Featured Article – Nonexempt Charitable Trusts – Issues & Answers (Part II) – Some Solutions

Law Office of Jonathan Ackerman, LLC Newsletter - Volume 6.2 (2020)

BY JONATHAN D. ACKERMAN, ESQUIRE

You had requested your attorney to consider options for your institution in dealing with the testamentary trust described in Part 1 – The Setup, especially considering the fact that the donor stated her intentions of creating an outright bequest to your institution subject only to broad use restrictions. In response, your attorney has talked to you about two possibilities.

One is to have the trust file a Form 1023 with the IRS to obtain private foundation status. If that happens, the trust would no longer be required to file a Form 1041 as a taxable trust (along with the Form 990-PF). In that event and depending on the character of the trust’s assets, the trust should also run no unexpected risk of incurring tax on its investment income, because it qualifies as a tax-exempt organization. However, the trust will still be a separate entity and be required to maintain its own accounting and investment account, and will be subject to the rules, definitions, excise taxes, and prohibited acts of a private foundation.

So, what is your second option?

The laws of most States recognize a court's authority to terminate or modify a charitable trust based upon either statutory or case law, and there may be at least three arguments in that regard – (i) specific statutory law, (ii) consent of the beneficiaries, and (iii) the common law doctrine of equitable deviation.

The most stringent legal standard to terminate a charitable trust is under the common law doctrine of equitable deviation. Historically, a court will permit the trustee of a charitable trust to deviate from the mechanical means of administering the trust, where circumstances not known or foreseen by the donor have come about, and where such change in circumstances, in combination with the administrative means provided in the trust, would defeat or substantially impair the accomplishment of the intended trust purpose. In such event, when deviation from the administrative provisions of a charitable trust is appropriate, a court may permit the trustee to accomplish acts that are unauthorized or even forbidden by the terms of the trust.

However, there is a recent trend in the law that broadens the legal standard for terminating a charitable trust. For instance, most States have adopted the Uniform Trust Code ("UTC"), and specifically Section 412, which provides that a court may modify the administrative or dispositive terms of a trust or terminate the trust if, because of circumstances not anticipated by the settlor, modification or termination will further the purposes of the trust, and to the extent practicable, the modification must be made in accordance with the settlor’s probable intention.

The Comments included with the UTC specifically state that Section 412 broadens the court’s ability to apply equitable deviation to terminate or modify a trust, and also clarifies that Section 412 relates to the termination or modification of a trust without the need to seek beneficiary consent, Also See Section 66(1) of the Restatement (Third) of Trusts. Thus, this new legal standard does not require proof of harm, i.e., that absent deviation, the material purpose of the trust would be substantially impaired or defeated.

It is arguable that the potentially excessive and unnecessary administrative costs associated with an NECT would not have been known to the donor and are wasteful of the trust’s assets. In that case, terminating the trust would further the material purposes of the trust and the donor’s stated intentions – providing annual income to your institution, subject only to broad use restrictions. It may also be argued that operating the trust as an NECT presents a substantial impairment to such overriding and material charitable purpose.

THE BIGGER PICTURE

If a planned giving or development officer runs into a similar situation as described in these articles, many questions will come up in determining how to best handle such a situation. Here is just a sampling – (i) is there a reasonable argument under the applicable State law to terminate the charitable trust, (ii) who is the trustee, (iii) what are the costs of administering the trust, (iv) are there any other beneficiaries – either current or contingent, (v) did the donor previously state his or her intentions to your institution, and (vi) what will the charity do with the trust funds upon termination, i.e., create an endowment.

IN SUMMARY

This two-part article has five intentions: first – to highlight the characteristics of an NECT, so you will 'know one when you see one'; second – to shine a spotlight on the NECT as a potentially undesirable charitable giving vehicle; third – to provide your institution with several legal arguments to consider in possibly resolving some or all of the issues associated with an NECT; fourth – to recommend that you consult with your attorney to determine the viability of terminating an NECT and possibly converting it into an endowment with your institution; and fifth and finally – to remember, that the first cut is the deepest.