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Trust Settlement Doesn’t Create Gift or GST Tax Issues

Issue involved whether adopted individuals qualified as descendants.

In Private Letter Ruling 202343005 (Oct. 27, 2023), a family sought confirmation that its settlement agreement regarding several family trusts wouldn’t cause adverse generation-skipping transfer (GST) or gift tax consequences.

A married couple created a series of testamentary trusts for their children under their wills. The trusts became irrevocable before Sept. 25, 1985 and, as a result, were grandfathered for GST tax purposes. Over the years, after one child died without children and pursuant to state court orders, the trusts for the children divided into further trusts for grandchildren.

The trust company serving as trustee of each of the trusts filed a petition with the state court to construe the definition of the term “children” and “descendants” because two of the eight grandchildren had adopted individuals who were older than 18. The issue at hand was whether those adopted individuals qualified as descendants of the original settlors and beneficiaries of the trust. A state law answered this question, but the law was enacted after the date of the settlors’ deaths, so it wasn’t clear if it was applicable to the trusts established under the settlors’ wills.

After years of litigation, the family members and trustee entered into a settlement agreement that the state court approved. The agreement provided that certain cash payments would be made to the adopted individuals and to separate trusts for their benefit.

The Internal Revenue Service ruled that the lengthy litigation clearly showed that the parties had adverse interests, the issue was bona fide and the settlement agreement was the product of an arm’s length negotiation. Further, the settlement was within the range of reasonable outcomes under the wills and state law. As a result, the various distributions and trust severances under the settlement didn’t interfere or affect the GST tax status of any of the trusts. In addition, none of the family members were treated as making taxable gifts.


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