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Saturday September 24, 2022

Case of the Week

Son's Intentions Paved with Gold -- Part 3


Several years ago, Martha and Frank built a very unique home on 45 acres of beautiful rolling hills and woods. Frank passed away three years ago, and Martha now solely owns the 45-acre parcel and home.

She enjoys the peaceful country view out her front window. However, the university adjacent to the property is very interested in acquiring the property for future growth. Not surprisingly, Martha is concerned. She does not want a new dormitory filled with college students in her front yard. In fact, she enjoys the peace and protection of her lovely home in the wooded countryside. However, at age 80, she recognizes that eventually some planning will have to be accomplished.

After obtaining a thorough understanding of Martha's needs and desires, Martha's attorney, Paul, crafted a wonderful four-part solution, which incorporated an outright sale, a unitrust, a gift annuity and a gift of a remainder interest in a home. (See Case Study "Peace in the Countryside" for a full explanation.)

One part of the plan involved Martha's 20-acre rear parcel of land. Specifically, Martha's unitrust would receive the 20-acre rear parcel, which the university intends on eventually developing. To generate the necessary trust income, the university would purchase the land from the trust with a 7% interest-only note. After the payment of the 6% unitrust payout each year and trust expenses, the trust would accumulate any excess income.

Sam, Martha's son, is the sole owner of Bank Co. Wanting the very best for his mother, Sam wants to provide trust and banking services to Martha's unitrust. Sam knows Bank Co. would provide excellent services at very reasonable prices.


May Bank Co., Sam's wholly owned company, provide trust and banking services to Martha's unitrust? Will this trigger any self-dealing taxes?


Charitable remainder trusts, charitable lead trusts and private foundations are subject to Sec. 4941, which prohibits acts of self-dealing. Self-dealing means any direct or indirect transfer to, or use by or for the benefit of, a disqualified person of the income or assets of a private foundation or charitable trust. Consequently, a disqualified person may not buy, sell, lease or otherwise transact business with a charitable trust or foundation. If an act of self-dealing occurs, then an excise tax may result.

In general, disqualified persons include lineal descendants of a donor. For example, children and grandchildren of a donor are disqualified persons. In this case, Martha created the unitrust and Sam is a lineal descendant of Martha. Therefore, Sam is a disqualified person with respect to Martha's unitrust. In addition, entities controlled or owned by Sam may also be disqualified persons. See Sec. 4946 for detailed ownership thresholds, but generally 35% ownership of a corporation or partnership would trigger the disqualified persons rules. In this instance, Sam owns 100% of Bank Co. Therefore, Bank Co. is also a disqualified person with respect to Martha's unitrust.

Accordingly, Sam and Bank Co. are prohibited from engaging in transactions with the unitrust. This is true regardless of the potential benefit to the unitrust. However, Sec. 4941(d)(2)(E) provides a narrow exception. If the payment of compensation to a disqualified person is for personal services which are reasonable and necessary, then it shall not be an act of self-dealing so long as the compensation is not excessive. In addition, Reg. 53.4941(d)-3(c)(2), Example 2, allows a disqualified person to provide investment counseling on the condition that the fees are not excessive.

Here, Bank Co. would provide general banking and trust services to Martha's unitrust for a reasonable fee. These personal services are necessary to the trust's goal of producing income while preserving the remainder value. Furthermore, this situation is similar to Reg. 53.4941(d)-3(c)(2), Example 2, which specifically allows a disqualified person to provide investment services. Therefore, after review by Martha's attorney, Paul, he stated that so long as the fees are not excessive, Bank Co. may receive fees for trust and bank services without violating the self-dealing rules.

Published September 24, 2021
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Previous Articles

Son's Intentions Paved with Gold - Part 2

Son's Intentions Paved with Gold - Part 1