Court-approved trust division preserved tax treatment and beneficial interests

Plain-English summary

Beneficiaries and trustees settled litigation by dividing a pre-1985 irrevocable trust into a successor trust with a corporate trustee and a second trust holding concentrated business interests. The two resulting trusts kept the same beneficiaries and substantially the same beneficial interests, while changing trustee succession, administration, and the order of distributions. The IRS ruled that the division and modifications would not expose the trusts to generation-skipping transfer tax, create gifts, cause estate inclusion, or give beneficiaries general powers of appointment. The division and transfers between the trusts that were not tied to an immediate beneficiary distribution would not trigger sections 661 and 662. A transfer for an immediate health, education, maintenance, or support distribution would produce a trust deduction and corresponding beneficiary income. Reimbursed legal fees from the administration dispute were deductible under section 212, subject to allocation rules for tax-exempt income.

Ruling snapshot

• Question: What GST, gift, estate, income-distribution, and legal-fee consequences followed from the court-approved division and modification of the irrevocable trust?
• Outcome: Approved.
• Key authorities: IRC §§ 212, 661, 662, 2033, 2036-2038, 2041, 2501, 2601, and 2611-2612.

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201642029 Third Party Communication: None
Release Date: 10/14/2016 Date of Communication: Not Applicable
Index Number: 2601.03-01, 2501.01-00,
2041.03-00 Person To Contact:
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---------------------------------------------------- -----------------
------------------------------------------------------------ Telephone Number:
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------------------------------------------------ Refer Reply To:
------------------------------------ CC:PSI:B04
------------------------------ PLR-141556-15
Date:
June 22, 2016

Legend

Husband = ------------------
Wife = -------------------
Grandchild 1 = -----------------------------------------------------------------
Grandchild 2 = ------------------------------------------------------------
Grandchild 3 = ---------------------------------------------------
Grandchild 4 = -------------------------------------
Daughter = ------------------------------------------------------------------
Trust 1 = ----------------------------------------------------
Trust 2 = -----------------------------------------------------
Trust 3 = ------------------------------------------------------------------
Trust 4 = -----------------------------------------------------------------------
Trust 5 = ----------------------------------------------------
Year = --------
Successor Trust = ----------------------------------
Trust A = ------------------------------------
LP1 = -----------------------------------------------
LP2 = ----------------------------------------
LP3 = ----------------------------------------
Corporation 1 = ----------------------------------------
Corporation 2 = -----------------------------------------------------------
State = ----------
Citation = ------------------------------------------------------------
-----------------------------------------------------
PLR-141556-15 2

State Court = -----------------------------------------------------------------------------
Settlement = ---------------------------------------------------
Agreement -------------------------------------------------
State Statute = -----------------------------------------------------------------------
a = ----
b = --------------
c = ------------------
d = ----
e = --
Individual 1 = ----------------------
Individual 2 = ---------------------------
Individual 3 = -----------------------------
Individual 4 = -------------------------------
Individual 5 = -------------------------
Individual 6 = --------------------------
Bank = ------------------
Date 1 = ---------------------------
Date 2 = --------------------------
Date 3 = ------------------------------

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

  This letter responds to your authorized representative’s letter dated

December 7, 2015, requesting income, gift, estate, and generation-skipping transfer
(GST) tax rulings with respect to the proposed modifications of Trust 1.

    The facts and representations submitted are summarized as follows:

   On Date 1, a date prior to September 25, 1985, Husband and Wife created five

irrevocable trusts with substantively similar terms for different beneficiaries. Trust 1 was
created for the primary benefit of Grandchild 1, Trust 2 was created for the primary
benefit of Grandchild 2, Trust 3 was created for the primary benefit of Grandchild 3,
Trust 4 was created for the primary benefit of Daughter, and Trust 5 was created for the
primary benefit of Grandchild 4.

    Article I of Trust 1 provides that the trustees are to pay to or for the benefit of

Grandchild 1 so much of the net income from Trust 1 as the trustees in their sole
discretion shall determine to be necessary and desirable to provide for the health,
education, maintenance, and support (HEMS) of said beneficiary. In the event that net
income is not sufficient to provide for the health, education, maintenance, and support
of said beneficiary, then the trustees may use such part of the principal as, from time to
time, in their sole discretion, they may determine to be necessary for such purposes.
PLR-141556-15 3

    Article II of Trust 1 provides that, upon the death of Grandchild 1, the trustees are

to pay to or for the benefit of the issue of Grandchild 1 such part of the net income from
Trust 1 as the trustees in their sole discretion shall determine to be necessary and
desirable to provide for the health, education, maintenance, and support of such issue.
In the event that the trustees determine that the net income is not sufficient to provide
for the health, education, maintenance, and support of any one or more of such issue,
then the trustees may use such part of the principal as, from time to time, in their sole
discretion, they may determine to be necessary for such purposes.

   Article III of Trust 1 provides that, in the event that Grandchild 1 and all issue of

Grandchild 1 shall die prior to the final distribution of Trust 1 properties, the remaining
Trust 1 properties, principal, and any accumulated income, shall be paid over and
delivered in equal shares among the other trusts (Trust 2, Trust 3, Trust 4, and Trust 5)
then in existence.

    Article XII of Trust 1 provides that Trust 1 will terminate 21 years after the last to

die of Grandchild 1, Grandchild 2, Grandchild 3, Daughter, or Grandchild 4. Upon
termination, all of the properties remaining in Trust 1 shall be distributed to the then
living beneficiaries of Trust 1, share and share alike.

    Trust 1 appoints seven initial individual trustees and Article VIII of Trust 1

identifies seven successor individual trustees of Trust 1. Article VIII of Trust 1
additionally provides that when fewer than four trustees are currently serving, the
remaining trustees shall have the power and authority to appoint one or more
individuals as trustees, so that at least four and not more than seven individuals may
serve as trustees. Further, Article VIII of Trust 1 grants the trustees then serving the
power to appoint a bank as successor trustee, to serve thereafter as the sole trustee.

   Grandchild 4 died in Year without issue. Pursuant to the terms of Trust 5, the

assets remaining after the death of Grandchild 4 were distributed equally among
Trust 1, Trust 2, Trust 3, and Trust 4.

   Currently, Trust 1, Trust 2, and Trust 3 (the GC Trusts) hold limited partnership

interests in LP1 and LP2 and shares of Corporation 1 and Corporation 2. Corporation 1
is a bank holding company and Corporation 2 is a closely-held corporation. Each of the
GC Trusts’ interests in LP2 and Corporation 2 is a significant percentage (approximately
a percent) of the GC Trusts’ net value, with the remaining assets consisting of cash and
marketable securities.

   Currently, Individual 1, Individual 2, Individual 3, Individual 4, Individual 5, and

Individual 6 (the current individual trustees) serve as co-trustees of Trust 1, Trust 2,
Trust 3, and Trust 4.
PLR-141556-15 4

    On Date 2, Grandchild 1 petitioned State Court, pursuant to State Statute, to

modify Trust 1, specifically requesting the appointment of a corporate trustee to replace
the current individual trustees. Grandchild 2, Grandchild 3, and Daughter filed similar
petitions for modifications to the respective trust of which each is a beneficiary. The
petitions allege that the current individual trustees failed to sufficiently communicate with
the beneficiaries of the trusts concerning the investment strategies for each of the
respective trusts and the respective beneficiary’s needs in relation to his or her health,
education, support, and maintenance. In addition, the petitions filed by Grandchild 1,
Grandchild 2, and Grandchild 3 allege that the current individual trustees failed to
sufficiently diversify trust assets and made questionable investments despite the
potential for conflicts of interests. The current individual trustees denied the allegations
in the petitions and opposed the request to appoint a corporate trustee for each trust.

   After an extended period of negotiations, including mediation, Grandchild 1,

Grandchild 2, Grandchild 3, Daughter, and the current individual trustees entered into
Settlement Agreement, which State Court approved by order dated Date 3. Settlement
Agreement is contingent on the receipt of favorable rulings from the Internal Revenue
Service.

   Settlement Agreement provides for similar modifications to apply to each of

Trust 1, Trust 2, and Trust 3. In regard to Trust 1, Settlement Agreement provides as
follows: (1) Trust 1 will be divided into Successor Trust and Trust A ; (2) Bank will be
appointed to serve as the sole corporate trustee of Successor Trust; (3) Individual 1,
Individual 2, and Individual 3 will be appointed to serve as co-trustees of Trust A;
(4) Successor Trust and Trust A will have the same beneficiaries in the same
proportions as Trust 1; (4) Successor Trust will be funded with the balance of Trust 1
assets after the funding of Trust A; (5) Trust A will be funded with Trust 1’s partnership
interests in LP1 and LP2 and shares of Corporation 1 and Corporation 2, and $b in cash
or other liquid assets; (6) Successor Trust and Trust A will be governed by the same
terms found in the Trust 1 instrument, except as modified by Settlement Agreement.
Trust 4 will not be divided, but Bank will be appointed to serve as the sole corporate
trustee of Trust 4.

    Settlement Agreement provides that the trustee provision of Trust 1 will be

modified in the trust instrument governing Successor Trust to provide the “distributees”
of Successor Trust, upon application to and order of State Court at State Court’s
discretion, the power to remove at any time and without cause any then-serving
corporate trustee of Successor Trust by written notice delivered to such trustee, and the
power to replace such trustee with another corporate trustee that—(1) has the power to
act as a trustee under the laws of the state governing the administration of the trust;
(2) has at least $c in assets under management; and (3) is not related or subordinate,
within the meaning of § 672(c), to the “distributees” of Successor Trust. Further, the
trustee provision of Trust 1 will be modified in the trust instrument governing Successor
Trust to provide the “distributees” of Successor Trust, in the event the then-serving
PLR-141556-15 5

corporate trustee resigns or can no longer serve as trustee, the power to appoint a
successor corporate trustee, without application to and approval by State Court, that—
(1) has the power to act as a trustee under the laws of the state governing the
administration of the trust; (2) has at least $c in assets under management; and (3) is
not related or subordinate, within the meaning of § 672(c), to the “distributees” of
Successor Trust. The term “distributees” refers to a majority of the competent adult
beneficiaries who are at the time authorized to receive distributions of principal or
income from the trust.

    Settlement Agreement provides that the trustee provision of Trust 1 will be

modified in the trust instrument governing Trust A so that the number of individuals
serving as co-trustees of Trust A shall be three as of the date of the division of Trust 1
into Successor Trust and Trust A. Upon the first of Individual 1, Individual 2, or
Individual 3, to die, resign, become incapacitated, or otherwise fail to serve, the
distributees of Trust A will be empowered to select one individual to serve as successor
trustee of Trust A. The trustee selected by the distributees will be subject to the
approval of the other two then-serving trustees. Succession to the office of trustee for
the other two trustees shall continue to be determined by the co-trustees.

    Under Settlement Agreement, the beneficiaries of Trust A agree to look to, and

the trustees of Trust A agree to utilize, the income and principal of Successor Trust first
for the beneficiaries’ HEMS distributions. Settlement Agreement provides that the
governing instrument of Trust A will provide that in making distributions in accordance
with the HEMS standard, the trustees are to take into consideration a beneficiary’s
distributions of income and principal received from Successor Trust and other sources
of income.

    Settlement Agreement provides that the beneficiaries of Trust A and the

beneficiaries of Successor Trust are and will be the same and each beneficiary has an
identical interest in Trust A as he or she has in Successor Trust. However, Settlement
Agreement provides that the trustees of Trust A will make all transfers and distributions
to the trustee of Successor Trust in order to satisfy any transfers or distributions the
trustees of Trust A may be required to make to Successor Trust or its beneficiaries
under the governing instrument of Trust A, by law, or under Settlement Agreement, so
that no distributions will be made directly from Trust A to the beneficiaries.

    The termination date of Successor Trust is the termination date of Trust 1, which

is 21 years after the last to die of Grandchild 1, Grandchild 2, Grandchild 3, Daughter, or
Grandchild 4. Settlement Agreement provides that the governing instrument of Trust A
will provide for a termination date d years after the effective date of Settlement
Agreement, unless trustee of Successor Trust elects, after consultation with the
distributees of Successor Trust, to extend the termination date of Trust A for an
additional e years. Since the sum of d years and e years is less than 21 years, and
Grandchild 1, Grandchild 2, Grandchild 3, and Daughter were all alive on the effective
PLR-141556-15 6

date of Settlement Agreement, the termination date of Trust A will be before the
termination date of Successor Trust. Upon termination of Trust A, the assets of Trust A
will be distributed to the trustee of Successor Trust to form part of the corpus of
Successor Trust.

   After the modification, both Successor Trust and Trust A continue to be subject to

the rule in Article III of Trust 1, which provides that in the event that Grandchild 1 and all
issue of Grandchild 1 all predecease the required termination date, the remaining trust
assets will be distributed equally to the other trusts (Trust 2, Trust 3, Trust 4, and
Trust 5) then in existence.

    Under Settlement Agreement, attorneys’ fees and expenses incurred by the

trustees and beneficiaries relating to the litigation and the Settlement Agreement will be
paid or reimbursed by Trust 1, Trust 2, Trust 3, and Trust 4. The direct payments and
reimbursements shall be made from each of Trust 1, Trust 2, Trust 3, and Trust 4, pro
rata, in relation to the total value of each trust.

   Finally, Settlement Agreement includes several provisions that concern the

trustees’ administration of Successor Trust and Trust A, such as provisions addressing
communications with beneficiaries and conflicts of interest.

  The current individual trustees of Trust 1 represent that no other additions have

been made to Trust 1 since September 25, 1985.

   Under the law of State, in administering a distribution standard tied to the needs

of a beneficiary, a trustee will consider all income enjoyed by the beneficiaries from any
and all sources, so long as it is available for support of the beneficiary. Citation.

   You have requested the following rulings:

1. The division and modification of Trust 1 pursuant to Settlement Agreement will
   not cause Trust 1 or the resulting trusts, Successor Trust and Trust A, to be
   subject to the provisions of chapter 13.

2. None of the terms or trust modifications set forth in Settlement Agreement will
   result in a gift under chapter 12 by any beneficiary or any trustee of Trust 1,
   Successor Trust, or Trust A.

3. None of the terms or trust modifications set forth in Settlement Agreement will
   cause any assets of Trust 1, Successor Trust, or Trust A to be includible in any
   beneficiary’s or trustee’s gross estate under § 2036, § 2037, or § 2038.
   PLR-141556-15 7

4. None of the powers granted to any of the beneficiaries of Trust 1, Successor
   Trust, or Trust A will cause the assets of any such trust to be included in any
   beneficiary’s gross estate under § 2041(a).

5. The division of Trust 1 into Successor Trust and Trust A pursuant to Settlement
   Agreement will not result in either (i) a distribution under § 661 from Trust 1 or
   (ii) gross income to Successor Trust or Trust A pursuant to § 662.

6. A transfer from Trust A to Successor Trust pursuant to Settlement Agreement
   that is made for a purpose other than to facilitate a HEMS distribution to a
   beneficiary will not result in either (i) a distribution under § 661from Trust A or
   (ii) gross income to Successor Trust pursuant to § 662.

7. A transfer from Trust A to Successor Trust for an immediate HEMS distribution to
   a beneficiary will result in (i) a deduction pursuant to § 661 for Trust A (to the
   extent of Trust A’s distributable net income) and (ii) inclusion of an equivalent
   amount in the recipient beneficiary’s gross income pursuant to § 662.

8. A payment by Trust 1, Successor Trust, or Trust A to a beneficiary of Trust 1,
   Trust 2, Trust 3, Trust 4, or one of the resulting divided trusts as reimbursement
   for the beneficiary’s prior payment of attorney’s fees and expenses will not result
   in a deduction under § 661 for the reimbursing trust or gross income to the
   recipient beneficiary under § 662, but such payment will result in a deduction for
   the reimbursing trust under § 212.

   Ruling 1

   Section 2601 imposes a tax on every GST made after October 26, 1986. A GST
   

   is defined under § 2611(a) as (1) a taxable distribution, (2) a taxable termination, and
   (3) a direct skip.

   Section 2612(a) provides that the term “taxable termination” means a termination
   

   (by death, lapse of time, release of a power, or otherwise) of an interest in property held
   in a trust unless (A) immediately after such termination, a non-skip person has an
   interest in such property, or (B) at no time after such termination may a distribution
   (including distributions on termination) be made from such trust to a skip person.

   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 a direct
   skip).

   Under § 2612(c)(1), a direct skip is a transfer subject to federal estate or gift tax
   of an interest in property to a skip person.
   PLR-141556-15 8

   Under § 1433(a) of the Tax Reform Act of 1986 (Act) and § 26.2601-1(a) of the
   Generation-Skipping Transfer Tax Regulations, the GST tax is generally applicable to
   GSTs made after October 22, 1986. However, under § 1433(b)(2)(A) of the Act and
   § 26.2601-1(b)(1)(i), the GST tax does not apply to a transfer under a trust that was
   irrevocable on September 25, 1985, but only to the extent that such transfer is not made
   out of corpus added to the trust after September 25, 1985 (or out of income attributable
   to corpus so added). Under § 26.2601-1(b)(1)(ii), any trust in existence on
   September 25, 1985, will be considered irrevocable unless the settlor had a power that
   would have caused inclusion of the trust in his or her gross estate under § 2038 or
   § 2042, if the settlor had died on 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)(1), (2), or (3) (hereinafter referred to
   as an exempt trust) will not cause the trust to lose its exempt status. In general, unless
   specifically provided otherwise, the rules contained in § 26.2601-1(b)(4) are applicable
   only for purposes of determining whether an exempt trust retains its exempt status for
   GST tax purposes. Thus (unless specifically noted), 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 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 (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.

   Section 26.2601-1(b)(4)(i)(D)(2) provides that for purposes of § 26.2601-1, 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 GST transfer or the creation of a new GST transfer. To determine whether a
   modification of an irrevocable trust will shift a beneficial interest in a trust to a
   beneficiary who occupies a lower generation, the effect of the instrument on the date of
   the modification is measured against the effect of the instrument in existence
   immediately before the modification. If the effect of the modification cannot be
   immediately determined, it is deemed to shift a beneficial interest in the 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 modification. A modification that is
   PLR-141556-15 9

administrative in nature that only indirectly increases the amount transferred (for
example, by lowering administrative costs or income taxes) will not be considered to
shift a beneficial interest in the trust.

    Section 26.2601-1(b)(4)(i)(E), Example 5, considers a situation in which, in 1980,

Grantor established an irrevocable trust for the benefit of his two children, A and B, and
their issue. Under the terms of the trust, the trustee has the discretion to distribute
income and principal to A, B, and their issue in such amounts as the trustee deems
appropriate. On the death of the last to die of A and B, the trust principal is to be
distributed to the living issue of A and B, per stirpes. In 2002, the appropriate state
court approved the division of the trust into two equal trusts, one for the benefit of A
and A's issue, and one for the benefit of B and B's issue. The trust for A and A's issue
provides that the trustee has the discretion to distribution trust income and principal to A
and A's issue in such amounts as the trustee deems appropriate. On A's death, the
trust principal is to be distributed equally to A's issue, per stirpes. If A dies with no living
descendants, the principal will be added to the trust for B and B's issue. The trust for B
and B's issue is identical (except for the beneficiaries), and terminates at B's death at
which time the trust principal is to be distributed equally to B's issue, per stirpes. If B
dies with no living descendants, principal will be added to the trust for A and A's issue.
The example states that the division of the trust into two trusts does not shift any
beneficial interest in the 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 division. In addition, the division does not extend the time for vesting of any
beneficial interest beyond the period provided for in the original trust. Therefore, the
two partitioned trusts resulting from the division will not be subject to the provisions of
chapter 13.

   Section 26.2601-1(b)(4)(i)(E), Example 10 considers the following situation. In

1980, Grantor established an irrevocable trust for the benefit of Grantor's issue, naming
a bank and five other individuals as trustees. In 2002, the appropriate local court
approves a modification of the trust that decreases the number of trustees which results
in lower administrative costs. The modification pertains to the administration of the trust
and 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. In addition, 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. Therefore, the trust will not be subject to the provisions of
chapter 13.

   In the present case, Trust 1 became irrevocable prior to September 25, 1985.

The trustee represents that there have been no additions, actual or constructive, to
Trust 1 after September 25, 1985.
PLR-141556-15 10

   With regard to the proposed modifications of Trust 1, we conclude:

a. The division of Trust 1 pursuant to the terms of Settlement Agreement will not
shift any beneficial interest in Trust 1 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 division. In addition, the division will not extend the
time for vesting of any beneficial interest in Trust 1 beyond the period provided
for in the original trust. Therefore, the two trusts resulting from the division,
Successor Trust and Trust A, will not be subject to the provisions of chapter 13.

b. The modification of Trust 1 pursuant to the terms of Settlement Agreement to
provide for a change in trustee and to modify the trustee succession procedures
is viewed as pertaining to the administration of the trust, comparable to the
administrative modification in Example 10 of § 26.2601-1(b)(4)(i)(E).

c. In addition, all other terms and trust modifications set forth in Settlement
Agreement (including the trustee procedures regarding HEMS distributions, the
payment of attorneys’ fees, trustee communications with beneficiaries, and
conflicts of interest) are viewed as administrative in nature and, under
§ 26.2601-1(b)(4)(i)(D)(2), will not be considered to shift a beneficial interest to a
lower generation in the trust or extend the time for vesting of any beneficial
interest in the trust beyond the period provided for in Trust 1.

   Accordingly, based upon the facts submitted and the representations made, we

further conclude that after the division and modification of Trust 1 pursuant to
Settlement Agreement, Trust 1, Successor Trust, and Trust A will not be subject to the
provisions of chapter 13.

Ruling 2

    Section 2501(a) imposes a tax for each calendar year on the transfer of property

by gift during the calendar year by any individual.

  Section 2511 provides, in part, that the tax imposed by § 2501 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 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

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 to be a gift,
and is included in computing the amount of gifts made during the calendar year.
PLR-141556-15 11

   In this case, the beneficiaries of Trust 1 will have the same interests after the

proposed modifications that they had prior to the modifications. Because the beneficial
interests of the beneficiaries are substantially the same, no transfer of property will be
deemed to occur as a result of the modifications. Accordingly, based on the facts
submitted and the representations made we conclude that none of the terms or trust
modifications set forth in Settlement Agreement will result in a gift under chapter 12 by
any beneficiary or any trustee of Trust 1, Successor Trust, or Trust A.

Ruling 3

   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 his 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 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.

   Section 2037 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
after September 7, 1916, 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, if
(1) possession or enjoyment of the property can, through ownership of such interest, be
obtained only by surviving the decedent, and (2) the decedent has retained a
reversionary interest in the property (but in the case of a transfer made before
October 8, 1949, only if such reversionary interest arose by the express terms of the
instrument of transfer), and the value of such reversionary interest immediately before
the death of the decedent exceeds five percent of the value of such property.

   Section 2038(a)(1) provides that the value of the decedent's 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
adequate and full consideration in money or money's worth), by trust or otherwise,
where the enjoyment thereof was subject at the date of his 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
where any such power is relinquished during the three-year period on the date of the
decedent's death.
PLR-141556-15 12

   In this case, the proposed modifications to Trust 1 are administrative in nature

and do not cause the beneficiary's interest in his trust assets to be includible in the
beneficiary's gross estate for purposes of § 2033. Further, the proposed modifications
do not constitute a transfer within the meaning of §§ 2036 through 2038. Accordingly,
based on the facts submitted and the representations made, we conclude that none of
the terms or trust modifications set forth in Settlement Agreement will cause any assets
of Trust 1, Successor Trust, or Trust A to be includible in any beneficiary’s or trustee’s
gross estate under § 2036, § 2037, or § 2038.

Ruling 4

   Section 2041(a)(2) provides that the value of the gross estate shall include the

value of all property to the extent of any property with respect to which the decedent
has, at the time of his death, a general power of appointment created after
October 21, 1942, or with respect to which the decedent has at any time exercised or
released a power of appointment by a disposition that is of such nature that if it were a
transfer of property owned by the decedent the property would be includible in the
decedent's gross estate under §§ 2035 to 2038, inclusive.

   Section 2041(b)(1) provides that a general power of appointment is a power that

is exercisable in favor of the decedent, the decedent's estate, the decedent's creditors,
or the creditors of the decedent's estate. However, a power to consume, invade, or
appropriate property for the benefit of the decedent that is limited by an ascertainable
standard relating to the health, education, support, or maintenance of the decedent shall
not be deemed a general power of appointment.

    Section 20.2041-1(b)(1) of the Estate Tax Regulations provides, in part, that a

donee may have a power of appointment if he has the power to remove or discharge a
trustee and appoint himself. For example, if under the terms of the instrument, the
trustee or his successor has the power to appoint the principal of the trust for the benefit
of individuals including himself, and the decedent has the unrestricted power to remove
or discharge the trustee at any time and appoint any other person including himself, the
decedent is considered as having a power of appointment. However, the mere power of
management, investment, custody of assets, or the power to allocate receipts and
disbursements as between income and principal, exercisable in a fiduciary capacity,
whereby the holder has no power to enlarge or shift any of the beneficial interests
therein except as an incidental consequence of the discharge of the fiduciary duties is
not a power of appointment.

   Rev. Rul. 95-58, 1995-2 C.B. 191, holds that a decedent/grantor's reservation of

an unqualified power to remove a trustee and to appoint an individual or corporate
successor trustee that is not related or subordinate to the decedent within the meaning
of § 672(c), is not considered a reservation of the trustee's discretionary powers of
PLR-141556-15 13

distribution over the property transferred by the decedent/grantor to the trust.
Accordingly, the trust corpus is not included in the decedent's gross estate under § 2036
or § 2038. The ruling notes that the Eighth Circuit in Estate of Vak v. Commissioner,
973 F.2d 1409 (8th Cir. 1992), concluded that the decedent had not retained dominion
and control over assets transferred to a trust by reason of his power to remove and
replace the trustee with a party that was not related or subordinate to the decedent.
Accordingly, the court held that under § 25.2511-2(c), the decedent made a completed
gift when he created the trust and transferred assets to it.

    Section 672(c) defines the term "related or subordinate party" to mean any

nonadverse party who is (1) the grantor's spouse if living with the grantor; or (2) any one
of the following: the grantor's father, mother, issue, brother or sister; an employee of the
grantor; a corporation or any employee of a corporation in which the stock holdings of
the grantor and the trust are significant from the viewpoint of voting control; a
subordinate employee of a corporation in which the grantor is an executive.

    In this case, the beneficiaries will have an increased ability to remove and

replace the trustees after the modification of Trust 1. The distributees of Successor
Trust can replace the corporate trustee with another corporate trustee. The distributees
of Trust A can replace the first individual trustee who dies, resigns, becomes
incapacitated, or otherwise fails to serve as trustee. The power of the respective
trustees of Successor Trust and Trust A to invade income and corpus to distribute funds
to the respective beneficiaries is limited by an ascertainable standard relating to the
health, education, support, or maintenance of the beneficiaries. Therefore, the power
that any trustee has cannot be classified as a general power of appointment.
Accordingly, based on the facts submitted and the representations made, we conclude
that none of the powers granted to any of the beneficiaries of Trust 1, Successor Trust,
or Trust A will cause the assets of any such trust to be included in any beneficiary’s
gross estate under § 2041(a).

Rulings 5 – 7

    Section 661(a) provides that in any taxable year a deduction is allowed in

computing the taxable income of a trust (other than a trust to which subpart B applies),
for the sum of (1) the amount of income for such taxable year required to be distributed
currently, and (2) any other amounts properly paid or credited or required to be
distributed for such taxable year.

    Section 662 provides that there shall be included in the gross income of a

beneficiary to whom an amount specified in § 661(a) is paid, credited, or required to be
distributed (by an estate or trust described in § 661), the sum of the following amounts:
(1) the amount of income for the taxable year required to be distributed currently to such
beneficiary, whether distributed or not; and (2) all other amounts properly paid, credited,
or required to be distributed currently for such taxable year.
PLR-141556-15 14

    Accordingly, based on the facts submitted and the representations made, we

conclude that the division of Trust 1 into Successor Trust and Trust A pursuant to the
Settlement Agreement will not result in a distribution under § 661 from Trust 1; and
accordingly, will not result in gross income to Successor Trust or Trust A under § 662.
Additionally, we conclude that a transfer from Trust A to Successor Trust pursuant to
the Settlement Agreement that is made for a purpose other than to facilitate a HEMS
distribution to a beneficiary will not result in a distribution under § 661 from Trust A; and
accordingly, will not result in gross income to Successor Trust under § 662.

   We further conclude that a transfer from Trust A to Successor Trust for an

immediate HEMS distribution to a beneficiary will result in a deduction pursuant to § 661
for Trust A (to the extent of Trust A’s distributable net income) and (ii) inclusion of an
equivalent amount in the recipient beneficiary’s gross income pursuant to § 662.

Ruling 8

  Section 212(2) states that in the case of an individual, there shall be allowed as a

deduction all the ordinary and necessary expenses paid or incurred during the year for
the management, conservation, or maintenance of property held for the production of
income.

   Section 1.212-1(i) of the Income Tax Regulations provides, in part, that

reasonable amounts paid or incurred by the fiduciary of a trust on account of
administration expenses, including expenses of litigation, which are ordinary and
necessary in connection with the performance of duties of administration are deductible
under § 212, notwithstanding that the trust is not engaged in a trade or business, except
to the extent that the expenses are allocated to the production or collection of
tax-exempt income.

   Section 265(a)(1) provides that expenses that are directly allocable to any class

or classes of tax-exempt income shall be allocated to the tax-exempt income. The
regulations further provide that if an expense otherwise allocable is indirectly allocable
to both nonexempt and exempt income, then a reasonable proportion is allocated to
each considering the particular facts and circumstances.

   Whether legal fees are deductible expenses under § 212, or are capital expenses

under § 263, requires an examination of the origin of the claim giving rise to the legal
fees. That analysis requires that prior transactions be examined in order to determine if
a cause of action originates from an ordinary or capital event. The origin of the claim
doctrine was established by U.S. v. Gilmore, 372 U.S. 39, 49 (1963).

  Section 263(a)(1) provides generally that no deduction is allowed for any amount

paid out for new buildings or for permanent improvements or betterments. See
PLR-141556-15 15

§ 1.263(a)-1(a)(1), 1.263(a)-2(a), 1.263(a)-2(h), and 1.263(a)-4 of the Income Tax
Regulations.

    The Supreme Court has stated that determining whether an expenditure is a

current expense or a capital expenditure entails a facts and circumstances analysis with
material distinctions being of degree and not of kind. In Commissioner v. Lincoln
Savings & Loan Ass’n, 403 U.S. 345, 354 (1971), the Court stated that a “payment that
serves to create or enhance . . . a separate and distinct additional asset” is a capital
expenditure. Accordingly, the capitalization rules were initially understood to require
that expenditures be capitalized only if they resulted in separate and distinct assets.
However, in INDOPCO, Inc. v. Commissioner, 503 U.S. 79, 86-87 (1991), the Court
clarified Lincoln Savings by stating that creation of a separate and distinct asset is a
sufficient, but not a necessary, condition to classification as a capital expenditure. In
INDOPCO, the Court established the future benefit test and stated that a taxpayer's
realization of benefits beyond the year in which the expenditure is incurred is undeniably
important in determining whether the appropriate tax treatment is immediate deduction
or capitalization.

     Section 1.263(a)-4 provides rules for applying § 263 to amounts paid to acquire

or create intangibles. Section 1.263(a)-4(b)(1) provides that, except as otherwise
provided in § 1.263(a)-4, a taxpayer must capitalize an amount paid to: (i) acquire an
intangible (see § 1.263(a)-4(c)); (ii) create an intangible described in § 1.263(a)-4(d);
(iii) create or enhance a separate and distinct intangible asset within the meaning of
§ 1.263(a)-4(b)(3); (iv) create or enhance a future benefit identified in the Federal
Register or the Internal Revenue Bulletin as an intangible for which capitalization is
required; and (v) facilitate (as defined in § 1.263(a)-4(e)(1)) the acquisition or creation of
an intangible.

     Section 1.263(a)-4(d)(2) provides, in relevant part, that a taxpayer must capitalize

amounts paid to another party to create, originate, enter into, renew or renegotiate with
that party any ownership interest in a corporation, partnership, trust, estate, limited
liability company or other entity.

    Legal fees relating to the proper investment of trust assets are a function of the

management of the trust property and are deductible if they are ordinary and necessary.
Trust of Bingham v. Commissioner, 325 U.S. 365, 376 (1945). In Herman A. Moore
Trust v. Commissioner, 49 T.C. 430 (1968), acq., 1968-2 C.B. 21, the Service
challenged the trustee’s deduction of certain attorneys’ fees in computing the trust’s
income. These fees arose from an action brought by the testator’s children to
accelerate their beneficial interests in the trust. Pursuant to state law, the court ordered
that the attorneys’ fees for the trust, the beneficiaries and the guardian ad litem be paid
from trust income. The court decided that (1) the state court decision aided the trustee
in its management of the trust property, and (ii) the trust benefitted by the involvement
of the beneficiaries and the guardian ad litem in the litigation. Thus, the court held that
PLR-141556-15 16

all of the litigants’ attorneys’ fees paid from trust income were deductible under
§ 212(2).

   In the present case, the legal fees paid by beneficiaries seeking to change the

trustee of the trust are not payments to acquire, create, or facilitate the acquisition or
creation of an intangible. The litigation involved only the proper administration of the
trust and not the beneficiaries’ ownership interests in the trust. The beneficiaries
already had an ownership interest in the trust and were not seeking a redetermination of
that ownership interest, but rather, merely a change in the administration of the trust.
Therefore the legal fees are not subject to capitalization under § 1.263(a)-4.

    Based on the facts submitted and the representations made, we conclude that

the purpose of the action brought by the beneficiaries of Trust 1 was to improve the
investment of the assets of the trust. Further, Trust 1 benefited by the involvement of
the beneficiaries in the proceedings. Thus, subject to allocations under § 1.265-1, we
conclude that the attorneys’ fees paid by Trust 1, Successor Trust, or Trust A to a
beneficiary of Trust 1, Trust 2, Trust 3, Trust 4, or one of the resulting divided trusts
pursuant to Settlement Agreement as reimbursement for the beneficiary’s prior payment
of attorney’s fees and expenses will result in a deduction for the reimbursing trust under
§ 212. Since the attorney’s fees and expenses are deductible under § 212, it is implicit
that those expenses are not deductible under § 661 or includible by the beneficiaries
under § 662.

  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.
PLR-141556-15 17

  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,



                                  Karlene M. Lesho
                                  Karlene M. Lesho
                                  Senior Technician Reviewer, Branch 4
                                  Office of the Associate Chief Counsel
                                  (Passthroughs and Special Industries)

Enclosures
Copy for § 6110 purposes
Copy of this letter

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