Private Letter Ruling 202108001 (released Feb. 26, 2021) addresses the intersection of the best of times – a grandfathered generation-skipping transfer (GST) tax-exempt trust funded generously enough to warrant the cost of a PLR application – and the worst of times, namely drafting careless enough to include a digit mid-word in the title of a trust article. And the hero of our PLR is, undoubtedly, the brave counsel who rode into the fray with the issue-spotting-telescope of a 1L confronting her first tort exam and diffused each of the potentially grandfathering-defying facts at play.
Original Testamentary Trust
Our tale begins with the execution of a will and two subsequent codicils (collectively, Father’s Will) by Decedent’s father (Father). Father died prior to Sept. 25, 1985, survived by Decedent, four of Decedent’s children and Decedent’s grandchild.
Under Father’s Will, a testamentary trust was established for the benefit of Decedent and Father’s descendants, and a corporate trustee was named. Decedent was granted a testamentary power of appointment (POA) over the trust, exercisable in favor of any descendant of Father or spouse of such descendant, excluding Decedent’s creditors, estate or the creditors of his estate.
Father’s Will included the following provisions, in relevant part:
- The trust shall terminate not later than 21 years after the death of the survivor of Father’s wife and descendants living at the time of Father’s death.
- The beneficiaries may discharge and replace a corporate trustee with a successor corporate trustee, subject to certain capitalization requirements.
- The trustee is empowered to distinguish between assets constituting income and those constituting principal.
- The trust is governed by the laws of State.
Subsequent to Father’s passing, the trust was modified through three judicial proceedings that respectively (1) modified the beneficiaries’ ability to remove and replace a corporate trustee; (2) modified the required capitalization of a successor corporate trustee; and(3) determined that capital gains constituted income of the trust.
Decedent’s Will
In Father’s tradition, Decedent executed a will, followed by two codicils.
Paragraph 1 of Article Two of Decedent’s will directed the trustee of “Decedent Exempt Trust” to distribute one share to the trustee of the trust created under that article for each child of Decedent who survived him.
Paragraph 2 of Article Two provided for distributions for the beneficiary’s health, education, support and maintenance and granted the beneficiary a testamentary POA exercisable in favor of any persons or entities other than the beneficiary, the beneficiary’s estate or the creditors of either.
Paragraph 3 of Article Two provided that “[n]otwithstanding any other provision to the contrary,” in no event shall any trust under “this Article” continue “by reason of the provisions of the foregoing paragraph 3” beyond the period permitted under the “applicable” perpetuities rules.
Article Three of Decedent’s will directed that the residue of Decedent’s estate be added to Decedent’s revocable trust.
Decedent’s first codicil deleted Article Two of Decedent’s will and replaced it with an article entitled “Disposi3tion of Residue,” [sic] which provided for the residue of Decedent’s estate to be added to Decedent’s revocable trust.
Decedent’s second codicil deleted Article Three of Decedent’s will and replaced it with an article entitled “Disposition of Residue,” which provided for the residue of Decedent’s estate to be added to Decedent’s revocable trust.
Decedent died, survived by four children and a grandchild.
Interpreting Decedent’s Will and Codicils
The bank, as trustee of the trust, filed a petition for a judicial determination of rights in relation to the trust, as well as for construction and interpretation of Decedent’s will.
The bank’s petition identified six separate ambiguities and scrivener’s errors in Decedent’s exercise of his POA over the trust, including:
- A reference to (a non-existent) “Decedent Exempt Trust” rather than the trust;
- Multiple mis-references to Article 2 and 3 of Decedent’s will;
- Decedent’s second codicil failing to reinstate Article Two (exercising Decedent’s POA over the trust), which was mistakenly deleted in the first codicil; and
- The perpetuities provision of Decedent’s will failing to carve out a limitation for appointed trust assets.
Decedent’s estate-planning attorney declared under penalties of perjury that Decedent intended to exercise his POA over the trust so that the trust would be divided into separate trusts for his children and held pursuant to the terms of Article Two of Decedent’s will.
The court issued a declaratory judgment contingent on the receipt of a PLR from the Internal Revenue Service. The contingent declaratory judgment corrected the mistaken cross-references in Decedent’s will and codicils, clarified that references in Decedent’s will to “applicable rules governing perpetuities,” included the limitations imposed by the perpetuities provision of Father’s Will, instructed the trustee to distribute the remaining trust assets to separate trusts for Decedent’s children and specified that such trusts were to terminate 21 years after the survivor of Decedent’s children and grandchild.
The trustee requested rulings from the IRS as to the impact of the judicial modifications of the trust and of Decedent’s will and codicils on the GST-exempt status of trust and whether Decedent’s POA over the trust triggered the trust’s inclusion in Decedent’s taxable estate.
Rulings and Analysis
The IRS issued the following rulings:
- The judicial modifications of the trust don’t impact its GST-exempt status.
- The judicial modifications of Decedent’s will and codicils didn’t impact the grandfathered GST-exempt status of the sub-trusts created from the trust for Decedent’s children.
- Decedent’s exercise of his testamentary POA didn’t trigger the trust’s inclusion in his taxable estate under Internal Revenue Code Section 2401(a)(3).
IRS’ Analysis for First Two Rulings
In general, transfers from a trust that was irrevocable and fully funded on Sept. 25, 1985 will be exempt from GST tax (a Grandfathered Trust). (See IRC Section 1433(b)(2)(A) and Treas. Regs. Section 26.2601-1(b)(1)(i)).
A judicial construction of a Grandfathered Trust to resolve an ambiguity or to correct a scrivener’s error that’s consistent with applicable state law and involves a bona fide issue won’t cause GST-exempt status to be lost. (Treas. Regs. Section 26.2601-1(b)(4)(i)(C)).
More broadly, a modification that neither shifts a beneficial interest to a lower generation nor extends the time for vesting of any beneficial interest in the trust beyond the period provided in the original trust won’t cause GST-exempt status to be lost. (Treas. Regs. Section 26.2601-1(b)(4)(i)(D)(1)).
An increase in the amount of a GST transfer is considered a shift in a beneficial interest to a lower generation; however, an administrative modification that indirectly increases the amount transferred (for example, by lowering administrative costs) won’t be considered an increase in the amount of a GST transfer. (Treas. Regs. Section 26.2601-1(b)(4)(i)(D)(2)).
The exercise of a limited POA over a Grandfathered Trust will be treated as an addition to such trust (undermining its GST tax exemption) when the power is exercised in a way that may postpone vesting for a period extending beyond 21 years after the death of the survivor of any life in being at the time of the creation of the trust. (See Treas. Regs. Section 26.2601-1(b)(1)(v)(B)).
A power exercised by creating another power will be deemed to be exercised to whatever extent the second power may be exercised.
The IRS categorized the first two trust modifications, relating to the corporate trustee succession, as administrative in nature and determined that under Treasury Regulations Section 26.2601-1(b)(4)(i)(D)(2), such modifications neither shifted a beneficial interest to a lower generation nor extended the time for a beneficial interest’s vesting.
Similarly, the IRS concluded that under Treas. Regs. Section 26.2601-1(b)(4)(i)(C), the judicial determination that capital gains constituted income of the trust addressed a bona fide issue and construed the relevant ambiguous term consistently with applicable state law.
Likewise, the IRS determined that Decedent’s exercise of his POA, as construed by the Declaratory Judgment, won’t postpone the vesting of trust beyond 21 years after the death of the survivor of Decedent’s children and grandchild and, therefore, won’t be treated as an addition to the trust under Treas. Regs. Section 26.2601-1(b)(1)(v)(B).
IRS’ Analysis for Third Ruling
In general, property will be included in the taxable estate of a decedent who exercises a testamentary POA by creating another POA that may be validly exercised under applicable local law to postpone the vesting of an interest for a period ascertainable without regard to the date of the creation of the original power.
Decedent exercised his testamentary POA to appoint the property of the trust to trusts for the benefit of his children and granted each child a limited POA over the trust for such child’s benefit. However, the effectiveness and scope of the exercise were unclear due to the numerous scrivener’s errors and ambiguities of Decedent’s codicils. The IRS determined that all trusts created under Decedent’s will will terminate 21 years after the death of the survivor of Decedent’s children and grandchild, if not sooner, pursuant to the Declaratory Judgment construing Decedent’s will and codicils, and therefore, the trust won’t be included in his taxable estate under IRC Section 2401(a)(3).
