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Proposed Modification of Trusts Won’t Change Tax Status

Proposed Modification of Trusts Won’t Change Tax Status

IRS ruling provides good news to settlor

In Private Letter Ruling 201417001 (released April 25, 2014), the Internal Revenue Service issued a ruling confirming a settlor’s participation in the modification of three irrevocable trusts pursuant to applicable state statute wouldn’t cause the value of the trusts to be included in the settlor’s gross estate for estate tax purpose nor would the settlor’s gifts to the trust to be incomplete for gift tax purposes.  In addition, the IRS found that the modification of the trusts wouldn’t cause the trusts to lose their generation-skipping transfer (GST) tax-exempt status.


Three Trusts Created

The settlor created three separate irrevocable trusts, each benefitting a grandchild.  The state law governing the administration of each trust authorized the modification or termination of an irrevocable trust without court approval if the settlor and all trust beneficiaries consented to the modification or termination.  In this case, the settlor and beneficiaries proposed to modify the trusts to change the successor trustees identified in two of the trusts and to modify the third trust to expand the trustee’s power to make discretionary distribution to the grandchild at any time and for any purpose.  


Possession of Transferred Property Not Retained

The first issue was whether the settlor’s participation in the proposed modification would cause the trust estate to be included in the settlor’s estate at his death under IRC Sections 2036 or 2038.  IRC Section 2036(a) provides the decedent’s gross estate will include the value of all property transferred by the decedent for less than full and adequate consideration when the decedent retained the possession or enjoyment of, or the right to income from, the transferred property, or retained the right, either alone or in conjunction with any other person, to designate the persons to benefit from the transferred property. 

IRC Section 2038 includes in the decedent’s gross estate the value of any property gratuitously transferred by the decedent when the enjoyment of the transferred property was subject at his death to any change through an exercise of a power by the decedent alone or in conjunction with any other person.  Treasury Regulations Section 20.2038-1(a)(2) further provides Section 2038 doesn’t apply if the decedent’s power could be exercised only with the consent of all parties having an interest in the transferred property and if the power adds nothing to the rights of the parties under local law.

The provisions contained in the trust agreements confirmed the settlor didn’t retain the possession or enjoyment of any property transferred to the trusts. In addition, the settlor’s right to alter, amend, revoke or terminate the trusts arose solely from the rights granted under the state statue and could only be exercised with the consent of respective beneficiaries of the trusts.  Accordingly, the settlor’s participation in the trust modification wouldn’t cause estate tax inclusion in the settlor’s estate under either Section 2036 or 2038.


No Incomplete Gift

The second issue was whether the settlor’s participation in the proposed modification would cause his initial gift to the trusts to be incomplete for gift tax purposes.  The IRS found the settlor parted with dominion and control of the property transferred.  As the trust modification was authorized under state statute requiring the consent of all beneficiaries, each of whom has a substantial interest in his trust, the IRS concluded the settlor’s gifts to the trust were complete when made.


Trusts Remain GST Tax Exempt

The final issue was whether the proposed modification would cause the trusts to lose their GST tax exempt status. In this case, the settlor allocated a sufficient amount of his GST tax exemption to the trusts on a timely filed gift tax return, resulting in each trust having an inclusion ratio for GST purposes of zero.  The IRS noted it has only issued guidance with respect to modification to grandfathered GST tax exempt trusts and has yet to issue guidance with respect to a trust wholly tax exempt from GST as a result of an affirmative allocation of a taxpayer’s GST tax exemption.  As the proposed modification wouldn’t have affected the GST status of the trusts if they were grandfathered GST trusts, the IRS ruled the proposed modification similarly wouldn’t affect the exempt status of the trusts in question.  Noting the proposed modifications were administrative in nature and didn’t shift the beneficial interest to a lower generation nor extended the vesting of any beneficial interest, the IRS concluded the trusts wouldn’t lose their tax exempt status for GST purposes.


Debra M. Doyle is a shareholder at Greenberg Traurig in Chicago.


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