Self-settled trust remains grantor-owned and gifts incomplete

Plain-English summary

A trustor proposed an irrevocable trust for herself and her descendants. An independent distribution adviser could direct distributions to the trustor, while distributions to descendants required the trustor's written consent, and the trustor retained limited lifetime and testamentary appointment powers and a borrowing power. The IRS ruled that the trustor would be treated as the owner of the trust under the grantor-trust rules. It also ruled that the initial transfer would be wholly incomplete for gift-tax purposes because the trustor retained control over beneficial interests. Distributions back to the trustor would merely return her property, while distributions or lifetime appointments to others would become completed gifts when made. The trust property would be included in the trustor's gross estate at death.

Ruling snapshot

• Question: Would the trust be owned by the trustor for income-tax purposes, and would contributions to it be completed gifts?
• Outcome: Favorable rulings: grantor-trust treatment and wholly incomplete gifts until property is distributed or appointed to others
• Key authorities: IRC §§ 671, 674(a), 675(2), 677(a), and 2511; Treas. Reg. § 25.2511-2

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201507008 Third Party Communication: None
Release Date: 2/13/2015 Date of Communication: Not Applicable
Index Number: 671.00-00, 674.00-00,
675.00-00, 677.00-00, Person To Contact:
2511.00-00 -------------------------, ID No. -----------------
-------------------
------------------------------------------ Telephone Number:
-------------------------------------------- ----------------------
--------------------------------------------------- Refer Reply To:
---------------------------- CC:PSI:B03
PLR-122301-14
Date:
October 30, 2014

Legend

Trust = ----------------------------------------------------------------------------------------------------------

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

Trustor = --------------------------------------

Trust Company = ---------------------------------------------------

Foundation = ------------------------------------------------------------------------

X = -------------------------

Y = ----------------------------------

Act = --------------------------------------------------------------------

State = -------------------

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

PLR-122301-14 2

   This is in response to a letter dated May 20, 2014, submitted by your authorized

representative, requesting rulings under §§ 671, 674(a), 675(2), 677(a), and 2511 of the
Internal Revenue Code.

    The information submitted states that Trustor proposes to create an irrevocable

trust (“Trust”) for the benefit of herself and her issue. Trust will be created and
governed by Act and the general laws of State. During the Trustor’s lifetime, the
Distribution Adviser may direct the Trustee (who is also an Independent Trustee) to
distribute so much of the net income and/or principal to Trustor as Distribution Adviser
deems appropriate in its sole discretion. During Trustor’s lifetime, the Distribution
Adviser may direct the Trustee (who is also an Independent Trustee) to distribute so
much of the net income and/or principal to any one or more of the Trustor’s issue then
living as the Distribution Adviser deems appropriate in its sole discretion, but only upon
obtaining Trustor’s written consent (“Trustor’s Consent Power”). Trustor shall exercise
this power in a non-fiduciary capacity and in her sole discretion. Distributions may be
made equally or unequally and to or for the benefit of any one or more of the
beneficiaries to the exclusion of others. No such distribution shall be deemed to be an
advance. If during Trustor’s lifetime, no issue of Trustor are then living, but issue of
Trustor’s father are then living, the issue of Trustor’s father shall be substituted for the
issue of Trustor for purposes of distributions allowed during Trustor’s lifetime. Any net
income not distributed by Trustee will be accumulated and added to principal.

    With the written consent of Trust Protector, Trustor may appoint during her

lifetime (“Trustor’s Lifetime Limited Power of Appointment”) or in her last will and
testament (“Trustor’s Testamentary Limited Power of Appointment”) any part of the
accumulated net income and principal to any one or more of Foundation and the issue
of Trustor’s father (but not to Trustor, Trustor’s creditors, Trustor’s estate, and/or the
creditors of Trustor’s estate).

    Upon Trustor’s death, the accumulated and unappointed net income and

principal shall be divided into as many equal shares as there are then living children of
Trustor and then deceased children of Trustor who have issue surviving Trustor. Each
such share shall be distributed to a separate family trust for the benefit of (i) each then
living child of Trustor and his or her issue, and (ii) the issue of each then deceased child
of Trustor. If all of Trustor’s issue predecease Trustor, the accumulated and
unappointed net income and principal shall be divided into as many equal shares as
there are then living children of Trustor’s father and deceased children of Trustor’s
father who have issue surviving Trustor, and each such share shall be distributed to a
separate family trust for the benefit of (i) each then living child of Trustor’s father and his
or her issue, and (ii) the issue of each then deceased child of Trustor’s father
(“Alternative Mechanism”). If no issue of Trustor’s father survive Trustor, the
accumulated and unappointed net income and principal shall be distributed to
Foundation.

PLR-122301-14 3

     The Distribution Adviser may direct Trustee (who is also an Independent Trustee)

to distribute so much of the net income and/or principal of each family trust to any one
or more of the beneficiaries as Distribution Adviser deems appropriate in its sole
discretion. Each family trust shall terminate upon the earlier of (i) the expiration of any
applicable rule against perpetuities, and (ii) the death of the last to die of the
beneficiaries of that family trust. If a family trust terminates pursuant to (i), the
accumulated net income and principal shall be distributed, in equal shares, per stirpes,
to the then living beneficiaries of that family trust. If a family trust terminates pursuant to
(ii), the accumulated net income and principal shall be distributed, in equal shares, to
the other family trusts, and in default thereof, pursuant to the Alternative Mechanism,
and in further default thereof, to the Foundation.

    During Trustor’s lifetime, Trustor may at any time and from time to time borrow

any part of the accumulated net income and principal of the Trust (“Borrowing Power”).
If the Trustor does so, Trustee (who is also an Independent Trustee) shall determine the
rate of interest to be charged, which rate shall not be less than a reasonable market rate
of interest at the time the loan is made, and shall determine whether or not the loan
should be secured. Trustor may release this Borrowing Power, in whole or in part.
Trustee (who is also an Independent Trustee) may also make loans (with adequate
collateral and interest) to any person.

    In the event no Distribution Adviser is serving, Trustee (who is also an

Independent Trustee) shall hold and exercise full power to make discretionary
distributions of net income and principal of any trust (pursuant to the same standards as
were applied to the Distribution Adviser).

    The initial Distribution Adviser is X. It is represented that the Distribution Advisor

is not related or subordinate to Trustor within the meaning of § 672(c). In addition, any
successor Distribution Adviser cannot be related or subordinate to the Trustor, within
the meaning of § 672(c). The initial Trustee (who is also an Independent Trustee) is
Trust Company. It is represented that Trust Company is an Independent Trustee, as
defined below. Any successor Independent Trustee may not be related or subordinate
to any beneficiary, within the meaning of § 672(c). The initial Trust Protector is Y. The
successor Trust Protector cannot be related or subordinate to the Trustor, within the
meaning of § 672(c) of the Code. The Independent Trustee, Distribution Advisor and
Trust Protector of Trust or any family trust must (i) have no interest, vested or
contingent, direct or indirect, in the trust estate of such trust, (ii) not be benefited by the
exercise or nonexercise of any power, authority or discretion given exclusively to or
vested exclusively in the Independent Trustee, Distribution Adviser, or Trust Protector,
respectively, by the provisions of the trust’s agreement or by law, and (ii) alone possess
and exercise each such power, authority and discretion without causing income,
accumulated income or principal of the trust fund of such trust to be attributable to any
beneficiary (excluding the Trustor) of such trust for income, gift tax or estate tax
purposes under the United States internal revenue laws in force and effect at such time

PLR-122301-14 4

prior to the time such income, accumulated income or principal is distributed to or for
the account of, or used or expended for the benefit of, such beneficiary.

LAW AND ANALYSIS

Ruling 1

   Section 671 provides that where it is specified in subpart E of Part I of

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

   Section 672(a) provides that the term “adverse party” means any person having

a substantial beneficial interest in the trust which would be adversely affected by the
exercise or nonexercise of the power which he possesses respecting the trust. A
person having a general power of appointment over the trust property shall be deemed
to have a beneficial interest in the trust.

    Section 672(b) provides that the term “nonadverse party” means any person who

is not an adverse party.

  Section 673 through 678 specify the circumstances under which the grantor or a

person other than the grantor is treated as the owner of a portion of a trust.

   Section 674(a) provides, in general, that the grantor shall be treated as the owner

of any portion of a trust in respect of which the beneficial enjoyment of the corpus or the
income therefrom is subject to a power of disposition, exercisable by the grantor or a
nonadverse party, or both, without the approval or consent of any adverse party.

   Section 674(b)(3) provides that § 674(a) shall not apply to a power exercisable

only by will, other than a power in the grantor to appoint by will the income of the trust
where the income is accumulated for such disposition by the grantor or may be so
accumulated in the discretion of the grantor or a nonadverse party or both, without the
approval or consent of any adverse party.

   Section 1.674(a)-1 of the Income Tax Regulations provides that § 674(a) may

apply, whether a power held by the grantor and/or a nonadverse party is a fiduciary
power, a power of appointment, or any other power.

  Section 674(b)(5) provides that § 674(a) shall not apply to a power to distribute

corpus either (A) to or for a beneficiary or beneficiaries or to or for a class of

PLR-122301-14 5

beneficiaries (whether or not income beneficiaries) provided that the power is limited by
a reasonably definite standard which is set forth in the trust instrument; or (B) to or for
any current income beneficiary, provided that the distribution of corpus must be
chargeable against the proportionate share of corpus held in trust for the payment of
income to the beneficiary as if the corpus constituted a separate trust.

  Section 1.674(b)-1(b)(5)(i) provides that if the trust instrument provides that the

determination of the trustee shall be conclusive with respect to the exercise or
nonexercise of a power, the power is not limited by a reasonably definite standard.

    Section 674(b)(6) provides that § 674(a) shall not apply to a power to distribute or

apply income to or for any current beneficiary or to accumulate the income for him,
provided that any accumulated income must ultimately be payable (A) to the beneficiary
from whom the distribution or application is withheld, to his estate, or to his appointees
(or persons named as alternate takers in default of appointment) provided that such
beneficiary possesses a power of appointment which does not exclude from the class of
possible appointees any person other than the beneficiary, his estate, his creditors, or
the creditors of his estate, or (B) on termination of the trust, or in conjunction with a
distribution of corpus which is augmented by such accumulated income, to the current
income beneficiaries in shares which have been irrevocably specified in the trust
instrument.

  Section 1.674(b)-1)(b)(6)(c) provides that § 674(b)(6) is not applicable if the

power is in substance one to shift ordinary income from one beneficiary to another.

   Section 674(c) provides that § 674(a) shall not apply to a power exercisable

(without the approval or consent of any other person) by a trustee or trustees, none of
whom is the grantor, and no more than half of whom are related or subordinate parties
who are subservient to the wishes of the grantor (1) to distribute, apportion, or
accumulate income to or for a beneficiary or beneficiaries, or to, for, or within a class of
beneficiaries, or (2) to pay out corpus to or for a beneficiary or beneficiaries or to or for a
class of beneficiaries (whether or not income beneficiaries).

    Section 674(d) provides that § 674(a) shall not apply to a power solely

exercisable (without the approval or consent of any other person) by a trustee or
trustees, none of whom is the grantor or spouse living with the grantor, to distribute,
apportion, or accumulate income to or for a beneficiary or beneficiaries, or to, for, or
within a class of beneficiaries, whether or not the conditions of § 674(b)(6) or (7) are
satisfied, if such power is limited by a reasonably definite external standard which is set
forth in the trust instrument.

   Section 675(2) provides that the grantor shall be treated as the owner of any

portion of a trust in respect of which a power exercisable by the grantor or a nonadverse
party, or both, enables the grantor to borrow the corpus or income, directly or indirectly,

PLR-122301-14 6

without adequate interest or without adequate security except where the trustee (other
than the grantor) is authorized under a general lending power to make loans to any
person without regard to interest or security.

   Section 1.675-1(b)(2) provides that § 675(2) shall not apply where a trustee

(other than the grantor acting alone) is authorized under a general lending power to
make loans to any person without regard to interest or security.

    Section 677 provides that the grantor shall be treated as the owner of any portion

of a trust, whether or not he is treated as such owner under § 674, whose income
without the approval or consent of an adverse party is, or, in the discretion of the grantor
or a nonadverse party, or both, may be (1) distributed to the grantor or the grantor’s
spouse; (2) held or accumulated for future distribution to the grantor or the grantor’s
spouse; or (3) applied to the payment of premiums on policies of insurance on the life of
the grantor or the grantor’s spouse.

    Based solely on the facts and representations submitted, we conclude that Trust

will be treated as owned by Trustor under §§ 671, 674(a), 675(2), and 677(a).

Ruling 2

   Section 2501(a)(1) provides for the imposition of a gift tax for each calendar year

on the transfer of property by gift. 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 25.2511-2(b) of the Gift Tax Regulations provides that a gift is complete

as to any property, or part thereof or interest therein, of which the donor has so parted
with dominion and control as to leave the donor no power to change its disposition,
whether for the donor's own benefit or for the benefit of another. But if upon a transfer
of property (whether in trust or otherwise) the donor reserves any power over its
disposition, the gift may be wholly incomplete, or may be partially complete and partially
incomplete, depending upon all the facts in the particular case. Accordingly, in every
case of a transfer of property subject to a reserved power, the terms of the power must
be examined and its scope determined. For example, if a donor transfers property to
another in trust to pay the income to the donor or accumulate it in the discretion of the
trustee, and the donor retains a testamentary power to appoint the remainder among
the donor's descendants, no portion of the transfer is a completed gift. However, if the
donor had not retained a testamentary power of appointment, but instead provided that
the remainder should go to X or his heirs, the entire transfer would be a completed gift.

 Section 25.2511-2(c) provides that a gift is incomplete in every instance in which a

donor reserves the power to revest the beneficial title in himself or herself. A gift is also
incomplete if and to the extent that a reserved power gives the donor the power to name

PLR-122301-14 7

new beneficiaries or to change the interests of the beneficiaries as between themselves
unless the power is a fiduciary power limited by a fixed or ascertainable standard.

   Section 25.2511-2(e) provides that a donor is considered as himself having a

power if it is exercisable by the donor in conjunction with any person not having a
substantial adverse interest in the disposition of the transferred property or the income
therefrom. A trustee, as such, is not a person having an adverse interest in the
disposition of the trust property or its income.

   Section 25.2511-2(f) provides that the relinquishment or termination of the power

to change the beneficiaries of transferred property, occurring otherwise than by the
death of the donor, is regarded as the event which completes the gift and causes the
gift tax to apply.

   Section 25.2511-2(g) provides that if a donor transfers property to himself as

trustee (or to himself and some other person, not possessing a substantial adverse
interest, as trustees), and retains no beneficial interest in the trust property and no
power over it except fiduciary powers, the exercise or nonexercise of which is limited by
a fixed or ascertainable standard, to change the beneficiaries of the transferred
property, the donor has made a completed gift and the entire value of the transferred
property is subject to the gift tax.

   Section 25.2511-2(e) does not define “substantial adverse interest.”

Section 25.2514-3(b)(2) provides, in part, that a taker in default of appointment under a
power has an interest that is adverse to an exercise of the power. Further, a coholder
of the power has no adverse interest merely because of his joint possession of the
power nor merely because he is a permissible appointee under a power. However, a
coholder of a power is considered as having an adverse interest where he may possess
the power after the possessor’s death and may exercise it at that time in favor of
himself, his estate, his creditors, or the creditors of his estate.

   In Estate of Sanford v. Commissioner, 308 U.S. 39 (1939), the taxpayer created a

trust for the benefit of named beneficiaries and reserved the power to revoke the trust in
whole or in part, and to designate new beneficiaries other than himself. Six years later,
in 1919, the taxpayer relinquished the power to revoke the trust, but retained the right to
change the beneficiaries. In 1924, the taxpayer relinquished the right to change the
beneficiaries. The Court stated that the taxpayer’s gift is not complete, for purposes of
the gift tax, when the donor has reserved the power to determine those others who
would ultimately receive the property. Accordingly, the Court held that the taxpayer's
gift was complete in 1924, when he relinquished his right to change the beneficiaries of
the trust. A grantor’s retention of a power to change the beneficial interests in a trust
causes the transfer to the trust to be incomplete for gift tax purposes, even though the
power may be defeated by the actions of third parties. Goldstein v. Commissioner, 37

PLR-122301-14 8

T.C. 897 (1962). See also Estate of Goelet v. Commissioner, 51 T.C. 352 (1968).

   In this case, Trustor retained the Trustor’s Consent Power over the income and

principal of Trust. Under § 25.2511-2(e), a donor is considered as himself having a
power if it is exercisable by him in conjunction with any person not having a substantial
adverse interest in the disposition of the transferred property or the income therefrom.
The Distribution Adviser may not have any beneficial interest in Trust or in any trust
created under Trust, and the Distribution Adviser is not a taker in default for purposes of
§ 25.2514-3(b)(2). Therefore, the Distribution Adviser has no substantial adverse
interest in the disposition of the assets of Trust. The Distribution Adviser is merely a
coholder of the Trustor’s Consent Power. Trust provides that, in the event no
Distribution Adviser is serving, Trustee (who is also an Independent Trustee) shall hold
and exercise full power to make discretionary distributions of net income and principal of
any trust (pursuant to the same standards as were applied to the Distribution Adviser).
Under § 25.2511-2(e), a trustee, as such, is not a person having an adverse interest in
the disposition of the trust property or its income. Further, Trustee (who is also an
Independent Trustee) has no beneficial interest in Trust and is not a taker in default for
purposes of § 25.2514-3(b)(2). Accordingly, Trustee (who is also an Independent
Trustee) has no substantial adverse interest in Trust. Therefore, Trustor is considered
as possessing the power to distribute income and principal to his issue because he
retained the Trustor’s Consent Power. The retention of this power causes the transfer
of property to Trust to be wholly incomplete for federal gift tax purposes.

     Trustor also retained a Lifetime Limited Power of Appointment to appoint income

and principal to the issue of Trustor’s father or Foundation. Trustor’s Lifetime Limited
Power of Appointment can only be exercised in conjunction with the Trust Protector.
Under §§ 25.2511-2(e) and 25.2514-3(b)(2), Trustor is considered to solely possess the
power to exercise Trustor’s Lifetime Limited Power of Appointment because the Trust
Protector (who is merely a coholder of Trustor’s Lifetime Limited Power of Appointment)
has no substantial adverse interest in the disposition of the assets transferred by the
Trustor to Trust because (i) the Trust Protector may not have any beneficial interest in
any trust (whether before or after the Trustor’s death), (ii) the Trust Protector is not a
permissible appointee of the Trustor’s Lifetime Limited Power of Appointment, and
(iii) the Trust Protector is not a taker in default of the exercise of the Trustor’s Lifetime
Limited Power of Appointment.

   Under § 25.2511-2(c), a gift is incomplete if and to the extent that a reserved

power gives the donor the power to name new beneficiaries or to change the interests
of the beneficiaries. In this case, Trustor’s Lifetime Limited Power of Appointment gives
Trustor the power to change the interests of the beneficiaries. Accordingly, the
retention of Trustor’s Lifetime Limited Power of Appointment causes the transfer of
property to Trust to be wholly incomplete for federal gift tax purposes. See Sanford v.
Commissioner.

PLR-122301-14 9

   Finally, Trustor retained the Testamentary Limited Power of Appointment to

appoint Trust property to issue of Trustor’s father or Foundation, other than to Trustor’s
estate, Trustor’s creditors, or the creditors of Trustor’s estate. Under § 25.2511-2(b) the
retention of a testamentary power to appoint the remainder of a trust is considered a
retention of dominion and control over the remainder. Accordingly, the retention of this
power causes the transfer of property to Trust to be incomplete with respect to Trust
remainder for federal gift tax purposes.

     Trustor retains dominion and control over the income and principal of Trust until

the Distribution Advisor (or Trustee (who is also an Independent Trustee) if there is no
Distribution Advisor) exercises his distribution power. Trustor’s Powers over the income
and principal are presently exercisable and not subject to a condition precedent.
Therefore, consistent with Goldstein v. Commissioner and Goelet v. Commissioner,
even if third party actions (i.e., distributions by the Distribution Adviser and/or the
Trustee (who is also an Independent Trustee) to the Trustor) may defeat the Trustor’s
ability to change beneficial interests, the transfer of assets by the Trustor to Trust is
wholly incomplete for gift tax purposes.

   Accordingly, based on the facts submitted and the representations made, we

conclude that the contribution of property to Trust by Trustor is not a completed gift
subject to federal gift tax. Any distribution from Trust to Trustor is merely a return of
Trustor’s property. Further, we conclude that any distribution of income or principal by
the Distribution Adviser from Trust to any beneficiary of Trust, other than Trustor, is a
completed gift by Trustor at the time of distribution. Similarly, an exercise of Trustor’s
Lifetime Limited Power of Appointment in favor of a person, other than Trustor, is a
completed gift of the appointed property. Finally, upon Trustor’s death, the fair market
value of the property in Trust is includible in Trustor’s gross estate for federal estate tax
purposes.

  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.

PLR-122301-14 10

   Pursuant to a Power of Attorney on file, a copy of this letter is being sent to your

authorized representative.

                                   Sincerely,



                                   Bradford R. Poston
                                   Senior Counsel, Branch 3
                                   Office of Associate Chief Counsel
                                   (Passthroughs & Special Industries)

Enclosures (2):
Copy of this letter
Copy for Section 6110 purposes