De-Ubit-Izing Crts: Recent Rulings

Charitable remainder trusts (CRTs) forfeit their tax-exempt status in any year in which they own interests in for-profit enterprises holding assets, under Internal Revenue Code (Code) Section 664(c). In three recent rulings, however, the Service has permitted CRTs to sidestep this bar, and invest indirectly in enterprises which use to acquire their assets. The Service's current position appears to be that, so long as the CRT is not invested directly in the debt-financing enterprise, but instead is invested in another entity which in turn invests in the debt-financing enterprise, and so long as there are plausible business reasons for this arrangement, the debt-financing will not trigger unrelated business income tax (UBIT) at the CRT level. In PLR 200252096, the Service ruled on a CRT which intends to form and fund a wholly-owned for-profit corporation, which in turn will invest in a for-profit LLC in the equipment leasing business which expects to use to pay part of its equipment acquisition costs. Stated business reasons for the arrangement included the shielding of the CRT from UBTI as to the debt-financed property acquisitions of the LLC. The Service approved of this arrangement, ruling that the CRT will not recognize UBTI in connection with the business. A more complex format was approved in PLRs 2002516016 - 018, in which a CRT is a limited partner in M partnership, which plans to create a foreign corporation, N; N in turn will acquire interests in a number of foreign funds, and borrow from third parties to finance its commitment to the funds. The business purposes of this arrangement were said to include: more flexibility in disposing of interests in the funds; insulating the CRT from fund liabilities; and sheltering the CRT from UBTI. The IRS ruled that the CRT will not recognize UBTI under this arrangement, as the income derived from the funds will be received as UBTI-exempt dividends. An even more complicated structure was approved in PLRs 200315028, 200315032, 200315034, and 200315035, in which four CRTs intend to create a foreign corporation which will purchase interests in US partnerships that use debt financing to acquire investment assets. Among the business purposes cited for this arrangement were the advantages of pooling the investment assets of the CRTs to help reduce costs and provide access to more investment opportunities. The Service ruled that the CRTs would not receive UBTI as a result of these investments and payments, as dividend income does not constitute UBTI. Why didn't the Service simply reject these indirect investments by the CRTs in enterprises using debt-financing, under the step transaction rules or similar doctrine? Perhaps the Service does not view UBTI in the CRT context as a very serious concern; in addition, the long-awaited CARE legislation would greatly soften the impact of UBTI on CRTs, which would not lose their exempt status altogether in years in which UBTI is recognized, but rather would simply pay tax on the UBTI component of their income.

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