• CLAT converts from non-grantor trust to grantor trust—In Private Letter Ruling 201730012 (May 1, 2017), a taxpayer established a charitable lead annuity trust (CLAT). The taxpayer sought to amend the CLAT under state law to allow the grantor’s sibling (who wasn’t a trustee) to have the power to substitute trust property under the meaning of Internal Revenue Code Section 675(4), which would convert the trust from a non-grantor trust to a grantor trust.
The grantor of the trust requested three rulings: (1) the conversion from a non-grantor trust to a grantor trust wasn’t a taxable transfer of property to grantor, (2) the conversion wasn’t an act of self-dealing under IRC Section 4941, and (3) the grantor would be entitled to an income tax charitable deduction in the year of conversion.
The Internal Revenue Service ruled that converting the trust from a non-grantor trust to a grantor trust wouldn’t be a transfer of property to the grantor under any income tax provision. It referred to Revenue Ruling 77-402, which dealt with the income tax consequence of relinquishing grantor trust status or other lapse of grantor trust status. This ruling wasn’t applicable here because the conversion was to grantor trust status, rather than from grantor trust status. While Rev. Rul. 85-13 related to a transaction that was in the right “direction” (the grantor who acquired trust property in exchange for a promissory note caused grantor trust status by “borrowing” the trust corpus), it didn’t conclude that the action was an income recognition event for the grantor. The IRS therefore held that because Rev. Rul. 85-13 didn’t treat conversion of a non-grantor trust to a grantor trust as an income tax realization event and there was a lack of authority imposing such consequences, conversion of the trust to a grantor trust wouldn’t be treated as a transfer of property to the grantor for income tax purposes.
On the self-dealing issue, the IRS noted that the self-dealing rules in Section 4941 apply to the CLAT as if the trust were a private foundation. The IRC defines “self-dealing” as any direct or indirect transfer to a disqualified person, including a substantial contributor, a manager or certain family members of those persons. The family members who are included as disqualified persons don’t include siblings. Therefore, because the power to substitute trust assets was given to the grantor’s sibling and the sibling wasn’t a disqualified person, holding or exercising such power wasn’t an act of self-dealing.
While the taxpayer received favorable rulings on the first two issues, he wasn’t so fortunate with the last. The IRS ruled that the grantor was unable to take an income tax deduction under IRC Section 170(a). Applying Section 170(a), the IRS reasoned that when the trust converts from a non-grantor trust to a grantor trust, the owner of a grantor trust can only claim a federal income tax deduction if there’s a property transfer to the grantor trust for income tax purposes, and because the conversion wasn’t a transfer of property for income tax purposes, no deduction was allowed.
• Incomplete non-grantor trust ruling—In PLR 201729009 (July 21, 2017), the grantor created a trust intended to be an incomplete non-grantor trust. These trusts are usually established to take advantage of favorable state income tax laws. Because the transfers to the trust aren’t completed gifts, there are no gift or estate tax consequences to funding the trust. However, the trust is designed to be taxed for income tax purposes as a non-grantor trust in its resident state, usually Delaware or Nevada, rather than being taxed to the grantor in his resident state.
In the PLR, an individual and a corporate trustee served together as trustees of the trust. There was also a distribution committee that was required to include at least two adults who were permissible beneficiaries. The grantor couldn’t be a member of the committee. Distributions were permitted to certain beneficiaries as directed by: (1) a majority of the distribution committee with the consent of the grantor, (2) the unanimous consent of the distribution committee, or (3) as directed by the grantor, but only for certain beneficiaries’ health, education, maintenance and support.
The taxpayer requested rulings that:
• the trust wouldn’t be treated as a grantor trust to the grantor for income tax purposes under IRC Section 671;
• the transfer of property to the trust was an incomplete gift by the grantor for gift tax purposes;
• distributions from the trust to beneficiaries (other than the grantor) at the direction of the distribution committee wouldn’t be taxable gifts by any member of the distribution committee;
• distributions made from the trust to beneficiaries (other than the grantor) at the direction of the distribution committee would be a completed gift by the grantor; and
• no member of the distribution committee would be deemed to have a general power of appointment (GPA) over the trust.
The IRS didn’t find that there were any circumstances that would cause grantor trust status, but it didn’t definitively conclude that the trust was a non-grantor trust. Instead, the PLR states that the operation of the trust will determine whether the grantor will be treated as the owner of any portion of the trust under IRC Section 675. It explained that this was “a question of fact, the determination of which must be deferred until the federal income tax returns…have been examined…”
Otherwise, the IRS ruled for the taxpayer on the remaining issues. It held that a contribution of property to the trust wouldn’t be a completed gift by the grantor to the trust. Distributions of trust property to a beneficiary by the distribution committee wouldn’t be a completed gift by any member of the distribution committee. However, a distribution of property to a beneficiary would be a completed gift by the grantor.
Lastly, no member of the distribution committee was deemed to have a GPA so no property of the trust would be includible in the estate of a distribution committee member.
Without a positive ruling from the IRS on the grantor trust issue at the federal level, it isn’t clear that the grantor is able to achieve the intended benefits of non-grantor trust status at the state level. If the taxpayer’s state defers to federal law regarding grantor trust status, without a ruling, the state could reach its own conclusion on whether the trust is a non-grantor trust. The uncertainty of this ruling leaves the success of the strategy in doubt for this taxpayer.