Trust amendments do not end grandfathered GST exemption

Plain-English summary

An irrevocable trust created before September 25, 1985, was exempt from the generation-skipping transfer tax unless a later amendment created an actual or constructive addition. A committee with a limited power to amend the trust changed contingent beneficiaries, clarified the measuring lives used for the trust's duration, and restricted committee members and successor trustees from benefiting themselves or related persons. A state court later construed an ambiguous amendment and held that any attempted addition of a new measuring life was invalid from the outset. The IRS concluded that the amendments did not postpone vesting beyond the original perpetuities period and were not constructive additions. The bona fide court construction was consistent with state law, so neither the amendments nor the order caused the trust to lose its grandfathered GST exemption.

Ruling snapshot

• Question: Did three trust amendments and a state-court construction cause a pre-September 25, 1985 irrevocable trust to lose its GST tax exemption?
• Outcome: approved
• Key authorities: IRC § 2601; Treas. Reg. §§ 26.2601-1(b)(1), 26.2601-1(b)(4)

Full text (IRS public release)

Internal Revenue Service                                       Department of the Treasury
                                                               Washington, DC 20224

Number: 201735009                                              Third Party Communication: None
Release Date: 9/1/2017                                         Date of Communication: Not Applicable
Index Number: 2041.01-00, 2601.00-00,
              2601.03-00, 2601.03-01,                          Person To Contact:
              2601.03-08                                       ----------------------, ID No. ------------------
                                                               Telephone Number:
-------------------------------------                          ----------------------
-----------------------------------                            Refer Reply To:
-----------------------                                        CC:PSI:B04
-------------------------------------------                    PLR-137243-16
                                                               Date:
---------------------------------------------------            May 25, 2017
---------------------------------------




Legend

Grantor                    =        ---------------------------
Trust                      =        ---------------------------------------------------------------------------------
Son                        =        ------------------------------
Daughter                   =        -------------------------
Spouse                     =        -------------------------------------------
Friend                     =        --------------------
Relative 1                 =        ---------------------------------
Relative 2                 =        --------------------------
Relative 3                 =        ----------------------------------------
Grantor’s Wife             =        ----------------------------
Relative 4                 =        ----------------------------------------
x                          =        --
y                          =        ----
Date 1                     =        -------------------
Date 2                     =        ------------------------
Date 3                     =        -------------------
Date 4                     =        ------------------------
Date 5                     =        -----------------------
Date 6                     =        --------------------------
Court                      =         --------------------------------------------------------------------------------
                                    ---------------------------------------------------------------------------
State                      =        ---------------------
Case                       =        -----------------------------------------------------------------
Statute                    =        --------------------------------------------------------------

PLR-137243-16                                  2


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

       This responds to the letter dated November 29, 2016, and subsequent
correspondence, submitted on your behalf by your authorized representative,
concerning the generation-skipping transfer (GST) tax consequences of modifications
and a judicial construction of a trust that is exempt from the application of GST tax
imposed under § 2601 of the Internal Revenue Code (Code).

        The facts and representations submitted are summarized as follows.

        On Date 1, a date prior to September 25, 1985, Grantor created Trust, an
irrevocable inter vivos trust for the primary benefit of Son and Son’s issue. Grantor and
Son died prior to September 25, 1985. Son was survived by Spouse and Daughter (the
granddaughter of Grantor). It is represented that no additions have been made to Trust
since its inception.

        Pursuant to a power to amend Trust, Committee amended Trust x times over a
y-year period prior to September 25, 1985. Trust as amended, restated, and in effect
on September 25, 1985, provides that the trustees shall distribute one-half of the net
income of Trust to Son’s issue by right of representation and one-half of the net income
of Trust to Spouse during her lifetime or until she remarries. Upon Spouse’s death or
remarriage, the trustees shall pay the entire net income of Trust to Son’s issue then
living by right of representation. Upon termination of Trust, the trustees shall distribute
the principal and all undistributed income to Son’s then living issue by right of
representation.

       Trust as in effect on September 25, 1985, further provides that Trust shall
terminate at the expiration of 21 years after the death of the last survivor of the following
measuring lives: Son; Spouse; all issue of Friend who were living on the date preceding
Date 1; and, “the three individuals who are designated as contingent beneficiaries in
[Clause 2(d) of Trust] and all their issue who were living on [the date preceding Date 1].”
However, if all issue of Son die prior to the expiration of 21 years after the death of the
above-designated measuring lives, Trust will terminate upon the death of Son’s last
surviving issue; provided, however, that if Spouse is then living and has not remarried,
Trust shall terminate upon her subsequent death or remarriage.

        Clause 2(d) of Trust as in effect on September 25, 1985, designates the
contingent beneficiaries of Trust, providing that in the event that Trust is terminated by
the death of Son’s last surviving issue, all undistributed income and principal shall be
distributed to Relative 1, Relative 2, and Relative 3, as contingent beneficiaries;
provided, however, that if any designated contingent beneficiary is not then living, that
beneficiary’s share of undistributed income and principal shall be distributed to his or
her surviving issue by right of representation. Relative 1, Relative 2, and Relative 3 are

PLR-137243-16                                3

either descendants of Grantor’s grandfather or the father of Grantor’s Wife and are
persons born before Date 1.

       Committee as constituted on September 25, 1985, consisted of three individuals
unrelated to any beneficiary of Trust. Trust as in effect on September 25, 1985, grants
Committee a joint power exercisable at any time or from time to time by a majority of the
members of Committee and by the last survivor of them to change and alter any or all of
the trusts declared in Trust, provided that this power as created or as amended by the
Committee must not extend to or be used to give any benefit in the trust property, either
direct or indirect, except to the issue of the grandfather of Grantor; to the issue of the
father of Grantor’s Wife; or to any wife of Son. Trust as in effect on September 25,
1985, further provides Committee with the power to appoint successor trustees.

       Pursuant to Committee’s power to amend, Committee amended Trust again on
Date 2, Date 3, and Date 4. Trust as amended on Date 2 provides that the trustees
shall distribute one-half of the net income of Trust to Son’s issue by right of
representation and one-half of the net income of Trust to and among Spouse or Son’s
issue, in the discretion of the trustees. Trust as amended on Date 2 further provides
that upon termination of Trust, the trustees shall distribute the principal and all
undistributed income to Son’s then living issue by right of representation.

       Trust as amended on Date 2 includes a termination provision similar to that of
Trust as in effect on September 25, 1985. Trust as amended on Date 2 provides that
trust will terminate upon the expiration of the 21-year period after the death of the last-
surviving designated measuring life. The termination provision includes the same
language to describe the measuring lives as provided in Trust as in effect on
September 25, 1985, except that the measuring lives formerly referred to as the “three
individuals who are designated as contingent beneficiaries in [Clause 2(d) of Trust]” are
referred to as the “three individuals who are designated as contingent beneficiaries in
[Clause 2(c) of Trust],” which reflects the revised paragraph order of Trust as amended
on Date 2. Similar to the termination provision of Trust as in effect on September 25,
1985, Trust as amended on Date 2 provides that Trust will terminate earlier if all issue of
Son die prior to the expiration of 21 years after the death of the named measuring lives.
However, Trust as amended on Date 2 does not provide for Trust to continue until
Spouse’s death or remarriage.

       Clause 2(c) of Trust as amended on Date 2 designates two contingent
beneficiaries of Trust. This is inconsistent with the reference to Clause 2(c) in the
termination provision of Trust as amended on Date 2, which refers to three (not two)
contingent beneficiaries of Trust. Specifically, Clause 2(c) of Trust as amended on
Date 2 provides that in the event that Trust is terminated by the death of Son’s last
surviving issue, all undistributed income and principal shall be distributed to Relative 3
and Relative 4, as contingent beneficiaries; provided, however, that if either designated
contingent beneficiary is not then living, that beneficiary’s share of undistributed income

PLR-137243-16                                  4

and principal shall be distributed to his or her surviving issue by right of representation.
Relative 4 is a descendant of the grandfather of Grantor and is a person born after
Date 1.

       The instrument amending Trust on Date 2 states that Committee intends that the
amendment shall not be treated as a constructive addition to Trust for purposes of
chapter 13 and further states that: “To that end, this amendment shall not be
interpreted in a manner that would postpone or suspend the vesting, absolute
ownership or power of alienation of an interest in property held under the Deed of Trust
for a period, measured from the date of creation of [Trust], extending beyond any life in
being at the date of creation of [Trust] plus a period of 21 years.”

       The amendment to Trust on Date 3 amended only the termination provision of
Trust. Trust as amended on Date 3 provides that Trust shall terminate at the expiration
of 21 years after the death of the last survivor of the following measuring lives: Son;
Spouse; all issue of Friend who were living on the date preceding Date 1; and
“Relative 1, Relative 2, and Relative 3 and all their issue who were living on [the date
preceding Date 1].” Trust as amended on Date 3 continues to provide that Trust will
terminate earlier if all issue of Son die prior to the expiration of 21 years after the death
of the named measuring lives.

       The instrument amending Trust on Date 3 states that, with respect to the
amendment to Trust on Date 2, Clause 2(c) was amended by Committee with the sole
intent of modifying the contingent beneficiaries of Trust, and not the intent of modifying
the measuring lives to be used in determining the duration of Trust. The instrument
amending Trust on Date 3 also includes the same statement as in the prior instrument
amending Trust on Date 2 regarding the intention that the amendment not be construed
or treated as a constructive addition to Trust for GST tax purposes.

       From September 25, 1985, through Date 4, members of Committee and the
trustees of Trust serving from time to time have been individuals unrelated and not
subordinate to any beneficiary of Trust. On Date 4, Committee amended Trust to
provide that: (1) Committee may not amend Trust to benefit a Committee member who
may also be a Trust beneficiary or to benefit any person whom any Committee member
may be legally obligated to support, and (2) with regard to Committee’s power to
appoint trustees, a successor to any trustee who is removed shall not be a related or
subordinate party (within the meaning of § 672(c) of the Code) with respect to any
Committee member who may also be a Trust beneficiary or may be legally obligated to
support any such beneficiary.

       On Date 5, the trustees of Trust sought judicial construction by Court of the effect
of the Date 2 amendment to Trust under applicable State law. In support of the
trustees’ Complaint for Declaratory Judgment, the trustees contend: (1) the express
terms of Trust as amended on Date 2, together with the express terms of the instrument

PLR-137243-16                                5

amending Trust on Date 2, support a construction that the addition of Relative 4 as a
contingent beneficiary did not add Relative 4 as a measuring life in determining the
duration of Trust; (2) under the State common law rule against perpetuities the Date 2
amendment was void ab initio (see Case); and (3) Statute, the State statutory rule
against perpetuities in effect on Date 2, also prohibited and thereby prevented a
violation of the rule by preventing an improper measuring life from being used to extend
the duration of Trust.

        On Date 6, Court issued an order construing Trust as amended on Date 2. Court
determined that the termination provision as amended on Date 2 did not extend the
duration of Trust beyond any life in being at the date of the creation of Trust plus a
period of 21 years. In addition, Court determined that to the extent the termination
provision of Trust as amended on Date 2 purported to add a new measuring life for
purposes of determining the duration of Trust, the provision was ineffective and invalid
at the time of the amendment to Trust on Date 2.

RULING REQUESTED

        You have requested a ruling that the amendments to Trust on Date 2, Date 3,
and Date 4, and the judicial construction of Trust as amended on Date 2 did not cause
Trust to lose its status as exempt from the application of GST tax imposed under
§ 2601.

LAW AND ANALYSIS

      Section 2601 provides that a tax is imposed on every GST (within the meaning of
subchapter B).

       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 trust where the property passes to a skip
person with respect to the transferor of the property. 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 made by a transferor to a skip person.

       Section 1433(a) of the Tax Reform Act of 1986 (Act), provides that the GST tax is
generally applicable to GSTs made after October 22, 1986. Under § 1433(b)(2)(A) of
the Act and § 26.2601-1(b)(1)(i) of the Generation-Skipping Transfer Tax Regulations,
the GST tax does not apply to a transfer from a trust if the trust was irrevocable on
September 25, 1985, and no addition (actual or constructive) was made to the trust after
that date.

PLR-137243-16                                  6

        Section 26.2601-1(b)(1)(iv) provides that, if an addition is made after
September 25, 1985, to an irrevocable trust, a pro rata portion of subsequent
distributions from (and terminations of interests in property held in) the trust is subject to
the provisions of chapter 13. When an addition is made, the trust shall be deemed to
consist of two portions, a portion not subject to chapter 13 and a portion subject to
chapter 13.

         Section 26.2601-1(b)(1)(v)(B) provides that the release, exercise, or lapse of a
power of appointment (other than a general power) is not treated as an addition to a
trust if (1) the power was created in an irrevocable trust that is not subject to the GST
tax because it was irrevocable on September 25, 1985, and (2) in the case of an
exercise, the power was not exercised in such a way that may postpone or suspend the
vesting, absolute ownership or power of alienation of an interest in property for a period,
measured from the date of creation of the trust, extending beyond any life in being at
the date of creation of the trust plus a period of 21 years plus, if necessary, a
reasonable period of gestation (the perpetuities period). If a power is exercised by
creating another power it will be deemed to be exercised to whatever extent the second
power may be exercised.

         A “general power of appointment” is defined in § 2514(c) as a power that is
exercisable in favor of the individual possessing the power, his estate, his creditors, or
the creditors of his estate. Section 25.2514-1(c)(1) of the Gift Tax Regulations provides,
in part, that a power of appointment is not a general power of appointment if by its terms
it is either (a) exercisable only in favor of one or more designated persons or classes
other than the possessor or his creditors, or the possessor's estate or the creditors of
his estate, or (b) expressly not exercisable in favor of the possessor or his creditors, the
possessor’s estate or the creditors of the possessor’s estate. Under § 25.2514-1(b)(1),
a “power of appointment” includes all powers that are in substance and effect powers of
appointment received by the donee of the power from another person, regardless of the
nomenclature used in creating the power and regardless of local property law
connotations. A power given to a donee to affect the beneficial enjoyment of a trust
property or its income by altering, amending or revoking the trust instrument or
terminating the trust is a power of appointment.

        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 this paragraph 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.

PLR-137243-16                                 7


        Section 26.2601-1(b)(4)(i)(A) provides that the distribution of trust principal from
an exempt trust to a new trust or retention of trust principal in a continuing trust will not
cause the new or continuing trust to be subject to the provisions of chapter 13, if—
(1) either—(i) the terms of the governing instrument of the exempt trust authorize
distributions to the new trust or the retention of trust principal in a continuing trust,
without the consent or approval of any beneficiary or court; or (ii) at the time the exempt
trust became irrevocable, state law authorized distributions to the new trust or retention
of principal in the continuing trust, without the consent or approval of any beneficiary or
court; and (2) the terms of the governing instrument of the new or continuing trust do not
extend the time for vesting of any beneficial interest in the trust in a manner that may
postpone or suspend the vesting, absolute ownership, or power of alienation of an
interest in property for a period, measured from the date the original trust became
irrevocable, extending beyond any life in being at the date the original trust became
irrevocable plus a period of 21 years, plus if necessary, a reasonable period of
gestation. If a distributive power is exercised by creating another power, it is deemed to
be exercised to whatever extent the second power may be exercised.

       Section 26.2601-1(b)(4)(i)(C) provides that a judicial construction of a governing
instrument to resolve an ambiguity in the terms of the instrument or to correct a
scrivener's error will not cause an exempt trust to be subject to the provisions of
chapter 13 if—(1) the judicial action involves a bona fide issue; and (2) the construction
is consistent with applicable state law that would be applied by the highest court of the
state.

        In Commissioner v. Estate of Bosch, 378 U.S. 456 (1967), the Supreme Court
considered whether a state trial court’s characterization of property rights conclusively
binds a federal court or agency in a federal estate tax controversy. The Court
concluded that the decision of a state trial court as to an underlying issue of state law
should not be controlling when applied to a federal statute. Rather, the highest court of
the state is the best authority on the underlying substantive rule of state law to be
applied in the federal matter. If there is no decision by that court then the federal
authority must apply what it finds to be state law after giving “proper regard” to the state
trial court's determination and to relevant rulings of other courts of the state.

        In the present case, Trust was irrevocable on September 25, 1985. Under the
terms of Trust as in effect on and after September 25, 1985, Committee possesses a
joint power to amend Trust that cannot be exercised to give any benefit in the trust
property except to the issue of the grandfather of Grantor; to the issue of the father of
Grantor’s Wife; or to any wife of Son. The power to amend Trust is a power of
appointment and is not a general power of appointment. See § 25.2514-1(b).

      Committee exercised its power to amend on Date 2, Date 3, and Date 4. Under
§ 26.2601-1(b)(1)(v)(B), Committee’s exercises of the power will be treated as an

PLR-137243-16                                8

addition to Trust if the exercise of the power may postpone or suspend the vesting,
absolute ownership, or power of alienation of an interest in property for a period beyond
the perpetuities period measured from the date of creation of Trust.

       The Date 2 amendment to Trust created an ambiguity regarding the termination
date of Trust. On Date 6, Court issued an order construing the Date 2 amendment.
Court’s construction of the effect of the termination provision of Trust as amended on
Date 2 involved a bona fide issue. Court’s determination that the Date 2 amendment to
Trust was void ab initio, to the extent it purported to add Relative 4 as a measuring life
for purposes of determining the duration of Trust, is consistent with applicable State law
that would be applied by the highest court of State. See Case; Statute.

       Based on the above, we conclude that Committee’s joint exercise of the power to
amend Trust as exercised on Date 2 amended the contingent beneficiaries of Trust but
did not amend the termination provision of Trust to postpone or suspend the vesting,
absolute ownership, or power of alienation of an interest in property beyond the
perpetuities period measured from the date of creation of Trust. Accordingly,
Committee’s exercise of the power to amend Trust on Date 2 is not treated as an
addition to Trust under § 26.2601-1(b)(1)(v)(B).

       In addition, Committee’s joint exercise of the power to amend Trust on Date 3
and Date 4 did not postpone or suspend the vesting, absolute ownership, or power of
alienation of an interest in property for a period beyond the perpetuities period
measured from the date of creation of Trust. Accordingly, Committee’s exercises of the
power to amend Trust on Date 3 and Date 4 are not treated as additions to Trust under
§ 26.2601-1(b)(1)(v)(B).

       The requirements of § 26.2601-1(b)(4)(i)(A) and (C) apply to determine whether
Trust retains its exempt status for GST tax purposes following the exercises of the
discretionary power to amend Trust on Date 2, Date 3, and Date 4 and Court’s
construction of the Date 2 amendment of Trust.

       Under the governing instrument of Trust as in effect on September 25, 1985,
Committee is granted a broad discretionary power to amend Trust. Based on the above
analysis of the effect of the Date 2 amendment on the termination provision of Trust, we
conclude that Committee’s exercises of the power to amend Trust on Date 2, Date 3,
and Date 4 do not extend the time for vesting of any beneficial interest in Trust in a
manner that may postpone or suspend the vesting, absolute ownership, or power of
alienation of an interest in property for a period, measured from Date 1 (the date Trust
became irrevocable), extending beyond any life in being on Date 1, plus a period of 21
years. Accordingly, we rule under § 26.2601-1(b)(4)(i)(A) that Committee’s exercises of
the power to amend Trust on Date 2, Date 3, and Date 4 do not cause Trust to be
subject to the GST tax provisions.

PLR-137243-16                                  9

       Further, because Court’s construction of the Date 2 amendment of Trust involved
a bona fide issue and is consistent with applicable state law that would be applied by
the highest court of State, we rule under § 26.2601-1(b)(4)(i)(C) that the Date 6 order of
Court construing the termination provision of Trust does not cause Trust to be subject to
the GST tax provisions.

       Accordingly, we rule that the amendments to Trust on Date 2, Date 3, and
Date 4, and the judicial construction of Trust as amended on Date 2, do not cause Trust
to be subject to the provisions of chapter 13 and, therefore, Trust does not lose its
status as exempt from the application of GST tax imposed under § 2601.

      The rulings contained in this letter are based upon information and
representations submitted by the taxpayer and accompanied by a penalty of perjury
statement executed by an appropriate party. While this office has not verified any of the
material submitted in support of the request for rulings, it is subject to verification on
examination.

       Except as expressly provided herein, no opinion is expressed or implied
concerning the tax consequences of any aspect of any transaction or item discussed or
referenced in this letter.

      This ruling is directed only to the taxpayer requesting it. Section 6110(k)(3) of
the Code provides that it may not be used or cited as precedent.

         In accordance with the Power of Attorney on file with this office, a copy of this
letter is being sent to your authorized representative.


                                       Sincerely,

                                       Karlene Lesho

                                       Karlene Lesho
                                       Senior Technician Reviewer, Branch 4
                                       Office of Associate Chief Counsel
                                       (Passthroughs & Special Industries)

Enclosures (2)

       Copy of letter
       Copy for § 6110 purposes


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