PLR 200612002: Retained trust powers leave gift incomplete; one income tax issue deferred

Plain-English summary

A trust creator retained a limited power to direct property at death and could receive trust property with a committee member's consent. The IRS ruled that the creator's transfer to the trust was an incomplete gift and that committee members would not make taxable gifts if trust property was distributed back to the creator. It also found that the trust terms did not make the creator the owner under several grantor trust provisions. Whether administrative control would make the creator an owner under IRC § 675 depended on how the trust operated, so the IRS deferred that issue until an examination. A gift could become taxable when property went to another beneficiary or the creator released the testamentary appointment power during life.

Ruling snapshot

• Question: Who would be taxed on trust income, and would the transfer or a distribution back to the creator be a completed gift?
• Outcome: Mixed: gift questions resolved in favor of no completed gift; the section 675 ownership question was deferred.
• Key authorities: IRC §§ 671-677, 2501, 2511, 2514; Treas. Reg. § 25.2511-2.

Full text (IRS public release)

Internal Revenue Service
Department of the Treasury
Washington, DC 20224
Number: 200612002
Third Party Communication: None
Release Date: 3/24/2006
Date of Communication: Not Applicable
Index Number: 671.00-00, 2501.01-00
Person To Contact:
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-------------------------, ID No. ------------
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Telephone Number:
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Refer Reply To:
CC:PSI:B02
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PLR-134405-05
Date:

November 23, 2005

X = ------------------------------------------------------------------------------------
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Y = ------------------------------------------------------------------------------------
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Z = ------------------------------------------------------------------------------------
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Individual = ------------------
Beneficiary
Trust = ------------------------

State 1 = -------------

State 2 = --------

D1 = ----------------

Dear ------------:

This letter responds to a letter dated June 23, 2005, submitted on behalf of X, Y, and Z by their authorized representative, requesting rulings under §§ 671 and 2501 of the Internal Revenue Code.

The information submitted states that X, a resident of State 1, executed Trust on D1, which is governed by the laws of State 2 and has a State 2 corporate trustee.

Paragraph 2.1 of Trust provides that during the lifetime of X, any property that is directed to be held in accordance with the terms and conditions set forth in Article Second shall be held by the trustee, in trust, nevertheless, in a separate trust for the
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following uses and purposes: to manage, invest and reinvest the same, to collect the income thereof, and to pay over or apply the net income and principal thereof to such extent, if any, including the whole thereof, and in such amounts and proportions, including all to one to the exclusion of the others, and at such time or times as (a) the Power of Appointment Committee by unanimous agreement shall appoint, or (b) X and one member of the Power of Appointment Committee by unanimous agreement shall appoint, to or for the benefit of such one or more members of the class consisting of X, Y (X’s sibling), Z, X’s descendants, Individual Beneficiary, and a named private foundation (Foundation) (if it is a qualified charitable organization) until the death of X. Any net income (which may be the whole of such income) not so paid over or applied shall be accumulated and added to the principal of Trust at least annually and thereafter shall be held, administered and disposed of as a part thereof.

Paragraph 2.2 provides that upon the death of X, the principal of Trust under Paragraph 2.1 of Article Second, as it is then constituted, and any accumulated accrued and undistributed income, shall be transferred, conveyed and paid over to such person or persons (other than X, X’s estate, X’s creditors and the creditors of X’s estate) to such extent, in such amount or proportions, and in such lawful interests or estates, whether absolute or in trust, as X may appoint by last will and testament by specific reference to this power. X may, at any time and from time to time during X’s life by a written, acknowledged instrument delivered to the trustee, release such power of appointment with respect to any or all of the property subject to such power or may further limit the persons or entities in whose favor or the extent to which this power may be exercised.

If the power of appointment is for any reason not effectively exercised in whole or in part, by X, the principal of Trust, as it is then constituted, to the extent not effectively appointed by X upon X’s death, shall be disposed of as follows: (a) the lesser of (1) 10% of the principal of Trust, as it is then constituted, together with any accumulated, accrued, and any undistributed income, to the extent not effectively appointed by X upon X’s death, or (2) two million dollars shall be transferred, conveyed, and paid over to the Foundation, if it is then in existence and a qualified charitable organization; and (b) the balance of the principal of Trust, as it is then constituted, together with any accumulated, accrued, and any undistributed income, to the extent not effectively appointed by X upon X’s death, shall be divided into a sufficient number of equal shares so that there shall be set aside one such share for X’s named current spouse (Spouse), if Spouse is then living, one such share for each child of X who is then living, and one such share for the collective descendants who are then living of any child of X who is not then living. From each such share so set aside for the collective descendants who are then living of any child of X who is not then living there shall be set aside per stirpital parts for such descendants. Each child who is then living for whom a share is set aside and each descendant who is then living of a child of X who is not then living for whom a per stirpital part is set aside is referred to as a “primary beneficiary.” The share set aside for Spouse, if Spouse is then living shall be transferred, conveyed, and paid over to Spouse. The share or part of a share set aside for a primary beneficiary shall be held
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in a separate trust in accordance with the terms and conditions set forth in Article Third of Trust. If Spouse is not then living or is not then married to X, and no descendant of X is then living, the balance of the principal of Trust, as it is then constituted, together with any accumulated, accrued, and any undistributed income, to the extent not effectively appointed by X upon X’s death, shall be disposed of in accordance with the terms and conditions set forth in Article Fourth of Trust.

Article Fourth provides that any property that is directed to be disposed of in accordance with the terms and conditions set forth in Article Fourth shall be divided into shares for the benefit of certain named individuals and Foundation (if it is then in existence and a qualified charitable organization) as provided therein.

Paragraph 12.4 provides that the Power of Appointment Committee shall initially consist of Y and Z. At all times, at least two persons who are beneficiaries under Trust (other than X, Spouse, or any successor spouse of X), or who are parents or guardians (other than X, Spouse, or any successor spouse of X) of such beneficiaries if there are less than two adult beneficiaries, shall be members of the Power of Appointment Committee. In the event that either Y or Z shall die before the death of X, Individual Beneficiary shall become the successor member of the Power of Appointment Committee. If any additional member of the Power of Appointment Committee dies before the death of X, the then eldest living descendant of X who is not a member of the Power of Appointment Committee shall become the successor member of the Power of Appointment Committee. Any member of the Power of Appointment Committee shall exercise the power of appointment granted under Article Second only in a non-fiduciary capacity and shall manifest any exercise of the power of appointment granted under Article Second by an acknowledged instrument in writing delivered to the trustee.

You have requested the following rulings:

1. So long as the Power of Appointment Committee is serving, no portion of the items of income, deductions, and credits against tax of Trust shall be included in computing the taxable income, deductions, and credits of X under § 671.

2. The contribution of property to Trust by X will not be a completed gift subject to federal gift tax.

3. Any distribution of property from Trust to X by the Power of Appointment Committee will not be a completed gift subject to federal gift tax.

RULING 1

Section 671 provides that where it is specified in subpart E of part I of subchapter J that the grantor or another person shall be treated as the owner of any portion of a trust, there shall then be included in computing the taxable income and credits of the grantor or the other person those items of income, deductions, and credits against tax of
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the trust which are attributable to that portion of the trust to the extent that such items would be taken into account under chapter 1 in computing taxable income or credits against the tax of an individual.

Section 672(a) provides, for purposes of subpart E, the term “adverse party” means any person having a substantial beneficial interest in the trust which would be adversely affected by the exercise or nonexercise of the power which he possesses respecting the trust.

Sections 673 through 677 specify the circumstances under which the grantor is treated as the owner of a portion of a trust.

Section 673(a) provides that the grantor shall be treated as the owner of any portion of a trust in which the grantor has a reversionary interest in either the corpus or the income therefrom, if, as of the inception of that portion of the trust, the value of such interest exceeds 5 percent of the value of such portion.

Section 674(a) provides, in general, that the grantor shall be treated as the owner of any portion of a trust in respect of which the beneficial enjoyment of the corpus or the income therefrom is subject to a power of disposition, exercisable by the grantor or a nonadverse party, or both, without the approval or consent of any adverse party.

Section 674(b)(3) provides that § 674(a) shall not apply to a power exercisable only by will, other than a power in the grantor to appoint by will the income of the trust where the income is accumulated for such disposition by the grantor or may be so accumulated in the discretion of the grantor or a nonadverse party, or both, without the approval or consent of any adverse party.

Under ' 675 and applicable regulations, the grantor is treated as the owner of any portion of a trust if, under the terms of the trust agreement or circumstances attendant on its operation, administrative control is exercisable primarily for the benefit of the grantor rather than the beneficiary of the trust.

Section 676(a) provides that the grantor shall be treated as the owner of any portion of a trust, whether or not he is treated as such owner under any other provision of part I, subchapter J, chapter 1, where at any time the power to revest in the grantor title to such portion is exercisable by the grantor or a nonadverse party, or both.

Section 677(a) provides, in general, that the grantor shall be treated as the owner of any portion of a trust, whether or not he is treated as such owner under ' 674, whose income without the approval or consent of any adverse party is, or, in the discretion of the grantor or a nonadverse party, or both, may be (1) distributed to the grantor or the grantor=s spouse; (2) held or accumulated for future distribution to the grantor or the grantor=s spouse; or (3) applied to the payment of premiums on policies of insurance on the life of the grantor or the grantor=s spouse.
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Based solely on the facts and representations submitted, we conclude an examination of Trust reveals none of the circumstances that would cause X to be treated as the owner of any portion of Trust under '' 673, 674, 676, or 677.

We further conclude that an examination of Trust reveals none of the circumstances that would cause administrative controls to be considered exercisable primarily for the benefit of X under ' 675. Thus, the circumstances attendant on the operation of Trust will determine whether X will be treated as the owner of any portion of Trust under ' 675. This is a question of fact, the determination of which must be deferred until the federal income tax returns of the parties involved have been examined by the office with responsibility for such examination.

RULINGS 2 AND 3

Section 2501(a)(1) provides for the imposition of a gift tax on the transfer of property by gift. Section 2511(a) provides that the gift tax applies to a transfer by way of gift whether the transfer is in trust or otherwise, whether the gift is direct or indirect, and whether the property is real or personal, tangible or intangible.

Section 25.2511-2(b) of the Gift Tax Regulations provides that a gift is complete as to any property with respect to which the donor has so parted with dominion and control as to leave the donor with no power to change the disposition of the property, whether for the donor’s own benefit, or for the benefit of another. But if upon a transfer of property (whether in trust or otherwise) the donor reserves any power over its disposition, the gift may be wholly incomplete, or may be partially complete and partially incomplete, depending upon all the facts in the particular case. Accordingly, in every case of a transfer of property subject to a reserved power, the terms of the power must be examined and its scope determined.

Section 25.2511-2(b) provides an example, where the donor transfers property in trust to pay the income to the donor, or accumulate it in the discretion of the trustee, and the donor retains a testamentary power to appoint the remainder among the donor’s descendants. The regulation concludes that no portion of the transfer is a completed gift. However, if the donor had not retained a testamentary power of appointment, but had instead provided that the remainder should go to X or his heirs, the entire transfer would be a completed gift.

Section 25.2511-2(c) provides that a gift is incomplete in every instance in which a donor reserves the power to revest the beneficial title in himself or herself. A gift is also incomplete if and to the extent that a reserved power gives the donor the power to name new beneficiaries or to change the interests of the beneficiaries as between themselves unless the power is a fiduciary power limited by a fixed or ascertainable standard. Under § 25.2511-2(e), a donor is considered as possessing a power if it is
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exercisable by the donor in conjunction with any person not having a substantial adverse interest in the disposition of the transferred property.

Section 25.2511-2(f) provides that the relinquishment or termination of a power to change the beneficiaries of transferred property, occurring otherwise than by death of the donor, is regarded as the event which completes the gift and causes the gift tax to apply.

In Estate of Sanford v. Commissioner, 308 U.S. 39 (1939), the taxpayer created a trust for the benefit of named beneficiaries and reserved the power to revoke the trust in whole or in part, and to designate new beneficiaries other than himself. Six years later, in 1919, the taxpayer relinquished the power to revoke the trust, but retained the right to change the beneficiaries. In 1924, the taxpayer relinquished the right to change the beneficiaries. The Court held that a donor's gift is not complete, for purposes of the gift tax, when the donor has reserved the power to determine those others who would ultimately receive the property. Accordingly, the Court concluded that the taxpayer's gift was complete in 1924, when he relinquished his right to change the beneficiaries of the trust.

Section 2514(b) provides that the exercise or release of a general power of appointment shall be deemed a transfer of property by the individual possessing such power.

Section 2514(c) provides that the term "general power of appointment" means a power exercisable in favor of the individual possessing the power, the individual's estate, the individual's creditors, or the creditors of the individual's estate.

Section 25.2514-1(c)(1) provides that a power of appointment is not a general power if by its terms it is exercisable only in favor of one or more designated persons or classes other than the possessor or his creditors, or the possessor's estate or the creditors of the estate.

Section 2514(c)(3)(B) provides, that in the case of a power of appointment created after October 21, 1942, which is exercisable by the possessor only in conjunction with another person, if the power is not exercisable by the possessor except in conjunction with a person having a substantial interest in the property subject to the power, which is adverse to the exercise of the power in favor of the possessor -- such power shall not be deemed a general power of appointment. For purposes of § 2514(c)(3)(B), a person who, after the death of the possessor, may be possessed of a power of appointment (with respect to the property subject to the possessor's power) which he may exercise in his own favor shall be deemed as having an interest in the property and such interest shall be deemed adverse to such exercise of the possessor's power.
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Section 25.2514-3(b)(2) provides, in part, that a co-holder of a power of appointment has no adverse interest merely because of his joint possession of the power nor merely because he is a permissible appointee under a power. However, a co-holder of a power is considered as having an adverse interest where he may possess the power after the possessor's death and may exercise it at that time in favor of himself, his estate, his creditors, or the creditors of his estate. Thus, for example, if X, Y, and Z held a power jointly to appoint among a group of persons which includes themselves and if on the death of X the power will pass to Y and Z jointly, then Y and Z are considered to have interests adverse to the exercise of the power in favor of X. Similarly, if on Y's death the power will pass to Z, Z is considered to have an interest adverse to the exercise of the power in favor of Y. See also, Rev. Rul. 79-63, 1979-1 C. B. 302, holding that the co-holder with the decedent of a power to appoint trust property to the decedent during decedent’s life does not have a substantial adverse interest to the exercise of the power, if the co-holder will receive the trust corpus only in the event the decedent fails to exercise decedent’s testamentary limited power of appointment over the trust property.

Section 25.2514-1(b)(2) provides that the term “power of appointment” does not include the powers reserved by a donor to himself or herself. However, no provision of section 2514 or the applicable regulations is to be construed as limiting the application of any other Code section or provision of the regulations.

In this case, X has retained a limited testamentary power to appoint the Trust corpus and accumulated income to any persons (other than X’s estate, etc.) In addition, X has retained a lifetime power to appoint the Trust corpus to X with the consent of either one of Y or Z, the members of the Power of Appointment Committee, individuals who would not have a substantial adverse interest in the disposition of the transferred property for purposes of § 2511. See, Rev. Rul. 79-63, 1979-1 C.B. 302. In view of these retained powers, X’s transfer of property to Trust will not be a completed gift subject to federal gift tax. See, §25.2511-2(b); § 25.2511-2(c); § 25.2511-2(e). However, X will be treated as making a taxable gift at such time as trust corpus is distributed to a beneficiary other than X, or if, during X’s lifetime, X releases the testamentary power to appoint the Trust property. §25.2511-2(f).

In addition, Y and Z as members of the Power of Appointment Committee, have the power to distribute Trust income and corpus to themselves. However, Y’s power can only be exercised with the consent of Z, and Z’s power can only be exercised with the consent of Y. Further, on the death of either Y or Z, the deceased’s power will devolve to the survivor and Individual Beneficiary jointly. Therefore, Y and Z will not have a general power of appointment by reason of the joint distribution power. §25.2514- 3(b)(2). Accordingly, neither Y nor Z will be treated as making a taxable gift if Trust income or corpus is distributed to X under the terms of Trust.
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Except as specifically set forth above, no opinion is expressed concerning the federal tax consequences of the facts described above under any other provision of the Code.

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

In accordance with the power of attorney on file with this office, a copy of this letter is being sent to the taxpayers’ authorized representative.

Sincerely,

J. THOMAS HINES
Chief, Branch 2
Office of the Associate Chief Counsel
(Passthroughs & Special Industries)

Enclosures: 2
Copy of this letter
Copy for § 6110 purposes