Choosing a trustee is one of the most important decisions that clients make for their estate plans. Some trust powers may be critical for tax planning — but giving those powers to the wrong person as trustee can actually undermine tax goals. “Tax-sensitive” powers are ones that change the estate, gift or income tax consequences depending upon who holds them.1 Failure to pay attention to these powers can result in very unhappy clients or heirs who end up paying the additional taxes.
So let's examine the dos and don'ts of tax-sensitive powers when dealing with both revocable and irrevocable trusts.
Question: Can a spouse be named, after the grantor's death, as the sole or co-trustee of a revocable trust without adverse estate-tax consequences? The short answer is, “Yes.” But estate planners must be careful to avoid giving the spouse a general power of appointment over the family trust. The spouse will have a general power of appointment over the family trust's assets under Internal Revenue Code Section 2041 if a spouse has the power to appoint the assets of the family trust to himself, his estate, his creditors or creditors of his estate.
This concern can come into play when, for example, a client and her spouse jointly own assets with rights of survivorship. If they do no estate planning and the client dies first, all the assets will pass to the spouse by operation of law without federal estate tax because of the marital deduction.2 The spouse also will have total control of those assets. But, when the spouse dies, everything in excess of his applicable exclusion amount will be subject to federal estate tax.
To avoid the additional estate tax, it's common for the client and her spouse to create revocable trusts and split the assets, funding each trust with half of the assets. If the client dies first, the client's trust creates a family trust protected by the client's applicable exclusion amount, with the balance in a marital share for the spouse.
Here's where things can go terribly wrong. If the trustee has the power to distribute the trust principal for his benefit for any purpose and the spouse is the sole trustee, then the spouse will have a general power of appointment. When he dies, all of the family trust's assets will be included in his gross estate. The spouse's power as trustee has negated the purpose of creating the family trust.
Similar care must be taken not to give the spouse a general power of appointment as trustee if the marital share will be held in a qualified terminable interest property (QTIP) trust. The spouse's general power as trustee will make the entire QTIP trust includible in the spouse's gross estate under IRC Section 2041 — even if only a partial QTIP election were made in the client's gross estate for tax-planning purposes.
Let's review exactly what powers a spouse should not have as sole trustee:
the power to distribute to himself for any purpose whatsoever, or for any vague purpose such as “comfort” or “happiness;”3
the power to use trust assets to pay his personal obligations, like paying his debts or taxes (like estate taxes);4
the power to distribute assets to pay for the support of minor children, if he is obligated to support the minor children.5
But there are some powers that the spouse can have as sole trustee without adverse estate-tax consequences, including a power to distribute to himself — so long as that power is limited by an “ascertainable standard.”6 Treasury Regulations Section 20.2041-1(c)(2) define the “ascertainable standard” as a standard “relating to the health, education, support, or maintenance of the decedent.” A distribution power is limited by such a standard if the power is reasonably measurable in terms of the power holder's “needs” for one or more of health, education, maintenance and support. Maintenance is something more than “bare necessities of life,” but is something less than “comfort,” “happiness” or “welfare” of the power holder. An estate planner should not get creative here! The estate planner should be careful not to negate the “ascertainable standard” by using language that the trustee's “determination is conclusive.”
So let's say, for example, that a client's trust agreement provides: “Trustee shall distribute principal for beneficiary's health, support and maintenance in a reasonable manner. The determination of the trustee with respect to the exercise or nonexercise of the power to make distributions shall be conclusive.” Under the Treasury regulations, this is not an ascertainable standard.7
What if the spouse is a co-trustee?
Having a co-trustee is an antidote if we limit the spouse's vote: The spouse's potential general power of appointment problem disappears if he has no power over distributions of income or principal. But another antidote is to limit the spouse's power over distributions to only those that fall within an ascertainable standard.8
We also could put in place a co-trustee with an adverse interest. The spouse could have the power to make distributions to himself that are not limited to an ascertainable standard if distribution decisions must be made jointly by him and a co-trustee whose interest in the trust is adverse to the spouse.9 Merely having two people holding the power at the same time or being in the class of permissible beneficiaries is not enough. If A and B jointly hold the power, to be adverse, there also has to be something more such as successive economic interests or successive powers to appoint. For example, A and B hold the power jointly, and if A dies, then B will hold the power. A and B's joint exercise of the power will diminish B's ability to later exercise the power. A's interest and B's interest in the power are adverse. If A takes in default of the exercise of the joint exercise of the power, then A is also considered adverse to B.
So, for example, say that the spouse is the client's second husband and the client has an adult child from her first marriage. The family trust provides that the co-trustees (second husband and adult child) have discretion to distribute to either one of them in any amount — but, here's the rub: they both have to agree to every distribution. Spouse and adult child are the trustees. While both the spouse and adult child are alive, the adult child's interest is adverse to the spouse's and the spouse does not have a general power of appointment because he can exercise the power only in conjunction with the adult child. But when the spouse dies, the adult child will have a general power of appointment if the child as surviving trustee can distribute to himself or herself. A word of caution: family dynamics may not make this arrangement advisable.
Income Tax Issues
If a client funds a revocable trust during her life and retains the power to revoke the trust during her lifetime, she'll be treated as the grantor of a grantor trust.10 The typical revocable trust ceases to be revocable and a grantor trust upon the grantor's death. Generally, under the nongrantor trust rules, whether or not her spouse is a trustee, he'll be taxable on the trust income after her death only to the extent that trust income is distributable to her spouse.
What powers held by the spouse as the trustee might change this result? IRC Section 678(a) provides that a person other than a grantor will be treated as the owner of a trust (or a portion of the trust) if that person has a power exercisable solely by himself to vest the corpus or income in himself. Section 678(a) treats a person who did not create or fund a trust — and is not the grantor — as if that person were the grantor/owner of the assets. If the spouse as trustee had the power to distribute income or principal to himself, then he'd be treated as the grantor of the trust under the grantor trust rules.
So, for example, if the spouse has a lifetime general power of appointment over the income or principal of the trust, then he is treated as the owner of the trust under Section 678(a) — and directly taxed on all of the income.11
In addition, the spouse would be treated as owner under Section 678(a) of the client's trust, and taxed on all of the income, if the spouse as trustee or co-trustee could use the trust income to satisfy his support obligation for the children AND the income was in fact used to satisfy his support obligation.
There's a potential issue if the spouse disclaims. How's that? Well, sometimes for flexibility, a client's estate plan provides that if a spouse survives, the trustee is directed to pay all the assets to the spouse — but if the spouse disclaims, then the trustee is directed to hold the disclaimed assets in the family trust. The disclaimer plan provides great flexibility and comfort to some clients in these uncertain times (particularly clients whose wealth is all in “stealth wealth,” such as insurance, retirement plans and a house; assets that cannot easily be spent, but that will be taxable upon death).
Generally, after a disclaimer, the disclaimed interest must pass automatically to someone other than the disclaiming person, without any direction from the disclaiming person.12 A surviving spouse has more options. The client's surviving spouse may disclaim and have the assets pass to himself (meaning pass to the disclaiming spouse) or for his benefit (including to the family trust for the benefit of the surviving spouse).13
However, after a disclaimer, the disclaimant — in our example, the spouse, as trustee or co-trustee — cannot have a “wholly discretionary power to direct the enjoyment of the disclaimed interest.”14
There are powers over disclaimed assets that the spouse can have as a trustee or co-trustee:
the fiduciary power to preserve or maintain the property: the spouse who is also the fiduciary may take actions to preserve or maintain the disclaimed assets, such as to harvest a crop or maintain a residence;15 and
the power to distribute pursuant to an ascertainable standard.16
But there also are powers over disclaimed assets that the spouse as trustee or co-trustee cannot have:
the power to sprinkle income among the spouse and other beneficiaries;17 and
the power to distribute principal among a class of designated beneficiaries for “comfort” or “welfare” or not otherwise limited to an ascertainable standard.18
Gift Tax Traps
Don't think that a spouse can just resign if there's a problem. The result may be a significant gift tax problem for that spouse.
The exercise or release of a general power created after Oct. 21, 1942, is treated as a transfer of all the property subject to the power under IRC Section 2514(b). If there's no consideration for the exercise or release of the general power, the person who has exercised or released the general power has made a gift.
If a spouse starts to act as a trustee and has a general power of appointment, then resigns, the risk is that the spouse has released the general power of appointment — meaning that the spouse has made a present gift of all the property subject to the power!
If the client already has died and you are facing this issue but her spouse has not yet started to act, the spouse can decline to act as trustee, thereby avoiding ever having the general power of appointment.
Also, if the spouse has started to act as trustee, but has not yet exercised the offending trustee provision and the period for making a qualified disclaimer has not yet run,19 consider having the spouse disclaim the trustee's power, if that's possible under applicable state law.
Making the spouse the sole trustee or a co-trustee with a discretionary power over distributions also can create a potential gift tax trap.
For example, say the client creates a family trust that is equal to the applicable exclusion amount. The spouse is the sole trustee. The trust provides that all income is payable to the spouse. The principal is payable to the spouse pursuant to an ascertainable standard. The client's children are all competent adults. The trustee has a power to distribute to the children only from the principal for any purpose.
The children are adults, so the spouse has no obligation to support them. The invasion of principal for the children is not, therefore, paying for the spouse's debt. The spouse's powers as trustee to distribute to himself is limited by an ascertainable standard. The spouse's powers as trustee over the principal should not, therefore, be treated as a general power of appointment over the family trust and cause that trust's assets to be included in his estate under Section 2041. The spouse, as trustee, is considered to have a limited power of appointment to appoint the principal among the children, so this is not an estate tax issue for the spouse.
Still, there could be a problem: a potential gift tax issue. The exercise of the limited power of appointment by the spouse during his life is a current gift of all of the lost future income that the spouse would have earned had the distributed assets stayed in the trust. The value of the gift is determined, according to the Internal Revenue Service, pursuant to IRC Section 7520 based on the spouse's actuarial life expectancy!20
One way to avoid this trap is by giving the withdrawal power to someone other than spouse. But, who?
Naming the client's child or other beneficiary as a trustee raises similar potential tax-sensitive issues as naming the spouse would — plus there's the non-tax problem of disrupting the relationship between the children and the parents by making the children trustees of their parents' wealth.
A Good Choice
It may be best to name an independent trustee. That choice insulates the client's family from the adverse tax consequences. For example, suppose a family trust permits distributions to the spouse and children for comfort, welfare and any other purpose. If the spouse or children were the trustee, that would constitute a general power of appointment because of the invasion power. But if the Mega Bank Corporation is trustee making all decisions concerning distributions of income and principal, then the spouse and children do not have general powers of appointment over the family trust's assets.
Problem solved, right? Except that, of course, Mega Bank Corporation has all the power over the family trust for the life of the trust.
Today, simply naming one independent trustee is not flexible enough. So, modern estate plans often include a mechanism for changing the institutional trustee if the institution no longer suits the purposes of the client's trust. A common practice is to add to the trust a special trustee or a trust protector who has the power to remove and replace the independent trustee.21
Under the Treasury regulations, a grantor who retains the power to remove and replace a fiduciary may be considered as having all the powers of the fiduciary itself.22 Also, if a beneficiary is given the power to remove and replace the trustee with anyone, then the beneficiary has been treated as having all the trustee's powers.23
But the IRS has provided a safe harbor: if the “remove and replace” power is limited to replacing the trustee with trustees who are neither related nor subordinate to the designating person pursuant to IRC Section 672(c), then the designating person will not be deemed to have all the trustee's powers merely because of the remove and replace power.24
So, here's a drafting tip: Estate planners who provide for a trust protector or a special trustee should be sure to include in the trust document an exculpatory clause protecting that trust protector or special trustee from liability to the extent that the same protection is afforded the trustee. Also, the document should include provisions for naming a successor trust protector or special trustee.
Sometimes a client wants to make a present (completed) gift of certain assets, but he does not want the recipient to have control over those assets. The answer to the control issue is to create an irrevocable trust. Who should be the trustee of this irrevocable trust?
If the client himself retains too much power over the irrevocable trust, the trust's assets will be included in his gross estate for federal estate tax purposes, defeating the purposes for making a gift to the irrevocable trust.
There are, therefore, certain powers that the client should not retain.
For example, the client's gift to the trust will be treated as incomplete if:
the trustee (whether or not it's the client) is directed to distribute to the client pursuant to an ascertainable power (the client's gift to the irrevocable trust will be treated as an incomplete gift to the extent of the ascertainable value of the rights that the client retained);25
the client, as trustee, has the power to distribute the trust assets to himself;26 and
the client, as trustee, can add beneficiaries or change their interests and his fiduciary interest is not limited by a fixed or ascertainable standard.27
There are some additional “don'ts,” including:
If the client, as trustee, retains the right to determine who will receive distributions from the irrevocable trust or when, then he will have retained an IRC Section 2038 power.28
If the client, as trustee, has the power to use the assets to pay for the support of his minor child while he has an obligation to support that child, then this would give the client a retained interest under IRC Section 2036 if the client contributed the assets to the trust. (Note, if someone else contributed the assets to the irrevocable trust, the client's power as trustee to use the assets to satisfy his support obligations still would make the assets includible in his estate, but as a general power of appointment under Section 2041.)
The client should not name himself as custodian of his gift under the Uniform Transfers to Minors Act. Under that act, the custodian has broad powers to determine the timing or manner of distribution. If the donor (client) names himself as custodian and dies while still the custodian, the assets will be includible in his estate under Section 2038.
The client should not name himself as trustee of the trust for his minor child under IRC Section 2503(c). Under that section, there can be no “substantial restrictions” on the trustee's powers to make distributions for the minor beneficiary.29 The expansive powers needed to make the trust qualify under Section 2503(c) would cause the trust assets to be included in the client's gross estate under Sections 2036 and 2038.30
Generally, the client should not retain any kind of power as trustee or co-trustee of an irrevocable life insurance trust (ILIT) that owns insurance on the client's life that could be an “incident of ownership” over the policy.31
The client should not retain the right to vote certain stock that the client transfers to the irrevocable trust. If the client transfers stock to the irrevocable trust, which he owned (directly or indirectly) or had the right (either alone or in conjunction with others) to vote 20 percent of voting classes of stock of the corporation, and after the transfer, the client as trustee retained the right to vote the stock, the transferred stock would be included in his estate under Section 2036(b).
If the client transfers partnership interests or limited liability company (LLC) interests to the irrevocable trust, consider carefully whether he should be the trustee at all — or consider limiting his power as trustee to control when those entities decide to distribute or liquidate. Section 2036(b), which expressly applies only to corporations, was a limited legislative response to the Supreme Court decision in United States v. Byrum,32 which held favorably for the taxpayer. In Byrum, the decedent was the controlling shareholder of a closely held corporation and a member of the board of directors. He transferred stock in the corporation to an irrevocable trust, with an independent trustee, but reserved the right to vote the stock and to veto the sale or disposition of the stock. The Supreme Court held that the stock was not included in the decedent's estate under Section 2036(a), because the decedent's fiduciary duties as controlling shareholder and director precluded the decedent from voting the stock for the decedent's personal gain. The decedent had neither a substantial economic benefit to cause inclusion under Section 2036(a)(1) nor an ascertainable or legally enforceable power to cause inclusion under Section 2036(a)(2). Until recently, it was assumed that Byrum was still good law and still applied to partnerships and LLCs. But the IRS recently challenged that assumption as part of the Service's overall battle against taxpayers transferring interests in partnerships and LLCs, then claiming substantial discounts.33
What powers can the client hold as trustee? The answer is that the client may be able to be the sole trustee if the powers are extremely limited. So, it's okay if:
- the irrevocable trust has no discretionary distributions at all and either directs that the income be paid to the child/beneficiary or directs that no income be paid until the child/beneficiary reaches a set age and does not permit invasions of principal until a predetermined time;
- the trust prohibits any distributions that benefit the client;
- the trust prohibits any distributions that satisfy any support obligations of the client;
- the trust prohibits the trust from owning insurance on the client's life;
- the trust holds only marketable securities; and
- the client does not contribute to the trust any stock in a corporation in which he owns 20 percent or more or for which he (either alone or with others) controls 20 percent or more of the voting stock, then the client should not have an estate tax risk if the client is acting as trustee. The client is only acting in a ministerial capacity with respect to distributions. The only benefit to the client is controlling investments of the trust (so long as the client stays away from entities in which the client has too much ownership or voting control). Other trusts may be drafted that also carefully limit the client's powers so that the client can act as the trustee.
The client can be a co-trustee. But the co-trustee who is not the client should have the sole power to exercise those tax-sensitive powers concerning distributions or voting stock that would be problematic for the client to have because of IRC Sections 2036, 2038 or 2041. Also, the co-trustee must be able to make these decisions independent of the client's wishes. If the co-trustee is required to make the decisions “in conjunction with” the client as co-trustee, then all bets are off — the assets may be includible under Sections 2036, 2038 or 2041.
Can a beneficiary be the trustee of the irrevocable trust? Yes, but then certain trustee powers may cause trust assets to be includible in the beneficiary's estate. That may suit the client's objectives. For example, the client may want to have the irrevocable trust included in the child/beneficiary's estate to avoid potential generation skipping transfer tax at the child's death.
Of course, as you may have divined by now, if the beneficiary has the power as trustee to distribute to herself and the power is not limited by an ascertainable standard, she will have a general power of appointment. Also, if the beneficiary has the power as trustee to make distributions to satisfy her obligations to support her spouse or dependents, she will have a general power of appointment.
There is, for the record, one power that absolutely no trustee should have as trustee of an ILIT that holds a policy on the client's life: the power to use the policy proceeds towards the payment of any of the client's obligations — not even the estate taxes due when the client dies. Break this rule, and the ILIT's proceeds will be included in the client's gross estate.34
That's pretty much it for estate tax considerations regarding trustee powers over an irrevocable trust. But there also are some income tax issues to consider. There, the tax sensitivity of the trustee's powers of the irrevocable trust depends on whether the trust will be treated as a grantor trust while the grantor is surviving. If the irrevocable trust is not a grantor trust, the irrevocable trust (or its beneficiaries) will pay the income taxes of the irrevocable trust pursuant to the non-grantor trust rules. If the irrevocable trust is treated as a grantor trust while the grantor is living, then the grantor will be taxed on all the income of the trust (and depending on how the trust is written, the capital gains as well), even if she is not a beneficiary of the trust.
Sometimes that is exactly what the client wants. A “defective” grantor trust is presently created and funded by the client to benefit her family. The client gifts or sells assets to the defective grantor trust so that the future growth of the assets will be excluded from the grantor's gross estate. The grantor continues to pay all income taxes with respect to ordinary income plus (if the trust is created to do so) all capital gains earned by the trust.35 Meanwhile, the trust grows free from the burden of paying those taxes. Although sometimes called an intentionally defective grantor trust, it is not “defective” at all. It's performing exactly as intended: triggering the grantor trust rules by taking advantage of differences between the income tax provisions and the estate tax provisions, without causing estate tax inclusion.
A client also might want to create a grantor trust because a grantor trust is one of the few kinds of trusts that can hold S corporation stock.36
Certain powers can be used to make the irrevocable trust a grantor trust.37 For example, when the client or spouse are given IRC Section 675 powers — that is to say, the power to substitute assets of equivalent value while acting in a nonfiduciary capacity or the power to loan without adequate security (but with adequate interest).38 Sometimes an independent trustee is given the power to add charitable beneficiaries or other beneficiaries (other than after-born or after-adopted children).39 The power holder, to achieve grantor trust status, cannot be an “adverse party.” To avoid estate tax inclusion issues or incomplete gift issues, the client should not have the power to add beneficiaries.
There also are powers that the client should not have to make the irrevocable trust a grantor trust:
- the IRC Section 676 power to revoke (which would cause inclusion at the client's death under Section 2038);
- the IRC Section 674 power to control beneficial enjoyment (which would cause inclusion in the client's gross estate under Section 2038); and
- the IRC Section 677 right to the income (which would cause inclusion at the client's death under Section 2036).
There also are certain powers to avoid grantor trust status:
- Use independent trustees (not the client, not the spouse, and not more than half of whom are related to the client or subordinate to the client) and give the independent trustees the authority to distribute only among a designated class of beneficiaries, with no power to add beneficiaries except for after-born or after-adopted children.40
- Use a trustee other than the client or spouse and limit distributions to reasonably definite external standards.41
- Use an adverse party as a trustee at all times.
- Use reasonably definite distribution standards to distribute corpus (or have separate shares for beneficiaries) and as to income, have one of the following:
- a vested trust for a single beneficiary;
- provide the income must pass to the current income beneficiaries in irrevocably specified shares;
- provide the income will be paid to the beneficiary's estate; or
- provide that the income must pass to the current income beneficiary's appointees (other than the beneficiary, the beneficiary's creditors, the beneficiary's estate or the creditor's of the beneficiary's estate).42
Wise drafters often use savings clauses buried in the powers and miscellaneous clauses of their documents to prevent most inadvertent exercises of a tax-sensitive trustee power. A suggested provision is the following:
“A trustee shall not exercise any discretionary fiduciary power to (a) distribute income from or principal of any trust under this Trust Agreement if the trustee is or may be a beneficiary of or is a donor to this trust; (b) distribute income from or principal of any trust under this Trust Agreement with respect to any assets disclaimed by the trustee; or (c) distribute income from or principal of any trust under this Trust Agreement for the health, maintenance, support, or education of a beneficiary if such trustee has a legal obligation to provide for the health, maintenance, support, or education of such beneficiary from the trustee's personal assets.”
This kind of clause is sometimes known as an Upjohn clause based on Upjohn v. United States.43 In that case, William and Janet Upjohn created five trusts for their minor children under Section 2503(c). The trusts included a savings clause that the trusts could not provide for maintenance and support which the Upjohns were legally obligated to provide. The IRS argued this was a substantial restriction on the trusts and therefore, the gifts did not qualify for the annual gift tax exclusion. The court disagreed and held for the taxpayer. The court did not discuss whether the savings clause was to prevent the Upjohns from being taxed on the income from the trusts or from having estate inclusion if the assets were used to satisfy their legal obligations. The savings clause worked for them, and has become a standard part of trust drafting ever since.
The savings clause, however, is only a back up. The savings clause prevents the making of distributions. If all you have is the savings clause to protect the client, then you may not have anyone to make the desired distributions if the client or someone else is acting as trustee and has a tax sensitive power, leaving unhappy heirs. Smart estate planners include the savings clause, but add other provisions for appointing an independent trustee to make the decisions if there is a problem and help the clients plan around the tax-sensitive trustee powers when choosing the trustee in the first place.
- If a trustee power causes assets to be subject to an estate or gift tax, the assets also may be subject to a generation-skipping transfer (GST) tax, depending upon whom the recipients of the assets are. But this article will not deal with the complexities of the GST tax.
- This article assumes both the client and the surviving spouse are U.S. citizens and residents.
- For examples of language when “happiness,” “emergencies,” “comfort” or “welfare” created general powers of appointment, see David Westfall and George P. Mair, Estate Planning Law and Taxation (4th Ed. 2001, 2003) at para. 18.02[a].
- Treasury Regulations Section 20.2041-1(c)(1).
- See Revenue Ruling 79-154, 1979-1 C. B. 301 (insurance fund not included in surviving spouse's estate although the spouse could appoint from the fund for children's support, because the children were adults and the spouse had no obligation to support them; therefore, spouse had no general power of appointment over the fund).
- See, for example, Private Letter Ruling 200637021.
- See Treas. Regs. Section 25.2511-1(g)(2).
- See PLR 200530020 for an example.
- Internal Revenue Code Section 2041(b)(1)(C)(ii).
- IRC Section 676.
- See PLR 8211057. The Internal Revenue Service also has ruled that a person holding a power to withdraw the larger of $5,000 or 5 percent of the corpus, a so-called “five or five” power, has an IRC Section 678(a) to the extent of the five or five power. See PLRs 9034004 and 200104005.
- Treas. Regs. Section 25.2518-2(e)(1).
- Treas. Regs. Section 25.2518-2(e)(2).
- Treas. Regs. Section 25.2518-2(d)(2).
- Treas. Regs. Sections 25.2518-2(e)(1)(i) and 25.2518-2(e)(2).
- Treas. Regs. Sections 25.2518-2(d)(2) and 25.2518-2(e).
- See IRC Section 2518.
- See Estate of Regester, 83 T.C. 1 (1984); Rev. Rul. 79-327, 1979-2 C.B. 342; Treas. Regs. Section 25.2514-1(b)(2); PLR 200427018. But see Self v. United States, 142 F. Supp. 939 (Ct. Cl. 1956).
- See Sheldon G. Gilman, “How and When to Use Trust Advisors Most Effectively,” Est. Plan., February 2008 at p. 30; Sheldon G. Gilman, “Effective Use of Trust Advisors Can Avoid Trustee Problems,” Est. Plan., March 2008 at p. 18. For other considerations in favor of naming individuals as trustees, see I. Mark Cohen, “Appreciating Individual Trustees,” Trusts & Estates, December 2006 at p. 32.
- Treas. Regs. Sections 20.2036-1(b)(3); 20.2038-1(a).
- See PLR 8916032.
- See Rev. Rul. 95-58, 1995-2 C.B. 191; Robert A. Vigoda, “Powers To Replace Trustees: A Key Element of (And Risk to) Dynasty Trusts,” Est. Plan., June 2008 at p. 20.
- Treas. Regs. Section 25.2511-2(b).
- Treas. Regs. Section 25.2511-2(c).
- Treas. Regs. Section 20.2038-1(a).
- Treas. Regs. Section 25.2503-4(b)(1).
- Compare Upjohn v. United States, 30 AFTR 2d 72-5918 (W.D. Mich. 1971) in which a savings clause prohibiting the use of trusts for minors to satisfy the support obligations of the parents was not a material restriction for purposes of Section 2503(c); it was not clear from the opinion if the Upjohns were serving as trustees.
- IRC Section 2042; Treas. Regs. Section 20.2042-1(c)(1).
- United States v. Byrum, 408 U.S. 125 (1972).
- The district court in Kimbell v. United States, 244 F. Supp. 2d 700 (N.D. Tex. 2003) agreed with the IRS and refused to apply Byrum, but the district court was reversed on other grounds, 371 F.3d 257 (5th Cir. 2004). For a discussion of the IRS' arguments and its successes and failures see Byrle M. Abbin, “A Practical Checklist for Planning with Family Limited Partnerships,” Est. Plan., October 2006 at p. 10; Jerry David August and Casey Scott August, “Income Tax Aspects of Forming, Operating, and Exiting FLP's,” Est. Plan., April 2007 at p. 13; Robert E. Madden, Lisa H.R. Hayes, and Frank S. Baldino, “FLP Again Included in Taxpayers' Estates/Valuation of Stock/Conservation Easements,” Est. Plan., May 2007 at p. 37; Daniel W. Matthews and Lorraine New, “An Academic and A Former IRS Agent Discuss the IRS Perspective on Family Limited Partnerships,” Mich. Tax Law., Winter 2008 at p. 15; Michael D. Mulligan, “Current Status of Use of Limited Partnerships in Estate Planning,” Tax Mgm't Est., Gifts and Tr. J., July 2005 at p. 199. In addition, see John W. Porter “FLP Wars Update,” Trusts & Estates, July 2005 at p. 49; Louis S. Harrison and John M. Janiga, “The Interplay of Behavioral Economics and Portfolio Management with the Current Examination of Family Partnerships by the Courts,“ Real Prop. Prob & Tr. J., Spring 2005 at p. 117; J. Joseph Korpics, “How Estate Planners Can Use Bongard To Their Advantage,” Est. Plan., July 2005 at p. 32. The IRS recently issued settlement guidelines with respect to discounts for family limited partnerships (UIL 2031.01-00), see James John Jurinski, “FLP Discount Settlement Guidelines — New Answers, New Questions,” Real Est. Tax'n No. 2 (2008) at p. 90. Two recent cases involving partnerships in which the taxpayer funded the partnership and made gifts are Estate of Anna Mirowski v. Commissioner, T.C. memo 2008-74 (March 26, 2008), and Holman v. Comm'r, 130 T.C. No. 12 (May 27, 2008).
- Treas. Regs. Section 20.2042-1(b).
- Rev. Rul. 2004-64, 2004-27 IRB 7 (July 1, 2004) confirmed that the grantor of a grantor trust is liable for the income taxes. Note, if the grantor trust requires reimbursement of the taxes to the grantor, the grantor has retained an IRC Section 2036 interest, causing inclusion of the trust assets in the grantor's gross estate. If the trustee has discretion to reimburse the grantor for the grantor's income taxes, the assets may be includible in the grantor's gross estate. The discretionary power to reimburse is another tax-sensitive power with respect to a defective grantor trust.
- IRC Section 1361(c)(2)(A)(i).
- See Robert T. Danforth, “The Use of Grantor Trusts in Estate Planning,” Tax Mgm't Est., Gift, and Tr. J., March 2006 at p. 103; George W. Gregory, “Drafting in Compliance with the Grantor Trust Rules,” 12th Annual Drafting Est. Plan. Documents Seminar, January 2003; Craig L. Janes and Bernadette M. Kelly, “When Using a Power of Substitution — Taking Nothing for Granted,” Est. Plan., August 2007 at p. 3; Todd Steinberg, Jerome M. Hesch, and Jennifer M. Smith, “Grantor Trusts: Supercharging Your Estate Plan,” Tax Mgm't Est., Gifts and Tr. J., January 2007 at p. 66; William R. Swindle, Edward R. Penn and N. Todd Angkatavanich, “Beneficiary Withdrawal Powers in Grantor Trusts — A Crumm(e)y Idea?” Est. Plan., October 2007 at p. 30.
- Rev. Rul. 2008-22, 2008-16 IRB 796 (modified to correct citation by Ann. 2008-46, 2008-20 IRB 983), recently confirmed that a grantor's retained power, exercisable in a non-fiduciary capacity, to substitute assets of equivalent value will not, by itself, cause the assets to be included in the grantor's gross estate under IRC Section 2036 or 2038. Note that Rev. Rul. 2008-22, was conditioned on (1) the trustee (who could not be the grantor) having and satisfying the trustee's fiduciary obligation to ensure that assets of equivalent value are substituted, and (2) the substitution power cannot be used to shift benefits among trust beneficiaries.
- IRC Section 674(a).
- IRC Section 674(c).
- IRC Section 674(d)(2).
- IRC Sections 674(b)(5) and 674(b)(6). Query whether Congress intended something different by the “reasonably definite external standard” in IRC Section 674(d) versus the “reasonably definite standard” in IRC Section 674(b)(5). The Treasury regulations, Treas. Regs. Section 1.674(d)-1, do not make a distinction and refer to the definition of “reasonably definite standard” in Treas. Regs. Section 1.674(b)-1(b)(5) to define the “reasonably definite external standard” of IRC Section 674(d).
- Upjohn v. United States, supra, note 30.
Marguerite Munson Lentz is a partner in the Bloomfield Hills, Mich., office of Honigman Miller Schwartz and Cohn LLP
Fabulous Faux — A group of three Gripoix for Chanel costume ruby, emerald and pearl necklaces made in France circa 1960 sold for $4,000 at Doyle's “The Brigid Berlin Collection of Costume Jewelry” on Oct. 7, 2008, in New York.