Tax Law Update: July 2020

• Internal Revenue Service rules on transaction relating to grantor trust status to beneficiary—In Private Letter Ruling 202022002 (released May 29, 2020), a beneficiary of an irrevocable trust (Trust 1) had the right to withdraw all trust property other than certain limited liability company (LLC) interests. Trust 1 proposed to sell the LLC interests for cash and a note to another irrevocable trust (Trust 2), which was a grantor trust to the beneficiary. Immediately after the proposed sale, the beneficiary would have the right to withdraw the cash and promissory note (the proceeds from the sale) from Trust 1. The IRS ruled that because the beneficiary had the right to withdraw the proceeds from the sale, Trust 1 would be treated as a grantor trust to the beneficiary under IRC Section 678 and that no gain or loss would be triggered on the sale. 

Interestingly, no gain or loss would be realized on the sale if Trust 1 was a grantor trust to the beneficiary, and the ruling held that the grantor trust status that resulted from the transaction made it a grantor trust for the transaction itself. The ruling cited Revenue Ruling 85-13 that had the same result: the “borrowing” of assets for a note by the grantor wasn’t a taxable event because the borrowing itself made it a grantor trust. That is, the grantor trust status was “retroactive” to the moment of the transaction. 

• IRS rules on state law changes—In PLR 202020008 (released May 15, 2020), the decedent was the sole beneficiary and the sole trustee of two irrevocable trusts. The general distribution provisions of the trust directed the trustee (decedent) to make distributions of principal to the beneficiary (decedent) for his support, maintenance, comfort, education and recreation, with additional distributions for the beneficiary’s best interests and welfare. 

There was no provision in either trust establishing the state law that governed the trust. The decedent lived in State A initially and then later moved to State B, where he lived until his death. While the decedent was a trustee, State A enacted a statute that limits a beneficiary-trustee’s discretion to make distributions to himself only under an ascertainable standard. State B had a similar statute. 

The ruling held that enactment of the statute in State A didn’t constitute a release of a general power of appointment (GPOA), the trusts weren’t included in the decedent’s estate and there was no constructive addition for generation-skipping transfer (GST) tax purposes or impact to the GST-exempt status of the trusts. The ruling was based on Revenue Procedure 94-44 issued when Florida enacted a similar statute, and the revenue procedure stated that the IRS won’t treat the Florida statute as causing the lapse of a GPOA for purposes of IRC Section 2514 when the scope of a fiduciary power held by a beneficiary was restricted as a result of the statute. 

• IRS rules on self-dealing with charitable lead annuity trust (CLAT) terminating transactions—In PLR 202021001 (released May 22, 2020), the trustee of a CLAT requested a ruling regarding transactions at the termination of the CLAT. The CLAT paid an annuity equally to two charities during its term, and at the end of the term, the remainder was to be paid to the children of the grantor. 

The trustee sought to confirm that the distribution to the remainder beneficiaries wouldn’t be considered an act of self-dealing. The IRS agreed and ruled that the private foundation status of the CLAT would terminate with the last payment of the annuity to the charities. Therefore, the payment of the remainder to the trustee’s children wasn’t self-dealing. In addition, the CLAT’s reimbursement of certain expenses paid by the trustee was similarly not self-dealing because it occurred after the last annuity payment. 

• Proposed regulations on certain deductions allowable for estates and non-grantor trusts—Treasury published proposed regulations, 85 FR 27693 (May 11, 2020), regarding certain deductions allowable for estates and non-grantor trusts. IRC Section 67(e) generally allows trusts and estates to deduct: (1) administrative costs that wouldn’t have been incurred or paid if the property weren’t held in such trust or estate, (2) deductions under IRC Section 642(c) relating to a personal exemption of the estate or trust, and (3) distribution deductions under IRC Section 651 for income distributions. Beginning in 2018 (through 2026), miscellaneous itemized deductions were suspended for certain taxpayers under the Tax Cuts and Jobs Act. The proposed regulations confirm a prior notice that the deductions under Section 67(e) aren’t miscellaneous itemized deductions. Therefore, they remain deductible when determining the adjusted gross income of an estate or non-grantor trust. 

The proposed regulations also provide guidelines on how to allocate excess deductions in the year of termination.