Trust reformations respected for gift and estate tax

Plain-English summary

A married couple created an irrevocable trust for their children, but several provisions mistakenly retained amendment, distribution, and reversionary powers inconsistent with their intent to make completed gifts and keep the trust assets outside their estates. A state court twice reformed the trust based on scrivener’s errors, supported by the grantors’ declarations, the drafting attorney’s affidavit, and their filed gift-tax returns. The IRS treated the reformations as effective from the trust’s creation, ruled that past and future transfers were completed gifts, and ruled that the trust and subtrust assets would not be included in the grantor’s gross estates under §§ 2036 or 2038.

Ruling snapshot

• Requests: Confirm completed-gift treatment after the state-court reformations and exclusion of the trust assets under §§ 2036 and 2038
• Outcome: Approved on both issues
• Key authorities: I.R.C. §§ 2036, 2038, 2501, 2511; Treas. Reg. § 25.2511-2; Commissioner v. Estate of Bosch, 387 U.S. 456 (1967)

Full text (IRS public release)

Internal Revenue Service                                       Department of the Treasury
                                                               Washington, DC 20224

Number: 201544005                                              Third Party Communication: None
Release Date: 10/30/2015                                       Date of Communication: Not Applicable
Index Number: 2501.01-00, 2036.00-00,
              2038.00-00                                       Person To Contact:
                                                               --------------------------, ID No. -----------
-------------------------------                                Telephone Number:
-----------------                                              ----------------------
------------------------------------------------               Refer Reply To:
                                                               CC:PSI:B04
                                                               PLR-103693-15
                                                               Date:
                                                               June 19, 2015

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




Legend

Grantor A         = -------------------
Grantor B         = ----------------------------------------------------
Trust             = ----------------------------------
Date 1            = ---------------------------
Date 2            = --------------------------
Date 3            = ---------------------------
Date 4            = ------------------------
Year 1            = -------
Year 2            = -------
Year 3            = -------
Court             = -------------------------------------------------------
Case 1            = --------------------------------------------------------------------
Case 2            = -----------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------
Case 3            = ----------------------------------------------------
Statute           = -----------------------------------------------
State             = --------------

Dear ------------------:
PLR-103693-15                                   2


This letter responds to your personal representative’s letter of December 8, 2014,
requesting gift and estate tax rulings with respect to Trust.

On Date 1, Husband (Grantor A) and wife (Grantor B), collectively “Grantors”, created a
trust (Trust) for the benefit of their two children. Article 6, paragraph 6.1 provides that
the trustee shall distribute from time to time as much of the trust income and principal
for the “well-being” of each child, prior to age 25. In making distributions, the trustee
shall emphasize education, health, and personal development of the beneficiary or
beneficiaries.

Article 6, paragraph 6.3 provides that after the oldest child reaches age 25, the trustee
shall pay the entire net income of his or her trust to the child. The trustee may withhold
all or any portion of the income for any child who is under the age of 25. If the trustee
considers the income to be insufficient, the trustee may also pay to the child as much of
the principal of the trust as the trustee, in the trustee’s discretion, considers necessary
for proper health, education, support, and maintenance. When the eldest child reached
age 25, Trust was divided into two subtrusts (Subtrusts).

Article 6, paragraph 6.3(b) provides that if the child dies before becoming entitled to a
full distribution from his or her trust, the trustee shall preserve the remaining balance of
the trust for the sole benefit of the surviving child or children. If all children of the
Grantors are deceased, then the trustees shall distribute the remaining balance of Trust
to the Grantors.

Article 5 provides that Trust is irrevocable.

Article 9 provides that the Grantors (or the survivor) have the power to amend the trust
to increase the benefits of this trust going to their children, but not to detract therefrom
and have the power to amend the trust to name additional trustees from time to time.

In Year 1 and Year 2, Grantors transferred real property and certain other property to
Trust. Grantors filed Forms 709, United States Gift (and Generation-Skipping Transfer)
Tax Returns, reporting the gifts to Trust.

Grantors were the trustees of Trust. However, while serving as trustees, the Grantors
never made any distributions from Trust to the beneficiaries.

Grantors became aware that the trust provisions above in Articles 6 and 9 failed to
reflect Grantors’ intent to have the transfers to Trust treated as completed gifts and to
exclude the Trust assets from the Grantors’ gross estates. In Year 3, Grantors filed a
petition with Court seeking reformation of the trust to correct these scrivener’s errors.

On Date 2, the court reformed the trust language as follows:
PLR-103693-15                                  3


       Article 6, paragraph 6.1 provides that until the Grantors children reach age
       25, the trustee shall distribute from time to time as much of the income
       and principal of Trust as the trustee consider necessary for health,
       education, maintenance, and support of the children. Article 6, paragraph
       6.3 provides that after the child reaches age 25, the trustee shall pay to
       each child the entire net income of his or her trust. The trustee may
       withhold all or any portion of the income for any child who is under age 25
       if the trustee, in the trustee’s discretion, determines that such income is
       not necessary for such child’s health, education, support, and
       maintenance. If the trustee considers the income to be insufficient, the
       trustee may also pay to the child as much of the principal of the trust as
       the trustee, in the trustee’s discretion, considers necessary for proper
       health, education, support, and maintenance.

Article 9 provides that the Grantors (or the survivor) shall have the power to amend the
trust to name additional trustees from time to time.

On Date 4, Grantors obtained a second Court order reforming Article 6.3(b) as follows:

       Article 6, paragraph 6.3(b) provides that if the child dies before becoming
       entitled to a full distribution from his or her trust, the trustee shall preserve
       the remaining balance of the trust for the sole benefit of the surviving child
       or children, if any, or, if none, the trustee shall distribute the remaining
       balance to the deceased child’s estate.

In declarations to the State Court, Grantors declared that each intended that Trust be
drafted in a manner that would ensure the transfers were completed gifts and that each
did not direct the attorney to include the stated language in Trust. In an affidavit, the
attorney who drafted Trust swore that Grantors intended the transfers to Trust to be
completed gifts and that the trust provisions, prior to reformation, were scrivener’s errors
and were not consistent with the Grantors’ intent. Grantors resigned as trustees,
effective Date 3. It is represented that Grantors established Trust for the main purpose
to leverage Grantors’ unified credit and transfer the maximum amount to their children.
One exhibit in the state court proceeding was a letter from the attorney indicating that
the “purpose of this trust is to set aside property for your children” and “[a]n irrevocable
trust . . . .”

You have requested the following rulings: (1) as a result of the State Court reformations
of Trust to correct several scrivener’s errors, the original transfers to Trust and future
transfers to the Subtrusts are and will be completed gifts for federal gift tax purposes;
and (2) the assets of Trust and the Subtrusts will not be includable in Grantor B’s gross
estates under § 2036 or 2038.
PLR-103693-15                                 4

Ruling # 1:
Section 2501 of the Internal Revenue Code 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(a) provides that the gift tax shall apply 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, in part, that a gift is complete
where the donor has so parted with dominion and control as to leave in him no power to
change its disposition, whether for his own benefit or for the benefit of another.

Section 25.2511-2(c) provides, in part, that a gift is incomplete in every instance in
which a donor reserves the power to revest the beneficial title to the property in himself.
A gift is also incomplete if and to the extent that a reserved power gives the donor the
power to name new beneficiaries or to change the interest of the beneficiaries as
between themselves unless the power is a fiduciary power limited by a fixed or
ascertainable standard.

In Commissioner v. Estate of Bosch, 387 U.S. 456 (1967), the Supreme Court held that
where the issue involved is the determination of property interests for federal estate tax
purposes, and the determination is based on state law, the highest court of the state is
the best authority on its own law. The Service, however, is not bound by a lower court
decision. If there is a decision by a lower court, then the federal authority must apply
what it finds to be state law after giving "proper regard" to the state trial court's
determination and to relevant rulings of other courts of the state. In this respect, the
federal agency may be said, in effect, to be sitting as a state court.

In Case 1, the scrivener gave a surviving spouse the power to revoke a credit shelter
trust which would have caused the assets to be included in the surviving spouse’s gross
estate. Due to ambiguities in the trust instrument, the court allowed extrinsic evidence
to determine the grantors’ intent, citing Case 2 for the proposition that where a trust
instrument contains some expression of the trustor’s intention, but as a result of a
drafting error that expression is made ambiguous, a trial court may consider extrinsic
evidence to resolve the ambiguity and give effect to the trustor’s intention. This
evidence indicated that the grantors intended to create the credit shelter trust to
minimize their overall estate tax liability and exclude the credit shelter trust from the
surviving spouse’s gross estate. The court concluded that the provision was a
scrivener’s error and reformed the trust to eliminate the power. The court stated that
the court had ample authority, founded in common law and under statutory law, to
reform the trust to accomplish the purposes of the grantors. The court cited Case 3 for
the proposition that state courts have the power to modify the terms of a trust to serve
the original intentions of the grantor. The court applied State Statute which recognizes
PLR-103693-15                                 5

the equitable common law power of a trial court to reform a trust agreement based on
mistake.

In this case, Article 5 provides that Trust is irrevocable. However, Article 9 gives
Grantors the power to amend Trust. These provisions are inconsistent and create an
ambiguity. Under State law, a state court would allow extrinsic evidence to determine
the Grantors’ intent. In this case, it is represented that Grantors intent was to leverage
the grantors’ unified credit and transfer the maximum amount to their children.
Retaining a reversionary interest or a distribution power not limited by an ascertainable
standard was contrary to this intention. Further, the attorney who drafted Trust has
sworn in an affidavit that Grantors intended the transfers to Trust to be completed gifts
and that the trust provisions, prior to reformation, were scrivener’s errors and were not
in line with the Grantors’ intent. In addition, Grantors filed Forms 709 reporting the
transfers to Trust and treating the transfers as completed gifts. Grantors submitted
declarations to Court of their intent to make completed gifts to Trust.

Therefore, we conclude that State Court’s orders on Date 2 and Date 4 reforming Trust
based upon scrivener’s errors are consistent with State law as applied by the highest
court of State. The reformations of Trust are effective as of Date 1.

Accordingly, based upon the facts submitted and representations made, we conclude
that as a result of the State Court reformations of Trust, the original transfers to Trust
and future transfers to the Subtrusts are and will be completed gifts for federal gift tax
purposes.

Ruling # 2:

Section 2001(a) imposes a tax on the transfer of the taxable estate of every decedent
who is a citizen or resident of the United States.

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 the
decedent's 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 an 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.
PLR-103693-15                                  6

Section 2038(a)(1) 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 an adequate and full
consideration in money or money's worth), by trust or otherwise, where the enjoyment
thereof was subject at the date of 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 when any such
power is relinquished during the 3-year period ending on the date of the decedent's
death.

In the present case, the reformation of Trust is effective as of Date 1. The reformed
trust provisions do not give Grantor an income interest in Trust or the divided trusts or
the right to designate the persons who will possess or enjoy the property or have an
interest in the income of the property for purposes of § 2036. Further, the reformed
Trust does not give the Grantor the power to alter, amend, revoke, or terminate Trust or
the divided trusts for purposes of § 2038. Accordingly, based upon the facts submitted
and representations made, we conclude that the assets of Trust and the Subtrusts will
not be includable in the Grantor’s gross estates under § 2036 or 2038.

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.

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,



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


Enclosures (2)