IRS permits NIMCRUT to invest in deferred annuities.

On Jan. 9, 1998, the IRS issued an unpublished technical advice memorandum (TAM) involving an investment by a net income charitable remainder unitrust (NIMCRUT) in deferred annuities. The outcome of this ruling is surprisingly favorable in light of the Service's previous opposition to income deferral investment strategies undertaken by NIMCRUTs to control the receipt of distributable income.

A NIMCRUT is a CRUT with a make-up provision. Unlike a standard CRUT, the principal of a NIMCRUT is not available for distribution to income recipients if the trust fails to earn enough distributable income. To mitigate this restriction, however, a NIMCRUT make-up provision permits the trust to schedule income distributions that could not have been made in the past to be made up in the future, when excess distributable income is later earned. A deferred annuity is a contractual promise to make periodic payments that will begin at a contingent date and a guarantee that the payments will continue for either a stated number of years or until the death of a named annuitant.

In the unpublished TAM, the NIMCRUT was originally funded with stock of a closely held corporation. The trust named the donor and his spouse as current life income recipients with the donor's nephew as the initial trustee. The trust sold the stock and bought two tax-deferred annuity contracts from a commercial life insurance company. Both the sale of the stock and the purchase of the annuity policies were authorized by an unrelated attorney who served as an interim trustee. The donor and his spouse were the initial annuitants. The NIMCRUT was designated the owner and the beneficiary of the policies if either annuitant failed to reach age 80. Subsequently, the donor and his spouse assigned their interest in the policy to the NIMCRUT Both the trust instrument and the applicable state law are ambiguous on whether a trust's right to receive money results in income to the trust.

The IRS determined that the purchase of the deferred annuity was not an act of self-dealing, that it did not disqualify the trust as a charitable remainder trust, and that no trust accounting income was created until the trust received money or other property. The Service reasoned that the donor's annuity rights in the policies were contingent on the owner-trust's action, so the donor did not receive a current benefit from the policies. The issue of self-dealing also turned on whether the income deferral was a permitted use. Because the investment decision in purchasing the annuity policies was made by an independent attorney-trustee and the intrinsic nature of charitable remainder trusts allows the use of trust corpus by the donor, the IRS reasoned that the investment in the annuity policies did not unreasonably affect the charitable remainder beneficiary's interest. Consequently, the income deferral was a permitted use.

The investment by NIMCRUTs in income deferral vehicles has attracted the Service's attention since the early 1990s. In the preamble to the proposed regulations under Sec. 664 issued in 1997 and in Notice 94-78, the IRS expressed discomfort with the use of charitable remainder trusts to control the timing of income recognition. Moreover, the Service announced in Rev. Proc. 97-23 that it would not issue rulings or determination letters on whether a NIMCRUT failed to function exclusively as a charitable remainder trust when a trustee, among others, could control the timing of the trust's receipt of income through the use of a deferred annuity or a partnership for the benefit of the unitrust recipient.

Despite the IRSs increasing interest in examining investment strategies pursued by NIMCRUTs, there are several benefits related to deferred annuity investments. The trustee generally has better investment flexibility and control. When the unitrust recipient can rely on other sources of income, the trustee can invest the trust assets in variable deferred annuities that do not provide much current income, but which have significant appreciation potential. Variable annuity owners are often offered a wide range of investment options (such as money market funds, balanced income and growth funds and other different types of stock funds with various investment objectives and appreciation potential). By investing in equity mutual funds via annuity policies instead of outright, the NIMCRUT is able to control the reinvestment (and subsequent liquidation of the assets if the trustee deems it desirable to generate income from an appreciated policy). At the same time, more assets could be made available for investment and to maximize the trust's total return over the long term.

The TAM highlights certain planning considerations pertinent to preserve the benefits of the deferred annuity investments. First, the NIMCRUT should be the owner, beneficiary and annuitant of the annuity policy. If the donor is named as the annuitant on the policy, he will receive the annuity payments personally once he attains the stated age for payments; the charity would potentially receive nothing. Second, the must agreement should dearly define fiduciary accounting income as cash receipts and not cash buildup within the annuity policy. The governing state law can often be ambiguous in defining whether the right to receive income from an annuity policy is equivalent to the actual cash receipts from the policy. Third, investment decisions should be made by an independent trustee. If the donor controls the investment decisions in a manner that unreasonably affects the charity's remainder interest, the Service could argue that the use of the trust assets in purchasing the annuity contract was an impermissible use, thus constituting an act of self-dealing.