• Estate tax account transcripts now available online—Prior to June 1, 2015, the Internal Revenue Service issued estate tax closing letters for every federal estate tax return filed. But, for all returns filed on or after June 1, 2015, estate tax closing letters are only issued on request, and in lieu of closing letters, taxpayers can request an account transcript. The transcript includes the date the return was received, payment and refund history, assessed penalties and interest, any balance due and the date on which the examination was closed. The IRS has now announced that these transcripts can be obtained online at irs.gov.
• Trust decanting doesn’t impact generation-skipping transfer (GST) tax status—In Private Letter Ruling 201820007 (released May 18, 2018), the settlor established an irrevocable trust, which established two separate trusts: one for the benefit of each of his sons. The settlor allocated his GST tax exemption to the trusts.
Years later, pursuant to a state statute, the trustee of the trust for one of the sons appointed all of the principal and accumulated income of that trust to a new trust, effective on receipt of a favorable PLR. The state statute hadn’t existed on the date the trust was executed but had become effective in the interim.
The new trust had administrative terms that differed from the original trust. It provided for the appointment of an independent trustee, a family trustee and a future trust protector. In addition, the new trust provided that if the son beneficiary didn’t exercise his limited power of appointment (LPOA), the trust property would be held in trusts for the benefit of the default beneficiaries (rather than outright under the original trust).
The PLR acknowledged that while there are regulatory safe harbors relating to modifications to GST-grandfathered trusts (trusts established prior to Sept. 1, 1985), there’s no guidance concerning modifications of a trust that’s exempt from GST tax because of the affirmative allocation of GST tax exemption. However, at a minimum, it reasoned that a modification that wouldn’t affect a grandfathered trust shouldn’t affect an otherwise GST tax-exempt trust.
There were two potentially applicable safe harbors. The first (Treasury Regulations Section 26.2601-1(b)(4)(i)(A)) provides that a distribution of trust principal from an exempt trust to a new trust won’t jeopardize the grandfathered GST tax status of the trust if the terms of the governing instrument authorize such distribution or if, at the time the trust became irrevocable, state law authorized such a distribution. The PLR held that because the state statute authorizing the decanting wasn’t in effect when the irrevocable trust was established, and the trust didn’t authorize such a distribution, it didn’t meet the requirements of this regulatory safe harbor.
Another safe harbor (Treas. Regs. Section 26.2601-1(b)(4)(i)(D)), however, did apply. That safe harbor provides that a modification of an exempt trust by judicial or nonjudicial reformation won’t interfere with the GST tax-exempt status of the trust if the modification doesn’t shift a beneficial interest in the trust to any beneficiary who occupies a lower generation than the persons who held the beneficial interest prior to the modification, and the time for vesting of any beneficial interest isn’t extended beyond the period provided in the original trust.
The IRS noted that the terms of distribution of income and principal during the son’s life in the new trust were identical to those of the prior trust, except for the new provision of an independent trustee with discretionary authority. The son remains the sole beneficiary during his lifetime. The son retains the same LPOA in the new trust, with the same class of permissible appointees. The default remainder beneficiaries who would receive the trust property in the event the son doesn’t exercise his LPOA remain the same, the only difference being that the property is held in trust for those persons, rather than being distributed outright to them.
The IRS held that the administrative changes to the trustees and trust protector don’t shift any beneficial interest in the trust. In addition, because the trusts established for default remaindermen included a testamentary general POA for the beneficiaries, which the IRS views as being functionally equivalent to outright ownership, the potential ongoing trusts didn’t shift a beneficial interest to a lower generation nor extend the time for vesting of any beneficial interest. Therefore, it met the requirements of the second safe harbor, and the decanting to the new trust wouldn’t affect the GST tax status of the trust.
Arguably, any such modification wouldn’t affect the GST tax status even if it doesn’t fall within the safe harbors for a grandfathered trust. There’s nothing in the Internal Revenue Code or regulations that would cause a trust to lose its GST tax-exempt status due to a modification (unless a taxable transfer is made resulting in a new transferor), and the only reason grandfathered trusts are an issue is because of the specific regulations saying so. Further, the trustee made this modification by exercising a POA, and such exercises haven’t been held to affect GST status unless it’s a taxable transfer.
• District court rules on summary judgment for IRS that grantor retained annuity trust (GRAT) is includible in estate—In Judith Badgley v. U.S. (4:17-cv-00877 (Cal. N.D.)), the court ruled on summary judgment motions relating to a GRAT established by Patricia Yoder. Judith Badgley, as executor of Patricia’s estate, had filed an estate tax return paying estate taxes of over $11 million. The estate tax return included the full value of the assets held in a GRAT established by Patricia. Later, Judith filed for a refund of nearly $4 million, alleging that the tax was overpaid and that the full value of the GRAT shouldn’t have been included.
Patricia established the GRAT on Feb. 1, 1998. She funded it with an interest in a partnership that held several multi-tenant parcels of California real estate. The GRAT provided for annuity payments each year of 12.5 percent of the value of her initial gift to the GRAT, for the lesser of 15 years or her prior death. When the GRAT terminated, the partnership interest was to pass to Patricia’s two living daughters. However, if Patricia failed to survive the term, the GRAT provided that the remaining annuity amounts due, plus any property includible in Patricia’s estate, should be paid to the trustee of her revocable trust.
The annuity payments were made and, as early as 2002, the income generated by the partnership interest/rental properties was sufficient to fully fund the annuity payments. However, Patricia died in 2012, prior to the 15-year term.
The estate argued that IRC Section 2036 shouldn’t include the value of the GRAT assets because Patricia retained an annuity interest, not an income interest. Section 2036(a)(1) provides, in part, that the gross estate of a decedent includes the value of all property transferred by the decedent (other than by a bona fide sale for full and adequate consideration) under which he’s retained for his life or for any other period that doesn’t in fact end before his death, the possession or enjoyment or the right to the income from the property.
Treas. Regs. Section 26.2036-1(c)(2)(i) further provides that a retained annuity interest constitutes a right to income from the property for purposes of Section 2036.
Patricia retained the right to an annuity payment, rather than income, and the estate first argued that Section 2036 shouldn’t apply because the statute itself doesn’t refer to an annuity interest, only an income interest. However, the court agreed with the government that the annuity is an interest justifying inclusion under Section 2036 because it would be unreasonable otherwise. The court looked to several cases and prior statutes that interpreted Section 2036’s “right to income” rule broadly and noted that holding otherwise would encourage unworkable situations in which the IRC could be circumvented merely because of a superficial difference in the language defining the retained interest or by structuring the funding source of the annuity differently. Relying on the substance-over-form doctrine, the court held that the annuity was a retained right to income. It also held that Patricia had an “implied right to income” because although the annuity wasn’t required to be paid from income, the income generated by the rental properties held by the GRAT (through the partnership) was sufficient and did, in fact, fund the annuity.
Further, the court upheld the Treasury regulation as a permissible interpretation of Section 2036. The estate argued that the formula used to calculate the value of the property includible in the estate resulted in a capriciously large amount subject to tax. This is because the formula assumes that the annuity is paid fully from income, rather than potentially from principal. The formula calculates the amount of property needed, given the interest rate applicable at the time of death, to fund the annuity. Because the interest rate was low at Patricia’s death, the property needed to generate the total annuity amount was much greater than the amount actually held in the GRAT. However, the court didn’t agree, finding the IRS basis for the formula to be persuasive and well-reasoned.
