In Private Letter Ruling 201341005 (Oct. 11, 2013), the Internal Revenue Service addressed a taxpayer’s concern about whether proposed modifications to five trusts would: 1) cause them to lose their grandfathered status for generation-skipping transfer (GST) tax purposes, and 2) cause a distribution or termination of any interest in the trusts to be subject to GST tax. The IRS concluded that the modifications wouldn’t cause the trusts to lose their grandfathered status for GST tax purposes and wouldn’t cause a distribution or termination of any interest to be subject to GST tax. Here’s why.
The Original Trusts
On Sept. 25, 1985, a grantor established a revocable trust to benefit his wife during her life and his three sons and their lineal descendants. At the time of the grantor’s death, he was survived by his wife, his three sons (Son 1, Son 2 and Son 3) and three grandchildren. When the grantor’s wife died, Son 1 had three children; Son 2 had two children; and Son 3 had one child. There were also 15 great-grandchildren and one great-great-grandchild.
At the grantor’s wife’s death, the trust was divided into three trusts: Son 1 Trust, Son 2 Trust and Son 3 Trust. At some point thereafter, these three trusts were divided into six separate trusts, Grandchild 1 Trust through Grandchild 6 Trust.
Paragraph 9 of the grantor’s original trust provided that, when each lineal descendant of a son reached a certain age, that descendant would be paid his full pro rata share of accumulated income, per stirpes, and then be paid a pro rata share of current income in installments until the trust terminated. Paragraph 9 was subsequently amended to provide for an income distribution amount equal to a certain percentage of the average fair market value of the grandchild’s shares as of the close of the last business day of the trust’s three prior calendar years or its net income, whichever was greater. The trustee had the power to make advances to any lineal descendant, in case of an emergency. Paragraph 9 also provided that the trust would terminate in 20 years and 11 months after the death of the grantor’s last lineal descendants living at the time of the grantor’s death. At termination, the corpus held for the grandchildren would be paid over to the lineal descendants of each son, share and share alike, per stirpes. Any undistributed income would be paid over to those who would have been entitled to it, had they attained a certain age. If any son died without leaving any surviving lineal descendant or should the last surviving lineal descendant of any son die before final distribution, this share of corpus and any accumulated income would equally be divided and added to the corpus of the shares held in trust for the children of the grantor’s remaining sons and held and distributed in the same manner as if it had originally been part of the corpus of such trusts.
The Proposed Modifications
The trustee petitioned the court to modify Grandchild 2 Trust though Grandchild 6 Trust. All living beneficiaries of those five trusts consented to the modifications. The court issued an order approving the modifications, pending a favorable PLR.
The proposed modifications would add Paragraph 9g, permitting the trustee to pay to or for the benefit of any grandchild amounts as the trustee deems advisable “from time to time for the medical care, education, support and maintenance in reasonable comfort of said grandchild.” The proposed modifications would also: 1) include the names of the measuring lives and clarify that on termination of a grandchild’s trust, the remaining principal would be distributed outright to a living lineal descendant of that grandchild; 2) provide that if a grandchild dies before the trust terminates, the trustee shall divide equally among and pay to the deceased grandchild’s children the distribution amount, as well as pay out of principal sums necessary for the medical care, education, support and maintenance, taking into account any other income or resources the deceased grandchild’s child has. This payment would be treated as an advancement and charged against the “ultimate distributive share of the beneficiary to whom or for whose benefit the payment is made”; clarify that if a grandchild dies prior to the termination of his trust, without leaving any surviving lineal descendants, the principal and accumulated income would be divided equally and added to the corpus of the other grandchild trusts; and clarify that the trustee, in its sole discretion, in cases of emergency, distribute principal, as an advance, from a grandchild’s trust to any lineal descendant of the grantor and the grandchild of that trust.
Under Internal Revenue Code Section 2601, there’s a tax on every GST typically made after Oct. 22, 1986. The tax doesn’t generally apply to a transfer under a trust like the one in the instant case, which was made irrevocable on Sept. 25, 1985, unless the transfer was made out of corpus added to the trust by an actual or constructive addition after September 1985. Treasury Regulations Section 26.2601-1(b)(4)(i)(D) provides that a modification of an exempt trust won’t cause it to be subject to GST tax, if the modification doesn’t shift a beneficial interest in the trust to any beneficiary who occupies a lower generation than the person who held the beneficial interest prior to the modification, and the modification doesn’t extend the time for vesting of any beneficial interest in the trust beyond the period provided for in the original trust.
In this case, the proposed modifications accelerated the distribution of principal in Grandchild 2 Trust through Grandchild 6 Trust to a grandchild and, when that grandchild dies, to a great-grandchild. The proposed modifications don’t shift a beneficial interest in the trust to a lower generation and don’t extend the time for vesting of any beneficial interest in the trusts. Thus, the IRS concluded that the proposed modifications wouldn’t cause the original trust or Grandchild 2 Trust through Grandchild 6 Trust to lose their grandfathered status for GST tax purposes and wouldn’t cause a distribution or termination of any interests in the trust to be subject to GST tax.