The Intersection of Charitable Remainder Trusts and Estate Tax, Part II

Pitfalls Calculating Gross Estate Inclusion Under IRC Sections 2036 and 2038

Author note: This series was originally contemplated to be two articles in length. However, doing so would have made this article extremely long. So, I will be breaking up this topic a bit more to focus on gross estate inclusion here, followed by the marital and charitable deductions in the next article.

Table of Contents

1. Intro

2. Gross Estate Inclusion At Grantor’s Death

3. Portion of Principal Subject to Inclusion

4. Principal Needed to Satisfy Annuity or Unitrust

5. Annuity Interest Calculation

6. Unitrust Interest Calculation

7. Concurrent or Successive Income Interest

8. 2038 Inclusion

Intro

In the prior article in this mini-series, we discussed an important question – whether assets in a charitable remainder trust (CRT, whether structured to provide an annuity as a CRAT or a unitrust interest as a CRUT) get a step-up in basis or if, instead, the actuarial interest(s) in a CRT are themselves subject to either (1) a step-up in basis or (2) are treated as income in respect of a decedent (IRD).  The conclusion was the former, for reasons set forth in that article. 

Importantly, gross estate inclusion under IRC 2036(a)(1) pops up in any situation where the grantor dies holding an income interest in the CRT.  Usually, we can assume that this gross estate inclusion will be completely offset by the estate tax charitable deduction.  But, if there is an ongoing income interest in the CRT (whether a joint-and-survivor interest held with the grantor, or a new contingent income interest for a beneficiary who survives the grantor), the portion of the CRT subject to gross estate inclusion may not be completely offset by this deduction.  Instead, there will be a portion that uses estate tax applicable credit, and/or generates estate tax. 

For purposes of this article and as illustrated below, I will define two different types of continuing income interests which come into play after a grantor of a CRT dies.  The first I will term a concurrent income interest, which is an interest held concurrently by the grantor and one or more other noncharitable beneficiaries (often a spouse, but occasionally a non-spouse) from the time of trust formation such that each surviving noncharitable beneficiary has a continuing interest.  The second I will term a successive income interest, which is an interest of one or more noncharitable beneficiaries which kicks in after the grantor’s death.  In each case, the continuing income interest is contingent upon a noncharitable beneficiary surviving the grantor. 

As we will see, the scope of gross estate inclusion may or may not extend to either type of continuing income interest under 2036(a)(1), or 2038 (this image captures the topics of this article and the next article in the series):

In these situation, identifying the scope of (1) gross estate inclusion, (2) whether gross estate inclusion is fully or only partially offset by estate tax charitable and marital deductions, and (3) basis step-up (or step-down) relating to gross estate inclusion, are important ancillary considerations which are often taken for granted when planning with a CRT. 

In this article, we will tackle the issue of gross estate inclusion, while teeing up a third series article on the marital and charitable deductions. 

Gross Estate Inclusion At Grantor’s Death