Separate beneficiary trusts preserve generation-skipping tax exemption

Plain-English summary

A trust created before September 25, 1985, was due to distribute its assets outright to two great-grandchildren. A state court modification instead placed each beneficiary's share in a separate trust with discretionary support distributions, staged principal payments, and a general testamentary power of appointment. The IRS found that the modification did not shift a beneficial interest to anyone in a lower generation and did not extend vesting beyond the original trust period. Each beneficiary's general power of appointment also caused the remaining separate-trust assets to be included in that beneficiary's estate and treated the beneficiary as the transferor for generation-skipping transfer tax purposes. The original trust and both separate trusts therefore retained exemption from the generation-skipping transfer tax.

Ruling snapshot

• Question: Would replacing outright distributions with two separate beneficiary trusts cause a grandfathered trust to lose its generation-skipping transfer tax exemption?
• Outcome: Approved, the modification preserves the exemption.
• Key authorities: IRC §§ 2041, 2601, 2611, and 2651; Treas. Reg. § 26.2601-1(b)(4)(i)(D)

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201521003 Third Party Communication: None
Release Date: 5/22/2015 Date of Communication: Not Applicable
Index Number: 2501.01-00, 2601.00-00
Person To Contact:
------------------------------- -----------------------, ID No. ------------
----------------- Telephone Number:
------------------------ --------------------
Refer Reply To:
------------------------------------------- CC:PSI:B04
PLR-120231-14
Re: ------------------------------------------------------- Date: NOVEMBER 12, 2015

LEGEND:
Settlor = ---------------------------
Trust = -----------------------------------------------------------------------

Date 1 = --------------------------
Date 2 = ---------------------
Date 3 = ---------------------
Date 4 = ---------------------------
Corporate Trustee = -------------------------------------------------
Child = --------------------------------------------
Grandchild = ---------------------------------
Great-grandchild A = -------------------------------
Great-grandchild B = ------------------------
State Court = ------------------------------------------------------------------------

x = ------------

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

This is in response to a letter dated May 12, 2014, and subsequent correspondence,
submitted by your authorized representative requesting a ruling under section 2601 of
the Internal Revenue Code.
PLR-120231-14 2

The facts and representations submitted are summarized as follows. Settlor created
and funded Trust, an irrevocable trust, on Date 1 (a date before September 25, 1985)
for the primary benefit of Grandchild. Corporate Trustee is the current trustee.
Under Article II(A) of Trust, the trustee is authorized to purchase and maintain insurance
on the life of Child. The net income is to be accumulated. However, the trustee may, in
its sole discretion, pay for the benefit of Grandchild so much of the net income as the
trustee may deem necessary and proper to provide for the support, maintenance and
education of Grandchild.

Article II(B) provides that in the event of Grandchild’s death during the life of the trust,
the trustee is to pay to, or expend for, the benefit of Grandchild’s descendants, so much
of the net income and to the extent necessary, principal of Trust as the trustee, in its
discretion may deem appropriate for the proper and appropriate education,
maintenance, comfort, care and support of Grandchild’s descendants.

Trust is to terminate on the earlier of Child’s death (if no descendants), the death of
Child’s last surviving descendant, or five years after Child’s death. Upon termination,
the trustee is to distribute all of the Trust assets in equal shares to Grandchild’s then
surviving descendants.

Child died on Date 2. Thus, Trust will likely terminate on Date 3, the fifth anniversary of
Child’s death. Grandchild, the income beneficiary of Trust, is living. Grandchild has two
children, Great-grandchild A and Great-grandchild B, who are to receive the Trust
principal outright on Date 3.

On Date 4, the parties petitioned State Court for an order modifying Trust to provide
that, on termination of Trust, the portion of principal and accumulated income otherwise
passing outright to Great-grandchild A will be held in a separate trust to be administered
for Great-grandchild A’s exclusive benefit, and the portion of Trust principal and
accumulated income otherwise passing outright to Great-grandchild B will be held in a
separate trust to be administered for Great-grandchild B’s exclusive benefit.

Corporate Trustee will serve as the trustee. Grandchild may serve as an advisor with
regard to discretionary distributions, but Grandchild’s suggestions will not be binding on
Corporate Trustee, and Corporate Trustee will have the final authority and responsibility
for all decisions regarding discretionary distributions.

Each Great-grandchild’s separate trust

Each Great-grandchild’s separate trust will provide that, throughout its duration, the
trustee is authorized, in its discretion, to distribute such amount of income of that
separate trust as may be reasonably necessary to provide adequately for the health,
education, support, and maintenance of the Great-grandchild-beneficiary of that
separate trust. Each trust will authorize the trustee, in its discretion, at any time, to
PLR-120231-14 3

distribute such amounts of the principal of that separate trust as may be reasonably
necessary to provide adequately for the health, education, support, and maintenance of
the Great-grandchild beneficiary of that separate trust.

In addition, the following distributions are to be made to a Great-grandchild-beneficiary
from that Great-grandchild’s separate trust. The sum of $ x will be distributed to him or
her upon reaching age 32. The trustee will distribute one-third of the Great-grandchild’s
separate trust assets to him or her upon reaching age 40. One-half of the Great-
grandchild’s separate trust assets then on hand will be distributed to him or her upon
reaching age 45.

Finally, a Great-grandchild’s separate trust will terminate on the first to occur of: (i) the
Great-grandchild’s reaching age 50 (at which time the remaining separate trust assets
will be distributed to him or her) or (ii) the Great-grandchild’s death (at which time the
remaining assets in that Great-grandchild’s separate trust will be distributed in
accordance with his exercise of a general testamentary power of appointment over the
principal and accumulated income of that separate trust). If the Great-grandchild fails to
exercise his general testamentary power of appointment, the separate trust assets will
be distributed to or for the Great-grandchild’s descendants per stirpes. If a Great-
grandchild-beneficiary becomes incapacitated during the term of his separate trust, the
assets of that Great-grandchild’s separate trust will be retained in the separate trust for
the duration of the incapacity or until his earlier death.

You have asked to rule that the proposed reformation and modification of the Trust
agreement will not cause the Trust, or any Great-grandchild’s separate trust to be
established on the partition, to be subject to the tax on generation-skipping transfers
under § 2601.

Section 2601 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 principal 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 generation-skipping transfer tax under § 26.2601-1(b) will not cause
the trust to lose its exempt status. In general, unless specifically provided otherwise,
these rules are applicable only for purposes of determining whether an exempt trust
retains exempt status for generation-skipping transfer tax purposes. The rules do not
PLR-120231-14 4

apply in determining, for example, whether the transaction results in a gift subject to gift
tax, or may cause the trust to be included in the gross estate of a beneficiary, or may
result in the realization of capital gain for purposes of § 1001.

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

In the instant case, the reformation and modification of Trust pursuant to the State Court
order will provide that the Trust principal that would otherwise pass outright to Great-
grandchild A on termination of Trust will be held in further trust for the exclusive benefit
of Great-grandchild A. Likewise, the Trust principal that would otherwise pass outright
to Great-grandchild B on termination of Trust will be held in further trust for the exclusive
benefit of Great-grandchild B. Each Great-grandchild will have a testamentary general
power to appoint the property of his respective separate trust to anyone, including his
estate or the creditors of his estate.

Under these circumstances, the assets held in a Great-grandchild’s separate trust at his
death will be included in his gross estate, for estate tax purposes, under § 2041(a)(2).
Further, each Great-grandchild will be treated as the transferor of the principal of his
separate trust for GST tax purposes under § 2041(a)(2).

Accordingly, the proposed modifications will not result in a shift of any beneficial interest
in Trust to any beneficiary who occupies a generation lower than the persons holding
the beneficial interest prior to the modification. Further, the modifications of Trust will
not extend the time for vesting of any beneficial interest in Trust beyond the period
provided for in the original trust. Finally, the modifications pertaining to trustee powers
are administrative in nature. Section 26.2601-1(b)(4)(i)(D).

Based on the facts submitted and the representations made, we conclude that the
proposed modifications comply with the provisions of § 26.2601-1(b)(4)(i)(D)(1) and will
not cause Trust or any Great-grandchild's separate trust to be subject to the tax on
generation-skipping transfers.

Except as expressly provided herein, we express no opinion on the federal tax
consequences of the transaction under the cited provisions or under any other
provisions of the Code.
PLR-120231-14 5

This ruling is directed only to the taxpayers requesting it. Section 6110(k)(3) of the
Code provides that it may not be used or cited as precedent.

In accordance with the Power of Attorney on file with this office, a copy of this letter is
being sent to your authorized representatives.

The ruling contained in this letter is 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.

                                       Sincerely,



                                       Melissa C. Liquerman
                                       Chief, Branch 4
                                       Office of Associate Chief Counsel
                                       (Passthroughs & Special Industries)

Enclosure:
Copy of letter for § 6110 purposes