The Pension Protection Act of 2006 (PPA 2006) permitted many Subchapter S shareholders to receive flow-through deductions for corporate charitable gifts of appreciated property. Under PPA 2006, the fair market value of the gift flows through to Sub S shareholders, with a reduction in outside basis in the Sub S stock equal to the inside basis of the gifted property. Previously, the Sub S shareholder had to reduce outside basis by the fair market value to take the deduction. See Sec. 1367(a)(2).

While this favorable PPA 2006 rule on Sub S appreciated gifts ended on Dec. 31, 2007, the Sub S appreciated gifts basis rule has been included in the list of 31 tax extenders that passed the House but not the Senate in November 2007. Therefore, it is quite possible that it will be extended for 2008 when the tax extenders are passed.

In Rev. Rul. 2008-16; 2008-11 IRB 1 (29 Feb 2008), the Service published guidelines and examples for 2006 and 2007 appreciated property gifts by Sub S corporations.

Example 1: Mary Sub S Shareholder

Mary Jones is sole shareholder in the AAA Subchapter S corporation. Mary has a basis in her stock of $5,000.

AAA makes a 2007 gift of IBM shares owned by the Sub S to a local charity. The IBM shares have a basis of $2,000 and a fair market value of $5,000. The $5,000 charitable deduction flows through, and Mary reduces her Sub S stock basis by the $2,000 inside basis of the gifted property. Mary's Sub S Stock basis is then $5,000 - 2,000 or $3,000.

Example 2: Joe "Income and Loss" Shareholder

Joe Wilson is sole shareholder in the BBB Subchapter S corporation. Joe has a basis in his stock of $50,000.

BBB makes a 2007 gift of IBM shares owned by the Sub S to a local charity. The IBM shares have a basis of $100,000 and a fair market value of $190,000. BBB also has income of $30,000 and a long-term capital loss of $25,000.

What is the deduction for Joe in 2007? First, the charitable deduction may not exceed the sum of (i) Joe's pro rata share of the gift appreciation, and (ii) the amount of the § 1366(d) loss limitation amount allocable to the gift property's adjusted basis under Reg. 1.1366-2(a)(4).

Therefore, Joe's basis is increased by the $30,000 income from $50,000 to $80,000. Next, the gift is allocated by multiplying the $80,000 basis times the fraction $100,000(gift property basis)/$125,000(basis plus $25,000 loss). The allocated basis for the gift portion is then $64,000. The charitable deduction for 2007 is thus $90,000 appreciation plus $64,000 basis, or a total of $154,000. The 2007 capital loss is $16,000, leaving Joe with basis of zero in his BBB Sub S stock.

The remaining $36,000 charitable deduction and $9,000 capital loss are carried forward under Sec. 1366(d)(2) to the next year.

After years of applying discounts to asset values in family limited partnerships, creative counsel developed a "Restricted Management Account" (RMA) to achieve a similar goal.

The RMA is typically a five year management account with a bank. Cash is transferred to the account and there are restrictions that state that the bank will reinvest all proceeds, the taxpayer will be taxable on income during that period of time and at the end of the five years, but the account plus growth will be returned to the taxpayer. However, during the five year period, the taxpayer is permitted to make gifts of part or all of the RMA. If the taxpayer transfers part of the RMA to a child or a grandchild, the bank will then sever the gifted amount and create a new RMA with the appropriate funds.

For example, assume that Eleanor creates an RMA with $50x. In year two, the RMA has grown to $60x and she gives 1/6 to her daughter. The daughter's RMA is now $10x and Eleanor's RMA is $50x. In year four, the RMA term is extended by mutual agreement to seven years. In year five, Eleanor passes away with RMA value of $75x. The question that is raised is whether or not the gift or the estate value will be subject to reduction in a manner similar to an FLP interest.

In Rev. Rul. 2008-35; 2008 29 IRB 116 (21 Jul 2008), the IRS refused to allow RMA discounts. First, the IRS compared the RMA to an IRA and noted that the potential tax on an IRA is not deemed subject to a discount for estate tax purposes. See Smith ex. rel. Estate of Smith v. United States, 391 F.d 621, 628 (5th Cir. 2004.). In this case no discount was allowed for potential income tax on the IRA.

The second claim by the IRS is that Sec. 2703(a) (2) does not permit restrictions created by the donor on an agreement such as an RMA to affect valuation. Because the donor and the bank are still the only two parties involved in the transaction, the restrictions are deemed ineligible for valuation discounts. Therefore, the value of funds in an RMA will be subject to estate tax at their fair market value on date of death.

In Rev. Rul. 2008-41, 2008-30 IRB 1 (8 Jul 2008), the IRS published guidelines for division of unitrust or annuity trust assets if there is a divorce.

Several private letter rulings have approved the CRT division process. Typically, a husband and wife fund a charitable remainder unitrust or annuity trust and later petition a court for a divorce. As part of the allocation of property, the charitable trust is divided between the parties. Each receives income from his or her trust. After one person passes away, the income from that share may be directed to the survivor or that trust share may be directed to qualified exempt charities.

The ruling covers a multiple party split (Situation 1) and a more common division between husband and wife (Situation 2). The general guidelines are:

1. Pro rata division - trust still qualifies as a CRT under § 664(d).


2. Basis allocation - no Sec. 1015 sale or exchange, and therefore basis is prorated. The Sec. 1223 holding period for each asset is carried forward.


3. No termination or private foundation penalties - no Sec. 507(a)(1) termination, no private foundation Sec. 4947(a)(2) penalties, and no Sec. 507(c) excise tax.


4. No self-dealing under Sec. 4941.


5. No taxable expenditure under Sec. 4945.

Editor's Note: This ruling clarifies the law for split-up CRTs. The key is that there is a pro rate allocation of assets, especially with multiple trusts. By following the pro rata rules, divisions and later combinations of CRTs are approved. It is also helpful that an annuity trust may be divided, so long as the assets and annuity are prorated. Under the ruling, the costs of trust division are paid by the recipients and not by the trusts.