In Private Letter Ruling 202432012 (Aug. 9, 2024), the Internal Revenue Service determined that proposed court modifications of a generation-skipping transfer (GST) tax-exempt trust’s distribution and trusteeship provisions were acceptable under Treasury Regulations Section 26.2601-1(b)(4)(i) and won’t subject the trust to the GST tax.
Court Modifications Requested
On the last to die of settlor and her spouse, the settlor’s will established trusts for her descendants. One such trust created—the trust at issue—is a GST-exempt trust created for the benefit of one of the settlor’s children and such child’s descendants. The trustee of the GST-exempt trust at issue petitioned the court to modify the trust. The court issued an order granting various modifications, pending a favorable tax ruling from the IRS.
Original Trust Terms
The original trust included these terms:
While the child is living, the trustee pays as much of the income as the trustee deems necessary for health, education and support of any class members consisting of the child, the child’s first grandchild and the first grandchild’s descendants. When the child dies, all principal and accrued income shall be distributed to the child’s first grandchild, otherwise the first grandchild’s descendants, provided that a beneficiary’s share shall be added to an existing trust the trustee is then holding for the primary benefit of that beneficiary. The settlor’s will provides that any trust in existence 21 years after the death of the last to survive of settlor and settlor’s descendants living at the time of settlor’s death shall then terminate.
The trustee provisions provide, in relevant part, that no beneficiary may become trustee, and no beneficiary may be appointed with the power to remove trustees.
The state statute provides that the court may modify the trust terms or change the trustee on the trustee or beneficiary’s petition if the order furthers the purposes of the trust.
Modifications Proposed
The court order proposed modifications to the distribution provisions such that property originally passing free of trust to a beneficiary would be retained in a separate trust for the beneficiary’s lifetime. First, any income distribution from the trust to the grandchild or more remote descendant of the child during the child’s lifetime may be retained in a separate trust of which such descendant is the lifetime beneficiary. Second, any distribution of income or principal from the trust to the grandchild or more remote descendant of the child at the child’s death shall be retained in a separate trust of which such descendant is the lifetime beneficiary. Third, the beneficiary of each separate trust shall have a general power of appointment (GPOA) under IRC Section 2041(a)(2), which renders the trust property includible in the gross estate of the beneficiary at their death.
Additionally, the court order proposed various modifications to the trustee removal and succession provisions, including that certain beneficiaries have the power to singularly or jointly appoint co-trustees and successor trustees and that a trustee appointee may not be a beneficiary or related or subordinate party under IRC Section 672(c).
GST Trust Modifications
Treas. Regs. Section 26.2601-1(b)(4)(i) provides the parameters for modifications to a GST-exempt trust. Specifically, the following must apply: (1) the modification must be a judicial reformation or nonjudicial reformation valid under applicable state law, (2) the modification won’t shift a beneficial interest in the trust to a beneficiary occupying a lower generation than those holding a beneficial interest prior to the modification, and (3) the modification doesn’t extend the time for vesting of a beneficial interest past the period provided in the original trust. Mere administrative changes that only indirectly increase the amount transferred won’t be considered a shift of beneficial interest.
IRS Rulings
Turning first to the issue of whether the GST tax would be imposed as a result of the proposed modifications, the IRS determined that the distribution passing to a trust which grants the primary beneficiary a GPOA under Section 2041(a)(2) didn’t trigger the GST tax because the primary beneficiary becomes the transferor at their death. The result is that the proposed modifications to have the distribution pass in trust rather than outright to such beneficiary won’t cause a shift of beneficial interest to a lower generation nor extend the period for vesting beyond what was originally provided in the trust.
Similarly, the IRS ruled that the proposed modifications to the trustee removal and succession provisions are administrative in nature and only indirectly increase the amount transferred. Therefore, these changes to trustee provisions won’t cause the trust to become subject to GST tax.
The IRS further determined that because the trust’s beneficial ownership remained the same after the proposed court modifications, no disposition or transfer subject to gift tax or gain or loss recognition occurred.
