PLR 200345006: Trustee changes preserve estate and generation-skipping tax treatment

Plain-English summary

Trustees of several irrevocable trusts for grandchildren proposed to change trustee selection and succession rules and appoint a trust company as an independent trustee. The plan included restrictions on who could take part in decisions about distributions to beneficiaries, even if beneficiaries held shares in the trust company. The IRS ruled that the changes and appointment would not cause trust assets to be included in a grantor's estate under IRC §§ 2036 or 2038 or in a beneficiary's estate under § 2041. It also ruled that the changes would not alter the trusts' zero inclusion ratios for generation-skipping transfer tax purposes. Those conclusions rest on the detailed restrictions and representations in the letter.

Ruling snapshot

• Question: Would the trustee restructuring cause estate inclusion or change the trusts' generation-skipping transfer tax inclusion ratios?
• Outcome: Approved: no estate inclusion under the cited sections and no change in the stated inclusion ratios.
• Key authorities: IRC §§ 2036, 2038, 2041, and 2601; Treas. Reg. § 26.2601-1(b)(4).

Full text (IRS public release)

Internal Revenue Service
Department of the Treasury

Number: 200345006
Washington, DC 20224
Release Date: 11/07/2003
Index Number: 2036.00-00, 2038.00-00, Person to Contact: 2041.00-00, 2601.03-01 Telephone Number:

Refer Reply To:
CC:PSI:B09 / PLR-138542-02
Date:
July 3, 2003

Legend

Grantor 1 =
Grantor 2 =
Trust Agreement =

Date 1 =
Grandchild 1 =
Grandchild 2 =
Grandchild 4 =
Grandchild 6 =
Grandchild 7 =
Grandchild 8 =
Trustee 1 =
Trustee 2 =
Bank =
Patriarch X =
Date 2 =
Trust 1 =
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PLR-138542-02

Date 3 =
Trust 2 =

Year 1 =
Year 2 =
Year 3 =
Year 4 =
Date 4 =
Trust 4 =

Date 5 =
Trust 6 =

Date 6 =
Trust 7 =

Date 7 =
Trust 8 =

Trust 3 =

Trust 5 =

Grandchild 3 =
Grandchild 5 =
Date 8 =
Family X =
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Family Y =

Trust Company =
State 1 =
Date 9 =
Patriarch Y =
Daughter 2 =
Daughter 3 =
Measuring Life 1 =
Measuring Life 2 =
Daughter 1 =
Measuring Life 3 =
Measuring Life 4 =
Measuring Life 5 =
Measuring Life 6 =
Date 10 =
Probate Court =
State 2 =
Trustee 3 =

Dear

This letter responds to your letter, dated July 12, 2002, and subsequent correspondence requesting rulings under §§ 2036, 2038, 2041 and 2601 of the Internal Revenue Code.

Grantor 1 and Grantor 2 (collectively referred to as “the grantors”) executed Trust Agreement on Date 1. Trust Agreement creates a series of irrevocable trusts for the grantors’ grandchildren. This letter ruling relates to the trusts created in Trust Agreement for the benefit of Grandchild 1, Grandchild 2, Grandchild 4, Grandchild 6, Grandchild 7, and Grandchild 8. Trust Agreement designates Trustee 1 as the initial family trustee and Trustee 2 as the initial independent trustee.

Article 1 of the Trust Agreement provides that the initial trust property shall constitute the initial corpus of a trust for the primary benefit of Grandchild 1. The first 4 PLR-138542-02

gift for each afterborn (or afteradopted) grandchild of the grantors shall constitute the corpus of a separate trust for the primary benefit of the grandchild.

Section 1.1(a) of the Trust Agreement provides that with respect to each grandchild’s trust, during the remainder of the grandchild’s lifetime the independent trustee may, in his discretion, distribute any part or all of the trust’s net income and/or corpus to (i) the grandchild (as primary beneficiary) and/or (ii) any one or more of the grandchild’s descendants (as secondary beneficiaries). Any income that is not thus distributed shall be added to principal. To provide greater equality among the grantors’ great-grandchildren, distributions made to a great-grandchild after age twenty-three (or before that age to get married, acquire a home, etc.) are to be treated as advances on that great-grandchild’s ultimate share of the trust (as are distributions to a great- grandchild’s children).

Section 1.1(b) of the Trust Agreement further provides that during the remainder of the grandchild’s lifetime, the grandchild, with the written consent of the then independent trustee, shall have the power to appoint any part or all of his or her trust assets during his or her lifetime (or effective at any later time during the trust’s continuation) to any one or more of the grantors’ descendants and/or their spouses (other than the grantors’ children and their spouses), but the appointment shall not benefit the grandchild, his or her creditors, his or her estate, or its creditors.

Section 3.1 of the Trust Agreement provides that the family trustee of each trust shall have the right to remove the independent trustee of that trust for any proper reason. The right to remove the family trustee of each trust (with or without cause) is held by the following persons: (a) Grantor 1 and Grantor 2 acting together, or after the incapacity or death of either Grantor 1 or Grantor 2, the other acting alone, (b) each of the grantors’ daughters (and, after a daughter’s death or incapacity, her husband) but only as to any trust for that daughter’s (or husband’s) lineal descendants and/or their spouses, (c) each of the grantors’ descendants, age twenty-five or older (or his or her designee), but only as to any trust with respect to which he or she (or his or her immediate family) is the primary beneficiary, or (d) the grantors’ eldest descendant (if at least age twenty-one), all in that order of preference.

Section 3.2 of the Trust Agreement provides that successor independent trustees shall be appointed by: (a) the family trustee of the trust, (b) the person or persons having removal rights over the family trusteeship, or (c) the then beneficiary (or beneficiaries) of that trust in that order of preference. Each independent trustee must be a properly independent person or bank as specified in Section 3.2 of the Trust Technical Provisions. Unless the appointment of a successor independent trustee is made during Grantor 1's lifetime, the successor shall not be an individual but must be a bank. Upon Grantor 1's death, unless the independent trustee of each trust is a bank, Bank shall become the successor independent trustee. By written notice to the affected independent trustee or trustees, Grantor 1 may render the preceding sentence of no effect as to one or more trusts. As to the specific trust(s) either Grantor 1 or Grantor 2, or after the death or incapacity of both grantors, any of the grantors’ daughters (or after 5 PLR-138542-02

a daughter’s death or incapacity, her husband), but only as to any trust(s) for the daughter’s (or her husband’s) lineal descendants and/or their spouses, may stipulate circumstances under which the trustee must be a bank.

Section 3.3 of the Trust Agreement provides that vacancies in the office of family trustee as to any trust may be filled (by any person then at least age twenty-five) or left vacant, all as determined by the person(s) having removal rights over that family trusteeship. After the death or incapacity of both grantors and, as to specific trusts, the death or incapacity of the grantors’ child who is the parent or ancestor of that trust’s primary beneficiary, each of the grantors’ descendants (once having attained age twenty-five) shall become the family trustee of any trust with respect to which the descendant is then the primary beneficiary.

Section 3.4 of the Trust Agreement provides that the decisions of the family trustee of each trust (if at least age thirty-five) shall control all matters relating to that trust (except any determinable solely by the independent trustee).

Article 4 of the Trust Agreement incorporates certain technical provisions that are intended to be a part of the trust agreement as though they were set forth verbatim in the agreement.

Section 5.1(b) of the Trust Technical Provisions provides that all other provisions to the contrary notwithstanding, the trusts created under Trust Agreement, unless earlier terminated shall, in any and all events, terminate on the day prior to the expiration of twenty-one years after the death of the last survivor of those lineal descendants of Patriarch X (and also lineal descendants of Trustee 2) who were living on Date 2 (when certain other family trusts involving those measuring lives were created). On termination of a trust under Section 5.1, the trustees shall pay over all of the net assets in the trust to the primary beneficiary to whom distributions of the income of the trust may properly be made (or, if there be more than one such beneficiary, then to the beneficiaries according to their then respective apparent proportionate interests in the trust as determined in the reasonable discretion of the trustees).

Trust 1 was the first trust to be created under the Trust Agreement as described in Article 1. Trust 1 is a trust for the benefit of Grandchild 1.

On Date 3, the grantors created Trust 2 under the Trust Agreement. Trust 2 is a trust for the benefit of Grandchild 2.

Date 1 and Date 3 are prior to September 25, 1985. Grantor 1 exercised a non- general power of appointment over a trust of which he was a beneficiary and appointed assets to both Trust 1 and Trust 2 in Year 1, Year 2, Year 3, and Year 4. The trustees represent that the trust over which the powers were exercised was a grandfathered trust for purposes of the generation-skipping transfer tax under the effective dates regulations and thus the additions to Trust 1 and Trust 2 did not cause any change in the generation-skipping transfer tax inclusion ratio of either trust. 6 PLR-138542-02

On Date 4, the grantors created Trust 4 under the Trust Agreement. Trust 4 is a trust for the benefit of Grandchild 4.

On Date 5, the grantors created Trust 6 under the Trust Agreement. Trust 6 is a trust for the benefit of Grandchild 6.

On Date 6, the grantors created Trust 7 under the Trust Agreement. Trust 7 is a trust for the benefit of Grandchild 7.

On Date 7, the grantors created Trust 8 under the Trust Agreement. Trust 8 is a trust for the benefit of Grandchild 8.

Additions by gift were made to the trusts after September 25, 1985. The trustees represent that all gifts qualified for the gift tax annual exclusion. Accordingly, the trustees represent that all gifts to the trusts prior to April 1, 1988, qualified for a zero generation-skipping transfer tax inclusion ratio under § 26.2601-1(b)(1)(i) or § 2642(c). The trustees also represent that, with respect to all gifts to the trusts made after March 31, 1988, a portion of the donor’s (and the donor’s spouse, when applicable) generation-skipping transfer tax exemption was allocated in an amount sufficient to give those trusts an inclusion ratio of zero for generation-skipping transfer tax purposes.

The grantors also created Trust 3 and Trust 5 under the Trust Agreement.
Trust 3 is a trust for the benefit of Grandchild 3 and Trust 5 is a trust for the benefit of Grandchild 5. Trust 3 and Trust 5, however, are not the subject of this private letter ruling. This private letter ruling addresses Trust 1, Trust 2, Trust 4, Trust 6, Trust 7, and Trust 8.

On Date 8, Family X and Family Y entered into a participation agreement and later filed the Articles of Association for Trust Company, a limited banking association, in State 1. As part of that agreement, the initial participants adopted bylaws to provide for the orderly management of Trust Company. Trust Company was formed to provide specialized services to individuals and families facing the same challenges in trust management as Family X and Family Y. The bylaws and participation agreement were amended and restated on Date 9. Additional modifications have been proposed that are the subject of this private letter ruling request. Excerpts from the bylaws and participation agreement in this letter reflect the Date 9 modifications and the proposed modifications.

Trust Company initially had two classes of shares, Class A and Class B, each of which represented fifty percent of the total voting power of all Trust Company’s outstanding shares. Family X owns all of the Class A shares and Family Y owns all of the Class B shares. The Class A shares were initially issued to and are still held by two trusts (not the subject of this letter ruling) whose grantor and beneficiaries are members of Family X and whose trustees are unrelated to members of Family Y. The Class B shares were initially issued to a voting trust of which eleven trusts for the benefit of the 7 PLR-138542-02

members of Family Y are the beneficial owners. Grantor 1 and Grantor 2 are members of Family X.

On Date 9, the Articles of Association of Trust Company were amended to authorize the issuance of shares of Class E stock. The Class E stock will have no voting rights except as set forth in Section 4.2(b)(2) of the Bylaws and Participation Agreement relating to the authorization of additional Class E shares and the amendment of the restrictions on transfer of ownership of the Class E shares. Under the amendment, Class A shares may only be transferred to Class A permitted transferees, Class B shares may only be transferred to Class B permitted transferees, and Class E shares may only be transferred with the approval the holders of more than sixty-five percent of the issued and outstanding Class E shares.

Section 7.2 of the bylaws and participation agreement of Trust Company provides in part that there shall initially be nine directors of Trust Company. The board of directors may expand the number of director positions. Notwithstanding the foregoing, Trust Company shall not have less than five or more than fifteen directors.

Section 7.17(a) of the bylaws and participation agreement of Trust Company provides that no officer or director of Trust Company shall participate in a decision of Trust Company (nor be present during any board or committee discussion of or vote on such a decision) involving the exercise of any discretionary power, other than investment powers, with respect to any trust of which Trust Company is a trustee if the officer, director, or spouse of the officer or director is:

(1) a grantor or donor to the trust;
(2) a current or contingent beneficiary of the trust; or (3) a descendant, or spouse (or former spouse) of a descendant of either Patriarch X or Patriarch Y. Section 7.17(a)(3), however, shall apply only to a trust a current or contingent beneficiary of which is a descendant, or a spouse (or former spouse) of a descendant, of either Patriarch X or Patriarch Y.

Section 7.17(b) provides that no officer or director of Trust Company shall participate in a decision of Trust Company (nor be present during any board or committee discussion of or vote on such a decision) involving the exercise of any incidents of ownership of any life insurance policy insuring the life of the officer or director.

Section 7.17 further provides that a director that is subject to the restrictions of this Section 7.17 with respect to a decision of Trust Company, although absent from at least that part of the meeting, shall be deemed present for the purpose of determining whether a quorum is present for that part of the meeting.

Section 7.18 of the bylaws and participation agreement provides that an “Independent Director” is a director who is neither an employee of Trust Company nor, with respect to a particular trust of which Trust Company is a trustee, related or 8 PLR-138542-02

subordinate within the meaning of § 672(c) to any individual described in Section 7.17(a)(1), (2), or (3). The board of directors and the participants shall take all necessary actions to cause there to be in office at all times at least one director who is not precluded under Section 7.18 or Section 7.19 from participating in the making of any decisions of Trust Company described in Section 7.17.

Section 7.19 of the bylaws and participation agreement provides that subject to the requirements of applicable law and to enable directors to comply when advisable with taxation laws, restrictions on self-dealing, or other matters, a director is authorized to renounce, either revocably or irrevocably, for any period of time, by an instrument in writing delivered to and accepted by Trust Company, his or her right and power to participate in the making of any Trust Company decision involving the exercise of any discretionary power, other than investment or administrative powers not affecting any beneficiary’s beneficial enjoyment, with respect to any trust of which Trust Company is a trustee.

The current trustees propose to modify Trust Agreement to update each trust’s administrative provisions and to revise each trust’s trustee requirements, trustee selection and trustee succession provisions to better provide for the long-term management of the trusts. Some of the modifications to the trusts redesignate substantive provisions from one article to another in order to provide uniformity in the structure of the Family X trusts. In addition to the proposed modifications, the current trustees intend to appoint Trust Company to serve as an independent trustee.

Section 3.1(a) of the Trust Agreement will provide that any one or more of the three trustee offices may either be occupied or left vacant, provided that the office of corporate independent trustee must at all times be occupied. Section 3.1(b) will provide that two of the trustee positions are “independent trustee” offices. One may be occupied by an individual and the other must be occupied by a corporate independent trustee. Section 3.1(c) will provide that the third trustee position will be the “family trustee” office.

Section 3.2(d) of the Trust Agreement will provide that the family trustee may remove the corporate independent trustee for the reasons set forth in Section 3.2(d)(1) of the Trust Technical Provisions. The individual independent trustee may remove the corporate independent trustee with or without cause.

Section 3.2(d)(1) of the Trust Technical Provisions will describe the circumstances in which the family trustee may remove the corporate independent trustee. Section 3.2(d)(1)(A) will provide that the removal power may not be exercised in a manner contrary to the specific restrictions on fiduciary actions listed in Section 4.2(a) of the Trust Technical Provisions.

Section 3.2(d)(1)(B) of the Trust Technical Provisions will provide that the notice of removal will set forth the reason(s) for the removal of the corporate independent trustee. The reasons need not be such as to justify judicial removal and include the 9 PLR-138542-02

following: (i) the family trustee believes the expense of administering the trust can be reduced, or its investment needs can be better served, by a trustee change; (ii) a personality conflict or difference of opinion as to the investment philosophy to be followed by the trust has arisen with the trustee (or the trust officer assigned); (iii) the trustee’s reports are not responsive to the needs of the family trustee; (iv) the trust would be more conveniently administered in another location; or (v) the trustee’s services are being adversely affected by ineffectiveness, unavailability, trust officer turnover, or inexperience.

Section 3.2(e) of the Trust Agreement will provide that the family trustee may remove the then acting individual independent trustee for the reasons set forth in Section 3.2(e) of the Trust Technical Provisions. Section 3.2(e) of the Trust Technical Provisions will describe the circumstances in which the family trustee may remove the individual independent trustee. Section 3.2(e)(1) will provide that the power may not be exercised in a manner contrary to the specific restrictions on fiduciary actions listed in Section 4.2(a) of the Trust Technical Provisions. Section 3.2(e)(2) will provide that the notice of removal will set forth the reason(s) for removal which must meet the criteria and, in general, be similar to those described in paragraph 3.2(d)(1)(B), except for sub- paragraph 3.2(d)(1)(B)(v). In addition, Section 3.2(e)(2) will provide that the individual independent trustee may be removed if the trustee’s services are being adversely affected by age, health, ineffectiveness, unavailability, or inexperience.

Section 3.2(f) of the Trust Agreement will provide that the right to remove the family trustee of each trust (with or without cause) is held by the top control list person(s) who shall be the first in order and is “eligible” to act. Section 3.2(f)(1)(A) will provide that first level of the control list includes Daughter 2 (or her designees) or Daughter 3 (or her designees), as the case may be, if she or a descendant of hers is the primary beneficiary of the trust. Section 3.2(f)(1)(B) will provide that the second level of the control list includes Daughter 2 or Daughter 3's most senior generation descendant(s), if any, who (or each of whom) is an ancestor of any of that trust’s primary beneficiary (or such ancestor’s designees). Section 3.2(f)(1)(C) will provide that the third level of the control list includes the primary beneficiary of the trust (or that individual’s designees). Section 3.2(f)(1)(D) will provide that the fourth level of the control list includes the primary beneficiary’s descendant(s) of the most senior generation having an eligible descendant (or the descendant’s or descendants’ designees). Section 3.2(f)(1)(E) will provide that the last level of the control list includes the most senior generation descendant(s) of the closest ancestor of any of that trust’s primary beneficiary who has an eligible descendant, provided that each most senior generation descendant is a descendant of Patriarch X (or such descendant’s or descendants’ designees). An individual is “eligible” to act as a family trustee control list person if he or she is not incapacitated and at least twenty-five years old (or at least twenty-one years old if he or she is one of the “most senior generation” descendants of a particular individual). When two or more persons occupy a place on a control list, their removal, appointment, and other actions must be by a majority of them. 10 PLR-138542-02

Section 3.3(a) of the Trust Agreement will provide that whenever a vacancy exists in the office of family trustee for any trust created under this trust instrument, the control list person(s) then having, and while continuing to have, the right to remove the family trustee of that trust, may, at any time, select and appoint an individual (age twenty-five or older), even the appointor himself or herself, to fill the vacancy (which, until thus filled, shall remain vacant).

Section 3.3(b) of the Trust Agreement will provide that whenever a vacancy exists in (i) the office of the corporate independent trustee of any trust, or (ii) the office of the individual independent trustee if the office is required to be kept filled (under the provisions of Section 3.5), the office shall be promptly filled by a qualified successor to that office. The successor independent trustee shall be selected and appointed by the family trustee of the trust. If the vacancy is not filled within thirty days (or if there is no family trustee when the vacancy occurs), the successor independent trustee shall be selected and appointed by the top control list person(s) for the trust. If the vacancy is not filled within thirty days of when the top control list person (or all of those persons) first becomes aware that the vacancy had not been (or could not be) filled, the successor shall be selected and appointed by the representative beneficiary (or the representative beneficiaries) of the trust. If the vacancy is not filled within sixty days of when the representative beneficiary (or all of them) first becomes aware that the vacancy had not been filled, the successor shall be selected and appointed by the court having jurisdiction over the trust.

Section 3.3(c) of the Trust Agreement will provide that whenever a trust has only one independent trustee then acting and its other independent trustee office is not then required to be kept filled or left vacant (under Section 3.5), that trust’s then family trustee may at any time appoint an individual independent trustee (meeting the qualifications of the vacant office). Until such appointment is made, or until the circumstances change, the other independent trustee office shall remain vacant.

Section 3.4(a) of the Trust Agreement will provide that a corporate independent trustee must be an “independent” bank or trust company as described in Section 3.4(a) of the Trust Technical Provisions. Section 3.4(a) of the Trust Technical Provisions will provide that to be eligible to serve as an independent trustee of a specific trust under the trust agreement, a bank or trust company must have certain “corporate independent trustee qualifications.”

Section 3.4(a)(2) of the Trust Technical Provisions will provide that the corporate independent trustee position must be filled by a bank or trust company with respect to which no donor to or current or contingent beneficiary of that trust personally holds voting rights, regardless of whether the rights are held in an individual or a fiduciary capacity (or both) that, when aggregated with any voting rights held by that trust, are more than fifty percent of the total voting rights relating to the control of the bank or trust company. 11 PLR-138542-02

Section 3.4(a)(3) of the Trust Technical Provisions will provide that the bank or trust company must maintain and enforce “firewall rules” prohibiting any individual who is “connected” to the bank or trust company (including an officer, director, employee, or “one percent shareholder”, as defined in the document) from participating in a decision of the bank or trust company involving the exercise of either: (A) any incidents of ownership with respect to any insurance on the life of such individual, whether owned by the bank or trust company or owned by any trust as to which the bank or trust company is acting as an independent trustee, and/or (B) any discretionary power, other than investment or administrative powers not affecting any current or contingent beneficiary’s enjoyment of that trust, the effect of which would be to make or withhold any distribution from (or to grant or withhold permission to enjoy any asset of) that trust in favor of: (i) any individual (if the connected individual is a living donor or an individual related to a living donor) or (ii) a current or contingent beneficiary or any individual whom the beneficiary is then under an obligation to support (if the connected individual is the beneficiary or an individual related to the beneficiary), but the paragraph (B) restriction shall not apply to any individual who would be eligible to serve as an individual independent trustee of that trust under paragraph (b)(3) of Section 3.4, substituting for this purpose, “one percent” for “fifty percent” in subparagraph (B) of Section 3.4(b)(3).

Section 3.4(a)(3)(B)(ii)(I) of the Trust Technical Provisions will provide that a “one percent shareholder” shall mean any individual who holds voting rights, whether the rights are held in an individual or a fiduciary capacity (or both) that, when aggregated with the voting rights of any trust of which the individual is a donor or a current or contingent beneficiary, represent more than one percent of the voting rights of all of the then issued and outstanding shares of the bank or trust company.

Section 3.4(a)(3)(B)(ii)(II) of the Trust Technical Provisions will provide that an individual shall be considered to be “related” to a living donor or current or contingent beneficiary if related in any of the following classifications: spouse, ancestor, lineal descendant, brother or sister.

Section 3.4(b) of the Trust Agreement will provide that each individual independent trustee shall be an “independent” and “experienced” individual who is not related to nor employed by any trust donor or beneficiary as described in Section 3.4(b) of the Trust Technical Provisions. Section 3.4(b) of the Trust Technical Provisions will provide that to be eligible to serve as an independent trustee of a specific trust under the trust agreement, an individual must have certain “individual independent trustee qualifications.” Section 3.4(b)(3) will provide the individual may not be either (A) a donor to or a current or contingent beneficiary of the trust nor related to a donor or beneficiary who is then living in any of the following classifications: spouse, ancestor, lineal descendant, brother, or sister; or (B) an employee of a donor to or current or contingent beneficiary of the trust or of any corporation, firm, or partnership (I) in which a donor or beneficiary is an executive or (II) with respect to which a donor or beneficiary personally holds voting rights, regardless of whether the rights are held in an individual or a fiduciary capacity (or both), that when aggregated with any voting rights held by 12 PLR-138542-02

that trust, are more than fifty percent of the total voting rights relating to the control of the corporation, firm, or partnership.

Section 3.5 of the Trust Agreement will provide that the top control list person(s) for any present or future trust under this agreement may by stipulation require that, under certain circumstances the office of individual independent trustee office shall be (i) kept filled, (ii) left vacant, or (iii) be filled or left vacant as the family trustee may, from time to time, determine.

Section 3.6 of the Trust Agreement will provide that except as to investment matters during any period in which investment powers are assigned to the corporate trustee alone, (i) if a bank and an individual are co-independent trustees, the individual independent trustee can decide what the independent trustee decisions will be (as to any and all matters) and (ii) the trust’s initial family trustee (and successors, age thirty- five or older) can decide what the trustees’ decisions will be as to any and all matters except those reserved to the independent trustee(s) alone (such as those relating to discretionary distributions to beneficiaries).

Section 4.2(a) of the Trust Technical Provisions will provide that all trustees at any time acting with respect to any trust under the trust agreement, when exercising their powers and discretions as trustees, shall act as fiduciaries and not as the holders of powers for their own benefit. Specifically, Section 4.2(a)(6) provides that any power that any trustee of any trust(s) established under Trust Agreement may have to remove any trustee(s) shall be exercisable in accordance with the terms and procedures set forth regarding removal. Furthermore, unless a trustee removal power is expressly referred to or described either: (a) as an absolute right and power that the powerholder may exercise to remove a trustee from office that is exercisable by the powerholder with or without cause or (b) as a power that is not held (or not intended to be held) in a fiduciary capacity, all trustee removal rights shall be exercisable only in furtherance of trust purposes and not as a means of obtaining the personal goals of the powerholder (or a trust beneficiary) by influencing, through trustee removal, the manner in which discretions granted exclusively to the trustee(s) subject to removal are to be exercised. Section 4.2(a)(6)(B) will provide a procedure for a removed trustee to obtain judicial review regarding whether a decision to remove a trustee was in furtherance of trust purposes or intended to achieve personal goals.

Section 5.1(b) of the Trust Technical Provisions will provide that all other provisions of the agreement to the contrary notwithstanding, each trust that comes into existence under the agreement shall be subject to the following limitations on its duration. Unless earlier terminated, each trust under the agreement (except any trust all of the assets of which are then unqualifiedly withdrawable by its primary beneficiary) shall, in any and all events, terminate on the “rule against perpetuities required termination date” applicable to that trust. The rule against perpetuities required termination date on which the trust shall terminate shall be the day prior to the expiration of twenty-one years after the death of the last survivor of a group of individuals composed of the lineal descendants of Patriarch X and Trustee 2 who were 13 PLR-138542-02

living on Date 2, namely: Grantor 1, Measuring Life 1, Measuring Life 2, Daughter 1, Daughter 2, Daughter 3, Measuring Life 3, Measuring Life 4, Measuring Life 5, and Measuring Life 6.

On Date 10, Probate Court in State 2 issued an order affecting the trusts that are the subject of this private letter ruling. The order approves an interim trustee succession plan proposed by the trustees and agreed to by the adult beneficiaries of the various trusts and a guardian ad litem representing the minor and unborn beneficiaries. The agreement signed by the parties defines a “trust restructuring period” that begins on Date 10. The trust restructuring period ends after the Internal Revenue Service issues a private letter ruling and Probate Court issues a final order approving the trust restructuring plan. The Date 10 Probate Court order provides that during the trust restructuring period, the requirement that a currently acting individual trustee must resign in favor of a bank or trust company upon the death of both grantors is suspended. In addition, the order creates an additional independent trustee office and appoints Trustee 3 to fill the office. If a vacancy occurs in a co-independent trustee office during the trust restructuring period, the vacancy shall be filled by a qualified individual or left vacant in the discretion of the person(s) who hold the power to appoint a successor independent trustee under the applicable section of the original Trust Agreement.

The trustees have requested the following rulings: (1) the implementation of the proposed trust restructuring plan will not cause the value of the assets of the trusts created under Trust Agreement to be included in the gross estate of any grantor or beneficiary under §§ 2036, 2038 or 2041; and (2) the implementation of the proposed trust restructuring plan will not result in any change in the inclusion ratio of any of the trusts created under Trust Agreement for purposes of the generation-skipping transfer tax.

Ruling 1

Section 2036(a) provides that the value of the gross estate shall include the value of all property to the extent of any interest therein of which the decedent has at any time made a transfer (except in the case of a bona fide sale for an adequate and full consideration in money or money’s worth), by trust or otherwise, under which he has retained for his life or for any period not ascertainable without reference to his death or for any period which does not in fact end before his death –

(1) the possession or enjoyment of, or the right to the income from, the property, or
(2) the right either alone or in conjunction with any person, to designate the persons who shall possess or enjoy the property or the income therefrom.

Section 2036(b)(1) provides in part that for the purposes of § 2036(b)(1), a corporation shall be treated as a controlled corporation if, at any time after the transfer of the property and during the three-year period ending on the date of the decedent’s 14 PLR-138542-02

death, the decedent owned (with the application of § 318), or had the right (either alone or in conjunction with any person) to vote, stock possessing at least twenty percent of the total combined voting power of all classes of stock.

Section 20.2036-1(b)(3) provides in part that if a decedent reserved the unrestricted power to remove or discharge a trustee at any time and to appoint himself as trustee, the decedent is considered as having the powers of the trustee.

Section 2038(a)(1) provides that the value of the gross estate shall include the value of all property to the extent of any interest therein of which the decedent has at any time made a transfer (except in the case of a bona fide sale for an adequate and full consideration in money or money’s worth), by trust or otherwise, where the exercise of a power (in whatever capacity exercisable) by the decedent alone or by the decedent in conjunction with any other person (without regard to when or from what source the decedent acquired the power), to alter, amend, revoke, or terminate, or where any power is relinquished during the three-year period ending on the date of decedent’s death.

Section 20.2038-1(a)(3) provides in part that if a decedent had the unrestricted power to remove or discharge a trustee at any time and appoint himself trustee, the decedent is considered as having the powers of the trustee.

Section 2041(a)(2) provides that the value of the gross estate shall include the value of all property to the extent of any property with respect to which the decedent has, at the time of his death, a general power of appointment created after October 21, 1942, or with respect to which the decedent has at any time exercised or released a power of appointment by a disposition which is of such nature that if it were a transfer of property owned by the decedent the property would be includible in the decedent’s gross estate under §§ 2035 to 2038, inclusive. For purposes of § 2041(a)(2), the power of appointment shall be considered to exist on the date of the decedent’s death even though the exercise of the power is subject to a precedent giving of notice or even though the exercise of the power takes effect only on the expiration of a stated period after its exercise, whether or not on or before the date of the decedent’s death notice has been given or the power has been exercised.

Section 2041(b)(1) provides that a general power of appointment is a power that is exercisable in favor of the decedent, the decedent’s estate, the decedent’s creditors, or the creditors of the decedent’s estate. However, a power to consume, invade, or appropriate property for the benefit of the decedent that is limited by an ascertainable standard relating to the health, education, support, or maintenance of the decedent shall not be deemed a general power of appointment.

Section 20.2041-1(b)(1) provides, in part, that a power in a donee to remove or discharge a trustee and appoint himself may be a power of appointment. For example, if under the terms of the instrument, the trustee or his successor has the power to appoint the principal of the trust for the benefit of individuals including himself, and the 15 PLR-138542-02

decedent has the unrestricted power to remove or discharge the trustee at any time and appoint any other person including himself, the decedent is considered as having a power of appointment. However, the mere power of management, investment, custody of assets, or the power to allocate receipts and disbursements as between income and principal, exercisable in a fiduciary capacity, whereby the holder has no power to enlarge or shift any of the beneficial interests therein except as an incidental consequence of the discharge of the fiduciary duties is not a power of appointment.

Rev. Rul. 95-58, 1995-2 C.B. 191, holds that a decedent/grantor’s reservation of an unqualified power to remove a trustee and appoint an individual or corporate successor trustee that is not related or subordinate to the decedent within the meaning of § 672(c), is not considered a reservation of the trustee’s discretionary powers of distribution over the property transferred by the decedent/grantor to the trust. Accordingly, the trust corpus was not included in the decedent’s gross estate under §§ 2036 or 2038. The ruling notes that the Eighth Circuit in Estate of Vak v. Commissioner, 973 F.2d 1409 (8th Cir. 1992), concluded that the decedent had not retained dominion and control over assets transferred to a trust by reason of his power to remove and replace the trustee with a party that was not related or subordinate to the decedent. Accordingly, the court held that under § 25.2511-2(c), the decedent made a completed gift when he created the trust and transferred assets to it.

Section 672(c) defines the term “related or subordinate party” to mean any nonadverse party who is (1) the grantor’s spouse if living with the grantor; or (2) any one of the following: the grantor’s father, mother, issue, brother or sister; an employee of the grantor; a corporation or any employee of a corporation in which the stock holdings of the grantor and the trust are significant from the viewpoint of voting control; a subordinate employee of a corporation in which the grantor is an executive.

In order for §§ 2036-2038 to apply, the decedent must have made a transfer of property or any interest therein (except in the case of a bona fide sale for an adequate and full consideration in money or money’s worth) under which the decedent retained an interest in, or power over, the income or corpus of the transferred property. For purposes of §§ 2036 and 2038, it is immaterial in what capacity the power was exercisable by the decedent.

In the present case, only the independent trustee(s) possess the power to make discretionary distributions from Trust 1, Trust 2, Trust 4, Trust 6, Trust 7 and Trust 8. Section 3.2 of the Trust Agreement and Technical Provisions governing all of the trusts will authorize the removal of the independent trustee(s) by either the family trustee (which may include the grantors or a beneficiary of the trusts) or the other independent trustee (which may include Trust Company). Section 3.3 of the Trust Agreement and Technical Provisions will describe how vacant trustee positions will be filled. Section 3.3(b) of the Trust Agreement will provide that if a vacancy occurs in the office of corporate independent trustee (or in the office of individual independent trustee and that office is required to be filled under Section 3.5), the appointment of a successor trustee will be made, in order of preference, by the family trustee, the top control list 16 PLR-138542-02

person, the representative beneficiary, or a court having jurisdiction over the trust. Section 3.3(c) of the Trust Agreement will provide that, if a vacancy in the office of individual independent trustee is not required to be filled under Section 3.5, the family trustee may fill the vacancy or allow the office to remain vacant. In either case, the person or corporation filling the independent trustee office must fill the requirements of the office as described in Section 3.4 of the Trust Technical Provisions.

Section 3.4(b) of the Trust Technical Provisions will preclude a donor to or a current or contingent beneficiary of a trust from serving as the individual independent trustee. In addition, Section 3.4(a) of the Trust Technical Provisions will preclude any donor to or current or contingent beneficiary of a trust from participating in discretionary distribution decisions if they are connected to a bank or trust company serving as the corporate independent trustee. Sections 3.4(a) and 3.4(b) of the Trust Technical Provisions will further preclude any individual related to a living donor or beneficiary as spouse, ancestor, lineal descendant, brother, sister, or employee from serving as the individual independent trustee of a trust. In addition, the sections preclude these individuals from participating in discretionary distribution decisions if they are connected to a bank or trust company serving as the corporate independent trustee.

Section 3.4(b) will provide that no employee of any corporation, firm, or partnership in which a donor or beneficiary is an executive or with respect to which a donor or beneficiary personally holds voting rights regardless of whether the rights are held in an individual or a fiduciary capacity (or both), that when aggregated with any voting rights held by that trust, are more than fifty percent of the total voting rights relating to the control of the corporation, firm, or partnership may serve as the individual independent trustee.

Section 3.4(a)(2) requires that the corporate independent trustee be a bank or trust company in which no donor to or current or contingent beneficiary of the trust personally holds voting rights that, when aggregated with any voting rights held by that trust, are more than fifty percent of the total voting rights relating to the control of the bank or trust company. Section 3.4(a)(3) will also include a “firewall” provision precluding anyone connected to the bank from participating in discretionary distribution decisions in favor of any individual (if the connected individual is or is related to a living donor), a current or contingent beneficiary, or any individual whom the beneficiary is then under an obligation to support (if the connected individual is or is related to the beneficiary) unless the connected individual meets the requirements of an individual independent trustee and is not an employee of any corporation, firm, or partnership in which a donor or beneficiary personally holds voting rights, regardless of whether the rights are held in an individual or a fiduciary capacity (or both), that, when aggregated with any voting rights held by that trust, are more than one percent of the total voting rights relating to the control of the corporation, firm, or partnership. The provisions thus prohibit the grantors from participating, directly or indirectly, in discretionary distribution decisions. In addition, the provisions prohibit any individual beneficiary from participating, directly or indirectly, in discretionary distribution decisions. Finally, the 17 PLR-138542-02

provisions preclude anyone closely related to a donor or a current or contingent beneficiary from participating in discretionary distribution decisions.

Furthermore, under the Trust Company bylaws and participation agreement, the grantors, beneficiaries and other family members are all eligible to participate as a director of Trust Company. However, Section 7.17 expressly prohibits any officer or director from participating in a decision of Trust Company involving the exercise of a discretionary power, other than investment powers, of any trust of which the officer, director, or spouse of the officer or director is a grantor or donor to the trust or a current or contingent beneficiary of the trust. In addition, family members are prohibited from participating in Trust Company decisions relating to discretionary distributions from trusts where the current or contingent beneficiary of the trust (or his or her spouse) is a descendant of either Patriarch X or Patriarch Y. Therefore, the grantors and the beneficiaries of the trusts created under Trust Agreement are sufficiently prohibited from participating in decisions regarding discretionary distributions from their own trusts. In addition, the structure of the bylaws prohibits the grantors and beneficiaries of the Family X and Family Y trusts from participating in Trust Company’s exercise of discretion to make distributions from any of either family’s trusts preventing the possibility of outside reciprocal agreements that may indirectly give members of Family X effective control over the discretionary distributions from Trust 1, Trust 2, Trust 4, Trust 6, Trust 7 and Trust 8.

The combination of the firewall provisions in the revised Trust Agreement, Trust Technical Provisions, and the Trust Company Bylaws preclude a donor of any of the trusts from having the retained dominion and control as contemplated by §§ 2036 or 2038. Neither grantor, therefore, will be considered as having the powers of the trustees under §§ 20.2036-1(b)(3), or 20.2038-1(a)(3) solely as a result of possessing, directly or indirectly, the power to remove and/or to replace either independent trustee under Trust Agreement. In addition, although both grantors may be shareholders in and participate in the daily activities of Trust Company, they are precluded from participating in discretionary distribution decisions made by Trust Company with respect to trusts created under Trust Agreement. Therefore, neither the appointment of Trust Company as trustee of the trusts nor its exercise of the discretionary powers over distributions to beneficiaries of the trusts will result in the inclusion of any portion of the trusts in the respective estates of either grantor. Accordingly, based on the facts submitted and the representations made, we conclude that the implementation of the proposed trust restructuring plan and the appointment of Trust Company as an independent trustee of the trusts will not result in the inclusion of any portion of the trusts in the estate of either grantor under §§ 2036 or 2038.

Furthermore, the combination of provisions also preclude a beneficiary from having the power to affect the beneficial enjoyment of the trust property as contemplated by § 2041. No beneficiary, therefore, will be considered as having the powers of the trustee under § 20.2041-1(b)(1) solely as a result of possessing, directly or indirectly, the power to remove and/or replace either independent trustee under Trust Agreement. In addition, although beneficiaries may be shareholders in and participate 18 PLR-138542-02

in the daily activities of Trust Company, they are precluded from participating in discretionary distribution decisions made by Trust Company with respect to trusts created under Trust Agreement. Therefore, neither the appointment of Trust Company as trustee of the trusts nor its exercise of the discretionary powers over distributions to beneficiaries of the trusts will result in the inclusion of any portion of the trusts in the respective estates of a beneficiary. Accordingly, based on the facts submitted and the representations made, we conclude that the implementation of the proposed trust restructuring plan and the appointment of Trust Company as an independent trustee of the trusts will not result in the inclusion of any portion of the trusts in the estate of a beneficiary under § 2041.

Ruling 2

Section 2601 imposes a tax on every generation-skipping transfer.

Section 2611(a) defines the term “generation-skipping transfer” to include a taxable distribution, taxable termination, and a direct skip.

The trusts created under Trust Agreement are generation-skipping transfer trusts because they provide for distributions to one or more generation of beneficiaries below the grantors’ generations. Date 1 and Date 3 are prior to September 25, 1985, and Trust 1 and Trust 2 were irrevocable on September 25, 1985. The trustees represent that, with respect to any additions made to Trust 1, Trust 2, Trust 4, Trust 6, Trust 7, or Trust 8 after September 25, 1985, the transfers qualified for the gift tax annual exclusion. In addition, transfers made to these trusts prior to April 1, 1988, qualified for a zero generation-skipping transfer tax inclusion ratio under § 26.2601-1(b)(1)(i) or § 2642(c). Finally, a sufficient portion of the donor’s (and donor’s spouse’s, when applicable) generation-skipping transfer tax exemption was allocated to the transfers made to the trusts after March 31, 1988. Accordingly, prior to the modifications, each trust had an inclusion ratio of zero.

Under § 1433(b)(2)(A) of the Tax Reform Act of 1986 and § 26.2601-1(b)(1)(i) of the Generation-Skipping Transfer Tax Regulations, the generation-skipping transfer tax provisions do not apply to any generation-skipping transfer under a trust (as defined in § 2652(b)) that was irrevocable on September 25, 1985, but only to the extent that the transfer is not made out of corpus added to the trust after September 25, 1985 (or out of income attributable to corpus so added).

Section 26.2601-1(b)(1)(ii)(A) provides that, except as provided in § 26.2601- 1(b)(1)(ii)(B) or (C), any trust in existence on September 25, 1985, is considered an irrevocable trust except as provided in §§ 26.2601-1(b)(ii)(B) or (C), which relate to property includible in a grantor’s gross estate under §§ 2038 and 2042. In the present case, the trusts created under Trust Agreement are considered to have been irrevocable on September 25, 1985, because neither § 2038 nor § 2042 applies. 19 PLR-138542-02

Section 26.2601-1(b)(4) provides rules for determining when a modification, judicial construction, settlement agreement, or trustee action with respect to a trust that is exempt from the generation-skipping transfer tax under § 26.2601-1(b)(1), (2), or (3) (hereinafter referred to as an exempt trust) will not cause the trust to lose its exempt status. The rules contained in § 26.2601-1(b)(4) are applicable only for purposes of determining whether an exempt trust retains its exempt status for generation-skipping transfer tax purposes. The rules do not apply in determining, for example, whether the transaction results in a gift subject to gift tax, or may cause the trust to be included in the gross estate of a beneficiary, or may result in the realization of capital gain for purposes of § 1001.

Section 26.2601-1(b)(4)(i)(D)(1) provides that a modification of the governing instrument of an exempt trust by judicial reformation, or nonjudicial reformation that is valid under applicable state law, will not cause an exempt trust to be subject to the provisions of chapter 13, if the modification does not shift a beneficial interest in the trust to any beneficiary who occupies a lower generation (as defined in § 2651) than the person or persons who held the beneficial interest prior to the modification, and the modification does not extend the time for vesting of any beneficial interest in the trust beyond the period provided in the original trust. Furthermore, a modification that is administrative in nature that only indirectly increases the amount transferred (for example, by lowering administrative costs or income taxes) will not be considered a shift in a beneficial interest in a trust.

With respect to Trust 1 and Trust 2, the proposed modifications do not shift a beneficial interest in any trust to a beneficiary who occupies a lower generation than the person(s) who held the beneficial interest prior to the modification. In addition, the modification does not extend the time for vesting of any beneficial interest in the trust beyond the period provided in the original trust. We therefore conclude that the proposed modifications will not change the inclusion ratio of Trust 1 or Trust 2.

A modification of the governing instrument of an exempt trust by judicial reformation, or nonjudicial reformation that is valid under applicable state law, will not cause an exempt trust to be subject to the provisions of chapter 13, if the modification does not shift a beneficial interest in the trust to any beneficiary who occupies a lower generation (as defined in § 2651) than the person or persons who held the beneficial interest prior to the modification, and the modification does not extend the time for vesting of any beneficial interest in the trust beyond the period provided in the original trust. Furthermore, a modification that is administrative in nature that only indirectly increases the amount transferred (for example, by lowering administrative costs or income taxes) will not be considered a shift in a beneficial interest in a trust.

In this case the proposed modifications do not shift a beneficial interest in any trust to a beneficiary who occupies a lower generation than the person(s) who held the beneficial interest prior to the modification. In addition, the modification does not extend the time for vesting of any beneficial interest in the trust beyond the period 20 PLR-138542-02

provided in the original trust. We therefore conclude that the proposed modifications will not change the inclusion ratio of Trust 4, Trust 6, Trust 7 or Trust 8.

Except as expressly provided herein, no opinion is expressed or implied concerning the federal tax consequences of any aspect of any transaction or item discussed or referenced in this letter.

The rulings contained in this letter are based upon information and representations submitted by the taxpayer and accompanied by a penalty of perjury statement executed by an appropriate party. While this office has not verified any of the material submitted in support of the request for rulings it is subject to verification on examination.

Pursuant to the Power of Attorney on file with this office, a copy of this letter is being sent your attorney.

This ruling is directed only to the taxpayer(s) requesting it. Section 6110(k)(3) provides that it may not be used or cited as precedent.

Sincerely,

James F. Hogan
Senior Technician Reviewer
Office of Associate Chief Counsel
(Passthroughs and Special Industries)

Enclosure
Copy of this Letter for § 6110 purposes