Did relinquishing a trust instrument's power to substitute assets convert the irrevocable grantor trust into a complex trust without a court order?

Subject

Relinquishing the substitution power ended grantor-trust status

Plain-English summary

The trust became a complex trust when the grantor relinquished the power to substitute assets. The trust agreement itself gave the grantor that power only until relinquishment and directed the trustee to comply with written notice.

The Commissioner distinguished an actual trust modification from the exercise or relinquishment of a power already authorized by the instrument. Because the agreement contemplated relinquishment, no court order or beneficiary consent was required under the modification statute.

Federal grantor-trust rules generally taxed the trust's income to the grantor while the relevant power existed. Once the grantor relinquished that power, the ruling treated the trust as a complex trust, whose income could be taxable to beneficiaries under the cited federal provision.

Result: P.D. 15-230 superseded the contrary conclusion in P.D. 15-46 to the extent of the conflict.

What this means for you

• Read the instrument first: an authorized relinquishment is different from amending the trust.
• Follow the instrument's notice and trustee-compliance procedure exactly.
• State trust-law authority and federal tax classification must both be analyzed.
• A change in grantor powers can shift who reports trust income.

Common questions

Q: Was a court order required?

A: No. The ruling found that relinquishment was authorized by the existing instrument and was not a modification.

Q: What power was relinquished?

A: The grantor's power to substitute trust assets.

Q: What earlier ruling changed?

A: P.D. 15-46 was superseded to the extent it had concluded the trust remained a grantor trust.

Citations and references

• Va. Code §§ 58.1-301, 64.2-729, and 64.2-777.
• IRC §§ 671 and 662(a).
• Treas. Reg. § 1.1001-2(c), Example 5.

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 15-230

Original ruling text

December 11, 2015

Re: Ruling Request: Fiduciary Income Tax

Dear *:

This will respond to your letter in which you request a ruling as to whether the 2005 (the "Trust"), an irrevocable grantor's trust, was converted into a complex trust.

FACTS

In Public Document (P.D.) 15-46 (3/18/2015), the Department ruled that the Trust remained an irrevocable grantor's trust when * (the "Grantor") relinquished certain powers absent a court order. SDTC (the "Trustee") has provided additional information and seeks a ruling that the Trust was converted from an irrevocable grantor's trust into a complex trust in accordance with Virginia law.

RULING

Virginia Code § 58.1-301 provides that terminology and references used in Title 58.1 of the Virginia Code will generally have the same meanings as provided in the Internal Revenue Code unless a different meaning is clearly required. Virginia "conforms" to federal law because it starts the computation of Virginia taxable income with federal adjusted gross income (FAGI).

Typically, under Internal Revenue Code (IRC) § 671, the grantor is subject to tax on the income generated by a grantor trust. Under IRC § 662(a), the beneficiaries are subject to tax on the income produced by a complex trust. The Trustee asserts that the Grantor's renouncement of the power to substitute assets converted the Trust from a grantor's trust to a complex trust.

Under Va. Code § 64.2-729 of the Uniform Trust Code, a non-charitable irrevocable trust may be modified through a court order provided that the beneficiaries consent. In this case, there is no court order or beneficiary consent to a modification.

The Trustee contends that the substitution of assets by the Grantor was not a modification of the trust, but a legitimate exercise of power as contemplated by the Trust instrument. In general, any power that a person has with respect to his property can be delegated to a trustee in a trust agreement. See Va. Code § 64.2-777. As such, a trustee's exercise of a power granted by a trust is not a modification of the trust and does not require a court order.

A review of the Trust instrument indicates that the Grantor was granted the power to substitute assets "until such time, if any, as the Settlor ( i.e. , Grantor) relinquishes the foregoing power. This power shall be exercised by written notice to the Trustee, who shall promptly comply with this notice." Thus, the trust agreement clearly contemplates relinquishment of the Grantor's power to substitute assets and empowers the Trustee to allow the Grantor's renouncement of the power. The relinquishment of the power to substitute assets by the Grantor was not a modification of the Trust. The relinquishment of a grantor trust power by a grantor changes a grantor trust into a complex trust. See Treas. Reg. § 1.1001-2(c), example 5.

To the extent that the ruling in P.D. 15-46 is contrary to the conclusion that the Trust changed from a grantor trust to a complex trust when the Grantor relinquished the power to substitute assets, it is superseded by this document. This ruling is based on the facts presented as summarized above. Any change in facts or the introduction of new facts may lead to a different result.

The Code of Virginia sections and public document cited are available on-line at www.tax.virginia.gov in the Laws, Rules & Decisions section of the Department's web site. If you have any questions regarding this ruling, you may contact * in the Office of Tax Policy, Appeals and Rulings, at ***.

Sincerely,

Craig M. Burns
Tax Commissioner

AR/1-6010084434.B