In PLR 201729009 (released July 21, 2017), the Internal Revenue Service addressed the income and gift-tax ramifications of an incomplete non-grantor trust.
Grantor Creates Irrevocable Trust
The grantor created an irrevocable trust for the benefit of himself, his wife, his descendants, his two siblings, two other individuals and charitable organizations (the permissible beneficiaries). During the grantor’s lifetime, the trust provides that distributions be made as follows:
1. Trustees shall distribute income and principal to the permissible beneficiaries as directed by a majority of the Distribution Committee, with the written consent of the grantor (the grantor’s consent power).
2. Trustees shall distribute income and principal to the permissible beneficiaries as directed by all members of the Distribution Committee (the unanimous member power).
3. Trustees shall distribute such amounts of principal to one or more of the grantor’s daughter, his siblings and the two other individual beneficiaries as directed by the grantor, acting in a nonfiduciary capacity, for purposes of their health, education, maintenance and support (the grantor’s sole power).
The Distribution Committee members act in a nonfiduciary capacity. At all times, there must be at least two individuals serving on the Distribution Committee, and there must be at least two members who are adult permissible beneficiaries. The grantor isn’t permitted to serve on the Distribution Committee. The initial members of the Distribution Committee are the grantor’s daughter, his siblings and the two other individual beneficiaries. The Distribution Committee will cease to exist at the grantor’s death.
The trust terminates on the grantor’s death, and the remaining balance will be distributed pursuant to the grantor’s limited power of appointment (LPA). If the Grantor doesn’t exercise his LPA, the trust principal will be distributed to his surviving descendants.
Requested Rulings
The following rulings were requested in connection with the trust:
1. As long as the Distribution Committee is serving, no portion of the income, deductions and credits of the trust shall be included in determining the grantor’s taxable income, deduction and credits under IRC Section 671.
2. The grantor’s contribution of property to the trust isn’t a completed gift.
3. Any distribution of property from the trust to a permissible beneficiary at the direction of the Distribution Committee won’t be a completed gift by any member of the Distribution Committee.
4. Any distribution of property from the trust to any beneficiary at the direction of the Distribution Committee will be a completed gift by the grantor.
5. No member of the Distribution Committee will have a general power of appointment (GPA) over any property held in trust upon his death.
Inclusion in Grantor’s Taxable Income
The IRS found that the grantor wasn’t the owner of any portion of the trust under IRC Sections 673, 674, 676 or 677. In addition, because none of the Distribution Committee members has the power exercisable solely by himself to vest trust income or principal in himself, no Distribution Committee member will be treated as the owner of any portion of the trust under IRC Section 678(a). Although the trust agreement doesn’t contain any provisions that would cause the grantor to be treated as the owner of the trust under IRC Section 675, the actual operation of the trust will determine whether Section 675 will cause the trust to be a grantor trust for income tax purposes. The determination of whether administrative controls are considered exercisable primarily for the benefit of the grantor under Section 675 is a question of fact. Therefore, the IRS wouldn’t rule on this issue, stating that the determination must be deferred until the income tax returns have been fully examined.
No Completed Gift
The IRS concluded the contribution of property to the trust by the grantor isn’t a completed gift for federal gift-tax purposes. As such, any distribution from the trust to the grantor is characterized as a return of the grantor’s property and on the grantor’s death, the fair market value of the property in the trust will be included in his gross estate for federal estate tax purposes.
First, the retention of the grantor’s consent power causes the transfer of property to the trust to be wholly incomplete for federal gift tax purposes. Under Treasury Regulations Section 25.2511-2(e), a donor is considered to have a power himself if it’s exercisable by him in conjunction with any person who doesn’t have a substantial adverse interest in the disposition of the transferred property or the income therefrom. Pursuant to the grantor’s consent power, the Distribution Committee can direct distributions with the written consent of the grantor. The Distribution Committee members are not takers in default for purposes of Treas. Regs. Section 25.2514-3(b)(2) and are merely co-holders of the power. A co-holder of a power is considered to have an adverse interest only when he may possess the power after the other co-holder’s death and may exercise it at that time in favor of himself, his estate, his creditors or the creditors of his estate. In this case, since the Distribution Committee ceases to exist on the grantor’s death, the Distribution Committee members don’t have interests adverse to the grantor. Therefore, the grantor is considered to possess the power to distribute income and principal to any beneficiary himself, causing his transfer of property to the trust to be incomplete.
Second, the grantor’s sole power causes the transfer of property to the trust to be wholly incomplete for federal gift tax purposes. Under Treas. Regs. Section 25.2511-2(c), a gift is incomplete to the extent that a reserved power gives the donor the power to name new beneficiaries or to alter the interests of the beneficiaries among themselves, unless the power is a fiduciary power limited by an ascertainable standard. The grantor’s sole power gives the grantor the power to change the interests of the beneficiaries, thereby causing the transfer to be incomplete. The fact that the power is limited by an ascertainable standard (that is, health, education, maintenance and support) doesn’t change this result because the power isn’t held in a fiduciary capacity.
Third, the grantor’s retention of a testamentary LPA causes the transfer of property to be incomplete with respect to the remainder of the trust. Treas. Regs. Section 25.2514-3(b)(2) provides that the retention of a testamentary power to appoint the remainder of a trust is considered a retention of dominion and control over the remainder.
Finally, the unanimous member power held by the Distribution Committee doesn’t cause the transfer of property to be complete with respect to the income interest of the trust. The unanimous member power requires that distributions be made on the unanimous direction of all Distribution Committee members; however, the grantor retains dominion and control over the trust income and principal until the unanimous member power is actually exercised. Thus, the unanimous member power isn’t a condition precedent to the grantor’s power over the income and principal, and its existence doesn’t cause the transfer of property to the trust to be complete.
No Completed Gift by Distribution Committee Members
Pursuant to the grantor’s consent power, the Distribution Committee members can only exercise their power in conjunction with the creator of the power—that is, the grantor. Thus, under IRC Sections 2514(b) and 2041(a)(2), the grantor’s consent power doesn’t confer a GPA on the Distribution Committee members. Further, because the Distribution Committee members have substantial adverse interests in the property subject to the unanimous member power, such power doesn’t create a GPA in the Distribution Committee members under IRC Sections 2514(b) and 2041(a)(2). As such, if the Distribution Committee exercises its authority under the grantor’s consent power or the unanimous member power, the distributions won’t be treated as gifts by the Distribution Committee members but will instead be treated as gifts by the grantor. Thus, any distribution of property from the trust to any beneficiary other than the grantor at the direction of the Distribution Committee won’t be a completed gift by any member of the Distribution Committee but will be a completed gift by the grantor. Further, since the Distribution Committee members don’t have a GPA over the trust assets, no property held in the trust will be includible in the gross estate of any member of the Distribution Committee on his death under Section 2041.
