Dividing grandfathered trust preserved GST exemption without gift tax

Plain-English summary

A trustee proposed dividing a pre-September 25, 1985 testamentary trust into four equal trusts, one for each grandchild’s family line, while continuing to provide for the grantor’s son. Each asset would be divided proportionately, distributions for the son would be shared equally, and the dispositive terms otherwise would remain the same. The IRS concluded that a court-approved modification would neither shift beneficial interests to a lower generation nor extend vesting beyond the original trust period. The original and resulting trusts therefore would retain their grandfathered exemption from generation-skipping transfer tax. Because the beneficiaries’ interests, rights, and expectations remained substantially the same, the division also would not create a transfer subject to gift tax.

Ruling snapshot

• Request: Confirm the GST-tax and gift-tax consequences of dividing a grandfathered trust
• Outcome: Approved; GST exemption preserved and no taxable gift created
• Key authorities: I.R.C. §§ 2501, 2511, 2512, 2601; Treas. Reg. § 26.2601-1

Full text (IRS public release)

Internal Revenue Service                                       Department of the Treasury
                                                               Washington, DC 20224

Number: 201543006                                              Third Party Communication: None
Release Date: 10/23/2015                                       Date of Communication: Not Applicable
Index Number: 2501.00-00, 2601.00-00
                                                               Person To Contact:
----------------------                                         ------------------------------, ID No--------------
------------------------------------------------------         ---------
---------------------
                                                               Telephone Number:
-----------------------------------------                      ----------------------
------------------------
                                                               Refer Reply To:
                                                               CC:PSI:B04
                                                               PLR-104272-15
                                                               Date: JUNE 24, 2015

In Re:
         ----------------------------------------



Legend

Grantor                    =        -----------------------------------
Trust                      =        ----------------------------------------
                           ------------------------
Son                        =        ---------------------------------
Grandchild 1               =        ----------------------------------------------------
Grandchild 2               =        ---------------------------------------------------------------
Grandchild 3               =        --------------------------------------------------------------
Grandchild 4               =        -----------------------------------------------------------
Date 1                     =        ------------------------
Date 2                     =        ---------------------------
Date 3                     =        -------------------
X                          =        ----
Trustee                    =        ----------------------
Foundation                 =        -----------------------------------------------
Court                      =        ---------------------------------------
State Statute              =        ----------------------------------------------------------------

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

       This letter responds to your authorized representative’s letter dated January 23,
2015, and subsequent correspondence, requesting rulings on the gift and generation-
skipping transfer (GST) tax consequences of the proposed modifications of a trust.
PLR-104272-15                                  2


Facts

      The facts submitted and representations made are as follows. Under Article IV of
Grantor’s Will, executed on Date 1, Grantor created a testamentary trust (Trust) for the
primary benefit of Son and his descendants. Grantor died on Date1, a date prior to
September 25, 1985, survived by Son. Son has 4 living children, Grandchild 1,
Grandchild 2, Grandchild 3 and Grandchild 4. A bank is the trustee (Trustee) of Trust.

       Article VI, section 4.2 of Trust provides, that upon Grantor’s death, Trustee will
divide Trust property into equal shares, one share for each child of Grantor and one
share for the living descendants (collectively) of each deceased child of Grantor. Each
share set aside for the descendants of a deceased child will be divided into portions for
such descendants per stirpes. Each such share set aside for a living child and each
portion set aside for a descendant of a deceased child will constitute a separate trust,
and the records of Trustee shall be kept accordingly. Each such trust shall be known by
the name of my child or their descendant for whom it was set aside and who shall be
the primary beneficiary of such trust (referred to as the “Beneficiary” of his or her trust).

        Article VI, section 4.3 of Trust provides, that Trustee will distribute so much of the
income and principal of each trust to the beneficiary of the trust and/or their
descendants as the trustee determines in the trustee’s absolute discretion. Trustee has
full discretion to distribute more or less or none or all of a child’s trust to such child. In
determining what distributions are to be made from each trust, Trustee may consider
possible income tax savings as well as other considerations. In addition to the
distributions provided for under this section Trustee may, in the Trustee’s sole discretion
distribute to Foundation any income of the trusts created under Article IV which is not
distributed to a Beneficiary or the descendants of a Beneficiary, and it is Grantor’s
desire that Trustee make such distributions of the excess income each year so long as
the security of my descendants is not impaired.

       Article VI, section 4.4 of Trust provides that at Son’s death, all Trust income and
principal remaining in Trust is to be divided equally among Son’s then-living
descendants per stirpes, and held in a separate trust for the benefit of each such
descendant until the termination of Trust.

      Article VII, section 7.4 of Trust provides that Trust is to terminate not later than
one day prior to the date twenty-one years after the date of death of the last to survive
of Grantor’s father’s descendants who were living at the date of the creation of Trust.
Upon termination all undistributed income and principal of Trust is to be distributed to
Foundation. Grandchildren were living at Grantor’s death.

       Son is currently X years old. All Grandchildren are adults. Trustee began
serving as trustee on Date 3. Trustee has made distributions from Trust in each year in
PLR-104272-15                                  3

which it has served as Trustee. In recent years, Grandchildren have had differing
investment goals and personal financial needs. As a result, the level of distributions to
Grandchildren has been significantly disproportionate and Trustee anticipates that this
will continue in the future. Under Trust terms, at Son’s death, the assets of Trust are to
be divided equally and distributed to separate trusts, one for each Grandchild, per
stirpes.

      Trustee intends to file a petition in Court requesting that the court judicially
modify Trust to divide Trust into four equal trusts (Resulting Trusts), one for the benefit
of each Grandchild, per stirpes. Each Resulting Trust would continue to provide for
Son. The division would be accomplished by a pro rata division of each Trust asset.
The modification would also clarify that distributions to Son are to be borne equally by
each Resulting Trust and that Trustee is not required to give preferential treatment as
between Son and Son’s descendants when making distributions.

       Trustee would continue to act as the sole trustee of each Resulting Trust. The
dispositive terms of the Resulting Trusts would be identical to the dispositive terms of
Trust, except that the distributees of income and principal of each Resulting Trust would
be limited to Son and Grandchild’s family line for whom the Resulting Trust is
established.

        State Statute 1 provides, that, on the petition of a trustee or a beneficiary, a court
may order that the terms of the trust be modified or that the trustee be directed to do
acts that are not authorized under the terms of the trust, if: (1) because of
circumstances not known to or anticipated by the settlor, the order will further the
purposes of the trust; or (2) modification of administrative, nondispositive terms of the
trust is necessary or appropriate to prevent waste or avoid impairment of the trust's
administration.

       You have requested the following rulings:

      1. That the proposed modifications to Trust will not cause Trust to lose its
grandfathered status as exempt from GST tax under chapter 13 of the Internal Revenue
Code.

        2. That the proposed division of Trust and pro rata allocation of each Trust asset
among the Resulting Trusts will not constitute a transfer by any Trust beneficiary that
will be subject to federal gift tax.

Ruling 1

      Section 2601 imposes a tax on each generation skipping transfer. Under section
1433(b)(2)(A) of the Tax Reform Act of 1986 Act and § 26.2601-1(b)(1)(I) of the
Generation-Skipping Transfer Tax Regulations, the generation-skipping transfer tax
PLR-104272-15                                 4

shall not apply to any generation-skipping transfer under a trust that was irrevocable on
September 25, 1985, but only to the extent that the transfer is not made out of corpus
added to the trust after September 25, 1985 (or out of income attributable to corpus so
added).

        Section 26.2601-1(b)(1)(ii)(A) of the Generation-Skipping Transfer Tax
Regulations provides that any trust in existence on September 25, 1985, will be
considered an irrevocable trust except as provided in § 26.2601-1(b)(1)(ii)(B) or (C)
(relating to property includible in the grantor’s gross estate under §§ 2038 and 2042).

        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 will not cause the trust to lose its
exempt status. The regulation provides that the rules contained in the paragraph are
applicable only for purposes of determining whether an exempt trust retains its exempt
status for generation-skipping transfer 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)(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 (b)(4)(i)(A), (B), or (C) of this section) 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, but only if B

       (1) 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

       (2) 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.

       Trust was irrevocable prior to September 25, 1985, and it is represented that
there have been no additions (constructive or otherwise) to Trust after that date.
Accordingly, Trust is exempt from the generation-skipping transfer tax.

       Based on the facts presented and representations made, we conclude that
provided the appropriate court issues an order approving the modifications of Trust,
discussed above, the modifications will not shift any beneficial interest in 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 modifications and division. In
addition, the modifications of Trust will not extend the time for vesting of any beneficial
interest in the trusts beyond the period provided for in the original trust. Accordingly,
PLR-104272-15                                 5

based on the facts submitted and the representations made, the modifications of Trust
will not cause Trust or Resulting Trusts for the benefit of Son, Grandchild 1, Grandchild
2, Grandchild 3 and Grandchild 4 to be subject to the generation-skipping transfer tax
imposed by chapter 13 of the Internal Revenue Code.

Ruling 2

        Section 2501 imposes a tax for each calendar year on the transfer of property by
gift during such calendar year by any individual, resident or nonresident.

       Section 2511 provides that, subject to certain limitations, the gift tax applies
whether the transfer is in trust or otherwise, direct or indirect, and whether the property
transferred is real or personal, tangible or intangible.

       Section 2512(a) provides that if the gift is made in property, the value thereof at
the date of the gift is considered the amount of the gift.

        Section 2512(b) provides that where property is transferred for less than an
adequate and full consideration in money or money's worth, then the amount by which
the value of the property exceeded the value of the consideration is deemed a gift that
is included in computing the amount of gifts made during the calendar year.

       In this case, the beneficiaries of the Resulting Trusts will have substantially the
same interests after the proposed division of Trust that they had as beneficiaries under
Trust. Because the beneficial interests, rights, and expectancies of the beneficiaries are
substantially the same, both before and after the proposed division of Trust, no transfer
of property will be deemed to occur as a result of the division. Accordingly, based on
the facts submitted and the representations made, we conclude that the division of
Trust, as described above, will not result in a transfer by any beneficiary of Trust, or the
Resulting Trusts that will be subject to federal gift tax under § 2501.

       Except as specifically ruled 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.

      This ruling is directed only to the taxpayer who requested it. Section
6110(k)(3) provides that it may not be used or cited as precedent.

       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.
PLR-104272-15                               6


    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.

                                             Sincerely,


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


Enclosures
      Copy for § 6110 purposes