the recipient of the unitrust amount income generated by the distribution as

68192

Federal Register /VoI. 63, No. 237/Thursday, December 10, 199B/Rules and Regulations

1. Paragraphs (a)(l)(i)(a),

occurring on the last day of the taxable
(a)(l)(i)(b)(l), and (a)(l)(i)(b)(2) are

year in which the annuity amount is
revised.

due.
2. Paragraphs (a)(l)(i)(b)(3),
(b) Special rule for trusts created
before December 10, 1998. In addition to (a)(l)(i)(b)(4), (a)(l)(i)(b)(5), and
(a)(l)(i)(e) through (a)(l)(i)(l) are added.
the circumstances described in
3. The third sentence of paragraph
paragraph (a)(l)(i)(a) of this section, a
(a)(l)(iv) is revised.
trust created before December 10, 1998
The added and revised provisions
will not be deemed to have engaged in
read as follows:
an act of self-dealing (within the
meaning of section 4941). to have
§ 1.664-3 Charitable remainder unitrust.
unrelated debt-financed income (within
(a)· • •
the meaning of section 514), to have
(I) • • ... (i) ...... • (a) General rule. The
received an additional contribution
(within the meaning of paragraph (b) of governing instrument prOVides that the
trust will pay not less often than
this section), or to have failed to
annually
a fixed percentage of the net
function exclusively as a charitable
fair market value of the trust assets
remainder trust (within the meaning of
determined annually to a person or
§ 1.664-1 (a) (4)) merely because the
persons described in paragraph (a)(3) of
annuity amount is paid after the close
this section for each taxable year of the
of the taxable year if such payment is
period specified in paragraph (a)(5) of
made within a reasonable time after the
this section. This paragraph (a) (1) (i) (a)
close of such taxable year and the sum
is applicable for taxable years ending
certain to be paid each year as the
after April 18, 1997.
annuity amount is 15 percent or less of
(b)· • ...
the initial net fair market value of the
(1) The amount of trust income for a
property irrevocably passing in trust as
taxable year to the extent that such
determined for federal tax purposes.
amount
is not more than the amount
(e) Reasonable time. For this
reqUired to be distributed under
paragraph (a)(l)(i), a reasonable time
paragraph (a) (1) (i) (a) of thiS section.
will not ordinarily extend beyond the
(2) An amount of trust income for a
date by which the trustee is required to
taxable
year that is in excess of the
file Form 5227, "Split-Interest Trust
amount reqUired to be distributed under
Information Return," (including
paragraph (a)(l)(i)(a) of this section for
extensions) for the taxable year.
such year to the extent that (by reason
(d) Example. The following example
of paragraph (a)(l)(i)(b)(l) of this
illustrates the rules in paragraph
section) the aggregate of the amounts
(a)(l)(i)(a) of this section:
paid in prior years was less than the
Example. X is a charitable remainder
aggregate of such reqUired amounts.
annuity trust described in section 664(d)(l)
(3) For this paragraph (a)(l)(i)(b), trust
that was created after December 10, 1998.
The prorated annuity amount payable from X income means income as defined under
section 643(b) and the applicable
for Year I is $100. The trustee does not pay
regulations.
the annuity amount to the recipient by the
close of Year I. At the end of Year I, X has
(4) For this paragraph (a)(l)(i)(b),
only $95 in the ordinary income category
proceeds from the sale or exchange of
under section 664 (b)(I) and no income in the any assets contributed to the trust by the
capital gain or tax-exempt income categories donor must be allocated to principal
under section 664 (b)(2) or (3), respectively.
and not to trust income at least to the
By April 15 of Year 2, in addition to $95 in
extent
of the fair market value of those
cash, the trustee distributes to the recipient
assets on the date of contribution.
of the annuity a capital asset with a $5 fair
(5) The rules in paragraphs
market value and a $2 adjusted basis to pay
the $100 annuity amount due for Year I. The (a)(l)(i)(b)(l), (2), and (3) of this section
trust owned the asset at the end of Year I.
are applicable for taxable years ending
Under § I.664-I(d)(5), the distribution is
after April 18, 1997, and the rule in
treated as a sale by X. resulting in X
paragraph (a)(l)(i)(b)(4) is applicable for
recognizing a $3 capital gain. The trustee
elects to treat the capital gain as occurring on sales or exchanges that occur after April
18, 1997.
the last day of Year I. Under § I.664-I(d)(I),
(c) Combination of methods. Instead
the character of the annuity amount for Year
of the amount described in paragraph
I in the recipient's hands is $95 of ordinary
income, $3 of capital gain income, and $2 of
(a)(l)(i)(a) or (b) of this section, the
trust corpus. For Year I. Xsatisfied
governing instrument may provide that
paragraph (a)(l)(i)(a) of this section.
the trust will pay not less often than
(e) Effective date. This paragraph
annually the amount described in
paragraph (a)(l )(i)(b) of this section for
(a)(l)(i) is applicable for taxable years
ending after April 18, 1997.
an initial period and then pay the
...
...
...
...
...
amount described in paragraph
Par. 4. Section 1.664-3 is amended as (a) (1) (i) (a) of this section (calculated
using the same fixed percentage) for the
follows:

remaining years of the trust only if the
governing instrument provides that­
(1) The change from the method
prescribed in paragraph (a)(l)(i)(b) to
the method prescribed in paragraph
(a)(l)(i)(a) is triggered on a specific date
or by a single event whose occurrence
is not discretionary with, or within the
control of, the trustees or any other
persons;
(2) The change from the method
prescribed in paragraph (a)(l)(i)(b) of
this section to the method prescribed in
paragraph (a)(l)(i)(a) of this section
occurs at the beginning of the taxable
year that immediately follows the
taxable year during which the date or
event specified under paragraph
(a)(l)(i)(e)(l) of this section occurs; and
(3) Following the trust's conversion to
the method described in paragraph
(a)(l)(i)(a) of this section, the trust will
pay at least annually to the permissible
recipients the amount described only in
paragraph (a)(l)(i)(a) of this section and
not any amount described in paragraph
(a)(l)(i)(b) of this section.
.
(d) Triggering event. For purposes of
paragraph (a)(l )(i)(c)(1) of this section, a
triggering event based on the sale of
unmarketable assets as defined in
§ 1.664-1 (a)(7)(ii), or the marriage,
divorce, death, or birth of a child with
respect to any individual will not be
conSidered discretionary with, or within
the control of, the trustees or any other
persons.
(e) Examples. The follOWing examples
illustrate the rules in paragraph
(a) (1) (i) (c) of this section. For each

example, assume that the governing

instrument of charitable remainder

unitrust Y provides that Y will initially

pay not less often than annually the

amount described in paragraph

(a)(l)(i)(b) of this section and then pay

the amount described in paragraph

(a) (1) (i) (a) of this section (calculated
using the same fIXed percentage) for the
remaining years of the trust and that the
requirements of paragraphs (a)(l)(i)(c)(2)
and (3) of this section are satisfied. The
examples are as follows:
Example 1. Y is funded with the donor's
former personal residence. The governing
instrument of Y provides for the change in
method for computing the annual unitrust
amount as of the first day of the year
follOWing the year in which the trust sells the
residence. Y provides for a combination of
methods that satisfies paragraph (a)(l)(i)(c) of
this section.
Example 2. Y is funded with cash and an
unregistered security for which there is no
available exemption permitting public sale
under the Securities and Exchange
Commission rules. The governing instrument
of Y proVides that the change in method for
computing the annual unitrust amount is
triggered on the earlier of the date when the

Federal Register/Vol. 63, No. 237/Thursday, December 10, 199B/Rules and Regulations

68193

stock is sold or at the time the restrictions on Because the change in methods for paying
which the court issues the order
the unitrust amount is triggered by an event
its publ ic sale lapse or are otherwise lifted.
reforming the trust, except for situations
Y provides for a combination of methods that that is within a person's control, Y does not
in which the governing instrument prior
provide for a combination of methods that
satisfies paragraph (a)(l)(i)(c) of this section.
to reformation already proVided for
Example 3. Y is funded wi th cash and with satisfies paragraph (a)(l)(i)(q of this section.
payment of the unitrust amount under
a security that may be pUblicly traded under
(1) Effective date-(J) General rule.
a combination of methods that is not
the Securities and Exchange Commission
Paragraphs (a)(l)(i)(c), (d), and (e) of this permitted under paragraph (a)(l)(i)(c) of
rules. The governing instrument of Y
section are applicable for charitable
this section and the triggering event
provides that the change in method for
remainder trusts created on or after
computing the annual unitrust amount is
occurred prior to the reformation.
December 10, 1998.
triggered when the stock is sold. Y does not
(g) Payment under general rule for
(2) General rule regarding
provide for a combination of methods that
fIXed percentage trusts. When the
satisfies the requirements of paragraph
reformations of combination of method
unitrust amount is computed under
(a)(l)(i)(c) of this section because the sale of
unitrusts. ]f a trust is created on or after
paragraph
(a)(l)(i)(a) of this section. a
the publicly·traded stock is within the
December 10, 1998 and contains a
trust will not be deemed to have
discretion of the trustee.
provision allowing a change in
engaged in an act of self-dealing (Within
Example 4. 5 establishes Y for her
calculating the unitrust amount that
the meaning of section 4941). to have
granddaughter. G, when Gis 10 years old.
does
not
comply
with
the
provisions
of
The governing instrument of Y proVides for
unrelated debt-financed income (wit.hin
paragraph (a)(l)(i)(c) of thiS section, the
the change in method for computing the
the meaning of section 514), to have
trust
will
qualify
as
a
charitable
annual unitrust amount as of the first day of
received an additional contribution
remainder unitrust only if it is amended
the year following the year in which G turns
(within the meaning of paragraph (b) of
18 years old. Y prOVides for a combination
or reformed to use the initial method for
this
section). or to have failed to
.
of methods that satisfies paragraph (aW)(i)(c) computing the unitrust amount
function exclusively as a Charitable
of this section.
throughout the term of the trust, or is
remainder trust (within the meaning of
Example 5. The governing instrument of Y reformed in accordance with paragraph
§ 1.664-1 (a)(4)) merely because the
prOVides for the change In method for
(a)(l)(i)(1)(3) of this section. ]f a trust
computing the annual unltrust amount as of
unitrust amount is paid after the close
was created before December 10, 1998
the first day of the year following the year in
of the taxable year if such payment is
and
contains
a
provision
allowing
a
which the donor is married. Y provides for
made
within a reasonable time after the
change in calculating the unitrust
a combination of methods that satisfies
close of such taxable year and the entire
amount
that
does
not
comply
with
the
paragraph (a)(I)(I)(c) of this section.
unitrust amount in the hands of the
provisions of paragraph (a) (1) (i)(c) of
Example 6. The governing instrument of Y
recipient is characterized only as
this section, the trust may be reformed
provides that If the donor divorces, the
income from the categories described in
change in method for computing the annual
to use the initial method for computing
unitrust amount w1l1 occur as of the first day the unitrust amount throughout the term section 664(b)(1). (2). or (3). except to
the extent it is characterized as corpus
of the year follOWing the year of the divorce.
of the trust without causing the trust to
described in section 664(b)(4) because­
Y provides for a combination of methods that fail to function exclusively as a
satisfies paragraph (a)(I)(I)(c) of this section.
(J) The trust distributes property

charitable remainder unitrust under
Example 7. The governing instrument of Y
(other than cash) that it owned at the

§
1.664-1
(a)(4),
or
may
be
reformed
in
provides for the change In method for
close of the taxable year to pay the

accordance with paragraph (a)(l)(i)(1)(3)
computing the annual unitrust amount as of
unitrust amount; and

of
this
section.
Except
as
prOVided
in
the first day of the year following the year in
(2) The trustee elects to treat any

paragraph (a)(l)(i)(1) (3) of thiS section, a
which the noncharitable beneficial)"s first
income generated by the distribution as

child is born. Y provides for a combination
qualified charitable remainder unitrust
occurring on the last day of the taxable

of methods that satisfies paragraph (a)(I)(I)(c) will not continue to qualify as a
year for which the unitrust amount is

of this section.
charitable remainder unitrust if it is
Example 8. The governing instrument of Y amended or reformed to add a provision due.

prOVides for the change in method for
(h) Special rule for fIXed percentage
allowing a change in the method for
computing the annual unltrust amount as of
trusts created before December 10, 1998.
calculating the unitrust amount.
the first day of the year following the year in
When the unitrust amount is computed

(3) Special rule for reformations of
which the noncharitable beneficial)"s father
under paragraph (a)(l)(i)(a) of this

trusts that begin by June 8, 1999.
dies. Y provides for a combination of
methods that satisfies paragraph (a)(I)(I)(c) of Notwithstanding paragraph (a) (I) (i) (1)(2) section, a trust created before December

10. 199B will not be deemed to have
of this section. if a trust either proVides
this section.
engaged in an act of self-dealing (within
Example 9. The governing instrument of Y for payment of the unitrust amount
prOVides for the change in method for
the meaning of section 4941), to have
under a combination of methods that is
computing the annual unitrust amount as of
unrelated debt-fmanced income (within
not permitted under paragraph
the first day of the year following the year In
(a)(l)(i)(c) of this section. or prOVides for the meaning of section 514). to have
which the noncharitable beneficial)"s
received an additional contribution
payment of the unitrust amount under
financial advisor determines that the
(within the meaning of paragraph (b) of
only
the
method
prescribed
in
beneficial)' should begin receiving payments
this section). or to have failed to
paragraph (a)(l)(i)(b) of this section,
under the second prescribed payment
function exclusively as a charitable
then the trust may be reformed to allow
method. Because the change in methods for
remainder trust (within the meaning of
paying the unitrust amount is triggered by an for a combination of methods permitted
§ 1.664-1 (a)(4)) merely because the
under paragraph (a)(l)(i)(c) of this
event that is within a person's control, Y
does not proVide for a combination of
unitrust amount is paid after the close
section without causing the trust to fail
methods that satisfies paragraph (a)(I)(I)(c) of to function exclusively as a charitable
of the taxable year if such payment is
this section.
remainder unitrust under § 1.664-1 (a) (4) made within a reasonable time after the
Example 10. The governing instrument of
close of such taxable year and the fixed
or to engage in an act of self-dealing
Y proVides for the change in method for
percentage to be paid each year as the
under section 4941 if the trustee begins
computing the annual unitrust amount as of
unitrust amount is 15 percent or less of
legal proceedings to reform by June 8,
the first day of the year following the year in
the net fair market value of the trust
1999. The triggering event under the
which the noncharitable beneficial)' submits
refonned governing instrument may not assets as determined under paragraph
a request to the trustee that the trust convert
(a) (I) (iv) of this section.
occur in a year prior to the year in
to the second prescribed payment method.

Federal Register/Vol. 63, No. 237/Thursday, December 10, 1998/Rules and Regulations

68194

(i) Example. The following example
illustrates the rules in paragraph
(a) (1)(i) (g) of this section:
Example. X is a charitable remainder
unilrust that calculates the unitrust amount

under paragraph (a)(l)(i)(a) of this section. X
was created after December 10, 1998. The

prorated unitrust amount payable from X for

Year 1 is S100. The trustee does not pay the
unitrust amount to the recipient by the end

of the Year I. At the end of Year I, Xhas
only S95 in the ordinary income category

under section 664 (b)(I) and no income in the
capital gain or tax-exempt income categories

under section 664(b) (2) or (3), respectively.
By April 15 of Year 2, in addition to S95 in
cash. the trustee distributes to the unitrust
recipient a capital asset with a S5 fair market
value and a S2 adjusted basis to pay the SIOO
unitrust amount due for Year I. The trust
owned the asset at the end of Year 1. Under
§ 1.664- J(d)(5) , the distribution is treated as
a sale by X. resulting in X recognizing a S3
capital gain. The trustee elects to treat the
capital gain as occurring on the last day of
Year I. Under § 1.664-1 (d)(I), the character
of the unitrust amount for Year I in the
recipient's hands is S95 of ordinary income,
S3 of capital gain income. and S2 of trust
corpus. For Year I, Xsatisfied paragraph
(a)(l)(i) (g) of this section.

(;) Payment under income exception.

When the unitrust amount is computed
under paragraph (a)(l)(i)(b) of this
section, a trust will not be deemed to
have engaged in an act of self-dealing
(within the meaning of section 4941). to
have unrelated debt-financed income
(within the meaning of section 514), to
have received an additional
contribution (within the meaning of
paragraph (b) of this section), or to have
failed to function exclusively as a
charitable remainder trust (within the
meaning of § 1.664-1 (a) (4)) merely

because payment of the unitrust amount

is made after the close of the taxable

year if such payment is made within a
reasonable time after the close of such
taxable year.
(k) Reasonable time. For paragraphs
(a)(l)(i) (g). (h), and (/J of this section, a
reasonable time will not ordinarily

extend beyond the date by which the

trustee is required to file Form 5227.

"Split-Interest Trust Information

Return," (including extensions) for the
taxable year.
(I) Effective date. Paragraphs (a)(I)(1)
(g), (h), (1), (;). and (k) of this section are
applicable for taxable years ending after
April 18, 1997.

•

•

•

•

•

(iv)· • • If the governing instrument
does not specify the valuation date or
dates, the trustee must select such date
or dates and indicate the selection on
the first return on Form 5227, "Split­
Interest Trust Information Return," that
the trust must file.· • •

•

•

•

•

•

PART 25-GIFT TAX; GIFTS MADE
AFTER DECEMBER 31, 1954

Approved: December I, 1998.
Robert E. Wenzel.

Par. 5. The authority citation for part
25 continues to read in part as follows:
Authority: 26 U.S.C. 7805. • • •

Donald C. Lubick,
Assistant Secretary ofthe Treasury (Tax
Policy).

Par. 6. In § 25.2702-1, paragraph
(c)(3) is revised to read as follows:

BilliNG CODE

§25.2702-1 Special valuation rules in the
case of transfers of interests In trust.

•

•

•

•

•

Deputy Commissioner ofinternal Revenue.

IFR Doc. 98-32559 Filed 12-9-98; 8:45 am]
4B3D-Ol~

DEPARTMENT OF DEFENSE
Office of the Secretary

(c)· • •
(3) Charitable remainder trust. (i) For

transfers made on or after May 19. 1997,
a transfer to a pooled income fund
described in section 642(c)(5); a transfer
. to a charitable remainder annuity trust
described in section 664 (d)(I); a transfer
to a charitable remainder unitrust
described in section 664 (d)(2) if under
the terms of the governing instrument
the unitrust amount can be computed
only under section 664(d)(2)(A); and a
transfer to a charitable remainder
unitrust if under the terms of the
governing instrument the unitrust
amount can be computed under section
664(d)(2) and (3) and either there are
only two consecutive noncharitable
beneficial interests and the transferor
holds the second of the two interests, or
the only permissible recipients of the
unitrust amount are the transferor. the
transferor's U.S. citizen spouse, or both
the transferor and the transferor's U.S.
citizen spouse.
(il) For transfers made before May 19,
1997, a transfer in trust if the remainder
interest in the trust qualifies for a
deduction under section 2522.

32 CFR Part 270
RIN 0790-AG67

Compensation of Certain Former
Operatives Incarcerated by the
Democratic Republic of Vietnam
AGENCY: Office of Under Secretary of
Defense for Personnel and Readines~.
DoD.
ACTION: Interim final rule.

SUMMARY: This rule amends part 270 to
reflect changes necessary as a result of
new language in Section 658 of the
FY99 National Defense Authorization
Act. Section 658 expands the field of
beneficiaries of the Vietnamese
Commandos Compensation Commission
to parents and siblings of deceased
Conlmandos. It also adds words
"notwithstanding any agreement
(including a power of attorney) to the
contrary, the actual disbursement" must
be made directly to the person who is
eligible for the payment. This rule also
amends part 270 to reflect necessary

technical changes to accommodate the

new language.

EFFEcnVE DAn:: This rule is effective

PART 602-oMB CONTROL NUMBERS
October 17. 1998. Comments are

UNDER THE PAPERWORK
requested by February 8. 1999.

REDUCTION ACT
ADDRESSES: Forward comments to
Par. 7. The authority citation for part
Commission on Compensation, Office of
the Secretary of Defense. 4000 Defense
602 continues to read as follows:

Pentagon, Washington. DC 20301-4000.
Authority: 26 U.S.C. 7805.
FOR FURTHER INFORMAnON CONTACT: Mr.

Par. 8. In § 602.101, paragraph (c) is

Chuck Witschorike. (703) 693-1059 or

amended by adding a new entry in

LTC Frank Hudson. (703) 588-6570.

numerical order to the table to read as

SUPPLEMENTARYINFORMATMlN:
follows:

Executive Order 12866. "Regulatory

§602.101 OMS Control numbers.
Planning and Review"

•

•

•

•

•

•

•

•

•

•

(c)· • •
CFR part or section
where identified and
described

1.664-1(a)(7)

Current OMS control
No.

It has been determined that this is not
a significant rule as defined under
section 3(0(1) through 3(f) (4) of
Executive Order 12866.

Public Law 96-354, "Regulatory
Flexibility Act" (5 U.S.C. 601)
1545-1536

It has been determined that this rule
will not have a significant economic
impact on a substantial number of small
entities because it affects only a limited