Estate of Melvine B. Atkinson v. Commissioner

115 T.C. No. 3

UNITED STATES TAX COURT

ESTATE OF MELVINE B. ATKINSON, DECEASED, CHRISTOPHER J.
MACQUARRIE, EXECUTOR, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 20968-97. Filed July 26, 2000.

R determined that the estate was not entitled to
deduct the charitable remainder interest in a trust
that was intended to be a charitable remainder annuity
trust (CRAT). R challenged the validity of the CRAT on
two bases: First, that the annual 5-percent minimum
distributions were not made as required by sec.
664(d)(1)(A), I.R.C., and second, that sec.
664(d)(1)(B), I.R.C., will be violated because the
trust corpus would have to be invaded to satisfy the
estate’s obligation to pay one of the noncharitable
secondary beneficiary’s apportioned part of the estate
tax.

Held: No charitable deduction is allowable
because: (1) Sec. 664(d), I.R.C., requires that
minimum payments be distributed annually from the
inception of the CRAT to certain designated persons,
and these payments were not made, and (2) no portion of
a purported CRAT may be paid to anyone other than
designated noncharitable beneficiaries or statutorily
 - 2 -

acceptable charitable entities, and here the trust will
be invaded to pay the estate tax attributable to a
portion of the estate received by one of the
noncharitable beneficiaries.

David D. Aughtry and Christopher J. MacQuarrie, for

petitioner.

Francis C. Mucciolo, for respondent.

GERBER, Judge: Respondent determined a deficiency in

petitioner’s Federal estate tax in the amount of $2,654,976. The

deficiency arose in connection with the operation of a charitable

remainder annuity trust (CRAT) created by decedent. The issue

for our consideration is whether the trust functioned exclusively

as a charitable remainder trust from its creation, thereby

remaining a valid trust, so as to qualify the estate for a

charitable deduction for the remainder interest.

FINDINGS OF FACT

The stipulation of facts and the exhibits attached thereto

are incorporated herein by this reference.

Melvine B. Atkinson (decedent), died on June 7, 1993, at the

age of 97, a resident of Miami Beach, Florida. The executor of

her estate, Christopher J. MacQuarrie (MacQuarrie), also resided

in Florida at the time the petition was filed.

On August 9, 1991, decedent placed stock worth $3,999,974 in

trust under a document entitled “Melvine B. Atkinson Charitable

Remainder Annuity Trust” (annuity trust) and named MacQuarrie as
 - 3 -

trustee. At that time, she also created the Melvine B. Atkinson

Irrevocable Trust (administrative trust) and placed stock worth

$953,012 in that trust. MacQuarrie was named trustee for this

second trust as well. On the same day, decedent signed her Last

Will and Testament (will), naming MacQuarrie as personal

representative.

The annuity trust provided that the trust would pay decedent

an annuity equal to 5 percent of the fair market value of the

assets of the trust as of the date of its creation, in equal

quarterly payments, until her death. At least seven quarterly

payments of $49,999.68 ($3,999,974 x 5% ÷ 4), totaling

$349,997.76, should have been made to decedent before her death.

No payments were actually made from the trust account during

decedent’s lifetime. The value of the trust was not diminished

by the 5-percent payments. MacQuarrie was aware that the trust

document and the statutes relating to CRAT’s required that a

minimum of 5 percent of the initial fair market value be paid out

each year, and he was aware that decedent was not withdrawing

money from the trust. No funds were ever transferred to decedent

from the trust. The amount of $366,334.92, representing the

amount due to decedent under the trust terms, was included as an

asset of decedent’s estate.

Upon decedent’s death, the trust document provided that the

same 5-percent annuity amount was to be distributed amongst
 - 4 -

various named individuals (secondary beneficiaries) but only if

those beneficiaries each furnished their share of the funds for

payment of Federal estate and State death taxes for which the

trustee might be liable upon Atkinson’s death. One of those

secondary beneficiaries was Mary Birchfield (Birchfield), who had

cared for decedent from 1984 until her death.

As trustee, MacQuarrie informed the secondary beneficiaries

of their right to receive an annuity under the trust and of the

condition that they must pay the related Federal estate and State

death taxes. After notifying the secondary beneficiaries of

their need to elect to receive, MacQuarrie moved to compel their

election. Ultimately, only Birchfield elected to take her share.

Birchfield agreed to take the money, but informed MacQuarrie that

the decedent had indicated that she would not be liable for her

share of the estate taxes and that she possessed a notarized

document from decedent to that effect. She informed MacQuarrie

that she expected to be given the money without paying any estate

tax. After increasingly hostile exchanges, MacQuarrie and a

second attorney (who was also evaluating the administration of

the estate) decided that it would be in the best interest of the

trust to settle Birchfield’s claim for the payment of any related

taxes. MacQuarrie filed a motion seeking the court’s approval of

payment out of the administrative trust for any estate taxes

related to the amount to be paid to Birchfield pursuant to the
 - 5 -

annuity trust. The probate judge signed a proposed order to that

effect. At that time $667,000, representing the annuity payments

due to Birchfield accrued from decedent’s death, was set aside

for Birchfield. MacQuarrie delayed paying the accrued amount to

Birchfield due to concern over a possible estate audit but

motioned the court for approval to distribute the funds before a

closing letter was obtained. The probate judge ordered that

those funds be distributed to Birchfield, and a payment of

$667,000 was made to Birchfield on December 31, 1996. Four

additional payments were made to Birchfield towards her 5-percent

annuity amount. No Federal estate or State death taxes were paid

by Birchfield on the amounts she received. It was subsequently

determined that funds from the administrative trust were

insufficient to pay both the estate tax attributable to

Birchfield’s interest and the administration expenses and

retirement of decedent’s debts. Accordingly, it will be

necessary to invade the CRAT to make up the shortfall.

Birchfield died of breast cancer on April 22, 1997. At the

time of the estate valuation calculation, MacQuarrie had asked

for and received an affidavit from Birchfield’s doctor stating

that Birchfield had a less than 5-year life expectancy. In

accordance with section 7520,1 the estate valued the charitable

1
Unless otherwise indicated, all section references are to
the Internal Revenue Code in effect as of the date of decedent’s
(continued...)
 - 6 -

remainder interest from the trust considering the annuity payment

to Birchfield based on her normal life expectancy. Petitioner

now asserts that this calculation had been done incorrectly and

that a shorter life expectancy should have been used resulting in

a greater charitable deduction for the remainder interest.

Respondent determined that the charitable remainder annuity

trust was not a valid CRAT and that no charitable deduction was

available to the estate. Respondent also determined that several

of the estate expenses were improperly deducted because they had

not been paid. Though respondent agrees that several of the

deductions are now allowable, respondent continues to maintain

that the charitable deduction taken by the estate should be

disallowed. Respondent determined that the trust did not

continue to function as a charitable remainder annuity trust for

two reasons: First, when it failed to pay the required annual

amount to decedent during her life and, second, when the trust

ostensibly agreed to pay money towards the tax liability on the

funds distributed to Mary Birchfield in accordance with the

settlement. Petitioner maintains that the estate qualifies for a

charitable deduction under section 2055 and that it is entitled

to a refund because a greater charitable deduction should have

1
(...continued)
death, and all Rule references are to the Tax Court Rules of
Practice and Procedure.
 - 7 -

been allowed in light of the revised actuarial values for

Birchfield’s annuity.

OPINION

The issue before us is whether, in its operation, decedent’s

charitable remainder annuity trust met the statutory requirements

so as to qualify for a charitable deduction. Specifically, we

consider whether the trust made the statutorily required payments

to decedent during her lifetime and the effect of the trust’s

obligation to make payments to the secondary beneficiary after

decedent’s death. If we decide that the trust was operationally

qualified, we must then decide the appropriate life expectancy of

Mary Birchfield to decide whether petitioner is entitled to a

larger charitable deduction. On brief and at trial,2 respondent

maintained that the trust failed to qualify as a CRAT for

purposes of sections 2055 and 664 because of actions of the

trustee and/or trustor. If the trust is so disqualified, section

2055 precludes the taking of a charitable deduction for the

charitable remainder interest.

Section 2055 provides for a deduction from the Federal gross

estate of an amount equal to the property passing from a decedent

to a charitable organization of the type described in subsection

2
At trial, respondent also raised the issue of whether
certain expenses of the trust were reasonable. After reviewing
the pertinent materials, we found that the reasonability of the
fees was a new issue and therefore could not be raised for the
first time at trial. Though respondent raises the issue again on
brief, we adhere to our earlier ruling.
 - 8 -

(a) of the section. Subsection (a) includes organizations

pursuing religious, charitable, scientific, literary, or

educational purposes, or fostering amateur sports competition, or

preventing cruelty to children or animals, from which no net

earnings inure to a noncharitable private party and which do not

participate in political campaigning. See sec. 2055(a)(2).

However, no deduction shall be allowed if a charity receives a

remainder interest in property and if an interest in the same

property also passes to an individual or a noncharitable entity,

unless the charitable remainder interest is in a charitable

remainder annuity trust, a charitable remainder unitrust, or a

pooled income fund. See sec. 2055(e)(2)(A). The trust

established by decedent purports to be a CRAT, and if it were, a

gift of trust assets to charity would qualify for the charitable

deduction.

Section 664(d)(1) contains the definition of a charitable

remainder annuity trust. A trust only qualifies as a CRAT if:

(1) It pays out a sum certain, not less than 5 percent of the

initial fair market value of the trust assets, annually or more

frequently to one or more persons for either the lifetime of such

person or a term of years (not more than 20 years); (2) no other

payments, besides those described in (1), are paid to or for the

use of a person other than an organization described by section
 - 9 -

170(c);3 (3) once the payments described in (1) cease, the

remainder interest is transferred to or for the use of an

organization described in section 170(c) or is retained by the

trust for such a use; and (4) the value of that remainder

interest is at least 10 percent of the initial fair market value

of the trust assets. See sec. 664(d)(1). Furthermore, the terms

of the trust must meet the statutory requirements, and the trust

must operate within those terms from its creation. See sec.

1.664-1(a)(4), Income Tax Regs.

Five-Percent Distribution Requirement

Section 664 provides for a narrow exception to the general

disallowance of deductions for charitable remainder interests

under section 2055(e)(2)(A). In order to qualify, all section

664 requirements for CRAT’s must be met upon creation and must

continue to be met throughout the existence of the CRAT. See

sec. 1.664-1(a)(4), Income Tax Regs. One of those requirements

is that a minimum payment of 5 percent of the initial fair market

value of the trust’s assets be distributed each year to the

noncharitable beneficiary. Petitioner argues that this

distribution requirement should be set aside or ignored because

it only serves to decrease the charitable contribution and

because decedent had no need for the distribution. One of the

3
Sec. 170(c) describes organizations organized and operated
exclusively for religious, charitable, scientific, literary, or
educational purposes, or to foster amateur sports competition, or
for the prevention of cruelty to children or animals.
 - 10 -

primary reasons for sections 2055 and 664 was to ensure that any

amount set aside for charity was not diminished by payments to

noncharitable beneficiaries.

The trust here, however, provides for four potential

secondary beneficiaries who could have survived decedent and

elected to receive payments that could have reduced the amount

due to charity. An expressed focus of Congress in enacting the

5-percent distribution requirement was to prevent a charitable

remainder trust from being used to circumvent the current income

distribution requirements imposed on private foundations. See S.

Rept. 91-552 (1969), 1969-3 C.B. 423, 481. If there were no such

requirement, a charitable remainder trust could be used to

accumulate trust income tax-free, while a private foundation

would remain limited in the amount of income it might accumulate.

See id.

Though the terms of the annuity trust met the letter of the

statutory requirement providing for distributions equal to 5

percent annually, the trust did not operate in accordance with

those terms. Petitioner bears the burden of proof in this

matter, including the burden of substantiation. See Rule 142(a).

Petitioner has presented no persuasive evidence that checks for

the 5 percent annuity ever existed or were ever sent to decedent.

Purportedly, MacQuarrie remitted checks to decedent that were not

cashed. However, there is no record of canceled or uncanceled
 - 11 -

checks, nor did petitioner present any evidence demonstrating a

gap in the check sequence. Though MacQuarrie testified that he

made copies of checks written on the trust account, no such

copies were presented to evidence these alleged payments. On the

other hand, we do have evidence that no payments were ever

actually consummated before decedent’s death. The trust was

never diminished by any payments during decedent’s life. Because

the trust value was undiminished and no transfer of funds

occurred, operationally the trust did not meet the express 5-

percent requirement of the statute and cannot qualify for

treatment as a charitable remainder trust. Accordingly, section

2055 applies, and the estate is not entitled to a deduction for

the bequest of a charitable split-interest.4

Petitioner alternatively argues that the trust should not be

disqualified as a CRAT for the lack of payments to decedent

because the failure of action took place during the trustor’s

lifetime. Petitioner argues that section 1.664-1(a)(5), Income

Tax Regs., allows for CRAT’s created inter vivos to ignore all of

the requirements established by section 664 until the moment of

4
The additional failure of the trust attributable to the
payments to the secondary beneficiary, when coupled with the more
technical “5 percent rule” makes respondent’s position that the
trust failed operationally more compelling. See infra pp. 14-15.
 - 12 -

death.5 Petitioner argues that, under this provision of the

regulation, the trust did not come into being until the date of

decedent’s death, and therefore no prior violation of the CRAT

requirements could disqualify the trust. Petitioner’s position

overlooks that this provision of the regulation is inapplicable

to the trust involved here--an irrevocable trust established and

funded by decedent during her lifetime. The application of this

provision of the regulation, as reflected in its terms and

illustrated by the accompanying examples, see sec. 1.664-1(a)(6),

Income Tax Regs., is confined to testamentary trusts funded for

the first time after the grantor’s death. In the present case,

the trust is deemed created at the earliest time that neither the

grantor nor any other person is treated as the owner of the

entire trust. See sec. 1.664-1(a)(4), Income Tax Regs. Here,

5
Sec. 1.664-1(a)(5), Income Tax Regs., provides:

(5) Rules applicable to testamentary transfers--
(i) Deferral of annuity or unitrust amount.
Notwithstanding subparagraph (4) of this paragraph
and §§ 1.664-2 and 1.664-3, for purposes of
sections 2055 and 2016 a charitable remainder
trust shall be deemed created at the date of death
of the decedent (even though the trust is not
funded until the end of a reasonable period of
administration or settlement) if the obligation to
pay the annuity or unitrust amount with respect to
the property passing in trust at the death of the
decedent begins as of the date of death of the
decedent, even though the requirement to pay such
amount is deferred in accordance with the rules
provided in this subparagraph. * * *
 - 13 -

decedent irrevocably relinquished ownership of the trust assets

during her lifetime when she signed the trust documents stating

that she was transferring the property to the trust on August 9,

1991. The CRAT was created on that date and was to function as a

CRAT from that day forward, as required in the regulations. See

id. The regulation providing for a deemed creation date upon the

death of a trustor does not apply to an operating inter vivos

trust that is to continue after the death of the grantor.

Though only mentioned in passing by petitioner, we also note

that reformation of the trust pursuant to section 2055(e)(3)

would not be an available remedy to petitioner. Section

2055(e)(3) provides that a trust or will may be reformed if it

was improperly created and yet conforms to the CRAT requirements.

The definition of “qualified reformation” demonstrates that the

reformation is meant to address only those problems arising in

the documentation of the trust. Section 2055(e)(3)(B) defines

qualified reformation as “a change of governing instrument by

reformation, amendment, construction, or otherwise”. The

legislative history indicates that reformation under section 2055

was created to address problems in trust creation as follows:

“The bill provides a permanent rule permitting reformation of

governing instruments of charitable split-interest trusts which

do not meet the requirements of the 1969 Act rules.” Staff of

the Senate Comm. on Finance, 98th Cong. 2d Sess., Explanation Of

Provisions Approved By The Committee On March 21, 1984, S. Prt.
 - 14 -

98-169, Vol. I at 732 (Comm. Print 1984). Here the trust was

validly formulated, and its terms were within the statutory

threshold requirements. Accordingly, reformation is not needed

to “rewrite” incorrect terms. The operational failure cannot be

corrected by reformation. Therefore, the concept of reformation

has no application here.

Payments to Birchfield

In addition to the failure in operation that occurred when

no payments were made to decedent in accordance with the trust

terms, the trust is disqualified from being a CRAT because it

will be necessary to invade the trust to satisfy the obligations

of the estate, which include the estate and death taxes

apportionable to Mary Birchfield’s beneficial interest in the

trust. The estate bears the responsibility for those tax

payments. As discussed earlier, the funds in the administrative

trust are not sufficient to pay decedent’s debts, the

administration expenses, and estate and death taxes. The

shortfall will have to come out of the trust corpus. Pursuant to

section 664(d)(1)(B), no amount of the trust, other than the

annuity, may be paid to or for the use of any person other than

an organization described in section 170(c). Because the trust

corpus will be invaded to pay expenses or debts of the estate,

including estate taxes, a substantial part of the trust funds may

be diverted from the charitable remainder. This is an additional
 - 15 -

reason for concluding that the trust failed to function

exclusively as a CRAT from the date of its creation. See sec.

1.664-1(a)(6), Example (3), Income Tax Regs. (reservation of

power to pay grantor’s debts precludes qualification as CRAT);

see also Rev. Rul. 82-128, 1982-2 C.B. 71 (ruling that “a trust

does not qualify as a charitable remainder trust and no deduction

is allowable under sections 170 and 2522 of the Code if it is

possible that federal estate and state death taxes may be payable

from the trust assets”).

We need not address the valuation of Birchfield’s life

interest and any correlated value of the remainder interest. At

the time the payments were made out of the trusts to and on

behalf of Birchfield, the estate did not qualify for the

exception to section 2055(e)(2)(A) and thus was not entitled to

any charitable deduction for the remainder interest in the trust.

On brief, respondent states that several deductions

previously disallowed will now be allowed, although the

deductions were not identified. At trial, respondent questioned

whether certain expenses were properly deducted due to

uncertainty about whether they had been actually paid. Testimony

about payment of the expense was received in evidence. On brief,

respondent did not address the issue of payment, and,

accordingly, we consider this issue to have been waived or
 - 16 -

conceded. See Stringer v. Commissioner, 84 T.C. 693, 708 (1985),

affd. without published opinion 798 F.2d 917 (4th Cir. 1986).

To reflect the foregoing,

Decision will be entered under Rule

155.