The Tax Management Transfer Pricing Report ™ provides news and analysis on U.S. and international governments’ tax policies regarding intercompany transfer pricing.
By Deborah M. Beers, Esq.
Buchanan Ingersoll & Rooney, Washington, DC
In a series of identical rulings issued on July 25, 2014 (PLR 201430003 - PLR 201430007), the Internal Revenue Service once again ruled on the income and transfer tax consequences of so-called "incomplete gift non-grantor trusts." The trusts in the rulings were established for the benefit of "Grantor;" his issue; his children's issue; and four named individuals. "Trustee" is a trust company located in an unspecified "State." During Grantor's lifetime, the Trust beneficiaries are Grantor and four adult beneficiaries.
Trust provides that Trustee must make distributions of income and principal as directed by Distribution Committee, which must at all times consist of at least two adult beneficiaries in addition to Grantor, and/or Grantor, as follows:
Upon Grantor's death, the principal and all income of Trust shall be distributed as Grantor may appoint by will, to or for the benefit of anyone, other than Grantor's estate, Grantor's creditors, or the creditors of Grantor's estate. In default of appointment, the balance of the Trust will be divided in two parts. The first part will be distributed among the four named beneficiaries who survive Grantor, and the second part will be distributed to Grantor's living descendants, or, in the absence of descendants, to "Foundation."
The Distribution Committee shall in all events cease to exist on the death of Grantor.
Similar trusts, nicknamed "DING" ("Delaware Incomplete Gift Non-Grantor") trusts, have been approved in the past. See, e.g., PLR 200612002. See also PLR 201310002 - PLR 201310006, approving a series of Nevada Incomplete Gift Non-Grantor ("NING") trusts. One of the purposes of establishing such trusts (in addition to asset protection) as non-grantor trusts is to save state income taxes. The trust is established in a jurisdiction, such as Delaware, that does not impose a state fiduciary income tax and does not tax distributions to out-of-state beneficiaries. Further, neither the trust nor its beneficiaries would normally be subject to state income tax in the beneficiaries' state of domicile on either the income or distributions of an out-of-state non-grantor trust.
1. NonGrantor Trust
The IRS determined that the circumstances that would cause Grantor to be treated as the owner of any portion of Trust under §673 (reversionary interest), §674 (powers over income and corpus), §676 (power to revoke), or §677 (income payable for the benefit of the grantor or grantor's spouse) either did not exist, or were exercisable only with the consent of an adverse party.
The IRS also concluded that none of the circumstances that would cause administrative controls to be considered exercisable primarily for the benefit of Grantor under §675 (administrative powers) existed. However, since the existence of such powers is a question of "facts and circumstances," the ultimate determination on their existence will be deferred until audit.
Members of Distribution Committee. Further, because none of the other Distribution Committee members have a power exercisable solely by himself to vest Trust income or corpus in himself (i.e., - a general power of appointment), none should be treated as the owner of any portion of the Trust under §678(a).
2. No Completed Gift by Grantor
Reg. § 25.2511-2(b) provides that a gift is complete as to any property, or part thereof or interest therein, of which the donor has so parted with "dominion and control" as to leave in the donor no power to change its disposition, whether for the donor's own benefit or for the benefit of another.
Reg. §25.2511-2(b) also provides an example where the donor transfers property to another in trust to pay the income to the donor or accumulate it in the discretion of the trustee, and the donor retains a testamentary power to appoint the remainder among the donor's descendants. The regulation concludes that no portion of the transfer is a completed gift. In this PLR, the IRS concluded that both Grantor's Consent Power and Grantor's Sole Power make the gift incomplete with respect to Grantor.
Grantor's Consent Power. In this case, the Distribution Committee ceases to exist upon Grantor's death. Accordingly, its members do not have interests adverse to Grantor under Reg. §25.2514-3(b)(2) and for purposes of Reg. §25.2511-2(e). Therefore, Grantor is considered as possessing the power to distribute income and principal to any beneficiary himself because he retained the Grantor's Consent Power. "The retention of this power [apparently in and of itself] causes the transfer of property to Trust to be wholly incomplete for federal gift tax purposes."
Grantor's Sole Power.Grantor also retained the "Grantor's Sole Power" over the principal of Trust. Under Reg. §25.2511-2(c), a gift is incomplete if and to the extent that a reserved power gives the donor the power to name new beneficiaries or to change the interests of the beneficiaries. In this case, Grantor's Sole Power gives Grantor the power to change the interests of the beneficiaries. Accordingly, the retention of the Grantor's Sole Power also causes the transfer of property to Trust to be wholly incomplete for federal gift tax purposes.
Note: Because Delaware law neither permits the grantor of an "asset protection trust" to retain a lifetime power of appointment (which is what the Grantor's Consent Power and the Grantor's Sole Power amount to), or to be a member of the distribution committee that may make distributions to him or herself, it is unlikely that this trust, like the earlier "DING" trusts, was formed under Delaware law. SeeDel. Code, Title 12 §§3570(11)b.2. and 3570(8)d.
Effect of Retention of Grantor's Special Testamentary Power of Appointment.In the 2014 PLRs, Grantor retained "Grantor's Testamentary Power" to appoint the property in Trust to any person or persons or entity or entities, other than Grantor's estate, Grantor's creditors, or the creditors of Grantor's estate. Under Reg. §25.2511-2(b), the retention of a testamentary power to appoint the remainder of a trust is considered a retention of dominion and control over the remainder. Accordingly, the IRS ruled, the retention of this power "causes the transfer of property to Trust to be incomplete with respect to the remainder in Trust for federal gift tax purposes." (Emphasis supplied.)
This ruling is similar to that issued in PLR 201208026 on slightly different facts, in which the IRS ruled that a grantor's special testamentary power of appointment was not sufficient to make a gift incomplete with respect to the term interest in a trust where the grantor retained no other interest in or powers over the trust.
3. No completed Gifts by Distribution Committee
Because the contribution of property by Grantor to the Trust was incomplete, any distribution from Trust to Grantor is merely a return of Grantor's property. "Therefore, … any distribution of property by the Distribution Committee from Trust to Grantor will not be a completed gift subject to federal gift tax, by any member of the Distribution Committee. Further, "Grantor retains dominion and control over the income and principal of Trust until the Distribution Committee members exercise their Unanimous Member Power. Accordingly, this power does not cause the transfer of property to be complete for federal gift tax purposes"
4. No General Powers of Appointment Held By Distribution Committee
Under §2514(c), a "general power of appointment" is a power that is exercisable in favor of the individual possessing the power (possessor), the possessor's estate, the possessor's creditors, or the creditors of the individual's estate. Under §2514(c)(3)(A), in the case of a power of appointment created after October 21, 1942, if the power is exercisable by the possessor only in conjunction with the creator of the power, such power is not deemed a general power of appointment. In addition, as noted above, if the post-1942 power is not exercisable by the possessor except in conjunction with a person having a substantial interest in the property subject to the power, which is adverse to the exercise of the power in favor of the possessor, the power shall not be deemed a general power of appointment.
Under Reg. § 25.2514-3(b)(2), a co-holder of a power has no adverse interest merely because of his joint possession of the power nor merely because he is a permissible appointee under a power. However, a co-holder of a power is considered as having an adverse interest where he may possess the power after the possessor's death and may exercise it at that time in favor of himself, his estate, his creditors, or the creditors of his estate.
The powers held by the Distribution Committee members under the Grantor's Consent Power are powers that are exercisable only in conjunction with the creator, Grantor. Accordingly, under §2514(c)(3)(A), the Distribution Committee members do not possess general powers of appointment by virtue of possessing this power. Further, the powers held by the Distribution Committee members under the Unanimous Member Powers are not general powers of appointment, because the Distribution Committee members have substantial adverse interests in the property subject to this power.
"Accordingly, any distribution made from Trust to a beneficiary, other than Grantor, pursuant to the exercise of these powers, the Grantor's Consent Power and the Unanimous Member Powers, are not gifts by the Distribution Committee members. Instead, such distributions are gifts by Grantor."
The IRS also ruled (unsurprisingly) that the property of Trust will be includible in Grantor's estate.
PLR 201430003 - PLR 201430007 may be viewed as "comfort" rulings that should allow practitioners to proceed with the creation of these types of trusts in appropriate jurisdictions. Taxpayers still have to be concerned, however, about whether their states of domicile will follow the decisions of the "ING" states and not tax the income from the nongrantor trusts. For example, New York recently enacted new income and estate tax laws that will treat "ING" trusts created by New York residents in jurisdictions such as Delaware or Nevada as "grantor trusts" for state income tax purposes. This will result in the grantor paying New York state income tax on all income earned after January 1, 2014.1 Other states may enact similar laws in the future.
For more information, in the Tax Management Portfolios, see Danforth and Zaritsky, 819 T.M., Grantor Trusts: Income Taxation Under Subpart E, Lischer, 845 T.M., Gifts, and in Tax Practice Series, see ¶6320, Gift Taxation, ¶6110, Estates and Trusts — The Income Taxation System Applicable to Estates, Gifts And Trusts.
1 N.Y. Tax Law sections 612(b)(40) and 612(b)(41); Administrative Code of the City of New York sections 11-1712(b)(36) and 11-1712(b)(37)).
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