Court-approved trust termination preserves GST exemption

Plain-English summary

A trust created before September 25, 1985 had eighteen living beneficiaries and had become disproportionately difficult and costly to administer. A court-approved settlement would terminate the trust and distribute equal shares to twelve adult grandchildren and great-grandchildren, while another adult and five minor great-great-grandchildren would receive nothing. No actual or constructive additions had been made after the grandfathering date. The IRS concluded that the termination would neither shift a beneficial interest to a lower generation nor extend the vesting period. The trust therefore would retain its generation-skipping transfer tax exemption, and the termination distributions would not be direct skips, taxable distributions, or taxable terminations.

Ruling snapshot

• Question: Will the court-approved termination of a grandfathered trust trigger GST tax or make its distributions generation-skipping transfers?
• Outcome: Approved, the trust remains GST-exempt and the distributions do not trigger GST tax
• Key authorities: IRC §§ 2601, 2611, and 2612; Treas. Reg. § 26.2601-1(b)(4)

Full text (IRS public release)

Internal Revenue Service                                       Department of the Treasury
                                                               Washington, DC 20224

Number: 201626016                                              Third Party Communication: None
Release Date: 6/24/2016                                        Date of Communication: Not Applicable
Index Number: 2601.03-06
                                                               Person To Contact:
-----------------------------------                            --------------------, ID No. ----------------
------------------------                                       Telephone Number:
-----------------------------                                  ---------------------
                                                               Refer Reply To:
                                                               CC:PSI:B4
                                                               PLR-137719-15
                                                               Date:
                                                               March 15, 2016


Legend

Trustor                             =        ----------------------
Trust                               =         --------------------------------------------------
         --------------------------------------------------------------------------------------------------
         --------------------------------------------------------
Son                                 =        ------------------------
A                                   =        ----------------------
B                                   =        -------------------
C                                   =        ---------------------------
Bank                                =        --------------------------
State Law 1                         =         ----------------------------------------------------------------
-------------------------------------------------------------
State Law 2                         =         ----------------------------------------------------------
-------------------------------------------------------------
State Law 3                         =         ----------------------------------------------------------
-------------------------------------------------------------
Court                               =         ---------------------------------------------------
------------------------------------------------------------------------------------------------
Nonjudicial Settlement              =        ------------------------------------------------------------------------
Agreement                                     --------------------------------------------------------------------
-------------------------------------------------------------
Date 1                              =        -------------------------
Date 2                              =        ----------------
Date 3                              =        -----------------
x                                   =        -------------

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

      This letter responds to the October 7, 2015 letter and subsequent
correspondence, submitted on your behalf by your authorized representative,

PLR-137719-15                                 2

requesting rulings on the generation-skipping transfer (GST) tax consequences of the
proposed termination of a trust.

FACTS

        The facts and representations submitted are summarized as follows. Trustor
died on Date 1. Trustor created Trust under the terms of his will for the benefit of Son
and Son’s descendants. The current trustees of Trust are A, a grandchild of Trustor, B,
a great-grandchild of Trustor, and Bank. Date 1 is a date prior to September 25, 1985.
It is represented that no additions, actual or constructive, have been made to Trust
since September 25, 1985.

       Trust is currently held for the benefit of Son’s lawful descendants in the manner
provided in paragraph (c) of Article IV of Trustor’s will. Paragraph (c) provides that the
trustees shall hold the fund created for Son’s descendants in trust for the benefit of
Son’s lawful descendants from time to time living and may distribute among those
descendants of Son so much or all of the net income of the fund as the trustees, in their
absolute discretion, shall from time to time deem advisable, with power to exclude any
one or more of the descendants from any distribution or to make unequal distributions
among them. Any remaining net income shall be accumulated and added to principal.

        Paragraph (c) further provides that if at any time or from time to time the funds
available to any of the descendants from all sources known to the trustees shall be
insufficient, in the judgment of the trustees, to provide for that descendant’s reasonable
comfort, support and education, the trustees may distribute to that descendant so much
of the principal of the fund as the trustees, in their discretion, shall deem necessary for
any such purpose. Twenty-one (21) years after the death of the last survivor of
Trustor’s wife, and all of Trustor’s descendants and their spouses living at Trustor’s
death, the trustees shall distribute the fund per stirpes to the then living lawful
descendants of Son, or if no such descendant shall then be living, to Trustor’s then
living lawful descendants.

        State Law 1 provides that termination of a trust may be resolved by a nonjudicial
settlement agreement, provided that court approval of such termination is obtained in
accordance with State Law 2 and the court concludes continuance of the trust is not
necessary to achieve any clear material purpose of the trust. Upon such termination,
the court may order the trust property distributed as agreed by the parties to the
agreement or otherwise as the court determines equitable consistent with the purpose
of the trust. State Law 3 provides that a minor beneficiary or unborn beneficiary may be
represented and bound by another beneficiary having a substantially similar interest.

       Currently, Trust has eighteen living beneficiaries, five of whom are minors. The
value of Trust is $x. It is represented that the number of living beneficiaries and
potential beneficiaries makes the administration of Trust unwieldy, and it is very difficult

PLR-137719-15                                  3

for the trustees to determine and weigh the relative needs of the beneficiaries and
potential beneficiaries for the purpose of making all distributions. As a result, the time
and cost expended in the administration of Trust has become disproportionate to the
value of Trust and made it difficult to maintain the intended purposes of Trust.

        On Date 2, the thirteen adult beneficiaries of Trust entered into a Nonjudicial
Settlement Agreement. Under the terms of Nonjudicial Settlement Agreement, Trust will
terminate and the trustees of Trust will distribute the trust estate in equal shares to
twelve of the current adult beneficiaries, each of whom is either a grandchild or
great-grandchild of Son. The remaining adult beneficiary, C, and the five minor
beneficiaries, each of whom is a great-great grandchild of Son, will not receive a
distribution.

       In accordance with State Law 2, the trustees and beneficiaries of Trust petitioned
Court to terminate Trust. On Date 3, Court issued an Order approving the Nonjudicial
Settlement Agreement, directing the trustees to apply for a private letter ruling from the
Internal Revenue Service to confirm that the contemplated distributions will be exempt
from GST tax, and directing the trustees, upon receipt of a favorable ruling, to terminate
Trust and distribute Trust assets pursuant to the terms of the Nonjudicial Settlement
Agreement.

RULING REQUESTED

        You have requested a ruling that termination of Trust pursuant to the
Court-approved Nonjudicial Settlement Agreement, by making distributions to existing
beneficiaries who are grandchildren and great-grandchildren, to the exclusion of
great-great-grandchildren and future beneficiaries of later generations: (1) will not
cause Trust to become subject to GST tax under chapter 13, and (2) no such
distribution will be a direct skip, a taxable distribution or a taxable termination within the
meaning of § 2612.

LAW

        Section 2601 imposes a tax on every generation-skipping transfer (GST), which
is defined under § 2611 as a taxable distribution, a taxable termination, and a direct
skip.

       Section 2612(a)(1) provides that the term “taxable termination” means the
termination (by death, lapse of time, release of power, or otherwise) of an interest in
property held in a trust unless immediately after such termination, a non-skip person
has an interest in such property, or at no time after such termination may a distribution
(including on termination) be made from such trust to a skip person.

PLR-137719-15                                   4

        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 direct skip).

       Section 2612(c) provides that the term “direct skip” means any transfer subject to
a tax imposed by chapter 11 or 12 of an interest in property to a skip person.

       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
corpus 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 GST tax under § 26.2601-1(b) will not cause the trust to lose its
exempt status. These rules are applicable only for purposes of determining whether an
exempt trust retains exempt status for GST 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 § 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. 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 generation-skipping transfer or the creation of a new generation-
skipping transfer.

      In the present case, Trust was irrevocable on September 25, 1985. It is
represented that no additions, actual or constructive, were made to Trust after that date.

       Based upon the facts submitted and the representations made, we conclude that
the proposed termination of Trust pursuant to the Court-approved Nonjudicial
Settlement Agreement will not cause a beneficial interest to be shifted to a beneficiary
who occupies a generation lower than the beneficiaries who held the interests prior to

PLR-137719-15                                  5

the termination, or extend the time for vesting of any beneficial interest in Trust beyond
the period provided for in the original Trust. Accordingly, we rule that the proposed
termination of Trust will not cause Trust to become subject to GST tax under
chapter 13, and that no termination distribution made pursuant to Order will be a direct
skip, a taxable distribution or a taxable termination within the meaning of § 2612.

      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.

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

Enclosures (2)

       Copy of for § 6110 purposes
       Copy of this letter


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