Trust transfers remain incomplete gifts and community property receives a basis adjustment

Plain-English summary

A married couple in a community property state transferred property to an irrevocable trust for descendants and charities while retaining several powers over income and principal. The IRS concluded that the trust terms did not make the grantors owners under IRC §§ 673, 674, 676, or 677, but left the IRC § 675 administrative-control question for examination of how the trust actually operated. Because the grantors retained consent, distribution, and testamentary appointment powers, their contributions were wholly incomplete gifts, although later distributions to beneficiaries would be completed gifts made one-half by each grantor. Each grantor's trust interest would be included in that grantor's estate, and all community property in the trust would receive a fair-market-value basis adjustment when the first grantor died.

Ruling snapshot

• Question: How do the retained powers affect grantor-trust status, gift completion, estate inclusion, and basis adjustment for the community property trust?
• Outcome: mixed; gift and basis rulings were favorable, while the IRC § 675 issue was deferred to examination
• Key authorities: IRC §§ 1014, 2036, 2038, 2501, 2511, 671-677; Treas. Reg. §§ 25.2511-2, 25.2514-3

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201653008 Third Party Communication: None
Release Date: 12/30/2016 Date of Communication: Not Applicable
Index Number: 671.02-00, 2501.00-00,
2514.00-00, 1014.00-00 Person To Contact:
---------------------, ID No. ------------
--------------------------------- Telephone Number:
----------------------------- --------------------
--------------------------------- Refer Reply To:
CC:PSI:01
PLR-109845-16
Date:
September 21, 2016

Legend

Date = ------------------

Grantor = ----------------------------------------------------------------------------------------
----------------------------------------

Spouse = ----------------------------------------------------------------------------------------
-----------------------------------------

Trust = ----------------------------------------------------------------------------------------
-----------------------------------------------------------------------------

State 1 = ---------

State 2 = ------------

Child 1 = ------------------------------------

Child 2 = ---------------------------------

Trustee = ----------------------------

Power of = ----------------------------------------------------------------------------------------
Appointment ----------------------------------------------------------------------------------------
Committee ----------------------------------------------------------------------------------------
---------------------

X = -----------------------------------
PLR-109845-16 2

Y = --------------------------------

Appointer = ---------------

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

This responds to a letter dated March 23, 2016, and subsequent correspondence,
requesting rulings under the Internal Revenue Code.

                                              Facts

The information and representations submitted are as follows. On Date, Grantors
(Grantor and Spouse) created an irrevocable trust (Trust) for the benefit of Grantors’
issue and charities (Beneficiaries). Trust is sited in State 1 and, pursuant to the Trust
agreement, is governed by the laws of State 1. A corporate trustee (Trustee) is the sole
trustee of Trust. Grantors are married and reside in State 2, a community property
state. Trust provides that all transferred property to Trust is community property or will
be transmuted into community property. Moreover, any and all property transferred to
Trust prior to the death of the first Grantor to die (Predeceased Grantor) is and shall
retain its character as community property.

Until the death of the survivor of Grantors (Surviving Grantor), Trustee may distribute to
Beneficiaries, such amounts of the net income or principal of the Trust as the Trustee
determines. Any net income not distributed by Trustee will be accumulated and added
to principal. Trust provides that at all times the Trustees of all trusts created under Trust
must be Independent Trustees who are not members of Grantors’ Family. “Independent
Trustee” is defined as any bank or individual who is not either of the Grantors and who
is not related or subordinate, within the meaning of § 672(c) of the Internal Revenue
Code, to either of the Grantors. “Grantors’ Family” is defined to include: Grantors,
Grantors’ issue, the issue of each of the Grantors’ grandparents, and all Charities (as
defined in the Trust).

In addition, the Appointer, acting in a fiduciary capacity, may appoint to any one or more
of the Beneficiaries, such amounts of the principal (including the whole thereof) as the
Appointer deems advisable. The Appointer cannot be related or subordinate as defined
in § 672(c) to either of Grantors.

In addition to distributions to be made by the Trustee and/or Appointer, the Power of
Appointment Committee, acting in a non-fiduciary capacity, may distribute amounts of
the net income to any one or more of the Beneficiaries as the Power of Appointment
Committee deems advisable. Any appointment by the Power of Appointment
Committee requires the written consent of the Appointer plus a majority of the then
PLR-109845-16 3

serving members of the Power of Appointment Committee plus the consent of either or
both of the Grantors (Grantor’s Consent Power).

Trust provides that at all times the Power of Appointment Committee must consist of at
least two members. The Power of Appointment Committee shall cease to exist upon
the first to occur of the date of death of the Surviving Grantor or the date on which the
Power of Appointment Committee is reduced to one member. The Power of
Appointment Committee initially consists of X and Y, who are acting as guardians for
Child 1 and Child 2, respectively. As each minor child reaches his or her majority, he or
she becomes a member of the committee and his or her guardian ceases to serve on
the committee.

Each Grantor has the power, in a non-fiduciary capacity, at any time and from time to
time to appoint such amounts of principal (including the whole thereof) to any one or
more of the Beneficiaries as either deems advisable to provide for the health, education,
maintenance, or support of the Beneficiaries (Grantor’s Sole Power). Grantors have
consented to the exercise of Grantor’s Sole Power by the other.

All distributions of the net income and principal from Trust to a Beneficiary prior to the
death of the Predeceased Grantor will be funded equally from Grantors’ respective
shares of community property held in Trust. At the time of the death of the
Predeceased Grantor, you have represented that the Predeceased Grantor will have a
one-half community property interest in Trust.

Upon the death of the Predeceased Grantor, Trustee shall distribute the Predeceased
Grantor’s entire interest in any income accumulated and principal of Trust to or for the
benefit of any person or persons or entity or entities, other than the Predeceased
Grantor’s estate, the Predeceased Grantor’s creditors, or the creditors of Predeceased
Grantor’s estate, as the Predeceased Grantor may appoint by will (Predeceased
Grantor’s Testamentary Power).

Upon the death of the Predeceased Grantor, any property remaining of the
Predeceased Grantor’s entire one-half interest in Trust that has not been effectively
appointed by Will shall be distributed, per stirpes, to the Grantors’ issue who are living,
or if none of the Grantors’ issue are then living, the trust property is to be divided into
two equal parts. The first part shall be distributed to the individuals and in the
proportions that the property of the Predeceased Grantor would be distributed according
to the applicable laws, as if the Predeceased Grantor died intestate at that designated
time, domiciled in State 1, unmarried and survived by no issue. The second part shall
be distributed to individuals and in the proportions that the property of Surviving Spouse
would be distributed according to the applicable laws, as if Surviving Spouse died
intestate at that designated time, domiciled in State 1, unmarried and survived by no
issue. If none of the individuals designated as distributes is living, the trust property is
to be distributed to any one or more charities that Trustee designates.
PLR-109845-16 4

Upon the death of the Surviving Grantor, Trustee shall distribute the balance of any
accumulated income to or for the benefit of any person or persons, entity or entities,
other than the Surviving Grantor’s estate, the Surviving Grantor’s creditors, or the
creditors of the Surviving Grantor’s estate, as the Surviving Grantor may appoint by will
(Surviving Grantor’s Testamentary Power).

Upon the death of the Surviving Grantor, any remaining property held in Trust that has
not been effectively appointed by will shall be distributed, per stirpes, to the Grantors’
issue who are living, or if none of the Grantors’ issue are then living, the trust property is
to be divided into two equal parts. The first part shall be distributed to the individuals
and in the proportions that the property of the Surviving Grantor would be distributed
according to the applicable laws, as if the Surviving Grantor died intestate died
intestate, unmarried and survived by no issue. The second part shall be distributed to
individuals and in the proportions that the property of Predeceased Grantor would be
distributed to according to the applicable laws, as if Predeceased Grantor died intestate,
unmarried and survived by no issue. If none of the individuals designated as distributes
is living, the trust property is to be distributed to any one or more charities that Trustee
designates.

No distribution by Trustee to a beneficiary, and distributions to a beneficiary pursuant to
the exercise of a power of appointment granted hereunder, shall discharge any
individual’s legal obligation to support the beneficiary.

   You requested the following rulings:

   1. No portion of the items of items of income, deductions, and credits against tax
      of Trust shall be included in computing under § 671 the taxable income,
      deductions, and credits of Grantors;

   2. The contribution of property to Trust by Grantors will not be a completed gift
      subject to federal gift tax;

   3. The basis of all community property in Trust on the date of death of the
      Predeceased Grantor will receive an adjustment in basis to the fair market
      value of such property at the date of death of the Predeceased Grantor.


                                 Law and Analysis

Ruling 1

Section 671 provides that where it is specified in subpart E of part I of subchapter J that
the grantor or another person shall be treated as the owner of any portion of a trust,
PLR-109845-16 5

there shall then be included in computing the taxable income and credits of the grantor
or the other person those items of income, deductions, and credits against tax of the
trust which are attributable to that portion of the trust to the extent that such items would
be taken into account under chapter 1 in computing taxable income or credits against
the tax of an individual.

Section 672(a) provides, for purposes of subpart E, the term “adverse party” means any
person having a substantial beneficial interest in the trust which would be adversely
affected by the exercise or nonexercise of the power which he possesses respecting the
trust.

Sections 673 through 677 specify the circumstances under which the grantor is treated
as the owner of a portion of a trust.

Section 673(a) provides that the grantor shall be treated as the owner of any portion of
a trust in which the grantor has a reversionary interest in either the corpus or the income
therefrom, if, as of the inception of that portion of the trust, the value of such interest
exceeds five (5) percent of the value of such portion.

Section 674(a) provides, in general, that the grantor shall be treated as the owner of any
portion of a trust in respect of which the beneficial enjoyment of the corpus or the
income therefrom is subject to a power of disposition, exercisable by the grantor or a
nonadverse party, or both, without the approval or consent of any adverse party.

Section 674(b) provides that § 674(a) shall not apply to the powers described in
§ 674(b) regardless of whom held.

Section 674(b)(3) provides that § 674(a) shall not apply to a power exercisable only by
will, other than a power in the grantor to appoint by will the income of the trust where the
income is accumulated for such disposition by the grantor or may be so accumulated in
the discretion of the grantor or a nonadverse party, or both, without the approval or
consent of any adverse party.

Section 674(b)(5) provides that § 674(a) shall not apply to a power to distribute corpus
to or for a beneficiary, provided that the power is limited by a reasonably definite
standard.

Section 674(c) provides that § 674(a) shall not apply to a power exercisable (without the
approval or consent of any other person) by a trustee or trustees, none of whom is the
grantor, and no more than half of whom are related or subordinate parties who are
subservient to the wishes of the grantor (1) to distribute, apportion, or accumulate
income to or for a beneficiary or beneficiaries, or to, for, or within a class of
beneficiaries, or (2) to pay out corpus to or for a beneficiary or beneficiaries or to a class
of beneficiaries (whether or not income beneficiaries).
PLR-109845-16 6

Under § 675 and applicable regulations, the grantor is treated as the owner of any
portion of a trust if, under the terms of the trust agreement or circumstances attendant
on its operation, administrative control is exercisable primarily for the benefit of the
grantor rather than the beneficiary of the trust.

Section 676(a) provides that the grantor shall be treated as the owner of any portion of
a trust, whether or not he is treated as such owner under any other provision of part I,
subchapter J, chapter 1, where at any time the power to revest in the grantor title to
such portion is exercisable by the grantor or a nonadverse party, or both.

Section 677(a) provides, in general, that the grantor shall be treated as the owner of any
portion of a trust, whether or not he is treated as such owner under § 674, whose
income without the approval or consent of any adverse party is, or, in the discretion of
the grantor or a nonadverse party, or both, may be (1) distributed to the grantor or the
grantor's spouse; (2) held or accumulated for future distribution to the grantor or the
grantor's spouse; or (3) applied to the payment of premiums on policies of insurance on
the life of the grantor or the grantor's spouse.

Based solely on the facts and representations submitted, we conclude an examination
of Trust reveals none of the circumstances that would cause Grantors to be treated as
the owner of any portion of Trust under §§ 673, 674, 676, or 677.

We further conclude that an examination of Trust reveals none of the circumstances
that would cause administrative controls to be considered exercisable primarily for the
benefit of Grantors under § 675. Thus, the circumstances attendant on the operation of
Trust will determine whether Grantors will be treated as the owner of any portion of
Trust under § 675. This is a question of fact, the determination of which must be
deferred until the federal income tax returns of the parties involved have been examined
by the office with responsibility for such examination.

Ruling 2

Section 2501(a)(1) provides for the imposition of a gift tax for each calendar year on the
transfer of property by gift during such calendar year by any individual. Section 2511(a)
provides that the gift tax applies 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 that a gift is complete as to
any property, or part thereof or interest therein, with respect to which the donor has so
parted with dominion and control as to leave the donor with no power to change the
disposition of the property, whether for the donor's own benefit, or for the benefit of
another. But if upon a transfer of property (whether in trust or otherwise) the donor
PLR-109845-16 7

reserves any power over its disposition, the gift may be wholly incomplete, or may be
partially complete and partially incomplete, depending upon all the facts in the particular
case. Accordingly, in every case of a transfer of property subject to a reserved power,
the terms of the power must be examined and its scope determined.

Section 25.2511-2(b) provides an example, where the donor transfers property in trust
to pay the income to the donor, or accumulate it in the discretion of the trustee, and the
donor retains a testamentary power to appoint the remainder among the donor's
descendants. The regulation concludes that no portion of the transfer is a completed
gift. However, if the donor had not retained a testamentary power of appointment, but
had instead provided that the remainder should go to X or his heirs, the entire transfer
would be a completed gift.

Section 25.2511-2(c) provides 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 or
herself. 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 interests of the
beneficiaries as between themselves unless the power is a fiduciary power limited by a
fixed or ascertainable standard.

Under § 25.2511-2(e), a donor is considered as possessing a power if it is exercisable
by the donor in conjunction with any person not having a substantial adverse interest in
the disposition of the transferred property or the income therefrom. A trustee, as such,
is not a person having an adverse interest in the disposition of the trust property or its
income.

Section 25.2511-2(f) provides that the relinquishment or termination of a power to
change the beneficiaries of transferred property, occurring otherwise than by death of
the donor, is regarded as the event which completes the gift and causes the gift tax to
apply.

Section 25.2511-2(f) provides that the relinquishment or termination of a power to
change the beneficiaries of transferred property, occurring otherwise than by death of
the donor, is regarded as the event which completes the gift and causes the gift tax to
apply.

Section 25.2511-2(g) provides that if a donor transfers property to himself as trustee (or
to himself and some other person, not possessing a substantial adverse interest, as
trustees), and retains no beneficial interest in the trust property and no power over it
except fiduciary powers, the exercise or nonexercise of which is limited by a fixed or
ascertainable standard, to change the beneficiaries of the transferred property, the
donor has made a completed gift.
PLR-109845-16 8

Section 25.2511-2(e) does not define "substantial adverse interest." Section 25.2514-
3(b)(2) provides, in part, that a taker in default of appointment under a power has an
interest that is adverse to an exercise of the power. Section 25.2514-3(b)(2) also
provides that a co-holder of a power is considered as having an adverse interest where
he may possess the power after the possessor's death and may exercise it at that time
in favor of himself, his estate, his creditors, or the creditors of his estate.

In Estate of Sanford v. Commissioner, 308 U.S. 39 (1939), the taxpayer created a trust
for the benefit of named beneficiaries and reserved the power to revoke the trust in
whole or in part, and to designate new beneficiaries other than himself. Six years later,
in 1919, the taxpayer relinquished the power to revoke the trust, but retained the right to
change the beneficiaries. In 1924, the taxpayer relinquished the right to change the
beneficiaries. The Court stated that the taxpayer’s gift is not complete, for purposes of
the gift tax, when the donor has reserved the power to determine those others who
would ultimately receive the property. Accordingly, the Court held that the taxpayer's
gift was complete in 1924, when he relinquished his right to change the beneficiaries of
the trust. A grantor’s retention of a power to change the beneficial interests in a trust
causes the transfer to the trust to be incomplete for gift tax purposes, even though the
power may be defeated by the actions of third parties. Goldstein v. Commissioner, 37
T.C. 897 (1962). See also Estate of Goelet v. Commissioner, 51 T.C. 352 (1968).

In this case, each Grantor retained the Grantor’s Consent Power over the income of
Trust. This power is exercised in conjunction with the agreement of a majority of the
Power of Appointment Committee members and the Appointer. Under § 25.2511-2(e),
a donor is considered as himself having a power if it is exercisable by him in conjunction
with any person not having a substantial adverse interest in the disposition of the
transferred property or the income therefrom. The Power of Appointment Committee
members are not takers in default for purposes of § 25.2514-3(b)(2). They are merely
coholders of the power. Under § 25.2514-3(b)(2), a coholder of a power is only
considered as having an adverse interest where he may possess the power after the
possessor’s death and may exercise it at that time in favor of himself, his estate, his
creditors, or the creditors of his estate. In this case, the Power of Appointment
Committee ceases to exist upon the death of the last Grantors to die. Accordingly, the
Power of Appointment Committee members do not have interests adverse to either
Grantor under § 25.2514-3(b)(2) and for purposes of § 25.2511-2(e).

   Similarly, the Appointer does not have any beneficial interest in the trust. The

Appointer is not a taker in default. The Appointer is merely a coholder of the power who
may not exercise his power after both Grantors die in favor of himself, his estate, his
creditors, or the creditors of his estate. Accordingly, the Appointee does not have an
interest adverse to either Grantor under § 25.2514-3(b)(2) and for purposes of
§ 25.2511-2(e).
PLR-109845-16 9

The Trustee has the power to distribute income to a beneficiary. However, the
Trustee’s power is not a condition precedent to each Grantor’s Consent Power. Each
Grantor’s Consent Power over income is presently exercisable and not subject to a
condition precedent. Thus, the Trustee’s power to distribute income does not cause the
transfer of property to be complete with respect to the income interest in Trust for
federal gift tax purposes. Therefore, each Grantor is considered as possessing the
power to distribute income to any beneficiary himself or herself because he or she
retained the Grantor’s Consent Power.

    Each Grantor also retained the power to appoint such amounts of principal

(including the whole thereof) to any one or more of the Beneficiaries (Grantor’s Sole
Power). Under § 25.2511-2(c), a gift is incomplete if and to the extent that a reserved
power gives the donor the power to name new beneficiaries or to change the interests
of the beneficiaries as between themselves unless the power is a fiduciary power limited
by a fixed or ascertainable standard. In this case, the Grantor’s Sole Power gives each
Grantor the power to change the interests of the beneficiaries. Finally, each Grantor
consented to allow the other Grantor to exercise the Grantor’s Sole Power alone. Even
though each Grantor’s Power is limited by an ascertainable standard, i.e., health,
education, maintenance and support, Grantors’ powers are not fiduciary powers. The
Trustee and Appointee, in their fiduciary capacity, also have the power to distribute
principal to one or more beneficiaries. Trustee is a corporate trustee and, under the
terms of the trust instrument, the Appointee cannot be related or subordinated within the
meaning of § 672(c) to the Grantors. The powers of the Trustee and Appointer are not
conditions precedent to the Grantors powers. Each Grantor’s Sole Power over principal
is presently exercisable and not subject to a condition precedent. Accordingly, each
Grantor retains dominion and control over the principal of Trust until either the Trustee
or the Appointer exercises his or her power to appoint principal. See Goldstein v.
Commissioner, 37 T.C. 897 (1962). Thus, the Trustee’s and Appointee’s powers to
distribute principal do not cause the transfer of property to be complete with respect to
the remainder in Trust for federal gift tax purposes. Accordingly, the retention of
Grantor’s Consent Power and Grantor’s Sole Power causes the transfer of property to
Trust to be wholly incomplete for federal gift tax purposes.

    Further, each Grantor retained either a Predeceased Grantor’s Testamentary

Power or the Surviving Grantor’s Testamentary Power (depending on the order of the
deaths of Grantor and Spouse), to appoint property in Trust to any person or persons or
entity or entities, other than his or her respective estate, his or her respective creditors,
or the creditors of his or her respective estate. Under § 25.2511-2(b)(2), the retention of
a testamentary power to appoint the remainder of a trust is considered a retention of
dominion and control over the remainder. Accordingly, the retention of this power
causes the transfer of property to Trust to be incomplete with respect to the remainder
in Trust for federal tax purposes.
PLR-109845-16 10

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

conclude that the contribution of property to Trust by the Grantors’ will not be completed
gift subject to federal gift tax. However, any distribution made from Trust to a
beneficiary is a completed gift at the time of the distribution made one-half by each
Grantor. Further, upon either Grantor’s death, the fair market value of his or her interest
in the property in Trust is includible in his or her respective gross estate for federal
estate tax purposes.

Ruling 3

Section 1014(a) provides, in part, that, except as otherwise provided in this section, the
basis of property in the hands of a person acquiring the property from a decedent or to
whom the property passed from a decedent will, if not sold, exchanged, or otherwise
disposed of before the decedent’s death by such person be the fair market value of the
property at the date of the decedent’s death.

Section 1014(b)(6) provides that, in the case of decedents dying after December 31,
1947, property which represents the surviving spouse’s one-half share of community
property held by the decedent and the surviving spouse under the community property
laws of any State, is considered, for purposes of section 1014(a), to have been acquired
from or to have passed from the decedent if at least one-half of the whole of the
community interest in such property was includible in determining the value of the
decedent’s gross estate.

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 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-109845-16 11

Grantor and Spouse reside in State 2, a community property state. Trust provides that
all transferred property to Trust is community property or is being transmuted into
community property. Moreover, any and all property transferred to Trust prior to the
death of the Predeceased Grantor is and shall retain its character as community
property. As concluded above, upon the death of each of Grantor and Spouse, his or
her respective interest in Trust as either the Predeceased Grantor or the Surviving
Grantor will be includible in his or her respective gross estate for federal estate tax
purposes.

Accordingly, based upon the facts submitted and representations made, we conclude
that the basis of all community property in Trust on the date of death of the
Predeceased Grantor will receive an adjustment in basis to the fair market value of such
property at the date of death of the Predeceased Grantor.

Except as specifically ruled herein, we express no opinion on the federal tax
consequences of the transaction under the cited provisions or under any other
provisions of the Code. Specifically, we express no opinion on the trust provisions
permitting Trustee to distribute income or principal to trustees of other trusts (decanting)
or any other trust provisions not referenced in this provisions not referenced in this
private letter ruling.

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, copies of this letter are being sent to the taxpayer's
authorized representative.

                                   Sincerely,


                                   Faith P. Colson
                                   Faith P. Colson
                                   Senior Counsel, Branch 1
                                   (Passthroughs & Special Industries)

Enclosures (2)
Copy of this Letter.
Copy for § 6110 purposes