June 13, 2013
Authored by: Kathy Sherby and Stephanie Moll
When is a modification or reformation of an irrevocable trust given effect for Federal tax purposes? In each of two recent private letter rulings, the government addressed the impact of a reformation and of a modification on Federal taxation of the trusts in question. Last week, we reviewed PLR 201243001, which held in favor of the IRS. Here, we will look at a ruling favorable to the taxpayer.
The taxpayer in PLR 201243006, obtained a much happier result, primarily because the taxpayer trustee was carrying out the actual terms of the trust, and was not changing the beneficial interests or keeping the property in trust longer than under the original trust provisions.
In PLR 201243006, the trust in question had been created and funded prior to September 25, 1985 so as to be grandfathered for GST purposes. Under the terms of the trust, the trustees had absolute discretion to make distributions to a class of persons consisting of the issue of the donor’s grandchild and their respective spouses. Such distribution could be on a pro rata or non-pro rata basis. The trustees had the further discretion to divide the trust or to terminate the trust, and on termination, could determine how to distribute the trust property among the beneficiaries.
The trustees proposed to divide the trust into 4 separate trusts, one trust for each great-grandchild’s family line, held under the same provisions and subject to the same trustee discretions applicable to the single trust prior to the division, except that each new divided trust would only be for a single great-grandchild’s family line. Although the trustees had the absolute discretion under the trust instrument to divide the trust, one of the trustees petitioned the court for approval of the division. The court entered its order approving the division, contingent on the trustees obtaining a favorable ruling.
The trustees requested a ruling that each new divided trust would continue to be GST exempt, the division would not cause inclusion in the estate of any beneficiary, or result in a taxable gift or create any adverse income tax consequences. The PLR reviewed applicable state law and found that the proposed modification was consistent with applicable state law. After reviewing Example 5 in Regs. § 26.2601-1(b)(4)(i)(E), concerning the requirements for modification of a grandfathered trust without losing its GST exempt status, the Ruling concluded that the divided trusts would continue to be exempt from GST tax, and would not cause any adverse gift tax, estate tax or income tax consequences. Cumulatively, the divided trusts were the same as the single trust, the division would not result in a shift of any beneficial interest in the trusts to any beneficiary in a lower generation, and would not extend the time for vesting any beneficial interest beyond what was otherwise provided in the single trust.