PLR 200804015: Dividing a family trust preserves its stated tax treatment

Plain-English summary

Trustees proposed dividing an existing family trust into three subtrusts, each primarily benefiting one son's descendants, and changing some trustee and distribution provisions. Based on the stated facts, the IRS ruled that the division would preserve the trust's exemption from generation-skipping transfer tax. The changes would not give beneficiaries taxable general powers of appointment, cause the subtrust assets to be included in their estates, or create taxable gifts. The division also would not count as a trust distribution or trigger gain or loss. The subtrusts would be separate income tax taxpayers, and the transferred assets would keep their tax bases and holding periods.

Ruling snapshot

• Question: Would dividing and modifying the family trust change its GST, estate, gift, or income tax treatment?
• Outcome: Approved; the IRS granted the nine requested rulings on the stated facts.
• Key authorities: IRC §§ 643(f), 661, 1001, 1015, 1223(2), 2041, 2514, 2601; Treas. Reg. § 26.2601-1(b)(4)(i).

Full text (IRS public release)

Internal Revenue Service
Department of the Treasury
Washington, DC 20224

Number: 200804015
Third Party Communication: None
Release Date: 1/25/2008
Date of Communication: Not Applicable
Index Number: 2601.04-01, 2601.04-03,
661.00-00, 643.00-00,
Person To Contact:
61.00-00, 1001.00-00,
------------------------, ID No. -------------
1015.00-00, 1223.00-00,
Telephone Number:
2041.00-00, 2514.00-00
---------------------
Refer Reply To:
----------------------------------------------------------- CC:PSI:B04
-----------------------------------
PLR-152039-06
------------------------------------
Date:
-----------------
October 04, 2007
------------------------------------

--------------------------------------
------------------------------------------
------------------------------------

-----------------------------------
------------------------------------------
--------------------------------------------

Legend

Trust Three = ------------------------
Date 1 = -------------------
Decedent = ----------------------------
Trust = -----------------------------------------------------------
State = -------------
Date 2 = --------------------------
Date 3 = -------------------
Date 4 = -----------------
Trust One = ----------------------
Trust Two = ----------------------
Spouse = -----------------
Date 5 = ----------------
Brother = ----------------------
Son 1 = -------------------
Son 2 = ----------------------
Son 3 = -------------------
Date 6 = ----------------------
Date 7 = ------------------------------------------
PLR-152039-06
2

State Court = ------------------------------------ State Statute 1 = -------------------------------------------- Subtrust One = ------------------------------ Subtrust Two = ------------------------------- Subtrust Three = ------------------------------ State Statute 2 = -------------------------------------------- State Statute 3 = --------------------------------------------

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

This responds to your letter dated October 31, 2006, submitted on your behalf by your authorized representative, concerning the income, estate, gift, and generation-skipping transfer (GST) tax consequences of the proposed division and modification of Trust Three.

FACTS

The facts and representations submitted are as follows.

On Date 1, Decedent created Trust, a revocable trust the terms of which are governed by the laws of State. An Amendment in Total to Trust was executed on Date 2, a date prior to October 22, 1986. Decedent was under a mental disability to amend the terms of Trust, as amended, continuously from October 22, 1986, until the date of his death on Date 3. The executor of Decedent’s estate timely filed a United States Estate (and Generation-Skipping Transfer) Tax Return (Form 706). In accordance with the requirements of § 26.2601-1(b)(3)(iii) of the Generation-Skipping Transfer Tax Regulations, the executor filed with Form 706 a certification from a qualified physician stating that Decedent was mentally incompetent at all times on and after October 22, 1986, and did not regain competence to modify or revoke the terms of the revocable trust prior to his death. The Internal Revenue Service (Service) issued an estate tax closing letter for Decedent’s estate on Date 4.

The value of the trust property was included in Decedent’s gross estate. Upon Decedent’s death, pursuant to the terms of the instrument, Trust was divided into three trusts, Trust One, Trust Two, and Trust Three. Trust Three is the subject of this ruling request. It is represented that there have been no actual or constructive additions to Trust Three for GST tax purposes after September 25, 1985.

Distributions from Trust Three were made to Spouse until her death on Date 5. The current distribution provisions of Trust Three are as follows.

Article 8.03 of Trust provides that the trustee shall distribute so much of the net income of Trust Three among all the grandchildren and the issue of the grandchildren of Decedent living at the date of each distribution in amounts and at times as the trustee in
PLR-152039-06
3

his sole discretion shall determine, without regard to equality of distribution. Any net income not so applied shall be accumulated and periodically added to principal. If no grandchild or issue of a grandchild is living on the date of any such distribution, then distribution shall be made to the then living issue of Decedent, in such amounts as the trustee in his sole discretion shall determine. If no issue of Decedent is living on the date of any such distribution, then distribution shall be made to the then living issue of Brother, in such amounts as the trustee in his sole discretion shall determine.

Article 8.04 of Trust provides that in the event any beneficiary of Trust Three then entitled to income under the provisions of Article 8.03 shall be in need of funds for his or her reasonable health, support, maintenance, and education, the trustee shall pay to or apply for the benefit of any one or more of such beneficiaries so much of the principal of the trust estate as the trustee shall determine necessary or proper for such purpose.

Article 8.05 of Trust provides that the discretionary power to sprinkle income or to invade the principal of Trust Three to or for a beneficiary who is then acting as a trustee shall be exercised by the trustee or trustees other than the trustee for whose benefit such discretionary distribution of income and or principal may be made.

Article 10 of Trust provides that Trust Three shall terminate twenty-one years after the death of the last to die of certain named individuals. Upon the termination of Trust Three, the balance of the trust estate shall be distributed on the principle of representation to the then living issue of Decedent, and if none, to the then living issue of Brother.

Article 13.01(Y) of Trust provides that upon any division or partial or final distribution of the trust estate, the trustee has the power to partition, allot, and distribute the trust estate in undivided interests or in kind, or in money, or partly in any of them, at such valuations and according to such method or procedure as the trustee shall determine.

Article 14.01 of Trust provides that upon the death of Decedent, Brother, Son 1, Son 2, and Son 3 will become co-trustees of Trust Three. Article 14.01 further provides that if only three of the individuals are living, willing, and able to act, then the three individuals will act as co-trustees, and if only two of the individuals are living, willing, and able to act, then the two individuals will act as co-trustees, and if only one of the individuals is living, willing, and able to act, then he will act as the sole trustee.

On Date 6, Brother resigned as a co-trustee. Pursuant to Article 14.01, no successor co-trustee was appointed to succeed Brother. Currently, Son 1, Son 2, and Son 3 remain as co-trustees.

On Date 7, the trustees of Trust Three petitioned State Court, pursuant to State Statute 1, for an order to divide and modify Trust Three. The trustees seek to modify Trust Three in order to: (1) divide the trust into three separate equal subtrusts, one for
PLR-152039-06
4

the benefit of the issue of Son 1, one for the benefit of the issue of Son 2, and one for the benefit of the issue of Son 3; (2) provide that each of Son 1, Son 2, and Son 3 may serve as sole trustee of the subtrust created for the benefit of his respective issue; and, (3) provide for the appointment and removal of successor trustees.

The original terms of Trust Three will apply to each separate subtrust, with the following modifications or additions.

Article 8.07 shall be added to Trust to provide that the trustee shall divide Trust Three into three equal and separate subtrusts, and administer those separate subtrusts, as follows:

A. One of the separate subtrusts shall be administered for the primary benefit of the descendants of Son 1 (Subtrust One), one for the primary benefit of the descendants of Son 2 (Subtrust Two), and one for the primary benefit of the descendants of Son 3 (Subtrust Three).
B. With respect to each son’s subtrust, the trustee of each respective trust shall distribute so much of the net income of the trust estate among all the descendants of the respective son living at the date of each such distribution in such amounts and at such times as the trustee in his sole discretion shall determine, without regard to equality of distribution. Any net income not so paid or applied shall be accumulated and periodically added to the principal of that subtrust.
C. In the event that at any time during the existence of a son’s subtrust any beneficiary then entitled to income shall be in need of funds for his or her reasonable health, support, maintenance, and education, the trustee shall pay to or apply for the benefit of any one or more of such qualified beneficiaries so much of the principal of that son’s subtrust as the trustee shall determine necessary or proper for such purposes.
D. If at any time during the existence of a son’s subtrust there should be no then living descendant of the respective son, the trustee shall distribute so much of the net income of that son’s subtrust to that son in such amounts and in such manner as the trustee shall determine. Any net income not so paid or applied shall be accumulated and periodically added to the principal of that subtrust.
In addition, if the trustee determines that the son shall be in need of funds for his reasonable health, support, maintenance, and education, the trustee shall pay to or apply for the benefit of that son so much of the principal of the son’s subtrust as the trustee shall determine necessary or proper for such purposes.
E. A son’s subtrust shall terminate upon the first to occur of (1) the termination date provided in Article 10 or (2) the date on which neither the respective son nor any descendant of son is then living. If a son’s subtrust terminates upon the termination date provided in Article 10, then despite the distribution provisions in Article 10, the balance of that son’s subtrust shall be distributed
PLR-152039-06
5
on the principle of representation to that son’s then living issue. If a son’s subtrust terminates on the date on which neither that son nor any descendant of that son is then living, the balance of that son’s subtrust shall be distributed as follows:

1. If at any time prior to the termination date provided in Article 10 neither a son nor any descendant of that son is then living, that son’s subtrust shall terminate and its remaining assets shall be added equally to the other son’s subtrusts, or, if only one exists, all to that subtrust.

2. If at any time prior to the termination of all the trusts created under document as provided in Article 10 there should be no then living descendant of Decedent, the trustee shall distribute so much of the net income of the last remaining son’s subtrust among the then living descendants of Brother, in such amounts and at such times as the trustee in his sole discretion shall determine, without regard to equality of distribution. Any net income not so paid or applied shall be accumulated and periodically applied to the principal of that last remaining son’s subtrust. In addition, if the trustee determines that any descendant of Brother shall be in need of funds for his or her reasonable health, support, maintenance, and education, the trustee shall pay to or apply for the benefit of one or more such qualified beneficiaries so much of the principal of the last remaining son’s subtrust as the trustee shall determine necessary or proper for such purposes.
F. The trustee may partition, allot, and distribute the assets of Trust Three in undivided interests or in kind, or partly in money and partly in kind, and the trustee may sell such assets as the trustee deems proper to make such division. The trustee may also distribute a disproportionate share of any assets to a particular subtrust, provided, however, that the fair market value of all assets distributed to a subtrust must equal the fair market value of the proportionate interest that subtrust is entitled to receive in all of the assets available for distribution at that time. The aggregate income tax basis of the assets distributed to each of the separate subtrusts shall be reasonably equal to the aggregate income tax basis of the assets distributed to the others.

Article 14.02 will be added to Trust to provide for the appointment and removal of trustees for each son’s subtrust, subject to the restrictions on trustee discretion contained in added Article 8.06, as follows.

A. Son 1 will be the sole trustee of Subtrust One, Son 2 will be the sole trustee of Subtrust Two, and Son 3 will be the sole trustee of Subtrust Three. A son of Decedent may appoint an additional person or persons as a co-trustee of that son’s subtrust. He may also remove without cause any additional co-trustee so appointed. If a co-trustee (including the respective son) ceases
PLR-152039-06
6
to serve, the remaining co-trustee or co-trustees may continue to serve and the co-trustee who ceased to serve need not be replaced. Thereafter, any complete vacancy in the trusteeship of a son’s subtrust shall be filled by the respective son for which the subtrust is named, if he is then living and has legal capacity, or if not, by that son’s descendants.
B. Whenever any son of Decedent dies or becomes incapacitated, his descendants shall have the right with respect to that son’s subtrust (1) to appoint a trustee to succeed the respective son, (2) to remove without cause any co-trustee appointed by the respective son, and (3) to remove without cause any trustee previously appointed by the descendants.
C. The right to appoint and remove without cause is exercisable by simple majority vote in descending generational orders, and a later generation shall only exercise this right if there are no surviving members of the prior generation.
D. The removal of an acting trustee shall not occur more often than once during any twelve month period.
E. Any trustee may resign at any time. In such event, a successor shall be selected as provided. If all such successors fail to qualify or cease to act, or if no successor trustee is effectively appointed pursuant to the foregoing provisions, a successor trustee shall be appointed by a court of competent jurisdiction upon the petition of the resigning trustee or any beneficiary of the trust.

Article 8.06 will be added to Trust to restrict the discretion of the trustee in certain circumstances, as follows.

A. Each individual co-trustee shall be disqualified from exercising any discretionary power to make distributions of income or principal to (or for the benefit of) himself or herself as a beneficiary. Instead, all such discretionary powers shall vest solely in (and be exercisable by) the other co-trustees.
B. Any individual serving as sole trustee who has the power to make discretionary distributions of income or principal for his or her own benefit may exercise that power in his or her favor only for his or her health, education, support, or maintenance within the meaning of §§ 2041 and 2514 of the Internal Revenue Code. A special co-trustee may be appointed for the limited purpose of making any other discretionary distributions to the regular trustee in his or her capacity as a beneficiary that are otherwise permitted under the provisions of trust. Any special co-trustee cannot be a “related or subordinate party” within the meaning of § 672(c) of the Internal Revenue Code with respect to the regular trustee.
C. Each individual trustee or co-trustee shall be disqualified from exercising any discretion given to the trustee to benefit, directly or indirectly, someone he or she is obligated to support. Instead, all such discretionary powers shall vest solely in (and be exercisable by) the other co-trustees and, if there is none, a
PLR-152039-06
7
special co-trustee may be appointed by the then acting regular trustee for this limited purpose. Any special co-trustee cannot be a “related or subordinate party” within the meaning of § 672(c) of the Internal Revenue Code with respect to the regular trustee. In addition, income or principal of the trust shall not be used to discharge in whole or in part any person’s legal obligation, under the laws of the state of that person’s domicile, to support or educate any beneficiary of the trust.
D. Any trustee or co-trustee who is appointed by any beneficiary, either alone or in conjunction with other beneficiaries, and is a “related or subordinate party” within the meaning of § 672(c) of the Internal Revenue Code with respect to that beneficiary, shall be subject to the same disqualifications or restrictions contained in subparagraphs A through C above with respect to that beneficiary and/or persons whom that beneficiary is obligated to support, in the same manner and with like effect as if that beneficiary were acting as the trustee or co-trustee.

State Statute 1 provides that, on petition by a trustee or beneficiary, a court may divide a trust into two or more separate trusts, if the court determines that dividing the trust will not defeat or substantially impair the accomplishment of the purposes or interests of the beneficiaries.

State Statute 2 provides that the trustee has the power to effect distribution of property and money in divided or undivided interests and to adjust resulting differences in valuation. A distribution in kind may be made pro rata or non pro rata, and may be made pursuant to any written agreement providing for a non pro rata division of aggregate value of the community property assets or quasi-community property assets, or both.

State Statute 3 provides, in part, that if a trust instrument confers “absolute,” “sole,” or “uncontrolled” discretion on a trustee, the trustee shall act in accordance with fiduciary principles and shall not act in bad faith or in disregard of the purposes of the trust. Moreover, notwithstanding the use of terms like “absolute,” “sole,” or “uncontrolled” by a settlor or a testator, a person who is a beneficiary of a trust that permits the person, either individually or as trustee or cotrustee, to make discretionary distributions of income or principal to or for the benefit of himself or herself pursuant to a standard, shall exercise that power reasonably and in accordance with the standard. State Statute 3 further provides that unless a settlor or a testator clearly indicates that a broader power is intended by express reference to this subdivision, a person who is a beneficiary of a trust that permits the person, as trustee or cotrustee, to make discretionary distributions of income or principal to or for the benefit of himself or herself may exercise that power in his or her favor only for his or her health, education, support, or maintenance within the meaning of §§ 2041 and 2514 of the Internal Revenue Code.
PLR-152039-06
8

State Court has determined that the state law requirements for modifying the trust have been met and that dividing Trust Three into separate trusts will not defeat or substantially impair the accomplishment of the purposes of the trust or the interests of the beneficiaries. Accordingly, State Court has granted the trustees’ petition to divide and modify the provisions of Trust Three as requested, conditioned on receiving a favorable ruling on the income, estate, gift, and GST tax issues from the Service.

You have requested the following rulings:

1. The division and modification of Trust Three will not cause Trust Three or the
   successor subtrusts to lose their exempt status under § 1433(b)(2)(A) of the Tax
   Reform Act of 1986 and § 26.2601-1(b)(4)(i) of the Generation-Skipping Transfer
   Tax Regulations.
2. The modification of Trust Three will not cause any beneficiary to be treated as
   having a general power of appointment with respect to any portion of a subtrust
   within the meaning of § 2041.
3. The division and modification of Trust Three will not cause any portion of the
   assets of the trust to be includible in the gross estate of any beneficiary of the
   successor subtrusts under §§ 2035, 2036, 2037, or 2038.
4. The distributions to and allocations among the new subtrusts will not create a
   transfer of property that is subject to federal gift tax under § 2501.
5. The exercise of discretionary distribution powers by a trustee/beneficiary under
   the modified provisions of Trust Three will not cause any beneficiary of Subtrust
   One, Subtrust Two, or Subtrust Three to be deemed to exercise a general power
   of appointment under § 2514.
6. The division of Trust Three will not be considered a distribution under § 661 or
   § 1.661(a)-2(f) of the Income Tax Regulations.
7. The three successor subtrusts will be treated as separate taxpayers for federal
   income tax purposes pursuant to § 643(f).
8. No gain or loss will be recognized for purposes of § 61 or § 1001 as a result of
   the division of Trust Three.
9. Pursuant to § 1015, the basis of the assets of the successor subtrusts will be the
   same after the division of Trust Three as the basis of those assets before the
   division. Pursuant to § 1223(2), the holding periods of the assets in the
   successor subtrusts will include the holding periods of those assets in Trust
   Three.

Ruling 1

Section 2601 of the Internal Revenue Code imposes a tax on every generation-skipping transfer (GST), which is defined under § 2611 as a taxable distribution, a taxable termination, or a direct skip.

Under § 1433 of the Tax Reform Act of 1986 (the Act), GST tax is generally applicable
PLR-152039-06
9

to GSTs made after October 22, 1986. However, under § 1433(b)(2)(A) of the Act and
§ 26.2601-1(b)(1)(i) of the Generation-Skipping Transfer Tax Regulations, the tax does not apply to a transfer under a trust that was irrevocable on September 25, 1985, except to the extent the transfer is made out of corpus added to the trust by an actual or constructive addition after September 25, 1985.

Under § 1433(b)(2)(C) of the Act and § 26.2601-1(b)(3)(i), if an individual is under a mental disability to change the disposition of his or her property continuously from October 22, 1986, until the date of his or her death, the GST tax provisions do not apply to any GST (A) under a trust to the extent such trust consists of property, or the proceeds of property, the value of which was included in the individual’s gross estate; or (B) which is a direct skip (other than a direct skip from a trust) that occurs by reason of the individual’s death. Section 26.2601-1(b)(3)(ii) defines mental disability as mental incompetence to execute an instrument governing the disposition of the individual’s property, whether or not there was an adjudication of incompetence and regardless of whether there has been an appointment of a guardian, fiduciary, or other person charged with either the care of the individual or the individual’s property.

Section 26.2601-1(b)(3)(iii)(A) provides that if there has not been a court adjudication that the decedent was mentally incompetent on or before October 22, 1986, the executor must file, with Form 706, either – (1) A certification from a qualified physician stating that the decedent was – (i) mentally incompetent at all times on and after October 22, 1986, and (ii) did not regain competence to modify or revoke the terms of the trust or will prior to his or her death; or (2) Sufficient other evidence demonstrating that the decedent was mentally incompetent at all times on and after October 22, 1986, as well as a statement explaining why no certification is available from a physician; and (3) Any judgment or decree relating to the decedent’s incompetency that was made after October 22, 1986. Section 26.2601-1(b)(3)(iii)(B) provides that such items will be considered relevant, but not determinative, in establishing the decedent’s state of competency.

Section 26.2601-1(b)(4)(i) provides rules for determining when a modification, judicial construction, settlement agreement, or trustee action with respect to a trust that is exempt from the GST tax under § 26.2601-1(b) will not cause the trust to lose its exempt status. These rules are applicable only for purposes of determining whether an exempt trust retains exempt status for GST 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) provides that a modification of the governing instrument by judicial reformation or nonjudicial reformation that is valid under applicable state law will not cause an exempt trust to be subject to the GST tax, if the modification does not shift a beneficial interest in the trust to any beneficiary who occupies a lower generation
PLR-152039-06
10

(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 for in the original trust. A modification of an exempt trust will result in a shift in a beneficial interest to a lower generation beneficiary if the modification can result in either an increase in the amount of a GST or the creation of a new GST.

Section 26.2601-1(b)(4)(i)(E), Example 5, provides as follows. In 1980, Grantor established an irrevocable trust for the benefit of his two children, A and B, and their issue. Under the terms of the trust, the trustee has the discretion to distribute income and principal to A, B, and their issue in such amounts as the trustee deems appropriate. On the death of the last to die of A and B, the trust principal is to be distributed to the living issue of A and B, per stirpes. In 2002, the appropriate local court approved the division of the trust into two equal trusts, one for the benefit of A and A's issue and one for the benefit of B and B's issue. The trust for A and A's issue provides that the trustee has the discretion to distribute trust income and principal to A and A's issue in such amounts as the trustee deems appropriate. On A's death, the trust principal is to be distributed equally to A's issue, per stirpes. If A dies with no living descendants, the principal will be added to the trust for B and B's issue. The trust for B and B's issue is identical (except for the beneficiaries), and terminates at B's death at which time the trust principal is to be distributed equally to B's issue, per stirpes. If B dies with no living descendants, principal will be added to the trust for A and A's issue. The division of the trust into two trusts does not shift any beneficial interest in the trust to a beneficiary who occupies a lower generation (as defined in § 2651) than the person or persons who held the beneficial interest prior to the division. In addition, the division does not extend the time for vesting of any beneficial interest in the trust beyond the period provided for in the original trust. Therefore, the two partitioned trusts resulting from the division will not be subject to the provisions of chapter 13.

Section 26.2601-1(b)(4)(i)(E), Example 10, provides as follows. In 1980, Grantor established an irrevocable trust for the benefit of Grantor’s issue, naming a bank and five other individuals as trustees. In 2002, the appropriate local court approves a modification of the trust that decreases the number of trustees which results in lower administrative costs. The modification pertains to the administration of the trust and does not shift a beneficial interest in the trust to any beneficiary who occupies a lower generation (as defined in section 2651) than the person or persons 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 for in the original trust. Therefore, the trust will not be subject to the provisions of chapter 13.

In the present case, it is represented that Trust Three is exempt from GST tax under
§ 26.2601-1(b)(3)(i) because the estate of Decedent met the requirements
§ 26.2601-1(b)(3)(iii) for establishing Decedent’s mental disability to change the
PLR-152039-06
11

disposition of his property continuously from October 22, 1986, until the date of his death. Further, no additions, actual or constructive, have been made to Trust Three after that date.

With regard to the proposed modifications of Trust Three, we conclude:

1) The proposed division of Trust Three into the three separate son’s subtrusts and
the modification of Trust Three in order to provide for the trust’s division is similar
to the facts in Example 5 of § 26.2601-1(b)(4)(i)(E).
2) The modification of Trust Three to provide procedures for the appointment and
removal of successor trustees, procedures which were not otherwise provided
under the original terms of Trust Three, is viewed as pertaining to the
administration of the trust, comparable to the administrative modification in
Example 10 of § 26.2601-1(b)(4)(i)(E).
3) The modification of Trust Three to limit the discretion of the trustees in some
circumstances is consistent with the original terms of Trust Three and state law.

We further determine that all of the proposed modifications (i) will not result in a shift of any beneficial interest in Trust Three to any beneficiary who occupies a lower generation (as defined in § 2651) than the person or persons holding the beneficial interests prior to the division, and (ii) will not extend the time for vesting of any beneficial interest beyond the period provided for under Trust Three.

Accordingly, based upon the facts submitted and the representations made, we rule that the division and modification of Trust Three, as provided, will not cause Trust Three, Subtrust One, Subtrust Two, or Subtrust Three to lose its status as exempt from the application of the federal GST by reason of the effective date rule contained in
§ 1433(b)(2) of the Act and § 26.2601-1(b)(3)(i), and the application of
§ 26.2601-1(b)(4)(i)(D).

Rulings 2 - 5

Section 2033 provides that the value of the gross estate shall include the value of all property to the extent of the interest therein of the decedent at the time of his death.

Section 2035(a) provides that if (1) the decedent made a transfer (by trust or otherwise) of an interest in any property, or relinquished a power with respect to any property, during the 3-year period ending on the date of the decedent's death, and (2) the value of such property (or an interest therein) would have been included in the decedent's gross estate under § 2036, § 2037, § 2038, or § 2042 if such transferred interest or relinquished power had been retained by the decedent on the date of the decedent's death, then the value of the gross estate shall include the value of any property (or interest therein) that would have been so included.
PLR-152039-06
12

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 case of a bona fide sale for 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 2037 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 after September 7, 1916, made a transfer (except in case of a bona fide sale for an adequate and full consideration in money or money's worth), by trust or otherwise, if (1) possession or enjoyment of the property can, through ownership of such interest, be obtained only by surviving the decedent, and (2) the decedent has retained a reversionary interest in the property (but in the case of a transfer made before October 8, 1949, only if such reversionary interest arose by the express terms of the instrument of transfer), and the value of such reversionary interest immediately before the death of the decedent exceeds 5 percent of the value of such property.

Section 2038(a)(1) provides that the value of the decedent's 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 case of a bona fide sale for adequate and full consideration in money or money's worth), by trust or otherwise, where the enjoyment thereof was subject at the date of his death to any change through 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 such power), to alter, amend, revoke, or terminate, or where any such power is relinquished during the 3-year period on the date of the decedent's death.

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 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 such a power of appointment by a disposition that is of such nature that if it were a transfer of property owned by the decedent, such property would be includible in the decedent's gross estate under §§ 2035 to 2038, inclusive.

Section 2041(b)(1)(A) 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
PLR-152039-06
13

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) of the Estate Tax Regulations provides, in part, that a donee may have a power of appointment if he has the power to remove or discharge a trustee and appoint himself. 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 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.

Section 2501 imposes a tax on the transfer of property by gift by an individual. Section 2511 provides that the tax imposed by § 2501 applies 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 2514(c)(1) provides that a general power of appointment is a power that is exercisable in favor of the individual possessing the power (the possessor), his estate, his creditors, or the creditors of his estate. However, a power to consume, invade, or appropriate property for the benefit of the possessor that is limited by an ascertainable standard relating to the health, education, support, or maintenance of the possessor shall not be deemed a general power of appointment.

Section 25.2514-1(b)(1) of the Gift Tax Regulations provides, in part, that a donee may have a power of appointment if he has the power to remove or discharge a trustee and appoint himself. 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 A, another person, has the unrestricted power to remove or discharge the trustee at any time and appoint any other person including himself, A 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 to appoint an individual or corporate successor trustee that is not related or subordinate to the decedent within the meaning
PLR-152039-06
14

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 is 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.

Under the proposed modification of Trust Three, any trustee or co-trustee is restricted from exercising any discretionary authority to make distributions of income or principal to or for the benefit of himself or someone he or she is obligated to support, unless the authority is pursuant to an ascertainable standard. Furthermore, if a beneficiary, either alone or in conjunction with other beneficiaries, appoints a trustee or co-trustee, and that beneficiary is a “related or subordinate party” within the meaning of § 672(c) with respect to such trustee or co-trustee, then such trustee or co-trustee so appointed is restricted from exercising its full discretionary authority to make distributions of income or principal with respect to that beneficiary or beneficiaries, or any person whom that beneficiary is obligated to support, in the same manner and with like effect as if that beneficiary were acting as the trustee or co-trustee. Given the restrictions on the trustee’s authority to make discretionary distributions, the removal and appointment powers given to the sons of decedent and the sons’ descendants are not the equivalent of the power referred to in the examples in §§ 20.2041-1(b)(1) and 25.2514-1(b)(1). The discretionary authority of any trustee appointed by a son of decedent or the sons’ descendants is restricted so that a trustee will never have unlimited discretion to appoint property (i) to or for the benefit of himself or herself, or someone he or she is obligated to support, (ii) to or for the benefit of a beneficiary appointing such trustee, either alone or in conjunction with other beneficiaries, or (iii) to or for the benefit of a person such a beneficiary (described in (ii)) is obligated to support. Instead, such discretionary authority either will be (i) limited to an ascertainable standard, (ii) exercised by the remaining trustees that have no similar restriction, or (iii) exercised by a special trustee that is not related or subordinate to any beneficiary and who is appointed for the sole purpose of making such discretionary distributions.

Accordingly, based on the facts submitted and the representations made, we rule that the modification to Trust Three and the division of Trust Three into the Son’s Subtrusts:
PLR-152039-06
15

a. Will not cause any beneficiary of a subtrust to be treated as having or exercising a general power of appointment with respect to any portion of the subtrust, within the meaning of § 2041; b. Will not cause any portion of a subtrust to be includible in the gross estate of any beneficiary of any subtrust, for federal estate tax purposes under § 2035, § 2036, § 2037, or § 2038; c. Will not create a transfer of property that is subject to federal gift tax under § 2501; and d. Will not cause any trustee/beneficiary who exercises a discretionary distribution power under the modified provisions of trust to be deemed to exercise a general power of appointment under § 2514.

Ruling 6

Section 661(a) provides that in any taxable year a deduction is allowed in computing the taxable income of a trust (other than a trust to which subpart B applies) for the sum of (1) the amount of income for such taxable year required to be distributed currently and (2) any other amounts properly paid or credited or required to be distributed for such taxable year.

Section 1.661(a)-2(f) of the Income Tax Regulations provides that gain or loss is realized by the trust or estate (or the other beneficiaries) by reason of a distribution of property in kind if the distribution is in satisfaction of a right to receive a distribution of a specific dollar amount, of specific property other than that distributed, or of income as defined under § 643(b) and the applicable regulations, if income is required to be distributed currently.

Section 662 provides that there shall be included in the gross income of a beneficiary to whom an amount specified in § 661(a) is paid, credited, or required to be distributed (by an estate or trust described in § 661) the sum of the following amounts: (1) the amount of income for the taxable year required to be distributed currently to such beneficiary, whether distributed or not; and (2) all other amounts properly paid credited, or required to be distributed to such beneficiary for the taxable year.

Based solely on the facts and representations submitted, we rule that the partition of Trust Three to create Son 1’s Subtrust, Son 2’s Subtrust, and Son 3’s Subtrust is not a distribution under § 661 or § 1.661(a)-2(f).

Ruling 7

Section 643(f) provides that, for purposes of subchapter J, under regulations prescribed by the Secretary, two or more trusts shall be treated as one trust if (1) such trusts have substantially the same grantor or grantors and substantially the same primary
PLR-152039-06
16

beneficiary or beneficiaries and (2) a principal purpose of such trusts is the avoidance of the tax imposed by chapter 1.

Son 1’s Subtrust, Son 2’s Subtrust, and Son 3’s Subtrust will each have different beneficiaries. Therefore, based solely on the facts and representations submitted, we rule that Son 1’s Subtrust, Son 2’s Subtrust, and Son 3’s Subtrust will be treated as separate taxpayers for income tax purposes.

Rulings 8 and 9

Section 61(a)(3) provides that gross income includes gains derived from dealings in property.

Section 1001(a) provides that the gain from the sale or other disposition of property shall be the excess of the amount realized therefrom over the adjusted basis provided in
§ 1011 for determining gain, and the loss shall be the excess of the adjusted basis provided in § 1011 for determining loss over the amount realized.

Section 1001(b) states that the amount realized from the sale or other disposition of property shall be the sum of any money received plus the fair market value of the property (other than money) received. Under § 1001(c), except as otherwise provided in subtitle A, the entire amount of gain or loss, determined under § 1001, on the sale or exchange of property shall be recognized.

Section 1.1001-1(a) of the Income Tax Regulations provides that the gain or loss realized from the conversion of property into cash, or from the exchange of property for other property differing materially either in kind or in extent, is treated as income or loss sustained.

Rev. Rul. 56-437, 1956-2 C.B. 507, provides that a partition of jointly owned property is not a sale or other disposition of property where the co-owners of the joint property sever their joint interests, but do not acquire a new or additional interest as a result of the transaction.

In Rev. Rul. 69-486, 1969-2 C.B. 159, a non-pro rata distribution of trust property was made in kind by the trustee, although the trust instrument and local law did not convey authority to the trustee to make a non-pro rata distribution of property in kind. The distribution was a result of a mutual agreement between the trustee and the beneficiaries. Because neither the trust instrument nor local law conveyed authority to the trustee to make a non-pro rata distribution, Rev. Rul. 69-486 held that the transaction was equivalent to a pro rata distribution followed by an exchange between the beneficiaries, an exchange that required recognition of gain under § 1001.
PLR-152039-06
17

Cottage Savings Ass'n v. Commissioner, 499 U.S. 554 (1991), concerns the issue of when a sale or exchange has taken place that results in realization of gain or loss under
§ 1001. In Cottage Savings, a financial institution exchanged its interests in one group of residential mortgage loans for another lender's interests in a different group of residential mortgage loans. The two groups of mortgages were considered “substantially identical" by the agency that regulated the financial institution.

The Supreme Court of the United States in Cottage Savings, concluded that § 1.1001-1 reasonably interprets § 1001(a) and stated that an exchange of property gives rise to a realization event under § 1001(a) if the properties exchanged are "materially different." In defining what constitutes a "material difference" for purposes of § 1001(a), the Court stated that properties are "different" in the sense that is "material" to the Code so long as their respective possessors enjoy legal entitlements that are different in kind or extent. Cottage Savings, 499 U.S. at 564-65. The Court held that mortgage loans made to different obligors and secured by different homes did embody distinct legal entitlements, and that the taxpayer realized losses when it exchanged interests in the loans. Cottage Savings, 499 U.S. at 566.

Section 1015(b) provides that if property is acquired by a transfer in trust (other than a transfer in trust by gift, bequest, or devise), the basis shall be the same as it would be in the hands of the grantor increased in the amount of gain or decreased in the amount of loss recognized to the grantor on such transfer.

Section 1.1015-2(a)(1) provides that in the case of property acquired after December 31, 1920, by transfer in trust (other than by transfer in trust by gift, bequest, or devise) the basis of property so acquired is the same as it would be in the hands of the grantor increased by the amount of gain or decreased by the amount of loss recognized to the grantor on the transfer under the law applicable to the year in which the transfer was made. In addition, the principles in § 1.1015-1(b) concerning the uniform basis are applicable in determining the basis of property where more than one person acquires an interest in property by transfer in trust. Section 1.1015-1(b) provides that property acquired by gift has a single uniform basis although more than one person may acquire an interest in the property. The uniform basis of the property remains fixed subject to proper adjustment for items under §§ 1016 and 1017.

Section 1223(2) provides that, in determining the period for which the taxpayer has held property however acquired, there shall be included in the period for which such property was held by any other person, if the property has the same basis in the taxpayer's hands as it would have in the hands of that other person.

In the present case, it is consistent with the Supreme Court's opinion in Cottage Savings to find that the interests of the beneficiaries of the subtrusts will not differ materially from the interests of the beneficiaries in Trust Three. Under the proposed division, the beneficiaries are severing their joint interests in Trust Three. However, because State
PLR-152039-06
18

law and the terms of the trust authorize non pro rata divisions, the proposed division into the separate subtrusts with substantially identical terms and provisions will not result in the beneficiaries acquiring any new or additional interests. Therefore, the division of Trust Three is not a sale or other disposition of property under Rev. Proc. 56-437 and does not result in a material difference in the legal entitlements enjoyed by the beneficiaries under Cottage Savings. Accordingly, no gain or loss is recognized on the division of Trust Three for purposes of § 61 or § 1001.

Additionally, because § 1001 does not apply to the division of Trust Three, under § 1015 the basis of the assets will be the same after the division as the basis of those assets before the division. Furthermore, pursuant to § 1223(2) the holding periods of the assets in the hands of separate trusts will include the holding periods of the assets in the hands of Trust Three.

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.

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

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 your authorized representative.

Sincerely,

James F. Hogan
Senior Technician Reviewer
Passthroughs and Special Industries