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What Constitutes Completed Gifts?

Grantor’s contribution of property to trust and committee’s distribution to beneficiaries are both incomplete for federal tax purposes

In Private Letter Ruling 201650005 (released Dec. 9, 2016), a grantor requested several rulings from the Internal Revenue Service regarding distributions from an irrevocable trust. While the IRS deferred ruling on whether the grantor was the “owner” of a trust, the IRS did rule that certain property contributed to the trust by the grantor wasn’t a completed gift, and distributions by the distribution committee members were likewise incomplete.

Terms of the Irrevocable Trust

A grantor created an irrevocable non-grantor trust for his benefit, as well as for the benefit of his spouse, mother and his issue. The grantor had two children who were minors. There was also a distribution committee, consisting of the grantor, his mother, guardians of each of the minor children and potential “eligible individuals.” Should a vacancy on the distribution committee arise, the trust provided for certain steps to be taken to fill the vacancy.

Under the terms of the trust, gifts to the trust weren’t completed gifts, and trust assets were to be included in the grantor’s gross estate. During the grantor’s lifetime, the sole trustee was to distribute net income and principal to the beneficiaries as directed by a distribution committee and/or the grantor. The trust specified the manner in which the trustee was to make distributions, including making distributions at the direction of the distribution committee, with the grantor’s written consent. Net income not distributed was to be accumulated and added to the principal.

When the grantor died, the trust was to terminate, with the balance distributed to persons, corporations or entities as the grantor may appoint by a living trust or will (a testamentary power). In default of this power to appoint, the balance was to be distributed per stirpes to the grantor’s then-living descendants. If there were no living descendants, the balance was to be distributed to charity. The distribution committee would terminate on the grantor’s death or on the date the committee was reduced to one eligible member other than the grantor—whichever occurred first.

Is the Grantor the “Owner?”
The grantor asked the IRS about which portions of income, deductions and credits should be part of this taxable income while the distribution committee was serving. Internal Revenue Code Sections 671-678 describe when a grantor of a trust will be treated as its owner, including if there’s administrative control exercisable primarily by a grantor rather than by a beneficiary (IRC Section 675). The IRS concluded that there were no circumstances that would cause the grantor to be treated as the owner of the trust as long as the distribution committee remained in existence, and the trust remained a U.S. person. The IRS also concluded that there was an issue of fact regarding whether there were circumstances that existed that would cause administrative controls to be considered exercisable primarily for the grantor’s benefit under Section 675. These factual issues could only be determined after the IRS examined the parties’ federal income tax returns; thus, the IRS deferred issuing a ruling on this issue until such examination occurred.

Grantor’s Consent Power

The grantor requested two rulings regarding completed gifts, and the IRS ruled that in both instances, the gifts weren’t complete for federal gift tax purposes.

Under IRC Section 2511(a), a gift tax applies whether a transfer is made in trust or not; whether a gift is direct or indirect; and whether property is real, personal, tangible or intangible. When a donor parts with dominion and control of a gift so as to leave him no power to change its disposition, a gift is complete (Treasury Regulations Section 25.2511-2(b). But, if a donor retains any power over the disposition of property, depending on the facts of the transfer, a gift may be wholly incomplete or may be partially complete and partially incomplete. Thus, “in every case of a transfer of property subject to a reserved power, the terms of the power must be examined and its scope determined,” stated the IRS.

Under Treas. Regs. Section 25.2511-2(b), a transfer is incomplete when a donor transfers property to another in trust to pay income to himself or accumulate it, and the donor retains a testamentary power to appoint the remainder among his descendants. The Treasury regulations state, however, that if the donor doesn’t retain a testamentary power of appointment (POA) and instead provides that the remainder should go to his heirs or someone else, the transfer is a completed gift.

In the instant case, the grantor retained consent power over the trust’s income and principal. Under Treas. Regs. Section 25.2511-2(e), this power wasn’t adverse to anyone’s interest, including the members of the distribution committee; the distribution committee members weren’t thus “takers in default.” Rather, they were co-holders of the power, and under Treas. Regs. Section 25.2514-3(b)(2), a co-holder only has an adverse interest when he may possess the power after the possessor’s death and may exercise it at that time in favor of himself, his estate, his creditors, or the creditors of his estate. Here, the distribution committee ended on the grantor’s death. Thus, the distribution committee members didn’t have interests adverse to grantor. As such, the grantor is considered to possess the power to distribute income and principal to any beneficiary because he retained the consent power. Therefore, the gifts were incomplete.

Grantor’s Sole Power/Testamentary Power

If a grantor has a reserved power to name new beneficiaries or change the beneficiaries’ interests, a gift is incomplete under Treas. Regs. Section 25.2511-2(c). In this instance, the grantor had a sole power over the trust principal, which gave him the power to change the beneficiaries’ interests. Although the power was limited by an ascertainable standard (health, education, maintenance and support), the grantor’s power wasn’t a fiduciary one. Thus, the retention of the grantor’s sole power caused the transfer of property to the trust to be wholly incomplete for federal gift tax purposes.

The grantor also retained a testamentary power to appoint the property in trust to persons other than to his creditors, estate or creditors of his estate. A retention of a testamentary power to appoint a trust remainder is a retention of dominion and control over the remainder, according to Treas. Regs. Section 25.2514-3(b)(2). Thus, retaining this power caused the transfer of property to the trust to be incomplete as it related to the remainder in trust for federal tax purposes.

Distribution Committee Power

The members of the distribution committee had unanimous member power over income and principal. However, that power wasn’t a condition precedent to the grantor’s powers; the grantor retained dominion and control over the income and principal until the distribution committee exercised its unanimous member power. Thus, the IRS found that this unanimous member power didn’t cause the transfer of property to be complete with respect to income interest for federal gift tax purposes.

The IRS also concluded that the grantor’s contribution of property to the trust wasn’t a completed gift subject to federal gift tax. Distributions from the trust to the grantor is simply a return of the grantor’s property; thus, any distribution of property by the distribution committee from the trust to the grantor won’t be a completed gift subject to federal gift tax, by any member of the distribution committee. At the grantor's death, the fair market value of the property in the trust would be includible in the grantor's gross estate for federal estate tax purposes.

POA

The IRS next examined the powers held by the distribution committee to ascertain whether any distribution of property by the committee to any trust beneficiary, other than grantor, could be a completed gift by a committee member subject to federal gift tax. The distribution committee members’ powers were exercisable only in conjunction with the grantor. Therefore, under IRC Sections 2514(b) (exercise or release of a general POA created after Oct. 21, 1942 will be deemed a transfer of property by the individual possessing such power) and 2041(a)(2) (value of gross estate shall include value of any property with respect to which the decedent has at the time of death a general POA created after Oct. 21, 1942, or with respect to which the decedent has at any time exercised or released such a power by a disposition which is of such nature that if it were a transfer of property owned by the decedent, such property would be includible in his gross estate), the distribution committee didn’t possess a general POA by virtue of this power. Similarly, the unanimous member power wasn’t a general POA under Sections 2514(b) and 2041(a)(2). Accordingly, any distribution made from the trust to a beneficiary (other than the grantor), pursuant to the exercise of these powers aren’t gifts by the distribution committee members. Rather, they’re gifts by the grantor.

Therefore, any property distribution by the distribution committee from the trust to any beneficiary (except the grantor) won’t be a completed gift subject to federal gift tax, by any member of the committee. The powers held by the distribution committee aren’t general POAs; therefore, no member of the committee should include on his death the value of any property held in the trust.

Bottom Line

The IRS thus ruled that the grantor’s contribution of property to the trust wasn’t a completed gift subject to federal tax. Similarly, the distribution committee’s distribution of trust property to the grantor wasn’t a completed gift, subject to federal gift tax, by any member of the distribution committee. Finally, any distribution of trust property by the distribution committee to any trust beneficiary, other than grantor, wasn’t a completed gift subject to federal gift tax, by any member of the distribution committee, other than the grantor.

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