Administrative trust modifications preserved estate and GST treatment

Plain-English summary

Four irrevocable pre-September 25, 1985 trusts proposed adding distribution trustees, separating investment and distribution authority, and limiting replacement trustees by family relationship. The IRS ruled that these administrative changes would not cause beneficiaries' interests to enter their gross estates, would not create, exercise, or release general powers of appointment for the settlor or beneficiaries, and would not shift beneficial interests or extend vesting. The trusts therefore retained their exemption from generation-skipping transfer tax.

Ruling snapshot

• Question: Would the proposed trustee and administrative changes create estate or gift tax consequences or end the trusts' GST-exempt status?
• Outcome: Approved. The modifications did not create the identified estate inclusions or powers of appointment and preserved GST exemption.
• Key authorities: IRC §§ 2033, 2036–2038, 2041, 2514, and 2601; Treas. Reg. § 26.2601-1; Rev. Rul. 95-58

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201432005 Third Party Communication: None
Release Date: 8/8/2014 Date of Communication: Not Applicable
Index Number: 2601.03-01, 2041.03-00,
2033.00-00, 2037.00-00, Person To Contact:
2036.00-00, 2038.00-00, ------------------, ID No. ----------------
2501.01-00, 2514.00-00 Telephone Number:
--------------------
------------------------------ Refer Reply To:
------------------------ CC:PSI:B04
-------------------------------------------- PLR-141740-13
Date:
March 05, 2014

Legend

Settlor = -------------------------
Trust 1 = ---------------------------------------------
Trust 2 = ---------------------------------------------
Trust 3 = ---------------------------------------------
Trust 4 = ---------------------------------------------
Child 1 = -------------------------
Child 2 = ------------------------
Child 3 = ------------------------------
Child 4 = ---------------------
Date 1 = -----------------------
Date 2 = --------------------------
Year = ------
Foundation = ---------------------------------------------
Independent Trustee = ---------------------------------------

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

   This letter responds to your authorized representative’s letter dated August 5,

2013, and prior correspondence, requesting gift, estate, and generation-skipping
transfer (GST) tax rulings with respect to the proposed modifications of four trusts.

     The facts and representations submitted are summarized as follows:

   On Date 1, Settlor created and funded three irrevocable trusts, Trust 1, Trust 2,

and Trust 3, to benefit three of her children, Child 1, Child 2, and Child 3. Currently,
Child 1 is the primary beneficiary of Trust 1; Child 2 is the primary beneficiary of Trust 2;
and Child 3 is the primary beneficiary of Trust 3. On Date 2, Settlor created and funded
another irrevocable trust, Trust 4. Currently, Child 4 is the primary beneficiary of
Trust 4. Dates 1 and 2 are prior to September 25, 1985. The initial co-trustees of the
trusts were Settlor’s brother, individual trustee, and a bank, Independent Trustee. The
trusts named Settlor’s sisters as successor individual trustees.

    Each trust is identical, except for beneficiaries. Each trust provides that, during

the life of a child (Child 1, Child 2, Child 3, or Child 4), the trustees may distribute so
much of the net income and principal to a child as the trustees, in their discretion, deem
necessary or advisable. In addition, the trustees at any time may pay so much of the
principal to a child and his or her issue as the trustees, in their discretion, deem
necessary or advisable; provided, that the purpose for which payment is to be made
justifies in the sole discretion of the trustees a reduction in the principal of the trust
estate. Upon the death of a child, the trustees, in their discretion, may pay so much of
the net income in equal shares, per stirpes, to the then living issue of the child for his or
her health, happiness, maintenance, education, welfare, or comfort.

   Each trust will terminate on the first to occur of (i) 20 years after the death of the

last survivor of the child and those of his siblings who were living when the trust was
created, or (ii) the death of the last survivor of the child and his or her issue. On the
termination of the trust, the accumulated income and principal will be distributed to the
issue of the child, per stirpes. If none of the child's issue is then living, the trust principal
and accumulated income is to be distributed to the other issue or trusts for the other
issue of the Settlor. If all of Settlor’s issue are deceased, the undistributed income and
principal will be distributed to Foundation.

   Each trust also provides that in no event shall any of the trust estate vest in the

Settlor, the Settlor’s parents, or any individual trustee named in their individual capacity.

    Each trust originally required that all investment decisions be made jointly by the

Independent Trustee and the individual trustee. In Year, each trust was modified to:
(i) provide for successor individual trustees, (ii) give the individual trustee the sole power
to make investment decisions (Investment Trustee), (iii) give the primary beneficiary, or
if he or she is deceased, a majority of the issue of the primary beneficiary, the power to
replace the Independent Trustee, (iv) provide that the successor Independent Trustee
cannot be related or subordinate to the Settlor or the beneficiaries within the meaning of
§ 672(c) of the Internal Revenue Code, and (v) provide that neither a child, child’s issue,
or spouse may serve as trustee of the trust created for their benefit.

  The Settlor and current trustees propose to add an individual trustee for the

purpose of making distribution decisions (Distribution Trustee). Each trust would be

modified to allow either the Distribution Trustee or the Independent Trustee to make the
distribution decisions. The Distribution Trustee cannot be related or if related, can not
be closer in relation than cousin, to the primary beneficiary, within the meaning of
§ 672(c). If the Distribution Trustee resigns or is replaced, the successor Distribution
Trustee cannot be related, or if related, cannot be closer in relation than cousin to the
current beneficiary, within the meaning of § 672(c). A cousin cannot serve as a
Distribution Trustee for a trust if the beneficiary is serving as the Distribution Trustee for
the cousin’s trust. The Investment Trustee is to be vested with authority to make
investment decisions. The primary beneficiary or, if deceased, a majority of the issue of
the primary beneficiary, may replace any trustee. No child, the issue or spouse of such
child, may ever serve as his own trustee or co-trustee of the trust created for his or her
benefit.

   You have requested the following rulings:

1. The proposed modifications to Trust 1, Trust 2, Trust 3, and Trust 4 will not
  cause the interest of any beneficiary of Trust 1, Trust 2, Trust 3, or Trust 4 to be
  includible in such beneficiary’s gross estate under §§ 2033, 2036, 2037, or 2038
  of the Internal Revenue Code.

2. The proposed modifications to Trust 1, Trust 2, Trust 3, and Trust 4 will not
  cause Settlor to be treated as having, having exercised, or released a general
  power of appointment for purposes of §§ 2041 and 2514.

3. The proposed modifications to Trust 1, Trust 2, Trust 3, and Trust 4 will not
  cause the beneficiary of his or her respective trust, including any beneficiary
  serving as co-trustee, to be treated as having, having exercised, or released a
  general power of appointment for purposes of §§ 2041 and 2514.

4. The proposed changes to Trust 1, Trust 2, Trust 3, and Trust 4 will not cause the
  trusts to lose their exempt status for purposes of the GST tax.

LAW AND ANALYSIS

Ruling 1

   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 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 five 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 three-year period on the date of the
decedent’s death.

    In this case, the proposed modifications to Trust 1, Trust 2, Trust 3, and Trust 4,

as described above, are administrative in nature and do not cause the beneficiary’s
interest in his or her trust assets to be includible in the beneficiary’s gross estate for
purposes of § 2033. Further, the proposed modifications do not constitute a transfer
within the meaning of §§ 2036 through 2038. Accordingly, based on the facts submitted
and representations made, we conclude that the proposed modifications to Trust 1,
Trust 2, Trust 3, and Trust 4 will not cause the interest of any beneficiary of his or her
trust to be includible in such beneficiary’s gross estate under §§ 2033, 2036, 2037, or
2038.

Rulings 2 and 3

   Section 2041(a)(2) provides that the value of the gross estate shall include the

value of all property to the extent of any property with respect to which the decedent
has, at the time of his death, a general power of appointment created after
October 21, 1942, or with respect to which the decedent has at any time exercised or
released a power of appointment by a disposition that is of such nature that if it were a

transfer of property owned by the decedent the property would be includible in the
decedent’s gross estate under §§ 2035 to 2038, inclusive.

   Section 2041(b)(1) provides that a general power of appointment is a power that

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

    Section 20.2041-1(b)(1) 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 2514(b) provides that the exercise or release of a general power of

appointment created after October 21, 1942, shall be deemed a transfer of property by
the individual possessing such power.

   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
decedent 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 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 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.

  In Rev. Rul. 95-58, 1995-2 C.B. 191, the Service ruled 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 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.

    Section 672(c) defines the term “related or subordinate party” to mean any

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

   In this case, after the proposed modifications, the primary beneficiary, or if

deceased, a majority of the issue of the primary beneficiary, will have the power to
remove and replace the Distribution Trustee and the Independent Trustee, or their
successors, only with a trustee who is not related, or if related, not closer than a cousin
to the beneficiaries, within the meaning of § 672(c). These powers are the equivalent to
the power referenced in Rev. Rul. 95-58 where a replacement trustee may not be
related or subordinate to the powerholder within the meaning of § 672(c). Settlor did not
and does not, as a result of the modifications, have a power to remove or replace a
trustee of the four trusts. Accordingly, based on the facts submitted and the
representations made, we conclude that the proposed modifications to Trust 1, Trust 2,
Trust 3, and Trust 4 will not cause Settlor to be treated as having, having exercised, or
released a general power of appointment for purposes of §§ 2041 and 2514. We further
conclude that the proposed modifications to Trust 1, Trust 2, Trust 3, and Trust 4 will not
cause the beneficiary of Trust 1, Trust 2, Trust 3, or Trust 4, including any beneficiary
serving as co-trustee, to be treated as having, having exercised, or released a general
power of appointment for purposes of §§ 2041 and 2514.

Ruling 4

    Section 2601 imposes a tax on every GST made after October 26, 1986. A GST

is defined under § 2611(a) as (1) a taxable distribution, (2) a taxable termination, and
(3) a direct skip.

    Section 2612(a) provides that the term “taxable termination” means a termination

(by death, lapse of time, release of a power, or otherwise) of an interest in property held
in a trust unless (A) immediately after such termination, a non-skip person has an

interest in such property, or (B) at no time after such termination may a distribution
(including distributions on termination) be made from such trust to a skip person.

    Section 2612(b) provides that the term “taxable distribution” means any

distribution from a trust to a skip person (other than a taxable termination or a direct
skip).

   Under § 2612(c)(1), a direct skip is a transfer subject to federal estate or gift tax

of an interest in property to a skip person.

   Under § 1433(a) of the Tax Reform Act of 1986 (Act) and § 26.2601-1(a), the

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),
the GST tax does not apply to a transfer under a trust that was irrevocable on
September 25, 1985, but only to the extent that such transfer is not made out of corpus
added to the trust after September 25, 1985 (or out of income attributable to corpus so
added). Under § 26.2601-1(b)(1)(ii), any trust in existence on September 25, 1985, will
be considered irrevocable unless the settlor had a power that would have caused
inclusion of the trust in his or her gross estate under § 2038 or 2042, if the settlor had
died on September 25, 1985.

    Section 26.2601-1(b)(4)(i) of the GST Tax Regulation 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)(1),
(2), or (3) (hereinafter referred to as an exempt trust) will not cause the trust to lose its
exempt status. In general, unless specifically provided otherwise, the rules contained in
this paragraph are applicable only for purposes of determining whether an exempt trust
retains its exempt status for GST tax purposes. Thus (unless specifically noted), 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 gain for purposes of § 1001.

    Section 26.2601-1(b)(4)(i)(D)(1) provides that a modification of the governing

instrument of an exempt trust (including a trustee distribution, settlement, or
construction that does not satisfy paragraph § 26.2601-1(b)(4)(i)(A), (B), or (C) by
judicial reformation, or nonjudicial reformation that is valid under applicable state law,
will not cause an exempt trust to be subject to the provisions of chapter 13, if the
modification does not shift a beneficial interest in the trust to any beneficiary who
occupies a lower generation (as defined in § 2651) than the person or persons who held
the beneficial interest prior to the modification, and the modification does not extend the
time for vesting of any beneficial interest in the trust beyond the period provided for in
the original trust.

    Section 26.2601-1(b)(4)(i)(D)(2) provides that for purposes of this section, a

modification of an exempt trust will result in a shift in beneficial interest to a lower
generation beneficiary if the modification can result in either an increase in the amount
of a GST transfer or the creation of a new GST transfer. To determine whether a
modification of an irrevocable trust will shift a beneficial interest in a trust to a
beneficiary who occupies a lower generation, the effect of the instrument on the date of
the modification is measured against the effect of the instrument in existence
immediately before the modification. If the effect of the modification cannot be
immediately determined, it is deemed to shift a 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 modification. A modification that is
administrative in nature that only indirectly increases the amount transferred (for
example, by lowering administrative costs or income taxes) will not be considered to
shift a beneficial interest in the trust.

   In § 26.2601-1(b)(4)(i)(E), Example 10 considers the following situation. 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 § 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 this case, the proposed modifications to Trust 1, Trust 2, Trust 3, and Trust 4,

as described above, are administrative in nature under § 26.2601-1(b)(4)(i)(D)(2), and
will not be considered to shift a beneficial interest to a lower generation in the trust. See
Example 10 of § 26.2601 1(b)(4)(i)(E). The changes will not result in a shift in any
beneficial interest to a lower generation nor do the changes extend the time for vesting
of any beneficial interest in Trust. Accordingly, based upon the facts submitted and the
representations made, we conclude that the proposed modifications to Trust 1, Trust 2,
Trust 3, and Trust 4 will not cause Trust 1, Trust 2, Trust 3, or Trust 4 to lose its exempt
status from GST tax.

  In accordance with the Power of Attorney on file with this office, we have sent a

copy of this letter to your authorized representatives.

   Except as expressly provided herein, we neither express nor imply any opinion

concerning the tax consequences of any aspect of any transaction or item discussed or
referenced in this letter.

  The rulings contained in this letter are based upon information and

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

  This ruling is directed only to the taxpayer requesting it. Section 6110(k)(3)

provides that it may not be used or cited as precedent.

                                             Sincerely,


                                             ________________________
                                             Lorraine E. Gardner
                                             Senior Counsel, Branch 4
                                             Office of the Associate Chief Counsel
                                             (Passthroughs and Special Industries)

Enclosures
Copy for § 6110 purposes
Copy of this letter

cc: