PLR 1051004: Trust settlement receives favorable federal tax treatment

Plain-English summary

A family sought IRS rulings on the federal tax consequences of a court-approved settlement resolving disputes over the distribution of a trust holding stock. The settlement divided the trust into separate shares and used a negotiated compromise between per capita and per stirpes distribution positions. The IRS ruled that the settlement would not cause the trust or its distributions to lose GST-tax-exempt status, and would not cause the parties to make taxable gifts. It also ruled that the settlement would not cause estate inclusion for the parties under the specified retained-interest rules, except that property actually distributed to a beneficiary could enter that beneficiary's transfer tax base. Finally, the IRS ruled that dividing the trust under the settlement would not recognize gain or loss under IRC § 1001.

Ruling snapshot

• Question: What are the GST, gift, estate, and income tax consequences of the proposed court-approved trust settlement?
• Outcome: approved
• Key authorities: IRC §§ 61, 2001, 2033, 2035, 2036, 2037, 2038, 2041, 2501, 2511, 2601, 2611, and 1001; Treas. Reg. §§ 25.2511-1, 26.2601-1, and 1.1001-1.

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

                                                           Third Party Communication: None

Number: 201051004 Date of Communication: Not Applicable
Release Date: 12/23/2010 Person To Contact:
-----------------------, ID No. -------------
Index Number: 61.00-00, 1001.00-00, Telephone Number:
2501.01-00, 2601.04-01, ---------------------
2036.00-00 Refer Reply To:
CC:PSI:04
-------------------------------- PLR-105033-10
Date: JULY 29, 2010

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

     In re: --------------------------------------------

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

LEGEND
Testator = ----------------------------
Child A = --------------------------------------
Child B = -----------------------------
Child C = ---------------------------------------
Stock = --------------------------------
Stock Trust = ------------------------------------------------------------------------------

Residuary Trust = ------------------------------------------------------------------------------

Children’s Agreement = ------------------------------------------------------------------------

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State = ------------------
State A = ----------
Date 1 = --------------------
Date 2 = -------------------
Date 3 = --------------------------
Date 4 = -------------------------
Date 5 = -------------------------
Date 6 = -----------------------
A = ------
B = -------
C = ------
D = ------
Stock Trust A = ------------------------------------------------------------------------

PLR-105033-10 2

Residuary Trust A = ---------------------------------------------------------------------------------

Cite 1 = ------------------------------------------------------------------------

Cite 2 = ---------------------------------------------------------------------------------

Cite 3 = ------------------------------------------------------
Cite 4 = ------------------------------------------------------------------------------

Cite 5 = -----------------------------------------------------------------------------

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Cite 6 = ------------------------------------------------------------------------

Cite 7 = -------------------------------------------------------
Cite 8 = ------------------------------------------------------------------------

Highest Court = -------------------------------------------
Highest Court of State A = -----------------------------------
State Court = ------------------------------------------------------------------------

State Statute = ---------------------------------------------------------------------------------

State Governing Statute A = ---------------------------------------------
State Governing Statute B = --------------------------------------------------
State A Statute = ---------------------------------
q = ----
r = ----
s = ----
t = ----
u = --------
v = --------
x = --------
y = ------
z = ------------

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

This responds to the January 28, 2010 letter from your authorized representative
requesting rulings on the income, gift, estate, and generation-skipping transfer (GST)
tax consequences of a proposed settlement agreement.

PLR-105033-10 3

The facts and representations are as follows. Testator died a resident of State on Date

1. He was survived by three children, Child A, Child B, and Child C (the Children). Five
   grandchildren (the Five Grandchildren) were then living. There were no
   great-grandchildren at the time.

Under Articles Third and Eighth of Testator’s will (the Will), his shares of Stock were to
be held in trust (the Stock Trust). Trust income was to be divided equally among the
Children. On a Child’s death, the Child’s income share was to be divided equally
among the Child’s then living children (Testator’s grandchildren). The Stock Trust was
to terminate twenty-one years after the death of Testator’s last surviving grandchild,
when the principal would be divided equally (per capita) among Testator’s then living
great-grandchildren and deceased great-grandchildren (whose then living descendants
would take by representation).1

Under Article Twenty-Second of the Will, the residue of Testator’s estate was to be held
in another trust (the Residuary Trust). The Residuary Trust provisions were identical to
those of the Stock Trust except that the Residuary Trust was to terminate when
Testator’s youngest great-grandchild reached age twenty-one.

                               The rule against perpetuities

Under the State rule against perpetuities in effect at Testator’s death, a bequest of a future
interest was void if, considered prospectively at the testator’s death, there was a possibility
that the interest would not vest by the end of twenty-one years after the death of a life or
lives in being at the testator’s death (the Permissible Period). A bequest to a class was
void if there was a possibility that all the members of the class would not be ascertained
and take vested interests within the Permissible Period. A void specific bequest passed to
the testator’s residuary estate. If the testator’s disposition of the residuary estate was void
as well, the residuary estate passed (as a reversion) by intestacy. Cite 1.

In this case, at Testator’s death, it was possible for the Children to have additional
children so that there could be grandchildren whose lives were not then in being. This
was the pivotal factor in determining whether his bequests of Stock Trust and Residuary
Trust income and remainders to his grandchildren and great-grandchildren violated the
rule against perpetuities.

Testator’s bequest of lifetime income interests to the grandchildren was to all of his
grandchildren as a class. A grandchild born after Testator’s death would be part of the
grandchildren’s class and would receive Stock Trust income for life. Based on this, it
was considered possible that not all of the grandchildren’s income interests would vest
during lives in being at Testator’s death.

1
Certain annuities were also created that have since terminated.

PLR-105033-10 4

Testator’s bequests of remainders to his great-grandchildren were to vest only after all
of Testator’s grandchildren died.2 The life of a grandchild born after Testator’s death
would also be a measuring life. Therefore, at Testator’s death, it was possible that the
time for vesting of the great-grandchildren’s remainders would be based on a life not in
being at Testator’s death. Accordingly, the validity of these bequests was in doubt. The
bequests in the Stock Trust, if void, passed to the Residuary Trust at Testator’s death.
The bequests in the Residuary Trust, if void, passed to Testator’s intestate estate as a
reversionary interest.

                                The Children’s Agreement

The Children were Testator’s heirs at law. They acquired his property passing by
intestacy. Consequently, on Date 2, shortly after Testator died, the Children entered
into an agreement (the Children’s Agreement) revising the time when the
great-grandchildren’s remainders were to vest. Under the Children’s Agreement, the
trusts were to terminate (and the great-grandchildren’s remainders were to take effect)
on the death of the survivor of the Children and Five Grandchildren (that is, lives in
being at Testator’s death).

The Children’s Agreement also changed the Will’s pro rata distribution of the Stock
Trust (and Residuary Trust) remainder to a per stirpes distribution. On termination,
trust principal would be divided into three equal parts and distributed per stirpes. Under
this revision, the great-grandchildren descended from Child A would share one third of
the principal per stirpes, those descended from Child B would share a second third per
stirpes, and those descended from Child C would share the last third per stirpes.

In all other respects, the terms of the revised Stock Trust (Stock Trust A) and Residuary
Trust (Residuary Trust A) were the same as those provided in Testator’s Will. On a
date before September 25, 1985, Testator’s shares of Stock were transferred to Stock
Trust A. Residuary Trust A was not funded. It is represented that no additions have
been made since then.

                                        The Litigation

Over more than x decades, the trust beneficiaries and others have instituted actions for
State court determinations regarding Testator’s Will and the Children’s Agreement.
Specifically, in Cite 2, the highest court of State (Highest Court) considered Testator’s

2
Each trust considered herein (i.e., Stock Trust and Residuary Trust in the Will and Stock Trust A and
Residuary Trust A under the Children’s Agreement) provided for distribution of the remainder at the end
of twenty-one years following the death of the last survivor of the persons whose lives measured the
duration of that trust. Because the perpetuities issue in this case centers on the lives measuring a
respective trust’s duration, and not on the twenty-one year period following the death of the last survivor,
the twenty-one year period is hereafter assumed to be a part of each trust’s duration even though it is
not specifically stated.

PLR-105033-10 5

bequests of income interests to the grandchildren. The court reasoned that under
Testator’s Will, a grandchild’s income interest would vest when his or her parent (Child
A, Child B, or Child C) died. Thus, the grandchildren’s class would necessarily close at
the death of the last survivor of the Children, who were in being at Testator’s death.
Highest Court held that, therefore, the bequest of lifetime income interests to the
grandchildren, as a class, did not violate the rule against perpetuities. The court held
the Stock Trust created in the Will to be valid through the lives of the grandchildren.3
Highest Court then considered Testator’s bequest of remainders to his
great-grandchildren.4 The court reasoned that the grandchildren’s life estates preceded
the remainders, and the grandchildren’s class was not limited to lives in being at
Testator’s death. Because the remainders would take effect only after all of those
(including afterborn) grandchildren died, it was possible that the remainders would not
vest within lives in being at Testator’s death. Therefore, Highest Court held the Stock
Trust remainders to be void and illegal as violating the rule against perpetuities.
Cite 7.5

                       State Statute: the “wait and see” rule

Nearly y decades after Highest Court rendered its decision in Cite 2, the State
legislature enacted State Statute. State Statute provides a “wait and see” rule in
determining whether a future interest satisfies the rule against perpetuities or is void.
Under the “wait and see” rule, a future interest does not violate the rule against
perpetuities if actual events demonstrate that the interest did, in fact, vest by the end of
the Permissible Period. State Statute applies retroactively “to all interests heretofore
. . . created.”

Following the enactment of State Statute, Highest Court considered the statute’s
retroactivity. Cite 3. In the case before the court, the trust was created many decades
before State Statute was enacted. At the time of creation, certain interests were void as
violating the rule against perpetuities. However, Highest Court applied State Statute’s
“wait and see” rule to conclude, in retrospect, that the interests were not void and did
not violate the rule against perpetuities.

3
Testator’s bequest to the grandchildren, though valid, did not provide for distribution of a grandchild’s
income share when the grandchild died before the trust ended. On the death of the first grandchild to
die on Date 3, the trustees petitioned the State Court for instructions. The State Court held that, based
on Testator’s intent, a deceased grandchild’s children succeeded to the income share for the duration of
the trust. Cite 6.
4
By inference, Highest Court also considered Testator’s bequest of the Residuary Trust remainders.
5
Highest Court, in effect, confirmed that the Stock Trust remainder (and Residuary Trust remainder)
passed by intestacy to the Children. However, the court did not rule on how the remainder would pass
to the great-grandchildren.

PLR-105033-10 6

As a result, the courts of State now apply the “wait and see” rule retroactively to
conclude that a future interest that was void, when created many years before State
Statute was enacted, is not void because, in hindsight, it vested before the Permissible
Period ended. Accordingly, such otherwise void interests are retroactively sustained as
not violating the rule against perpetuities. Cite 4. However, Highest Court has not yet
addressed due process issues that may be presented.6

                                    The actualities in this case

No additional grandchildren were born after Testator’s death. The lives of the Children
and the Five Grandchildren were all in being at Testator’s death. All of the Children
have died. The last survivor of the Five Grandchildren died on Date 4. At the time,
there were z great-grandchildren of Testator. The trust will terminate twenty-one years
after Date 4, which is Date 5.

Of Testator’s z great-grandchildren, A descended from Child A, B descended from Child
B, and C descended from Child C. If the “wait and see” rule is applied to validate
Testator’s bequest of remainders to his great-grandchildren, the principal would be
divided into z equal shares and distributed under the Will. Alternatively, if Testator’s
disposition of the remainders is considered void, the principal would be divided into
three equal shares and distributed per stirpes under the Children’s Agreement. The
portion of a one-third share distributable to a great-grandchild would depend on the
framework of the family line (i.e., Child A’s, Child B’s, or Child C’s) to which that
great-grandchild belongs.

                               Great-grandchildren’s litigation

There is a substantial difference between what a great-grandchild would receive in a per
capita distribution and what he or she would receive in a per stirpes distribution. On
Date 6, the great-grandchildren benefitting from a per capita distribution (the Per Capita
Parties) instituted their action in State Court for adjudication on the distribution of the
Stock Trust remainder. The great-grandchildren benefitting from a per stirpes
distribution (the Per Stirpes Parties) opposed the suit and also requested adjudication.
In addition, an action was instituted concerning the distribution of income during the
twenty-one year period. State Court combined the proceedings to consider the income
and principal issues together. Cite 8.

6
In contrast, the legislature of State A enacted State A Statute, which (like State Statute) retroactively
applies a “wait and see” rule to determine whether a future interest, that was void at the time it was
created before the State A Statute was enacted, did, in fact, vest during the Permissible Period. Highest
Court of State A refused to apply the “wait and see” rule retroactively despite the relevant language in
State A Statute. Instead, that court addressed issues of constitutionality and held that State A Statute
could not be applied retroactively to destroy vested or substantive rights created before State A Statute
was enacted. Cite 5.

PLR-105033-10 7

Over a D-year period, guardians ad litem were appointed, there was extensive
discovery, counsel filed three voluminous sets of briefs, and the court heard two days of
oral arguments. The Per Capita Parties argued that the wait and see test of State
Statute now applies. Under that test, Testator’s (the Will’s) disposition of the Stock
Trust remainder does not violate the rule against perpetuities. Therefore, the Stock
Trust principal is distributable per capita to Testator’s living great-grandchildren and
deceased great-grandchildren (whose living descendants would take by representation).

The Per Stirpes Parties argued that the Highest Court’s determinations were final, and
those rulings can not now be constitutionally impaired by a later-in-time State Statute or
judicial ruling. Because Highest Court determined the remainders in the Will to be void,
they passed as reversionary interests (by intestacy) to the Children. As such, the
remainders passed per stirpes under the Children’s Agreement.

Some parties argued that trust income should be distributed per stirpes through the
roots of the Children for the duration of the Stock Trust. Others argued that the income
is distributable per capita.

The court encouraged the parties to explore ways to resolve their differences through
negotiation and compromise rather than through continued litigation. Among the
potential outcomes regarding trust principal was a judicial ruling that:

(i) Principal is distributable per capita on Date 5 under the terms of the Stock
Trust in the Will; or

(ii) Principal is distributable per stirpes on Date 5 under the terms of the
Children’s Agreement; or

(iii) Principal was distributable as of the last surviving grandchild’s death under
the Residuary Trust in the Will, which vested or will vest in the takers under
the Residuary Trust.

Among the potential outcomes regarding trust income was a judicial ruling that:

(iv) Income is distributable per stirpes from the death of the last surviving
grandchild to Date 5 under either the Will or the Children’s Agreement; or

(v) Income is distributable per capita from the death of the last surviving
grandchild to Date 5 under the Will or the Children’s Agreement; or

(vi) All rights to receive Stock Trust income terminated when the last surviving
grandchild died, at which time the Stock Trust principal was distributable
under the Residuary Trust of the Will.

PLR-105033-10 8

                      The great-grandchildren’s settlement agreement

The parties negotiated extensively. At the outset, they agreed that the issues could be
settled using a fractional difference settlement based on an assessment of the relative
strengths of their adverse positions.

Under the general framework of the compromise, the great-grandchildren’s settlement
agreement (the GGC Agreement) provides for the Stock Trust principal to be divided
into z separate shares based on the number of Testator’s then living
great-grandchildren and deceased great-grandchildren (with then living children).7 The
share of a deceased great-grandchild will be divided per stirpes among that
great-grandchild’s living descendants.

The Stock Trust assets will be divided in accordance with certain percentages. The
formula of the compromise provides for a q% per stirpes/r% per capita fractional
difference as to income, and an s% per stirpes/t% per capita fractional difference as to
principal. After the division into separate shares, u% of each great-grandchild’s share
will be distributed outright to the great-grandchild, if living, or, if the great-grandchild is
deceased, to his or her living descendants per stirpes. The remaining v% of each share
will continue in trust for such great-grandchild (or such descendants) until the
termination date, Date 5. Each share will be a separate trust. The respective
great-grandchild (or deceased great-grandchild’s descendants) will be the sole
beneficiary of the share for distributions of income and principal.

A sophisticated algorithm taken to thirteen decimal places will be used in the pro rata
division and outright distributions. The division will take into account both the market
value and respective tax bases of the assets.

The GGC Agreement was presented to State Court for consideration. The State Court
approved the settlement and ordered the division and distribution of the Stock Trust as
set forth in the GGC Agreement. The GGC Agreement is subject to a favorable ruling
from the Internal Revenue Service.

You have asked for the following rulings:

  (1) The terms of the GGC Agreement will not cause distributions from the Stock
      Trust or the continuing separate settlement trusts to become subject to the
      generation-skipping transfer tax.

  (2) The terms of the GGC Agreement will not cause any party to the agreement to
      make a gift to any other party to the GGC Agreement.

7
For purposes of describing the GGC Agreement, the Stock Trust and Stock Trust A are considered to be
the same trust.

PLR-105033-10 9

(3) The terms of the GGC Agreement will not cause any party to the agreement to
be required to include trust assets in his or her gross estate unless such assets
are distributable or have been distributed to such party prior to his or her death.

(4) The terms of the GGC Agreement will not cause any party to the agreement to
realize income from the sale or exchange of any trust assets or interests.

Ruling 1: GENERATION-SKIPPING TRANSFER (GST) TAX

Section 2601 of the Internal Revenue Code imposes a tax on every generation-skipping
transfer, 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
to generation-skipping transfers 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.

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)(B) provides that a court-approved settlement of a bona fide
issue regarding the administration of the trust or the construction of terms of the
governing instrument will not cause an exempt trust to be subject to chapter 13 if (1) the
settlement is the product of arm's length negotiations; and (2) the settlement is within
the range of reasonable outcomes under the governing instrument and applicable state
law addressing the issues resolved by the settlement. A settlement that results in a
compromise between the positions of the litigating parties and reflects the parties'
assessments of the relative strengths of their positions is a settlement that is within the
range of reasonable outcomes.

In this case, the Stock Trust was irrevocable on September 25, 1985. Further, it is
represented that there have been no actual or constructive additions to the Stock Trust
after September 25, 1985. Accordingly, the Stock Trust is exempt from GST tax under
§ 26.2601-1(b)(1).

PLR-105033-10 10

The terms of the GGC Agreement, including the proposed division of the Stock Trust
into separate shares and partial distributions of principal, are the result of a settlement
of substantial issues between the Per Capita Parties and the Per Stirpes Parties.
These issues have been tenaciously litigated over more than x decades. Highest Court
rendered opinions regarding these trusts many years ago. However, State Statute has
since been enacted with retroactive effect, and Highest Court has affirmed State
Statute’s retroactive application to a similarly-created trust. In light of this, that court’s
earlier determinations of the issues in this case are now in question.

We conclude that the GGC Agreement constitutes a settlement of bona fide issues
concerning the provisions of the Stock Trust and its administration. We also conclude
that the terms of the GGC Agreement are the product of arm's length negotiations.
They represent a compromise between the positions of the parties and reflect the
parties' assessments of the relative strengths of their positions. We further conclude
that the GGC Agreement is within the range of reasonable outcomes under the
governing instruments and the applicable State law addressing the issues resolved in
the GGC Agreement.
Accordingly, based upon the facts submitted and the representations made, we rule that
the division of the Stock Trust (into the z separate great-grandchildren’s trusts) and the
distributions (to the living great-grandchildren and the descendants, by representation,
of a deceased great-grandchild) made in accordance with the GGC Agreement will not
cause the Stock Trust, the continuing separate Stock Trusts, or the distributions, as
described above, to be subject to the generation-skipping transfer tax.

Ruling 2: GIFT TAX ISSUE

Section 2501(a) provides that a tax is imposed for each calendar year on the transfer of
property by gift during such calendar year.

Section 2511(a) provides that the gift tax 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 25.2511-1(b) of the Gift Tax Regulations provides that, as to any property, or
part thereof or interest therein, of which the donor has so parted with dominion and
control as to leave in him or her no power to change its disposition, whether for his or
her own benefit or for the benefit of another, the gift is complete.

Section 25.2511-1(c)(1) provides that any transaction in which an interest in property is
gratuitously passed or conferred upon another, regardless of the means or device
employed, constitutes a gift subject to tax.

Whether an agreement settling a dispute is effective for gift tax purposes depends on
whether the settlement is based on a valid enforceable claim asserted by the parties

PLR-105033-10 11

and, to the extent feasible, produces an economically fair result. See Ahmanson
Foundation v. United States, 674 F.2d 761, 774-75 (9th Cir. 1981) (citing Commissioner
v. Estate of Bosch, 387 U.S. 456 (1967)). Thus, state law must be examined to
ascertain the legitimacy of each party's claim. If it is determined that each party has a
valid claim, the Service must determine that the distribution under the settlement
reflects the result that would apply under state law. If there is a difference, it is
necessary to consider whether the difference may be justified because of the
uncertainty of the result if the question were litigated.

The proposed settlement is a mediated settlement and is based on arm's length
negotiations among all the parties. All interested parties who hold or may hold an
interest in the trusts, including any minors and unborn heirs, have been represented in
the negotiations.

As discussed above, the GGC Agreement represents the resolution of a bona fide
controversy between the parties. The terms of the GGC Agreement are the product of
arm's length negotiations and represent (i) a compromise between the positions of the

Per Capita Parties and the Per Stirpes Parties, and (ii) reflect the parties' assessments
of the relative strengths of their positions.

We further conclude that the GGC Agreement is within the range of reasonable
outcomes under the governing instruments and applicable State law. Accordingly,
based on the facts submitted and representations made, we conclude that the terms of
the GGC Agreement as described above, will not cause any of the beneficiaries to have
made a taxable gift for purposes of the federal gift tax under § 2501.

Ruling 3: ESTATE TAX ISSUE

Section 2001 imposes a tax on the transfer of the taxable estate of every decedent who
is a citizen or resident of the United States.

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

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

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

PLR-105033-10 12

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 that does not in fact end before his death, (1) 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 from the property.

Section 2037(a) provides that the value of the gross estate includes 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 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, 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 gross estate includes 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 fine 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, either by
the decedent alone or in conjunction with any person, to alter, amend, or revoke, or
where the decedent relinquished any such power during the 3-year period ending on the
date of the death.

Section 2041(a)(2) provides that the value of the gross estate shall include the value of
all property with respect to which the decedent possessed a general power of
appointment at the time of death. Section 2041(b)(1) defines the term “general power of
appointment” as 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.

In order for §§ 2035 through 2038 to apply, a decedent must have made a transfer of
property or an 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.

As discussed above, the GGC Agreement represents the resolution of a bona fide
controversy between the parties. It is a settlement of bona fide issues and is the
product of arm's length negotiations. It reflects the parties' assessments of the relative
strengths of their positions. No great-grandchild (or deceased great-grandchild’s
descendants by representation) has made a transfer to the Stock Trust or to any other
great-grandchild by reason of the settlement agreement. Accordingly, based upon the
facts submitted and representations made, we conclude that the terms of the GGC

PLR-105033-10 13

Agreement will not cause any party to the agreement to have made a transfer within the
meaning of §§ 2035 through 2038.

However, once the GGC Agreement becomes effective, any trust property actually
distributed (or receivable by) a beneficiary (or his or her assignee) would generally be
included in the beneficiary’s federal transfer tax base. See, e.g., §§ 2033, 2041, 2501.

Ruling 4: INCOME TAX ISSUE

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 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) provides 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.

Cottage Savings Ass'n v. Commissioner, 499 U.S. 554 (1991), addresses the issue of
whether a sale or exchange that has taken place results in the 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 in Cottage Savings, 499 U.S. at 560-61, 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.

PLR-105033-10 14

In the present case, State Governing Statute A allows the court, for cause shown, to
authorize the division of a trust into two separate trusts on such terms and conditions
and with such notice as the court directs. In addition, State Governing Statute B gives
trustees the power to distribute in cash or in kind or partly in each and allocate particular
assets in proportionate or disproportionate shares.

In this case, the court order approving the GGC Agreement orders the division and
distribution of the Stock Trust as set forth in the GGC Agreement. Accordingly, the
court approved the non-pro rata distributions called for in the GGC Agreement and
further authorized the trustees “to make the necessary transfers and assignments of the
unconverted investment securities [t]herein awarded in kind.” Accordingly, the
submission concludes that the distribution scheme in this case is authorized by State
law. We agree.

The Stock Trust will be divided into z trusts on a non pro-rata basis. Under the State
statutes cited above, the court has the authority to authorize the trustees to make this
type of non pro-rata apportionment. Thus, the proposed division and distribution of the
Stock Trust assets among the z trusts will not result in a material difference in kind or
extent of the legal entitlements enjoyed by the beneficiaries within the meaning of
Cottage Savings. Accordingly, based upon the facts submitted and representations
made, we conclude that the division of the Stock Trust into the z great-grandchildren’s
trusts will not result in the recognition of gain or loss under § 1001(a) by the Stock Trust,
any beneficiary of the Stock Trust, or any separate great-grandchild’s trust.

The rulings in this letter pertaining to the federal estate and/or generation-skipping
transfer tax apply only to the extent that the relevant sections of the Internal Revenue
Code are in effect during the period at issue.

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.

                               Sincerely yours,


                               Leslie H. Finlow
                               Acting Senior Technician Reviewer, Branch 4
                               Office of the Associate Chief Counsel
                               (Passthroughs & Special Industries)

Enclosure:
Copy for 6110 purposes