In Private Letter Ruling 201349002 (released Dec. 6, 2013), a taxpayer’s representative requested six rulings on the gift, estate, generation-skipping transfer (GST) and income tax consequences of proposed modifications and division of a trust. The Internal Revenue Service ruled in favor of the taxpayer’s representative on all six issues.
The Terms of the Trust
A grantor established a revocable trust and subsequently amended it to provide that on his death, the trustees would divide all of the assets into as many equal shares as there are children of the grantor. If any child were deceased, his living spouse or children would receive a share, which would be held in a separate trust.
After the grantor died (prior to Sept. 25, 1985), the trustees divided the trust and created a separate trust for the grantor’s only child, a son. Subsequently, a court entered an order changing the trust’s corporate trustee and at a later date, again changed the corporate trustee, as well as transferred the situs of the trust to another jurisdiction. The laws of the original jurisdiction, however, continued to govern the validity and construction of the trust.
At a later time, a different court in a second jurisdiction approved the resignation of a corporate co-trustee; confirmed the appointment of a successor corporate co-trustee; accepted jurisdiction over the son’s trust; reformed it to create an investment advisor; appointed the son as the initial investment advisor; and gave the individual trustees a power to remove and replace the corporate trustees.
The trust provided that the trustees, in their discretion, may distribute income to the grantor’s son, his spouse, or any of the son’s descendants. It also provided that undistributed income could be added to trust principal. Trustees could also make distributions of principal to any income beneficiary of the trust for any purpose and may distribute income or principal to qualifying charities.
The trust also provided that should the grantor’s son die, leaving no child under 21 years of age and no spouse who wasn’t remarried, the trustees must divide the principal and undistributed income into as many shares as there are grandchildren and hold those shares in a separate trust for each grandchild (or, if deceased, the grandchild’s issue).
Proposed Trust Modifications
The grantor’s son was married and had three adult children. Only two of the adult children had children—one child each, both of whom were minors. Each of the three adult children had different investment philosophies, which led to a desire to invest the trust assets differently among the children’s shares. The trustees thus wanted to divide the trust into successor trusts, to allow each successor trust follow the desires of each child. The terms of each successor trust would substantially be the same as the trust from which they were divided.
The trustees petitioned the second court, requesting division of the trust property into three shares: one share for the son, his spouse, his child, his child’s descendants (if applicable) and charity.
The taxpayer’s representative asked the IRS to rule on six issues. The issues and the IRS’ decisions are as follows:
Ruling 1. Do the modifications and division of the trust into successor trusts alter the
inclusion ratio of the trust or the successor trusts for GST tax purposes?
No. Internal Revenue Code Section 2601 imposes a tax on each GST. However, the GST tax doesn’t apply to a trust that was irrevocable on Sept. 25, 1985, provided that the transfer wasn’t made out of corpus added to the trust after Sept. 25, 1985. Under Treasury Regulations Section 26.2601-1(b)(1)(ii)(A), a trust in existence on Sept. 25, 1985 is considered “irrevocable” except as provided under other Treasury regulation sections. The trust in this instance was created before Sept. 25, 1985, and no additions were made to the trust. As such, the trust is irrevocable and exempt from GST tax.
Furthermore, the proposed modifications into three trusts—each for the benefit of the son, spouse, son’s children, their issue and charity—don’t change any of the dispositive provisions of the original trust, except for limiting each successor trust to a certain family line. Thus, there’s no shift in beneficial interest to a beneficiary who occupies a lower generation than the person who held the beneficial interest prior to the modification. There’s also no extension of time for the vesting of any beneficial interest in the successor trusts, beyond the period that the original trust so provided. Therefore, the modifications and division into successor trusts won’t alter the inclusion ratio of the trust or the successor trusts for GST tax purposes.
Ruling 2. Do the modifications and division of the trust into successor trusts create a
transfer of property subject to federal gift tax under IRC Section 2501?
No. IRC Section 2511(a) imposes a gift tax on a transfer, even when the transfer is in trust. However, the dispositive provisions of each successor trust are substantially the same as the dispositive provisions in the original trust. Thus, the modifications and division don’t create a “transfer” subject to gift tax under Sections 2501 and 2511.
Ruling 3. Do the modifications and division of the trust into successor trusts cause any
portion of the assets of the trust or the successor trusts to be includible in the
gross estate of any beneficiary under IRC Sections 2035, 2036, 2037 or 2038?
No. For Sections 2035 through 2038 to apply, a deceased taxpayer must have transferred property under which he retained an interest in, or power over, the income or corpus of the transferred property. In this instance, the modifications and division don’t constitute a transfer by any beneficiary, because the beneficiaries of the successor trusts have the same interests post-modifications and division, as they had pre-modifications and division. That is, they aren’t transferring any interests as a result of the modifications and division. Thus, the modifications and division won’t cause any portion of the assets of the trust or the successor trusts to be includible in any beneficiary’s gross estate under Sections 2035 through 2038.
Ruling 4. Will the successor trusts be treated as separate taxpayers for federal income
tax purposes pursuant to IRC Section 643(f)?
Yes. Under Section 643(f), two or more trusts are treated as one trust if such trusts have substantially the same grantor and substantially the same primary beneficiary, and a principal purpose of such trusts is to avoid tax. This section only applies to irrevocable trusts in which a portion of the trust is attributable to contributions of corpus after March 1, 1984. In this instance, each successor trust has different beneficiaries, and no portion of principal of the trust was contributed after March 1, 1984. Moreover, the successor trusts will be separately managed and administered. Accordingly, the successor trusts will be treated as separate trusts for federal income tax purposes.
Ruling 5. Will the modifications and division result in treating any trust property as paid, credited, or distributed for purposes of IRC Section 661 or Treas. Regs. Section 1.661(a)-2(f), so as to result in the realization of any income, gain, or loss under IRC Sections 661 or Sections 662 by the trust, the successor trusts, or a beneficiary of any of the trusts? And, will the modifications and division result in the realization of any income, gain or loss to the trust, the successor trusts, or a beneficiary of any of those trusts under IRC Section 61 or IRC Section 1001?
No. Under Treas. Regs 1.661(a)-2(f), a gain or loss is realized by reason of a distribution if the distribution is in satisfaction of a right to receive a distribution of a specific dollar amount, specific property, or other income as defined in IRC Section 643(b). The division of the trust to create three separate trusts isn’t a distribution under Section 661.
Under Section 61(a)(3), gross income includes gain from dealings in property. Under Treas. Regs. Section 1.1001-1(h)(1), severing a trust isn’t an exchange of property for other property differing materially in kind, if there’s an applicable state statute authorizing a trustee to sever a trust, and any non-pro rata funding of the separate trusts is authorized by a state statute or governing instrument. In this instance, the trust’s assets will be distributed equally among the three successor trusts; each successor trust retains the son’s child as a beneficiary; the original state authorized the trustees to divide the trust; and any non-pro rata funding of the successor trusts is authorized by the governing instrument. Accordingly, the modifications and division won’t result in the realization of gain or loss under Sections 61 and 1001.
Ruling 6. Do the modifications and division result in each successor trust holding its share of the trust’s property with the same basis as it had when owned by the trust at the time of the division into successor trusts under IRC Section 1015?
Yes. If property is acquired by gift, the basis is the same as it would be in the hands of the donor, except that if the basis is greater than the fair market value (FMV) of the property at the time of the gift, the basis is the FMV (Section 1015(a)). For property acquired by transfer in trust after Dec. 31, 1920, the basis is the same as it would have been 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. If a taxpayer acquired property by a transfer in trust, this basis applies whether the property is in the hands of a trustee or beneficiary and whether it was acquired before the trust terminated and property was distributed (Treas. Regs. Section 1.1015-2(a)(1)).
Because Section 1001 didn’t apply to the division of trust assets and result in gain or loss, under Section 1015, the basis of the trust assets will be the same after the modifications and division of the trust as the basis of those assets before such actions.