Lifetime trust modification retains GST-tax exemption

Plain-English summary

A great-grandmother created an irrevocable trust before September 25, 1985, for later-generation family members. One beneficiary lacked capacity to exercise the trust's withdrawal and appointment rights, so a state court conditionally approved holding that beneficiary's share in trust for life. The modified remainder provisions depended on the beneficiary's age at death and, in some cases, directed property to the beneficiary's estate. The IRS ruled that the modification would preserve the trust's generation-skipping transfer tax exemption and that distributions or terminations of interests would not become subject to that tax.

Ruling snapshot

• Question: Will modifying the beneficiary's share into a lifetime trust preserve the grandfathered trust's generation-skipping transfer tax exemption?
• Outcome: Approved
• Key authorities: IRC §§ 2601, 2611, and 2651; Treas. Reg. § 26.2601-1(b)

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201633022 Third Party Communication: None
Release Date: 8/12/2016 Date of Communication: Not Applicable
Index Number: 2601.00-00
Person To Contact:
------------------------------------- --------------------------- -------------------------
----------------------------------------- -----------------
---------------------------- Telephone Number:
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Refer Reply To:
CC:PSI:B04
In Re: --------------------------------------------------- PLR-135970-15
------------------------------------------------------------ Date:
------------------------------------------------------------ April 20, 2016

Legend

Trust -------------------------------------------------------------------------------------------
-------------------------------------------------------------------------------------------
Great-grandmother -------------------------------------------------------------------------------------------
Grandfather -------------------------------------------------------------------------------------------
Beneficiary -------------------------------------------------------------------------------------------
Date 1 -------------------------------------------------------------------------------------------
Date 2 -------------------------------------------------------------------------------------------
Date 3 -------------------------------------------------------------------------------------------
State Statute -----------------------------------------------------------
Trial Court

Charity

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

   This letter responds to your authorized representative’s letter dated

October 9, 2015, requesting a ruling concerning the generation-skipping transfer (GST)
tax consequences of the proposed modification of Trust pursuant to § 2601 of the
Internal Revenue Code.

     The facts and representations submitted are summarized as follows:

   On Date 1, a date prior to September 25, 1985, Great-grandmother executed an

irrevocable trust, Trust, for the benefit of the grandchildren of her son, Grandfather.
PLR-135970-15 2

  Article 1 of Trust provides that the trustees are to promptly divide the trust

property into equal parts, one for the account of each now living child of Grandfather.
Each of said parts is to be a separate and distinct trust.

   Article 2 of Trust provides, in relevant part, that each trust for the account of a

child of Grandfather is to be held undivided during the period or periods when he or she
has no living issue. When a child is born to a child of Grandfather, the trustees are to
create a share for the account of said great-grandchild of Great-grandmother.

   Article 3.B.1. provides, in relevant part, that with respect to each share, until

termination of the trust, the trustees may from time to time or at any time pay to the
great-grandchild such amounts, if any, from the net income and/or principal of said
share as they may determine, adding to principal from time to time any income not so
expended. In addition, if and when the great-grandchild has attained the age of 25, the
trustees are to distribute to him or her such amount of the principal of said share as he
or she may from time to time or at any time demand in writing, provided that the total
subject to withdrawal does not exceed one-half of the value of said share when the
great-grandchild attains the age of 25.

    Article 3.B.2. provides, in relevant part, that the trust of said share is to terminate

when the great-grandchild attains the age of 35 or sooner dies. Upon such termination,
the trust property of said share is to be paid over to the great-grandchild, if then living. If
the great-grandchild is not living, the trust property of said share is to be paid over to his
or her spouse, Grandfather’s issue other than the great-grandchild, or spouses of such
issue as the great-grandchild may have appointed by will executed after he or she
attained the age of 18. In default of appointment, the remaining property of said share
is to be paid to the issue of great-grandchild, per stirpes; or if great-grandchild has no
issue then living, to the then living issue of great-grandchild’s parent, who is
Grandfather’s child, per stirpes; or if there is no such issue then living, to said parent;
otherwise per stirpes to Grandfather’s then living issue; or if there is no issue of
Grandfather then living, to Charity.

    Beneficiary is a grandchild of Grandfather and a great-grandchild of

Great-grandmother. Beneficiary was born with cognitive deficits and other disabilities.
Beneficiary does not have the capacity to execute the power of appointment provided in
Article 3.B.1. or Article 3.B.2. On Date 2, Beneficiary’s parents were appointed as her
permanent conservators.

    State Statute provides that the court may modify the administrative or dispositive

terms of a trust or terminate the trust if, because of circumstances not anticipated by the
settlor, modification or termination will further the purposes of the trust. To the extent
practicable, the modification shall be made in accordance with the settlor's probable
intent. The court may modify the administrative terms of a trust if continuation of the
PLR-135970-15 3

trust on its existing terms would be impracticable or wasteful or impair the trust's
administration.

     The trustees of Trust have petitioned Trial Court to modify the terms of Trust as

they apply to the shares created for the benefit of Beneficiary. As modified, Article
3.B.1. of Trust will provide that with respect to each share, until termination of the trust,
the trustees may from time to time or at any time pay to Beneficiary such amounts, if
any, from the net income and/or principal of said share as they may determine, adding
to principal from time to time any income not so expended. As modified, Article 3.B.2.
of Trust will provide that the trust of said share is to terminate upon the death of
Beneficiary. If Beneficiary is less than 25 years of age at the time of her death, the
remaining trust property of said share is to be paid over to her issue, per stirpes; or if
she has no issue then living, to the then living issue of her parent, who is Grandfather’s
child, per stirpes; or if there is no such issue then living, to said parent; otherwise per
stirpes to Grandfather’s then living issue; or if there is no issue of Grandfather then
living, to Charity. If Beneficiary is at least 25 years of age but less than 35 years of age
at the time of her death, one-half of the remaining property of said share is to be paid
over to the personal representatives of her estate to be disposed of as part of her
estate. The balance of the property is to be paid over to her issue, per stirpes; or if she
has no issue then living, to the then living issue of her parent, who is Grandfather’s
child, per stirpes; or if there is no such issue then living, to said parent; otherwise per
stirpes to Grandfather’s then living issue; or if there is no issue of Grandfather then
living, to Charity. If Beneficiary is at least 35 years of age at the time of her death, the
remaining property of said share is to be paid over to the personal representatives of
her estate to be disposed of as part of her estate.

   It is represented that Beneficiary's legal incompetency is a circumstance that was

not anticipated by Great-grandmother and that the modification to keep Beneficiary’s
inheritance in trust for her lifetime furthers the essential purpose of Trust to provide
financially for Great-grandmother’s great-grandchildren. On Date 3, Trial Court ordered
that Trust be modified, contingent upon a favorable ruling from the Internal Revenue
Service.

    You have requested a ruling that after the proposed modification of the terms of

Trust, Trust will remain exempt from the application of the GST tax and that no
distribution from or termination of any interest in Trust will be subject to the GST tax.

LAW AND ANALYSIS

   Section 2601 imposes a tax on every GST, which is defined under § 2611 as a

taxable distribution, a taxable termination, or a direct skip.

   Section 1433(b)(2)(A) of the Tax Reform Act of 1986 (the Act), 1986-3 (Vol. 1)

C.B. 1, and § 26.2601-1(b)(1)(i) of the Generation-Skipping Transfer Tax Regulations,
PLR-135970-15 4

provide that the GST tax shall not apply to any GST under a trust that was irrevocable
on September 25, 1985, but only to the extent that such transfer was 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)(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)(1), (b)(2), or (b)(3), will not cause the
trust to lose its exempt status. The rules of § 26.2601-1(b)(4) are applicable only for
purposes of determining whether an exempt trust retains its 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)(1) provides that a modification of the governing

instrument of an exempt trust 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 a beneficial interest to a lower generation beneficiary if the
modification can result in either an increase in the amount of a GST or the creation of a
new GST.

   In the present case, the proposed modification of Trust, under State Statute,

provides that Beneficiary's interest in Trust will continue to be held in trust for the
exclusive benefit of Beneficiary during her lifetime. Since Beneficiary does not have the
capacity to execute the power of appointment provided in Article 3.B.2. of Trust, if
Beneficiary dies before the age of 25, the property in Trust will pass under the terms of
the modified Trust in the same manner as under the terms of the original Trust. If
Beneficiary dies after the age of 25 and before the age of 35, one-half of the then
remaining property of Trust is includible in Beneficiary’s gross estate for federal estate
tax purposes and the other one-half portion will pass as it would have passed under the
terms of the original Trust. If Beneficiary dies after the age of 35, upon Beneficiary’s
death, the entire Trust will terminate and all of the trust property will be includible in
Beneficiary’s gross estate for federal estate tax purposes.

    Accordingly, based on the facts presented and the representations made, we find

that after the proposed modification of Trust, Trust will remain exempt from the
application of the GST tax and that no distribution from or termination of any interest in
Trust will be subject to the GST tax.
PLR-135970-15 5

  In accordance with the Power of Attorney on file with this office, we have sent a

copy of this letter to your authorized representatives.

   Except as expressly provided herein, we neither express nor imply any opinion

concerning the tax consequences of any aspect of any transaction or item discussed or
referenced in this letter.

  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.

 A copy of this letter should be attached to any gift, estate, or GST tax returns that

you may file relating to this matter.

  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.

                                     Sincerely,



                                     Leslie H. Finlow
                                     Leslie H. Finlow
                                     Senior Technician Reviewer, Branch 4
                                     Office of the Associate Chief Counsel
                                     (Passthroughs and Special Industries)



  Enclosures
        Copy for § 6110 purposes
        Copy of this letter