In Private Letter Ruling 201426014 (June 27, 2014), the Internal Revenue Service issued four rulings in relation to property held in an irrevocable trust.
The Irrevocable Trust
A settlor proposed to create an irrevocable trust for his benefit and the benefit of his two daughters, their issue and six individuals (A through F). He designated a trust company to be the corporate trustee. He also designated a distribution committee, consisting of his two daughters and A through F. If any distribution committee member was unable to serve, that member wouldn’t be replaced.
Under the terms of the trust, while the settlor was alive, the corporate trustee shall distribute, for any purpose, to the settlor and the distribution committee, the trust’s net income and/or principal as unanimously determined by the distribution committee (the unanimous member power).
The corporate trustee shall also distribute to the settlor and any of the settlor’s lineal descendants, net income and/or principal as determined by a majority of the distribution committee. The settlor must consent to this distribution (the settlor’s consent power). Moreover, the corporate trustee must distribute principal to any of the settlor’s lineal descendants as the settlor, in his non-fiduciary capacity, determines to be for the lineal descendant’s health, education, maintenance and support (the settlor’s sole power). The settlor isn’t required to exercise this power, and any net income not distributed by the corporate trustee will be added to the principal.
On the settlor’s death, the distribution committee will cease to exist. The trust property will be distributed to persons whom the settlor appoints in his will, other than to himself or his creditors or to his estate and his estate’s creditors (the settlor’s testamentary power). In default of this power of appointment (POA), the trust property will be distributed per stirpes to the settlor’s then-living descendants.
If both of the settlor’s daughters are no longer serving as distribution committee members or there are less than two distribution committee members, the trust property will be distributed to the settlor and the trust will terminate.
The settlor requested that the IRS address four issues. First, the settlor requested a ruling on whether, during the time the distribution committee members were serving, no portion of income, deductions and credits against the trust’s tax be included in computing the settlor’s taxable income, deductions and credits (under Internal Revenue Code Section 671) or be included in computing any distribution committee member’s taxable income, deductions and credits (under IRC Section 678(a)). The IRS examined the relevant portions of IRC Sections 671, 672(a) and 673 through 677, to determine whether a grantor or another person should be treated as the owner of any portion of a trust. The IRS concluded that none of the circumstances attendant to the trust’s operation could determine whether the settlor would be treated as the owner of any portion of the trust under Section 675. Rather, this determination was a question of fact, which the IRS deferred until the parties filed their federal income tax returns.
The IRS next addressed two issues—whether the contribution of property by the settlor to the trust was a completed gift subject to federal gift tax, and whether any distribution of property by the distribution committee to the settlor was a completed gift, subject to federal gift tax, by any members of the distribution committee. IRC Section 2501(a)(1) imposes a gift tax on the transfer of property by gift; IRC Section 2511(a) provides that the gift tax applies whether the transfer is in trust or otherwise. Treasury Regulations Section 25.2511-2(b) provides that a gift is complete when a donor parts with dominion and control of a property and has no power to change such disposition. If a donor reserves any power of a property’s disposition, the gift may be incomplete. The IRS examined the Treasury regulations, along with Estate of Sanford v. Commissioner, 308 U.S. 39 (1939), and applied them to the instant case.
First, the IRS analyzed the settlor’s consent power, which gave the settlor power to distribute income and principal to any beneficiary, and determined that retention of this power caused the transfer of property to the trust to be wholly incomplete for federal gift tax purposes. Specifically, the distribution committee members didn’t have interests adverse to the settlor under Treas. Regs. Section 25.2514-3(b)(2); they were merely co-holders of the power and as such, the settlor retained an exercisable power. Moreover, the settlor retained a sole power over the trust’s principal; the sole power gave the settlor the power to change the beneficiaries’ interests and as such, the gift was incomplete. Furthermore, the settlor’s testamentary power to appoint trust property to anyone (other than his estate, his creditors or creditors of his estate) was a retention of power sufficient to cause the transfer of property to the trust to be incomplete for federal gift tax purposes.
The distribution committee’s unanimous member power over income and principal wasn’t a condition precedent to the settlor’s powers over the income and principal. The settlor retained dominion and control over the trust income and principal until the distribution committee exercised its unanimous member power. Thus, the unanimous member power didn’t cause the transfer of property to be complete for federal gift tax purposes.
Given the settlor’s retained powers, the IRS determined that the settlor’s contribution of property to the trust wasn’t a completed gift subject to federal gift tax. Rather, a distribution from the trust to the settlor “is merely a return of the Settlor’s property.” Accordingly, any distribution by the distribution committee from the trust to the settlor isn’t a completed gift by any member of the distribution committee. On the settlor’s death, the fair market value of the trust property would be included in the settlor’s gross estate for federal estate tax purposed.
General Power of Appointment
In its fourth ruling, the IRS looked at whether the exercise or release of a general POA is a transfer of property by an individual possessing such power. Under Treas. Regs. Section 25.2514-1(c)(1), a POA isn’t a general POA if it’s exercisable in favor of designated persons other than the possessor or his creditors, or the possessor’s estate or the estate’s creditors. In the instant case, the powers held by the distribution committee under the settlor’s consent powers are exercisable only in conjunction with the settlor. Thus, the distribution committee members don’t have a general POA through the settlor’s consent power. Similarly, under the unanimous member power, distributions made to a beneficiary, other than the settlor, aren’t gifts by the distribution committee—instead, they are gifts by the settlor. The IRS, therefore, ruled that any distribution by the distribution committee to any beneficiary, other than the settlor, will not be a completed gift subject to federal gift tax, by the distribution committee. Any distribution of property to a beneficiary, other than the settlor, will be a completed by the settlo