What kinds of powers can an individual have (or exercise) over trust property without causing that property to be included in the individual’s gross estate at death? A recent private letter ruling sheds some light on the answer.
A power of appointment (POA), generally, is the right to designate who will enjoy property. In the world of trusts, such power comes in many different forms. For example, trust beneficiaries with a right to demand property or designate additional or future beneficiaries are deemed to have a POA over the trust assets. Similarly, a power granted to a beneficiary to remove or discharge a trustee and appoint himself may be a POA.
POAs over trust property granted to an individual may be so great, in fact, that there appears to be no line separating the trust property from that of the individual’s own property.
It makes sense, then, that a beneficiary with nearly unlimited control over all the assets of a trust would have the entire value of the trust brought into his gross estate. Internal Revenue Code Section 2041(a)(2) includes in the gross estate of a decedent property over which the decedent had a general POA at the time of his death, provided such power was created after Oct. 21, 1942. But, as the additional provisions of that section detail, even the exercise of powers other than general POAs can cause a portion of the trust assets to be brought into the powerholder’s gross estate.
Trust Gives POA to Deceased Grantor’s Son
PLR 20212003 (released May 21, 2021) involves an ongoing trust exempt from generation-skipping transfer (GST) tax and created by a deceased grantor for the benefit of his son. During the son’s life, the trustee can make distributions of income and principal to or for the benefit of the grantor’s son and his descendants in the trustee’s discretion for their education, maintenance and support. Additionally, the trustee can, in its sole discretion, use as much of the income or principal as the trustee deems appropriate to purchase a home for the grantor’s son or to invest in a business enterprise for him. The trust agreement provides that the trust “shall terminate not later than 21 years after the death of the survivor of” the grantor, his wife and his son.
The trust agreement gives the grantor’s son the power to remove the trustee (provided he reached a specified age). Any successor trustee must be a national bank having trust powers and appointed by an appropriate state court. Additionally, the trust confers a POA to the grantor’s son, exercisable by his will, to appoint trust property to and among such persons and/or charitable organizations that he chooses; provided, however, such POA can’t be exercised in favor of the grantor’s son, his estate, his creditors or the creditors of his estate.
The grantor’s son proposes to exercise his power to appoint the property remaining in the trust on his death to separate trusts for his three children. Such separate trusts permit the three children to appoint the property to specified individuals other than the child for whom the trust was created, that child’s estate, that child’s creditors and the creditors of that child’s estate. Notwithstanding the foregoing, the separate trusts are required to terminate by the day preceding the expiration of 21 years after the date of death of the last survivor of the grantor’s son and other named individuals, all of whom were born (or were in gestation) prior to the date the original trust agreement was established.
Is Some Value Included in the Son’s Gross Estate?
On these facts, three powers seem to be subject to the most scrutiny in the PLR.
The power held by the son to exercise the POA in favor of other individuals or charities. As alluded to earlier, IRC Section 2041(a)(2) provides the value of a decedent’s gross estate includes the value of all property over which the decedent has a general POA at his death. The mere existence of the general power brings the value of the property into the decedent’s gross estate. The decedent needn’t exercise the power or even have notice of its existence to trigger taxation at death.
Section 2041(b)(1)(A) defines the term “general power of appointment,” as a power that’s exercisable in favor of the decedent, the decedent’s estate, the decedent’s creditors or the creditors of the decedent’s estate, except that a power to consume, invade or appropriate property for the benefit of the decedent, which is limited by an ascertainable standard relating to the health, education, support or maintenance of the decedent isn’t deemed a general POA. A POA isn’t a general POA, according to Treasury Regulation Section 20.2041-1(c)(1), if by its terms it’s either: (1) exercisable only in favor of one or more designated persons or classes other than the decedent, his creditors, his estate or the creditors of his estate, or (2) expressly not exercisable in favor of the decedent, his creditors, his estate or the creditors of his estate.
There’s no doubt the son’s ability to direct the beneficial interests of the original trust is a POA. Not only can he choose certain beneficiaries of the property, but also, he holds the power to direct how the beneficiaries receive and enjoy the property (that is, such property can be held in further trust as opposed to being distributed outright). However, such powers can’t be deemed a “general” POA as defined in Section 2041(a)(2) because the son can’t appoint the property to himself, his creditors, his estate or the creditors of his estate. Therefore, no portion of the property will be included in the son’s gross estate on his death pursuant to Section 2041(a)(2). This type of power is known as a “limited” or “special” POA.
The power held by the son to remove and replace trustees. Treas. Regs. Section 20.2041-1(b)(1) provides that a donee may have a POA if he has the power to remove or discharge a trustee and appoint himself. This section addresses the obvious concern that a beneficiary may remove and replace a trustee with himself and then, as beneficiary-trustee, appoint assets to himself.
While the trust gives the son a power to remove a trustee, it doesn’t authorize him to appoint a successor trustee. Rather, the trust requires an appropriate court to make the appointment. Based on this fact alone, the son can’t be said to have a POA pursuant to Section 2041(b).
The IRS went one step further and noted that even if the son desires to become a trustee, he’s disqualified from serving because the trust requires a national bank serve as successor trustee. The son, an individual having no powers over a national bank, can’t be said to have the power to distribute assets to himself.
The proposed exercise of the son’s POA to require the trust assets be held in further trust for son’s children. Section 2041(a)(3) includes in the gross estate the value of property to the extent a POA: (1) is exercised (either by will or a disposition which is of such nature that if it were a transfer of property owned by the decedent, the property would otherwise be includible in the decedent’s gross estate); and (2) creates a new POA that could be validly exercised to postpone the vesting of any estate or interest in such property or suspend the absolute ownership or power of alienation of such property, for a period ascertainable without regard to the date of the creation of the first power.
The son’s proposed exercise of the POA by will to hold the trust assets in further trust creates POAs in the successor trusts. However, the proposed successor trusts make clear that no assets may continue to be held in trust beyond the day preceding the expiration of 21 years after the death of a class of persons all of whom were lives in being, or in gestation, at the date the original trust was created. The proposed exercise of the son’s POA in this case doesn’t postpone or suspend the vesting, absolute ownership or power of alienation of any interest in the trust property beyond any life in being at the date of creation of the original trust plus a period of 21 years and a reasonable period of gestation. Therefore, the proposed exercise of the testamentary POA, should it be exercised, wouldn’t cause the property to be included in the son’s gross estate upon his death under Section 2041(a)(3).
GST Tax Implications
As mentioned earlier, the original trust assets evaluated in the ruling are exempt from GST tax. This is because the tax doesn’t apply to any GST under a trust that was irrevocable on Sept. 25, 1985, as is the case here. But this exemption from GST tax can be undone if certain conditions are met.
Pursuant to Treas. Regs. Section 26.2601-1(b)(1)(v)(A), if any property remains in a GST-exempt trust due to the release, exercise or lapse of a POA over that portion of the trust, and such release, exercise or lapse is treated to any extent as a taxable transfer under chapter 11 or chapter 12, the value of the entire portion of the trust subject to the power is treated as if that portion had been withdrawn and immediately retransferred to the trust at the time of the release, exercise or lapse. When there’s a release, exercise or lapse of a POA other than a general POA, Treasury Regs. Section 26.2601-1(b)(1)(v)(B) provides that such event isn’t treated as an addition to a trust if: (1) such POA was created in an irrevocable trust not subject to chapter 13 of the IRC under Treas. Regs. Section 26.2601-1(b)(1); and (2) such POA isn’t exercised in a manner that may postpone or suspend the vesting, absolute ownership or power of alienation of an interest in property for a period, measured from the date of creation of the trust, extending beyond any life in being at the date of creation of the trust plus a period of 21 years.
The potential of triggering GST tax, while critically important to analyze, doesn’t exist according to the proposed exercise of the son’s POA here. First, the son’s power to appoint trust property isn’t a general POA; therefore, it isn’t subject to tax under chapter 11 or chapter 12 of the IRC. The IRC, therefore, doesn’t treat the son as withdrawing the trust assets and immediately retransferring them to another trust. Further, the requirements of Treas. Regs. Section 26.2601-1(b)(1)(v)(B) were both met: (1) the irrevocable trust isn’t subject to chapter 13 of the IRC under Treas. Regs. Section 26.2601-1(b)(1); and (2) there’s no suspension in the vesting, absolute ownership or power of alienation of an interest in trust property beyond what the regulations dictate. Accordingly, the son’s proposed exercise of his testamentary POA doesn’t subject the property to the GST tax.
Based on the facts of the PLR, neither the power held by the son nor the proposed exercise of his POA causes any portion of the trust property to be includible in the son’s gross estate on his death. Also apparent from the ruling is that Section 2041 and the Treasury regulations thereunder present many pitfalls for practitioners. The intricacies can’t be disputed. Drafters must take great care to evaluate each and every power they or their clients desire to grant to any individuals who have a role in the ongoing administration of any trust. Individuals needn’t exercise the power, let alone have notice a power exists, for there to be tremendous estate tax consequences on the powerholder’s death.
Note: This article and the private letter ruling discussion contained herein exclusively examine powers of appointment created after Oct. 21, 1942. For powers of appointment created on or before Oct. 21, 1942, see IRC Section 2041(a)(1) and the Treasury Regulations thereunder.