Pro rata division of grandfathered trust was tax neutral

Plain-English summary

An irrevocable pre-September 25, 1985 trust for a son and his issue proposed dividing pro rata into five equal subtrusts, one for each child and that child's issue, because the children had different investment and distribution needs. The governing terms, the son's interests, and the ultimate termination date would remain substantively unchanged, and a state court had authorized the division subject to a favorable ruling. The IRS ruled that the division would preserve the trust's grandfathered GST status, create separate income-tax taxpayers, trigger no distribution or gain or loss, carry over asset bases and holding periods, cause no estate inclusion for beneficiaries, and produce no taxable gift.

Ruling snapshot

• Question: What GST, income, basis, estate, and gift tax consequences would follow a pro rata division of the grandfathered trust into five subtrusts?
• Outcome: All six requested rulings were approved, assuming separate management and administration where specified.
• Key authorities: IRC §§ 61, 643(f), 661, 662, 1001, 1015, 1223, 2035–2038, 2501, and 2601; Treas. Reg. § 26.2601-1

Full text (IRS public release)

Internal Revenue Service                                       Department of the Treasury
                                                               Washington, DC 20224

Number: 201928004                                              Third Party Communication: None
Release Date: 7/12/2019                                        Date of Communication: Not Applicable
Index Number: 61.00-00, 661.00-00, 662.00-
                     00, 643.06-00, 1001.00-00, Person To Contact:
                     1015.03-01, 2036.01-00,    ------------------------, ID No. ------------------
                     2038.01-01, 2501.01-00,    ---------------------------------------------------
                     2601.01-00                 Telephone Number:
                                                --------------------
---------------------------------------         Refer Reply To:
-----------------------------------             CC:PSI:B04
--------------------------------------------    PLR-125352-18
---------------------------------------         Date:
                                                March 21, 2019


In Re: ----------------------------------------------------
------------------------------------------------------------
------------------------------------------------------------
--------------------------



Legend

Date 1                     =        --------------------------
Husband                    =        --------------------
Wife                       =        ---------------------
Trust Agreement            =         -----------------------------------------------------------------------
------------------------------------------------------------------------------------------------------
Bank                       =        ---------------------------------------
x                          =        ---
Son                        =        ----------------- - ------------------------
Trust                      =         --------------------------------------------------------------------------------
------------------------------------------------------------------------------------------------------------------
-------------------------------------------------------------------------------------------------------------
-----------------------------------------------------------------------------------------------
Child 1                    =        -------------------- --------------------------
Child 2                    =        ------------------------------- - ------------------------
Child 3                    =        --------------------------- - ------------------------
Child 4                    =        ------------------ - ------------------------
Child 5                    =        -------------------- --------------------------
Date 2                     =        -----------------
Court                      =        ------------------------------------------------------
Order                      =         --------------------------------------------------------------------------------
-----------------------------------------------------------------------------------------------------------
-----------------------------------------------------------------------------------------------------------------

PLR-125352-18                                             2

-----------------------------------------------
Statute                    =        -----------------------------------------------------

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

This letter responds to your personal representative’s letter of July 31, 2018, in which
rulings are requested on the income, estate, gift and generation-skipping transfer (GST)
tax consequences of the proposed division of Trust.

The facts and representations submitted are as follows:

On Date 1, a date prior to September 25, 1985, Husband and Wife (“Trustors”)
executed Trust Agreement, creating an irrevocable trust for the benefit of their issue.
Pursuant to the terms of Trust Agreement, the trustee accumulated the net income of
the trust and added it to principal for a period of x months following Date 1. Upon the
conclusion of the x-month period, the trustee divided the principal of the trust into equal
shares among the Trustors’ living children, including a share to be held for the benefit of
Son and his issue (“Trust”). Son has five children, Child 1, Child 2, Child 3, Child 4 and
Child 5 (collectively, “Son’s Children”). Bank is currently serving as trustee of Trust
(“Trustee”). Trust is the subject of this ruling request.

Pursuant to § 3(b)(i) of Trust Agreement, Trustee is to pay so much of the income or
principal of Trust to or for the benefit of Son or his issue as Trustee deems advisable for
their care, comfort, support and education, or in the case of sickness or other
emergency. Upon Son’s death, Trust is held in continuing trust for Son’s Children until
the youngest of Son’s Children is age 21, at which point Trust terminates and is
distributed to Son’s issue, per stirpes. All of Son’s Children have reached age 21.

If upon Son’s death, Son has no issue living, then distribution will be made to Son’s
brothers or sisters, per stirpes. Because Son’s Children have different investment goals
and distribution needs, Trustee proposes to divide Trust into five subtrusts (“Subtrust”;
collectively, the “Subtrusts”) for the benefit of Son and each of Son’s Children and their
respective issue (“Proposed Division”). Each Subtrust will be funded with one-fifth of
the assets of Trust. The terms of each Subtrust will be identical and unchanged from
the terms of Trust Agreement, except that each Subtrust will be held for the benefit of
Son and his respective child for whom the Subtrust was created and such child’s issue.
Any distribution to Son from a Subtrust will be pro rata from each Subtrust.

In accordance with the terms of the Trust Agreement, each Subtrust will terminate on
Son’s death and remaining Subtrust assets will be distributed to the then living child for
whom the Subtrust was created, or, if such child is deceased, to the then living issue of
the deceased child, per stirpes. If the child dies without living issue, then the Subtrust
will be distributed to Son’s other living issue, per stirpes.

PLR-125352-18                                3

On Date 2, after proper notice to all interested parties, Court issued Order authorizing
the Proposed Division upon the receipt of a favorable private letter ruling from the
Internal Revenue Service. Statute provides that after notice to the qualified trust
beneficiaries and to the holders of powers of appointment, a trustee may divide trust
property into 2 or more separate portions or trusts and allocate property between them if
the trusts have substantially identical terms and conditions or if the result does not
impair the rights of any beneficiary or adversely affect the achievement of the purposes
of the trust.

It is represented that Trust was irrevocable prior to September 25, 1985, and that no
additions, actual or constructive, have been made to Trust.

Trustee requests the following rulings:

1.      The Proposed Division of Trust into the Subtrusts and the pro rata allocation of
the assets of Trust among the Subtrusts will not cause Trust or any of the Subtrusts to
lose its grandfathered status for purposes of the GST tax, or otherwise become subject
to GST tax.

2.    The Subtrusts will be treated as separate taxpayers for federal income tax
purposes under § 643(f) of the Internal Revenue Code (Code).

3.    The Proposed Division will not be treated as a distribution and cause any of the
Subtrusts to recognize income, gain or loss from a sale or other disposition of property
under § 61, § 661, § 662 or § 1001.

4.    The adjusted basis and holding periods of each of the Subtrust assets will be the
same as the adjusted basis and holding periods of the Trust assets under § 1015 and
§ 1223(2).

5.     The Proposed Division of Trust and the pro rata allocation of the assets of Trust
among the Subtrusts will not cause such assets to be includable in the gross estate of
any of the beneficiaries under § 2035, § 2036, § 2037, or § 2038.

6.    The Proposed Division of Trust and the pro rata allocation of the assets of Trust
among the Subtrusts will not constitute a transfer subject to federal gift tax under
§ 2501.

Ruling 1

Section 2601 imposes a tax on every GST, which is defined under § 2611 as a taxable
distribution, a taxable termination, and a direct skip.

PLR-125352-18                                 4

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
generation-skipping transfers made after October 22, 1986. However, under
§ 1433(b)(2)(A) of the Act and § 26.2601-1(b)(1)(i) of the regulations, the 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).

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 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.

Section 26.2601-1(b)(4)(i)(D) 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. 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 or
the creation of a new GST.

Section 26.2601-1(b)(4)(i)(E), Example 5, provides as follows. In 1980, Trustor
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 local 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 distribute 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

PLR-125352-18                                   5

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 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 in the trust 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.

In the present case, Trust was irrevocable on September 25, 1985. It is represented
that no additions, actual or constructive, have been made to Trust after that date.

The Proposed Division of Trust is substantially similar to the situation described in
§ 26.2601-1(b)(4)(i)(E), Example 5. Under the Proposed Division, the Subtrusts will,
except as described above, be administered under the original terms of Trust.

Based on the facts submitted and the representations made, we conclude that the
Proposed Division of Trust will not shift a beneficial interest in the respective Subtrust to
any beneficiary who occupies a lower generation than the persons holding the beneficial
interests prior to the division. In addition, the Proposed Division will not extend the time
for vesting of any beneficial interest in the Subtrusts beyond the period provided in the
original terms of Trust. Accordingly, the Proposed Division of Trust into the Subtrusts
and the pro rata allocation of the assets of Trust among the Subtrusts will not cause
Trust or any of the Subtrusts to lose its grandfathered status for purposes of the GST
tax, or otherwise become subject to GST tax.

Ruling 2

Section 643(f) provides that two or more trusts shall be treated as one trust if (1) such
trusts have substantially the same grantor or grantors and substantially the same
primary beneficiary or beneficiaries, and (2) a principal purpose of such trusts is the
avoidance of federal income tax.

Section 1806(b) of the Tax Reform Act of 1986 provides that § 643(f) shall apply to
taxable years beginning after March 1, 1984; except that, in the case of a trust that was
irrevocable on March 1, 1984, it shall apply only to that portion of the trust that is
attributable to contributions of corpus after March 1, 1984.

Accordingly, based on the facts submitted and representations made, the Proposed
Division of Trust will result in each Subtrust having different primary beneficiaries. We
conclude that as long as each Subtrust created by the Proposed Division is separately
managed and administered, they will be treated as separate trusts for federal income
tax purposes.

PLR-125352-18                                    6

Ruling 3

Section 61(a)(3) and (15) provides that gross income includes gains derived from
dealings in property and income from an interest in a trust.

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 1.661(a)-2(f) of the Income Tax Regulations provides that gain or loss is
realized by the trust or estate (or the other beneficiaries) by reason of a distribution of
property in kind if the distribution is in satisfaction of a right to receive a distribution of a
specific dollar amount, of specific property other than that distributed, or of income as
defined under § 643(b) and the applicable regulations, if income is required to be
distributed currently.

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 to such beneficiary for the taxable year.

Section 1001(a) provides that the gain from the sale or other disposition of property
shall be the excess of the amount realized therefrom over the adjusted basis provided in
§ 1011 for determining gain, and the loss shall be the excess of the adjusted basis
provided in § 1011 for determining loss over the amount realized.

Section 1001(b) states that the amount realized from the sale or other disposition of
property shall be the sum of any money received plus the fair market value of the
property (other than money) received. Under § 1001(c), except as otherwise provided
in subtitle A, the entire amount of gain or loss, determined under § 1001, on the sale or
exchange of property shall be recognized.

Section 1.1001-1(a) provides that the gain or loss realized from the conversion of
property into cash, or from the exchange of property for other property differing
materially either in kind or in extent, is treated as income or loss sustained.

A partition of jointly owned property is not a sale or other disposition of property where
the co-owners of the joint property sever their joint interests, but do not acquire a new or
additional interest as a result thereof. Thus, neither gain nor loss is realized on a
partition. See Rev. Rul. 56-437, 1956-2 C.B. 507 (conversion of a joint tenancy in stock

PLR-125352-18                                  7

to a tenancy in common in order to eliminate the survivorship feature and the partition of
a joint tenancy in stock are not sales or exchanges).

Similarly, divisions of trusts are also not sales or exchanges of trust interests where
each asset is divided pro rata among the new trusts. See Rev. Rul. 69-486, 1969-2
C.B. 159 (pro rata distribution of trust assets not a sale or exchange).

In the present case, the legal entitlements, as well as the rights and powers, of the
beneficiaries will remain the same in kind and extent after the Proposed Division of
Trust into the Subtrusts. Accordingly, based on the facts submitted and representations
made, the Proposed Division of Trust will not result in the realization of gain or loss
under § 61 and § 1001.

Moreover, based on the facts submitted and representations made, we conclude that
the Proposed Division is not a distribution under § 661 or § 1.661(a)-2(f). We further
conclude that the Proposed Division of Trust assets among the Subtrusts will not cause
Trust, the Subtrusts, or beneficiaries to recognize any income, gain, or loss under
§ 662.

Ruling 4

Section 1015(b) provides that if property is acquired after December 31, 1920, by a
transfer in trust (other than a transfer in trust by a gift, bequest, or devise), the basis
shall be the same as it would be in the hands of the grantor increased in the amount of
gain or decreased in the amount of loss recognized to the grantor on such transfer.

Section 1.1015-2(a)(1) provides that in the case of property acquired after December
31, 1920, by transfer in trust (other than by transfer in trust by gift, bequest, or devise),
the basis of property so acquired is the same as it would be in the hands of the grantor
increased in the amount of gain or decreased in the amount of loss recognized to the
grantor on the transfer under the law applicable to the year in which the transfer was
made. If the taxpayer acquired the property by transfer in trust, this basis applies
whether the property is in the hands of the trustee or the beneficiary, and whether
acquired prior to termination of the trust and distribution of the property, or thereafter.

Section 1223(2) provides that in determining the period for which the taxpayer has held
property, however it is acquired, there shall be included the period for which the
property was held by any other person, if under this chapter such property has, for the
purpose of determining gain or loss from a sale or exchange, the same basis in whole
or in part in his hands as it would have in the hands of the other person.

Based on the facts submitted and the representations made, we conclude that because
§ 1001 does not apply to the Proposed Division, under § 1015 the basis of the assets
received by Subtrusts will be the same as the respective basis of the assets held by

PLR-125352-18                                 8

Trust. We further conclude that under § 1223(2) the holding period of the assets
received by the Subtrusts will be the same as the holding period of the assets in Trust.

Ruling 5

Section 2001(a) imposes a tax on the transfer of the taxable estate of every decedent
who is a citizen or resident of the United States.

Section 2033 provides that the value of the gross estate includes the value of all
property to the extent of the interest therein of the decedent at the time of death.

Section 2035(a) provides that if (1) the decedent made a transfer (by trust or otherwise)
of an interest in any property, or relinquished a power with respect to any property,
during the 3-year period ending on the date of the decedent’s death, and (2) the value
of such property (or an interest therein) would have been included in the decedent’s
gross estate under § 2036, § 2037, § 2038, or § 2042 if such transferred interest or
relinquished power had been retained by the decedent on the date of the decedent’s
death, the value of the gross estate shall include the value of any property (or interest
therein) which would have been so included.

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 an 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(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 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, and the value of such reversionary interest immediately before the death of
the decedent exceeds 5 percent of the value of such property.

Section 2038(a)(1) 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 an 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

PLR-125352-18                                  9

power, either by the decedent alone or in conjunction with any person, to alter, amend,
revoke, or terminate, or where the decedent relinquished any such power during the
3-year period ending on the date of the decedent’s death.

In order for § 2036 through § 2038 to apply, the decedent must have made a transfer of
property or any interest therein (except in the case of a bona fide sale for an adequate
and full consideration in money or money’s worth) under which the decedent retained
an interest in, or power over, the income or corpus of the transferred property.

In the present case, the beneficiaries of the Subtrusts will have the same interests after
the Proposed Division that they had as beneficiaries under Trust. The distribution,
management, and termination provisions of each Subtrust will be substantially similar to
the current distribution, management, and distribution provisions of Trust. Accordingly,
based on the facts submitted and the representations made, we conclude that the
Proposed Division of Trust and the pro rata allocation of the assets of Trust among the
Subtrusts will not cause any portion of the assets of the Subtrusts to be includible in the
gross estate of any of the beneficiaries of the Subtrusts under § 2035, § 2036, § 2037,
or § 2038.

Ruling 6

Section 2501 imposes a tax for each calendar year on the transfer of property by gift
during such calendar year by any individual, resident or nonresident.

Section 2511 provides that, subject to certain limitations, the gift tax applies whether the
transfer is in trust or otherwise, direct or indirect, and whether the property transferred 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 an 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 a gift that is included
in computing the amount of gifts made during the calendar year.

In the present case, the beneficial interests, rights, and expectancies of the
beneficiaries will be substantially the same, both before and after the Proposed Division
of Trust. Thus, we conclude that no transfer of property will be deemed to occur as a
result of the Proposed Division. Accordingly, based on the facts submitted and
representations made, we conclude that the Proposed Division of Trust and the pro rata
allocation of Trust among the Subtrusts will not result in a transfer by any beneficiary of
Trust that is subject to the gift tax under § 2501.

PLR-125352-18                                  10

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.

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.

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.

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

                                           Sincerely,

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



Enclosures (2):
      Copy for § 6110 purposes
      Copy of this letter