Trust modifications preserve GST tax exemption

Plain-English summary

A decedent’s trust created generation-skipping trusts with zero inclusion ratios because GST exemption was allocated to them. The trustees proposed a court-approved amendment giving each primary beneficiary a limited testamentary power to appoint trust property among specified family members and charities. The amendment barred appointments that would shift an interest to a lower generation or extend the trust beyond its original termination date. The family had also amended trustee-succession provisions through a nonjudicial settlement. The IRS ruled that the limited powers did not shift beneficial interests or extend vesting, and that the succession changes were merely administrative, so neither modification harmed the trusts’ GST tax exemption.

Ruling snapshot

• Question: Would the judicial limited-power amendment or the nonjudicial trustee-succession amendment adversely affect the trusts’ GST tax exemption?
• Outcome: No. Both modifications preserved the GST tax exemption.
• Key authorities: IRC §§ 2601, 2611, 2612, 2642, 2651; Treas. Reg. § 26.2601-1(b)(4)

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201829005 Third Party Communication: None
Release Date: 7/20/2018 Date of Communication: Not Applicable
Index Number: 2652.00-00
Person To Contact:
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------------------------------------ Telephone Number:
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Refer Reply To:
CC:PSI:B04
--------------------------------------------------- PLR-134328-17
------------------------------ Date:
April 17, 2018

Legend

Decedent --------------------------
Trust ---------------------------------
GST Residuary ------------------------------------------------------------------------------------
Trust
Spouse --------------------
Son --------------------
Daughter ------------------------------
Date 1 -------------------
Date 2 ------------------------
Date 3 --------------------
Date 4 ------------------
Date 5 ------------------------
Court ---------------------------------------------------------------------------------------
a ----
b ----
State ------------

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

   This letter responds to your personal representative’s letter of

November 10, 2017, and subsequent correspondence, requesting rulings regarding the
generation-skipping transfer tax (GST) consequences of a proposed judicial
modification of a trust.

     The facts and representations submitted are summarized as follows:

  Decedent established Trust, a revocable trust, on Date 1 (a date after September

25, 1985). Trust was restated on Date 2, and later amended two times prior to
Decedent’s death.
PLR-134328-17 2

   Trust provides that when Decedent dies, the trustees are to divide Trust into a

Marital Trust, a GST Marital Trust, and a GST Residuary Trust. These trusts provide
income to Spouse during her lifetime. Upon Spouse’s death, any remaining portion of
these trusts are to be added to the GST Trusts, which are separate trusts to benefit
each child of Decedent or the descendants of a deceased child of Decedent.

    Article II, Paragraph E of Trust contains provisions that will govern the GST

Trusts. Paragraph E provides that the trustee shall divide the trust estate of the GST
Trusts into equal shares – one share for each living child of Decedent and one share for
each deceased child of Decedent who has one or more descendants then living
(Primary Beneficiary). If Decedent has no living descendants, the trust estate shall be
distributed pursuant to Article III (distributes trust estate to a charity). Paragraphs E(1)
and (2) provide for discretionary distributions of income and principal to any one or more
of the group consisting of the Primary Beneficiary and the Primary Beneficiary’s
descendants as necessary for health, education, maintenance or support. Any net
income not distributed is added to principal.

   Article II, Paragraph E(4) provides that upon the death of the Primary Beneficiary,

the trust estate shall be distributed as follows:

   (a) Pursuant to the Primary Beneficiary’s general testamentary power to appoint
       a portion of the trust to his/her creditors in a situation where, upon the Primary
       Beneficiary’s death, a portion of the trust estate is subject to GST taxes.

   (b) Except as provided in (a), the remaining principal and accumulated income
       shall be divided into shares for the Primary Beneficiary’s descendants; if
       none, in equal shares for the Primary Beneficiary’s siblings who is a
       descendant of Decedent, with the share for any deceased sibling being
       created only if he or she has one or more living descendants; if none, in
       shares for the descendants of the Primary Beneficiary’s nearest ancestor who
       is a descendant of Decedent and has descendants then living; if none, for
       Decedent’s descendants. Each share created under this paragraph shall be
       held as (or added to) the trust estate of a separate GST Trusts for such
       beneficiary. If Decedent has no living descendants, the trust estate shall be
       distributed pursuant to Article III.

   Article IV, Paragraph F provides that notwithstanding any other provision of

Trust, unless earlier terminated by the terms of Trust, the termination date of each trust
created under Trust shall be twenty-one years after the death of all the descendants of
the parents of Decedent and Decedent’s Spouse who were living at the time of
Decedent’s death, or if later, the date before the term of the trust must cease under
applicable state law.
PLR-134328-17 3

   Article V contains the Trustee provisions. In the event that Decedent shall fail or

cease to act as Trustee of any trust, for any reason, Spouse, Son, and Daughter shall
become the successor co-trustees of Trust. After the death of Spouse, Son and
Daughter may become the sole individual Trustee of any separate GST Trust and
Family Trust created for his or her benefit at any time after reaching age a by removing
the other individual Trustee(s) then serving as to such trust.

   Article VII, Paragraph L provides that a beneficiary may exercise his/her power of

appointment to appoint outright or in trust. No beneficiary may exercise a limited power
of appointment so as to create another power of appointment which can be validly
exercised to postpone vesting of a trust or suspend absolute ownership or power of
alienation for a period ascertainable without regard to Decedent’s date of death. No
limited power of appointment may be exercised to cause a trust to be included in the
beneficiary’s gross estate.

    Article XI contains Special Trustee provisions. Under Paragraph A(1), following

Decedent’s death, a trustee may appoint one or more of Decedent’s advisors as a
Special Trustee. Special Trustee has the right to appoint his/her successor. Paragraph
B(1) provides that Special Trustee has the express power to amend any provision of
Trust if Special Trustee deems it necessary to adjust to situational changes, undesirable
tax consequences, or provide clarity. Special Trustee has the authority to change the
distributions standards; create, limit or delete powers of appointment (either general or
limited) in one or more beneficiaries even if the creation of the power of appointment
would cause trust assets to be included in the beneficiary’s gross estate; and alter the
timing of distributions. However, Special Trustee does not have a general power of
appointment to appoint trust assets to him or herself. Special Trustee has the authority
to release any of his/her powers.

    Decedent died on Date 3, survived by his spouse, Spouse, two children, Son and

Daughter, and six grandchildren. Trust became irrevocable upon Decedent’s death.
Trust is governed under the law of State. After Decedent’s death, Decedent’s remaining
GST exemption was allocated to GST Residuary Trust resulting in a zero inclusion ratio.
It is represented that an amount of Spouse’s remaining GST exemption, if any, equal to
the value of the assets transferred to the GST Trusts from the Marital Trust upon the
death of Spouse, if any, will also be allocated to the GST Trusts, resulting in a zero
inclusion ratio for such assets.

   On Date 4, Spouse, Son, and Daughter entered into a non-judicial settlement

agreement to modify Article V of Trust in order to provide an orderly succession of
Trustees. The modified Article V provides, in relevant part, that in the event that
Decedent shall fail or cease to act as Trustee of any trust, for any reason, Spouse, Son,
and Daughter shall become the successor co-trustees of Trust. If Son shall fail or
cease to act as Trustee of any trust, for any reason, Son’s wife shall serve as successor
co-trustee. If Daughter shall fail or cease to act as Trustee of any trust, for any reason,
Daughter’s husband shall serve as successor co-trustee. In the event any named
PLR-134328-17 4

individual co-trustees should fail or cease to act as trustee of any trust, for any reason,
the one or more remaining named individuals shall continue to act as the Trustees of
such trust. After the death of Spouse, Son and Daughter shall become the sole
individual Trustee of any separate GST Trust and Family Trust created for his or her
benefit. If Son is then deceased, or is then living but thereafter fails for any reason to
act as Trustee of any such GST Trust or Family Trust, Son’s wife shall become the sole
individual Trustee of any separate GST Trust and Family Trust created for the benefit of
Son or his descendants. If Daughter is then deceased, or is then living but thereafter
fails for any reason to act as Trustee of any such GST Trust or Family Trust, Daughter’s
husband shall become the sole individual Trustee of any separate GST Trust and
Family Trust created for the benefit of Daughter or her descendants. Notwithstanding
the above, each of the descendants of a deceased child of Grantor may become the
sole individual Trustee of any separate GST Trust or Family Trust created for his or her
benefit at any time after reaching age b by removing the other individual Trustee(s) then
serving as to such trust.

   Trustees and Special Trustee petitioned Court to modify Trust to grant the

Primary Beneficiary a testamentary limited power of appointment to appoint his/her GST
Trust estate to his/her spouse, his/her descendants, the spouse of his/her descendants,
and/or charities. This limited power of appointment is exercisable over the portion of the
GST Trust that is remaining after any exercise of a Primary Beneficiary’s general power
to appoint to his/her creditors is exercised. All of the dispositive provisions in Article II,
Paragraph E(4)(b) remain, without modification. Accordingly, in default of the limited
power of appointment, the GST Trust assets would go in further trust to the Primary
Beneficiary’s descendants, if none, siblings, if none, Decedent’s descendants, if none, a
charity. The modification to Article II, Paragraph E(4)(b) also includes the following
language:

   Notwithstanding any contrary provision of this Trust agreement, no exercise of a
   power of appointment granted in this paragraph (b) shall result in a termination
   date for a GST Trust or a share thereunder or created pursuant to such power of
   appointment which is later than the termination date set forth in Article IV,
   Paragraph F of the Trust Agreement as such provision existed on the Decedent’s
   date of death, and such power of appointment may not be exercised in favor of
   any beneficiary in which the exercise would result in shifting a beneficial interest
   in the trust to any beneficiary, who occupies a lower generation (as defined in
   § 2651) than the person or persons who hold the beneficial interest in the
   absence of the exercise of the testamentary limited power of appointment.

  On Date 5, Court issued an Order authorizing the modifications to the trust,

subject to a favorable letter ruling from the Internal Revenue Service.

   You have requested the following rulings:

1. The proposed judicial modification of the GST Trusts will not adversely affect the
   PLR-134328-17 5

   exemption of the GST Trusts from GST tax for purposes of chapter 13.

2. The Date 4 modification of Trust by Non-Judicial Settlement Agreement will not
   adversely affect the exemption of the GST Residuary Trust or the resulting GST
   Trusts from GST tax for purposes of chapter 13.

LAW AND ANALYSIS

Rulings 1 and 2

   Section 2601 of the Internal Revenue Code imposes a tax on each

generation-skipping transfer made after October 26, 1986. A generation-skipping
transfer 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.

   Section 2602 provides that the amount of tax imposed under § 2601 is

determined by multiplying the taxable amount by the applicable rate. Under § 2641, the
term “applicable rate” means the product of the maximum federal estate tax rate in the
year that the GST occurs and the inclusion ratio. Under § 2642(a)(1), the inclusion ratio
with respect to any property transferred in a GST is one minus the applicable fraction.
Under § 2642(a)(2), in general, the numerator of the applicable fraction is the amount of
GST exemption allocated to the property transferred and the denominator is the value of
the property transferred.

   Under § 2631, every individual is allowed a GST exemption amount which may

be allocated by the individual or the individual's executor to any property with respect to
which the individual is the transferor.

   Under § 1433(a) of the Tax Reform Act of 1986 (Act), 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) of the Generation-Skipping Transfer Tax Regulations,
the tax does not apply to any GST from a trust if the trust was irrevocable on
PLR-134328-17 6

September 25, 1985, and no addition (actual or constructive) was made to the trust after
that date.

    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 paragraph (b)(4)(i)(A), (B), or (C) of this section) 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 this section, 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
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 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
PLR-134328-17 7

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.

   No guidance has been issued concerning judicial modifications that may affect

the status of trusts that are exempt from GST tax because sufficient GST exemption
was allocated to the trust to result in an inclusion ratio of zero. At a minimum, a
modification that would not affect the GST status of a grandfathered trust should
similarly not affect the exempt status of such a trust.

    In the instant case, Trust became irrevocable after September 25, 1985. It is

represented that sufficient GST exemption will be allocated to the GST Trusts so that
the GST Trusts have an inclusion ratio of zero under § 2642. No guidance has been
issued concerning changes that may affect the status of trusts that are exempt from
GST tax because sufficient GST exemption was allocated to the trust to result in an
inclusion ratio of zero. At a minimum, a change that would not affect the GST status of
a trust that was irrevocable on September 25, 1985, should similarly not affect the
exempt status of such a trust.

   The proposed judicial modification to Trust will grant the Primary Beneficiary of

each GST Trust a testamentary limited power of appointment to appoint his/her GST
Trust estate to his/her spouse, his/her descendants, the spouse of his/her descendants,
and/or charities. This limited power of appointment is exercisable over the portion of the
GST Trust that is remaining after any springing general power of appointment is
exercised. Further, despite the proposed judicial modification, the GST Trusts shall
terminate no later than twenty-one years after the death of all the descendants of the
parents of Decedent and Decedent’s Spouse who were living at the time of Decedent’s
death, or if later, the date before the term of the trust must cease under applicable state
law.

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

that the proposed judicial modification of Trust will not result in a shift of any beneficial
interest in the trust to any beneficiary who occupies a generation lower than the persons
holding the beneficial interests prior to the proposed judicial modification. Further, the
proposed judicial modification of Trust will not extend the time for vesting of any
beneficial interest in the trust beyond the period provided for in the original trust.
Therefore, based upon the facts submitted and representations made, we conclude that
the proposed judicial modification of the GST Trusts will not adversely affect the
exemption of the GST Trusts from GST tax for purposes of chapter 13.

   The Date 4 modifications to Article V only affect trustee succession. These

modifications are administrative in nature and under § 26.2601-1(b)(4)(i)(D)(2), will not
PLR-134328-17 8

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. See Example 10 of § 26.2601-1(b)(4)(i)(E). Therefore, based upon the facts
submitted and representations made, we conclude that the Date 4 modification of Trust
by Non-Judicial Settlement Agreement will not adversely affect the exemption of the
GST Residuary Trust or the resulting GST Trusts from GST tax for purposes of chapter
13.

  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 ruling contained in this letter is 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.

  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,

                                      Lorraine E. Gardner
                                      _____________________________
                                      Lorraine E. Gardner
                                      Senior Counsel, 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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