By Deborah M. Beers, Esq.
Buchanan Ingersoll & Rooney PC, Washington, DC
In PLR 201245006, the IRS ruled that the basis of property held in a trust established by a deceased non-resident alien taxpayer will be stepped up to fair market value under §1014(a) on the taxpayer's death, despite the fact that the assets in the trust are not subject to U.S. estate tax, and that the taxpayer will be treated as the owner of the trust under §677(a) ("Income for Benefit of Grantor").
In Rev. Rul. 84-139,1 the IRS ruled that foreign real property inherited from a nonresident alien decedent not subject to the estate tax is treated as passing from a decedent, thus acquiring a basis equal to its fair market value at the date of the decedent's death. PLR 201245006, released on November 9, 2012, applies the holding of this ruling to publicly traded stock which may have been "property within the United States" within the meaning of §2104(a).
Taxpayer, a citizen and resident of Foreign Country ("Country"), proposed to transfer assets to Trust, an irrevocable trust subject to the laws of Country. Taxpayer and an unrelated party, were the Trustees. The assets of Trust included cash and stock in Company 1 and Company 2 that are publicly traded in Country and on the New York Stock Exchange. While the ruling does not recite that the stock was "stock in a domestic corporation" within the meaning of §2104(a), the fact that it was traded on the New York Stock Exchange indicates that it may well have been. Nonresident alien decedents are subject to U.S. estate tax on property within the United States, including stock of a domestic corporation.
Under the terms of Trust, Trustees are to pay all of the income of Trust to Taxpayer during his lifetime and may, in Trustees' absolute discretion, pay principal of Trust to Taxpayer. Upon the death of Taxpayer, in default of appointment, corpus and accumulated income will be held in further trust for the benefit of Taxpayer's issue. Trust further provides that during Taxpayer's lifetime no adverse party within the meaning of §672(a) is eligible to serve as Trustee.
On the above facts, the IRS issued two rulings:
1. Basis Step-up. Following the death of Taxpayer, the basis of the property held in Trust at Taxpayer's death will be the fair market value of the property at the date of Taxpayer's death under §1014(a). The IRS reasoned as follows:
Applying the foregoing, and taking into account Rev. Rul. 84-139, the IRS concluded that, because Taxpayer's beneficiaries will acquire, "by bequest, devise, or inheritance," assets from Trust at Taxpayer's death, such assets fall squarely within the description of "property acquired from a decedent" under §1014(b)(1). Therefore, Trust will receive a step-up in basis in Trust assets under §1014(a) determined by the fair market value of the property on the date of Taxpayer's death, without regard to whether it is includible in Taxpayer's estate as described in §1014(b)(9). This rule applies to property located outside the United States, as well as to property located inside the United States.
2. Grantor Trust Status. In its second ruling, the IRS began by taking note of the generally applicable rule that, under §677(a)(1), the grantor of a trust shall be treated as the owner of any portion of a trust whose income, without the approval or consent of any adverse party is, or in the discretion of the grantor or a nonadverse party, or both, may be distributed to the grantor or the grantor's spouse. Under the terms of Trust, the trustees (including grantor and a nonadverse party) are required to pay all Trust income to Taxpayer during his lifetime and the trustees are authorized to pay, in their absolute discretion, any amounts out of the capital of Trust to Taxpayer. Normally, this would be sufficient to make Trust a grantor trust with respect to Taxpayer.
Taxpayer, however, is a nonresident alien, and §672(f)(1) and Regs. §1.672(f)-1 provide that, as a general rule, the grantor trust rules apply only to the extent that their application results in an amount being taken into account in computing the income of a citizen or resident of the United States (or a domestic corporation). This rule does not apply, however, to any portion of a trust if the only amounts distributable from such portion during the lifetime of the grantor are amounts distributable to the grantor or the spouse of the grantor.2
Under the terms of Trust, the trustees are required to pay all Trust income to Taxpayer during his lifetime and the trustees are authorized to pay, in their absolute discretion, any amounts out of the capital of Trust to Taxpayer. In addition, the only distributions that Trust may make during the Taxpayer's lifetime are to Taxpayer. Thus, §672(f) will not prevent Taxpayer from being treated as the owner of Trust under §677(a).
While the rulings issued here may be unsurprising given the precedent of Rev. Rul. 84-139, the basis step-up ruling may have application in other contexts where the assets in question are not subject to estate tax. One such case that might arise is the potential application of the basis step-up rules to the situation in which a grantor of an intentionally defective grantor trust dies holding an intra-family note after having sold assets to the trust. Should the assets of the trust be stepped-up to fair market value in that situation in the absence of a taxable event?
This commentary also will appear in the January 2013 issue of the Tax Management Estates, Gifts and Trusts Journal. For more information, in the Tax Management Portfolios, see Streng, 800 T.M., Estate Planning, and in Tax Practice Series, see ¶6140, Gifts, Estates and Related Income Tax Basis Rules.
1 1984-2 C.B. 168.
2 §672(f)(2)(A)(ii); Regs. §1.672(f)-3(b)(1).