Private Letter Ruling 202152006 (released Dec. 30, 2021) is yet another PLR addressing a drafting error with tax implications substantial enough to warrant the cost and hassle of a judicial reformation and a PLR request.
In this particular PLR, over the course of a series of restatements of the decedent’s revocable trust, a restriction on the surviving spouse’s ability to remove and replace an acting trustee of the marital trusts was removed. Based on retroactive judicial modification of the decedent’s trust to incorporate the omitted Internal Revenue Code Section 672(c) safe harbor language in relation to the marital trusts, the Internal Revenue Service concluded that surviving spouse didn’t have a general power of appointment (GPOA) over the marital trusts and therefore upheld the reverse qualified terminable interest property (QTIP) election made on the decedent’s estate tax return.
The decedent died (as all good stories begin), leaving Spouse, a validly executed fourth restatement of his revocable trust (the Trust) and its drafter, Estate Planner.
In relevant part, the Trust provided for the establishment of a generation-skipping transfer tax (GST) exempt Marital Trust (the GST Marital Trust) and a GST non-exempt Marital Trust (the Non-GST Marital Trust) for Spouse. During Spouse’s lifetime, each Marital Trust provided for mandatory distributions of income to Spouse, as well as distributions of principal as deemed advisable by trustee for any reason.
The Trust named Spouse and Estate Planner as co-trustees. If Estate Planner was unable to act as trustee of a Marital Trust, Trust instructed Spouse to designate a successor to fill such vacancy. In contrast, a trustee vacancy for a trust established for a beneficiary under age 25 (a Youth Trust) was to be filled by designation by the beneficiary thereof, and the Trust required that such designee meet certain qualifications and be neither “related or subordinate to such beneficiary” as those terms are defined in IRC Section 672(c).
The Trust empowered Spouse to remove a trustee of the Marital Trust, with or without cause; and similarly empowered the beneficiary of a Youth Trust in relation to such Youth Trust.
In preparing Decedent’s estate tax return, Estate Planner recognized a conflict of interest, resigned and was replaced as co-trustee by Independent Trustee.
In reviewing the Trust for the impact of her resignation, Estate Planner noticed that the Trust omitted the requirement that a successor trustee appointed by Spouse to fill a trusteeship vacancy for a Marital Trust be neither related nor subordinate, as defined by Section 672(c), to Spouse.
Spouse and Independent Trustee, as co-trustees, petitioned the relevant probate court to retroactively modify the Trust as of the date of execution of the Fourth Restatement. Based on a probate court evidentiary hearing at which Estate Planner testified that she had committed scrivener’s errors with respect to her drafting of the Trust, the relevant State Supreme Court issued an order modifying the Trust as of the desired date to provide that a successor trustee appointed by a person with the power to remove the acting trustee shall not be related or subordinate to such person within the meaning of Section 672(c).
Elections on Estate Tax Return
On Decedent’s timely filed estate tax return, Executor made a QTIP election with respect to both Marital Trusts and allocated a portion of Decedent’s available GST exemption to the GST Marital Trust.
The co-trustees of the Trust requested rulings that: (1) under the Trust, as modified, Spouse had no GPOA over the Trust or the Marital Trusts created thereunder, and therefore; (2) executor made a valid reverse QTIP election with respect to the GST Marital Trust.
No GPOA Over Trust
IRC Section 2041(a)(2) provides, in relevant part, that the value of property over which a decedent holds a GPOA at death is includible in the decedent’s gross estate. Section 2041(b)(1)(a) explicitly provides that a power to appropriate property for the benefit of decedent that’s limited by an ascertainable standard isn’t a GPOA.
Treasury Regulations Section 20.2041-1(b)(1) provide that a decedent who has an unrestricted power to remove and replace a trustee, who in turn has the power to enlarge or shift beneficial interests, is treated as having a power of appointment.
Revenue Ruling 95-58 holds that a decedent empowered to remove and replace a trustee, but restricted in appointing a successor trustee to selecting a successor trustee who isn’t related or subordinate to the decedent within the meaning of Section 672(c) isn’t treated as possessing such trustee’s discretionary powers of distribution.
Under the terms of the modified Trust, a trustee of a Marital Trust may make principal distributions to Spouse as the trustee deemed advisable for any reason and may be removed and replaced by Spouse only with a successor who’s neither related nor subordinate to Spouse within the meaning of Section 672(c). The IRS therefore held that Spouse didn’t have a GPOA over either Marital Trust by virtue of the removal/replacement power.
Reverse QTIP Election Valid
Section 2056(a) provides that an interest in property passing to a surviving spouse is deducted from a decedent’s gross estate. Section 2056 further provides that “qualified terminable interest property,”namely property passing from a decedent, in which the surviving spouse has a “qualifying income interest for life” and to which an election under Section 206(b)(7)(A) applies (a QTIP election) is treated as passing to the surviving spouse. Under Section 2056(b)(7)(B)(ii),
a surviving spouse has a qualifying income interest for life when during such spouse’s life, the spouse is entitled to all of the income from the property and no person can appoint such property to anyone other than the surviving spouse.
In other words, property with a valid QTIP election is included in the surviving spouse’s gross estate, rather than the decedent’s gross estate, for estate tax purposes.
Section 2652(a)(3) provides, in relevant part, that with respect to property for which a QTIP election is made, the executor may elect to treat such property for GST tax purposes as if such QTIP election wasn’t made (a reverse QTIP election).9 In short, a reverse QTIP election may only be made when a valid QTIP election was made.
Based on the first ruling, holding that both Marital Trusts were eligible for QTIP elections because Spouse didn’t have a GPOA over either Marital Trust, the IRS held that the GST Marital Trust was eligible for a reverse QTIP election, which once made, was valid.
This PLR reads like a simple case of careless drafting on the part of Estate Planner with regards to Section 672(c) safe harbor language,and a reminder to all drafters to include such a restriction when giving a trustee unlimited distributionary discretion over a marital trust and a surviving spouse the ability to remove and replace such trustee.
However, a reader can’t help noting an additional omission, which likely stems from the drafting of the PLR itself (rather than from the terms of Trust). Based on the PLR’s description of the Trust: (1) principal distributions from each Marital Trust may be made “as the trustee deems advisable for any purpose,” and (2) Spouse and Estate Planner are named as co-trustees of each Marital Trust. Nowhere in the Trust description is Spouse, as co-trustee, prohibited from making principal distributions to herself as she “deems advisable for any purpose.”
I searched the PLR for such a restriction, as it seemed inconceivable that in the course of the probate court case, the state Supreme Court case and the subsequent PLR request, that the focus on the attribution of co-trustee’s unlimited discretion to Spouse would eclipse the seemingly more obvious issue of Spouse’s authority, as co-trustee, to make distributions to herself under an unlimited standard.
In an effort to confirm that the Trust did, in fact, prohibit Spouse from authorizing distributions to herself as she “deem[ed] advisable for any purpose,” I undertook the Sisyphean task of searching for the underlying state court cases in the hopes that a more thorough description of the Trust’s terms would be available. Unfortunately, while I believe I identified the state Supreme Court case (assuming PLR readers are permitted to posit publicly as to the identity of taxpayers… In re James D. Cook Revocable Trust, Case No. 2020-0102, Supreme Court of New Hampshire) reforming the Trust terms retroactively, I couldn’t find a copy of the underlying probate court cases that may have addressed my question.