PLR 1124008: IRS approves trust's annuity contract rulings

Plain-English summary

The IRS ruled on a trust's plan to buy flexible premium deferred annuity contracts for several individual beneficiaries. The contracts would be held by the trust during the life of the surviving grantor, then distributed to the beneficiaries before the annuity starting dates. The IRS treated the contracts as owned by natural persons for purposes of § 72(u) and ruled that the distributions would not be treated as uncompensated assignments under § 72(e)(4)(C), because the annuitants would not change and the required-distribution rules would not be avoided. These conclusions address how the trust arrangement affects the federal income tax treatment of the annuity contracts.

Ruling snapshot

• Question: Would the proposed annuity contracts be treated as owned by natural persons, and would their later distribution to beneficiaries be treated as an assignment without full and adequate consideration?
• Outcome: Approved.
• Key authorities: IRC §§ 72, 6110.

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201124008 Third Party Communication: None
Release Date: 6/17/2011 Date of Communication: Not Applicable
Person To Contact:
Index Number: 72.00-00 -------------------, ID No. -----------------
Telephone Number:
---------------------
------------------------------- Refer Reply To:
------------------------ CC:FIP:B04
------------------------- PLR-140901-10
------------------------------ Date:
--------------------------------- March 16, 2011

Trust --------------------------------------------------------

H ------------------------

W ------------------------

Beneficiary A --------------------

Beneficiary B -------------------

Beneficiary C ------------------

Beneficiary D ----------------------

Beneficiary E ----------------

Beneficiary F ---------------

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

This is in reply to your request for rulings under §§ 72(u)(1) and 72(e)(4)(C) of the
Internal Revenue Code.

FACTS

Taxpayer represents that:

Prior to death, H established Trust as a grantor trust. The named beneficiaries were W
and A, B, C, D, E, and F (“Beneficiaries”), the descendants of H and W.
PLR-140901-10 2

During H’s life, H and W were co-trustees. H died. Upon H’s death, W became sole
trustee and Trust was divided into three sub-trusts: Trust A, Trust B, and Trust C. Trust
A was allocated an amount based on the allowed exemption and marital deduction for
Federal estate tax purposes. Trust C was allocated an amount based on the exemption
from the Federal Estate Tax provided the amount was not used for the payment of
taxes, debts, or administration expenses of H’s estate. Once all taxes, debts, and
expenses have been paid, the assets of Trust C are to be distributed to Trust B. Trust B
contains all the property not in Trusts A or C. During the life of W, trustee (in this case,
W) may in its discretion pay or use the property of Trust B for the benefit of W, and
others partly or wholly dependent upon W, to maintain the standard of living which W
enjoyed prior to H’s death, and for the support an education of descendants and others
dependent upon W. At W’s death, the property of Trust B is to be divided and
distributed among Beneficiaries A, B, C, D, E, and F in the proportions stated in Trust.

Trustee intends to purchase flexible premium deferred annuity contracts (Annuity
Contracts), naming each of Beneficiaries A, B, C, D, E, and F as the annuitant on one
Annuity Contract, in proportion to each Beneficiary’s residuary share of Trust. The
material provisions of each Annuity Contracts will be substantially the same except for
the dates of annuitization. Trust will be the owner and beneficiary of the Annuity
Contracts during the life of W. In the event of the death of an annuitant, the proceeds
from that annuity will be paid to Trust.

Trust projects that its other assets will be sufficient to fund its expenses (including
taxes) and make nominal distributions to W; there should not be any need for the Trust
to take a distribution(s) from the Annuity Contracts.

Upon final distribution of Trust, each Beneficiary will be distributed the Annuity Contract
for which that Beneficiary is the annuitant; it is anticipated that this distribution will occur
prior to that Annuity Contract’s annuity starting date. Trust will not receive any
consideration from any Beneficiary in exchange for the distribution of the Annuity
Contracts.

REQUESTED RULINGS

Taxpayer requests rulings that:

   1. the Annuity Contracts are considered owned by natural persons for purposes
      of § 72(u); and,
   2. the distribution of the Annuity Contracts by the Trust to the Beneficiaries will
      not be treated as an assignment of an annuity contract without full and
      adequate consideration under § 72(e)(4)(C).

LAW AND ANALYSIS
PLR-140901-10 3

Request #1

Section 72(u)(1) provides, in part, that if any annuity contract is held by a person who is
not a natural person, such contract shall not be treated as an annuity contract for
purposes of the Federal income tax (other than subchapter L). However, for purposes
of this rule, holding by a trust or other entity as an agent for a natural person shall not
be taken into account.

This rule is explained by H.R. Rep. No. 99-426 at 703-04 (1985) and S. Rep. No. 99-
313 at 567-68 (1986)

          The committee believes that the present-law rules relating to
          deferred annuity contracts present an opportunity for
          employers to fund, on a tax-favored basis, significant
          amounts of deferred compensation for employees. This
          favorable tax treatment may create a disincentive for
          employers to provide benefits to employees under qualified
          pension plans, which are subject to significantly greater
          restrictions. In addition, because deferred annuity contracts
          can be provided to a limited class of employees, rather than
          to employees generally (as is required in the case of a
          qualified pension plan), the committee is concerned that the
          present-law treatment of deferred annuity contracts dilutes
          the effect of the nondiscrimination rules applicable to
          qualified pension plans.

          Under the bill, in the case of a contract the nominal owner of
          which is a person who is not a natural person (e.g., a
          corporation or a trust), but the beneficial owner of which is a
          natural person, the contract generally is treated as held by a
          natural person. Thus, if a group annuity contract is held by a
          corporation as an agent for natural persons who are
          beneficial owners of the contract, the contract is treated as
          an annuity contract for Federal income tax purposes.
          However, the committee intends that, if an employer is the
          nominal owner of an annuity contract, the beneficial owners
          of which are employees, the contract will be treated as held
          by the employer. The committee intends this rule because it
          is concerned that the Internal Revenue Service would have
          difficulty monitoring compliance with the general rule that a
          deferred annuity is not available on a tax-favored basis to
          fund nonqualified deferred compensation.

PLR-140901-10 4

Here, the annuity contracts are owned by a trust under which all the beneficial interests
are owned by natural persons in a non-employment context. Accordingly, the contracts
will be treated as being owned by a natural person for purposes of § 72(u)(1).

Request #2

Section 72(e)(4)(C)(i) provides that if an individual who holds an annuity contract
transfers it without full and adequate consideration, such individual shall be treated as
receiving an amount equal to the excess of (i) the cash surrender value of such contract
at the time of transfer, over (ii) the investment in such contract at such time, under the
contract as an amount not received as an annuity.

Explaining the rule as originally proposed, H.R. Rep. No. 99-426 at 971 indicates that

            The bill also adds a provision which states that if an
            individual who holds an annuity contract transfers it by gift
            or, in the case of a holder which is not an individual, if there
            is any change in the primary annuitant, then such transfer or
            change shall be treated as the death of the holder.[1] This
            correction is made in order to implement fully the forced
            distribution rules adopted under the 1984 Act[2], which were
            intended to terminate deferral allowed in annuity contracts
            when such contracts were no longer required as a retirement
            vehicle for the contractholder who was enjoying the tax
            deferral on the income accumulating in the contract. Without
            the correction covering gratuitous transfers of annuity
            contracts, the required distribution rules adopted in the 1984
            Act could be avoided easily because they would allow
            taxpayers to continue tax deferral beyond the life of an
            individual taxpayer.

The Senate amendment3 was in the same vein, and explained at S. Rep. No. 99-313 at
994 that

            The bill also adds a provision which states that if an
            individual who holds an annuity contract transfers it by gift
            or, in the case of a holder which is not an individual, if there

1
Cf. § 72(s)(7).
2
Codified at § 72(s).
3
The Conference Report indicates that the conference agreement followed the Senate amendment, with
changes. H.R. Rep. No. 99-841 (Vol. II) at 846 (1986) (Conf. Rep.). As codified, § 72(e)(4)(C) provides
that if an individual who holds an annuity contract transfers it without full and adequate consideration,
such individual shall be treated as receiving a specified amount; § 72(s)(7) provides that in the case of a
holder of a contract which is not an individual, if there is a change in a primary annuitant such change
shall be treated as the death of the holder.
PLR-140901-10 5

          is any change in the primary annuitant, then such change
          shall be treated as an assignment of the contract (sec.
          72(e)(4)), which treats the amount assigned as received as
          an amount not received as an annuity. … Without the
          clarification treating gratuitous transfers of annuity contracts
          as assignments, the required distribution rules adopted in
          the 1984 Act could be avoided easily because they would
          allow taxpayers to continue tax deferral beyond the life of an
          individual taxpayer.

Here, the transfer of the contracts from the Trust to the Beneficiaries does not have the
effect of avoiding the required distribution rules of § 72(s); the annuitant is not changed.
Accordingly, the distribution of the contracts from Trust to Beneficiaries will not be
treated as an assignment of an annuity contract without full and adequate consideration
under § 72(e)(4)(C).

RULINGS

Accordingly, we rule that:

   1. the Annuity Contracts are considered owned by natural persons for purposes
      of § 72(u); and,
   2. the distribution of the Annuity Contracts by the Trust to the Beneficiaries will
      not be treated as an assignment of an annuity contract without full and
      adequate consideration under § 72(e)(4)(C).

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 specifically set forth above, no opinion is expressed as to the tax treatment of
the Annuity Contracts or Trust under the provisions of any other section of the Code or
applicable Regulations. Specifically, no opinion is expressed as to whether or not the
Annuity Contracts are in fact annuity contracts for purposes of § 72, nor is any opinion
expressed regarding the application of Subchapter J (relating to estates, trusts,
beneficiaries, and decedents) or of Chapters 11 (Estate Tax), 12 (Gift Tax) or 13
(Generation-Skipping Transfers) of the Code, to Trust or any transaction involving H, W,
Trust, or Beneficiaries.

These rulings are directed to Taxpayer only. Section 6110(k)(3) provides that they may
not be used or cited as precedent.
PLR-140901-10 6

A copy of this letter ruling should be attached to Taxpayer’s return as required by
§ 7.05, Rev. Proc. 2010-1, 2010-1 I.R.B. 1, 29.

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,

                                      /s/

                                   John E. Glover
                                   Senior Counsel, Branch 4
                                   (Financial Institutions & Products)