March 26, 1998 | Read Time: 2 minutes
The I.R.S. has released a notice that clarifies how payments from a charitable remainder trust should be taxed and distributed in light of changes made by the Taxpayer Relief Act of 1997.
A charitable remainder trust enables a donor to designate a gift to charity, take a tax deduction, and receive regular income payments from the gift. Upon the death of the beneficiary of the trust, the remainder of the trust goes to charity.
Often, a donor uses an appreciated asset, such as stock, to create the trust. Once that asset is sold, the difference between the asset’s original value and its selling price generally is subject to capital-gains taxes.
In Notice 98-20 the I.R.S. spells out how those gains should be handled by the trust. The notice specifies three new tax rates for long-term capital gains: 28 per cent, 25 per cent, and 20 per cent.
The notice also clarifies the I.R.S.’s position that a charitable remainder trust should make distribution payments from its highest-taxed income first instead of using a pro rata system to pay out income taxed at various rates. The method specified by the I.R.S. is described as “worst-in, first-out” by planned-giving experts.
Under that method, a trust that owed its beneficiary a $3,000 distribution would have to make that payment as follows. Say, for example, that the trust only had long-term capital-gains income and that the income broke down as follows: $3,000 from gains taxed at 28 per cent, $3,000 from gains taxed at 25 per cent, and $3,000 from gains taxed at 20 per cent. The trust would have to pay the entire $3,000 distribution out of the gains taxed at the 28-per-cent rate and carry forward the remaining $6,000 in gains to be used toward the following year’s distribution.
The proposed regulations, once published, take effect January 1, 1998 and apply to all trusts — including ones started before 1998.
The notice is available on the I.R.S.’s World-Wide Web site at http://www.irs.ustreas.gov/prod/bus_info/tax_pro/adv-notice.html. The service said it would also appear in the March 30 Internal Revenue Bulletin 1998-13.
