Keeping Administrative Powers Without Adverse Transfer Tax Consequences

By Alan S. Acker, Esq.  

Carlile, Patchen & Murphy, Columbus, OH

Perhaps it is human nature for persons to want to control to some extent the enjoyment, use, and management of property transferred to an irrevocable trust. This nature is in conflict with our tax laws which provide that if too much control is retained, then the trust property will be included in the transferor's gross estate and this conflict is constantly being navigated by practitioners.  However, not all forms of control will lead to estate tax inclusion.

One type of control is the direct ability to determine who will receive or benefit from the property transferred and when such receipt or benefit will occur. This type of control often will result in estate tax inclusion because it relates directly to the economic benefits of the enjoyment of the trust property.  However, where such control is limited to ascertainable standards, then estate inclusion can be avoided. Section 2041 describes ascertainable standards as relating to support, maintenance, health, and education.  Determining whether particular trust language falls within an ascertainable standard can be more art than science and many courts have had to interpret many trust provisions for this exact issue. Therefore, precision in drafting is a virtue and understanding the boundaries of ascertainable standards is critical. Some states have laws that pertain to trust distribution standards for, and the state law that will govern the trust should be taken into account even though the ascertainable standard is a concept of the federal tax law.

Another type of control is the ability to control or have a say in the administration or management of the trust property.  As far back as 1929, the Supreme Court has held that this type of control is not considered to relate to the economic benefits of the trust property. One ought not be surprised that the line between mere administrative or managerial control and control affecting economic benefits can be blurry. And, yet, the practitioner often must navigate this dividing line to accomplish client goals.

Sometimes control is indirect, and, thus, may be overlooked, as when the settlor or beneficiary can remove the trustee and replace him with anybody, including the settlor or beneficiary.  Where such ability exists, the powers of the trustee will be attributable to the settlor or beneficiary.

The degree of control retained by a donor who transfers property in trust can affect not only whether a gift is complete, but also whether a completed gift will be entitled to the gift tax annual exclusion. If the administrative or other powers granted to the trustee or kept by the settlor render the value of the gift unascertainable at the time the gift is made, then no annual exclusion will be available. For example, the IRS ruled in Rev. Rul. 69-344 that a trust intended to own life insurance policies will not be entitled to the annual exclusion absent Crummey withdrawal powers. And this was so notwithstanding language mandating the distribution of all income.

The practitioner who can navigate these turbulent waters brings added value to his counsel.

 For more information, in the Tax Management Portfolios, see Acker, 820 T.M., Administrative Powers, and in Tax Practice Series, see ¶6200, Pre-death Transfers — Sections 2035, 2036, 2037 and 2038, and ¶6230, Powers of Appointment — Section 2041.