Modifications to Successor Trustee Provisions and Distribution Standards Will Not Affect Grandfathered Status of GST-Exempt Trust

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Deborah M. Beers, Esq.

By Deborah M. Beers, Esq. Buchanan Ingersoll & Rooney PC Washington, D.C.

Overview

The generation-skipping transfer tax is applicable to generation skipping-transfers made after October 22, 1986. However, the GST tax does not apply to a transfer from a trust if the trust was irrevocable on September 25, 1985, and no actual or constructive additions were made to the trust after that date. Regulations issued pursuant to the authority of this “grandfather” rule provide rules for determining whether a modification, judicial construction, settlement agreement, or trustee action with respect to a trust that is exempt from the generation-skipping transfer tax will not cause the trust to lose its exempt status. Under these regulations, a modification will not cause an exempt trust to be subject to the provisions of the GST if the modification does not shift a beneficial interest in the trust to any beneficiary who occupies a lower generation than the person or persons who held the beneficial interest prior to the modification, and the modification does not extend the time for vesting of any beneficial interest in the trust beyond the period (usually the “rule against perpetuities” period) provided for in the original trust. These rules are illustrated in PLR 201634016 and PLR 201634017.

Facts

On a date that was prior to September 25, 1985, Trustor created Trust, an irrevocable inter vivos trust, for the benefit of Taxpayer and Taxpayer's issue. Trust named as initial trustees, A and B, who are unrelated to Taxpayer, and C, who is Taxpayer's mother. No additions, actual or constructive, have been made to Trust since September 25, 1985.

Successor Trustee Provisions. Trust provides, that, if any trustee fails or ceases to act, Trustor, or if Trustor is not then living, D, may appoint a successor trustee. If neither Trustor nor D is then living, Bank will become trustee. Thereafter, no successor trustee may be appointed to act in the place of the next individual trustee who fails or ceases to act. The remaining individual trustee may then appoint a trustee to act in his or her place and may also revoke that appointment. If there is no individual trustee able and willing to act, Bank may appoint an individual as a co-trustee. If at any time there is no trustee willing and able to act, one or more trustees may be appointed by or on behalf of the beneficiary or beneficiaries of at least two-thirds of the current Trust income.

Distribution Standards. Trust provides for discretionary distributions of the income and principal to Taxpayer and Taxpayer's issue during Taxpayer's life. Upon the death of Taxpayer, the trust estate will be distributed to the issue of Trustor's parents and/or the spouses of such issue, but if none of such issue is then living, to such one or more persons and corporations as Taxpayer may appoint by will; provided, however that no appointment may be made in favor of Taxpayer, Taxpayer's estate, the creditors of Taxpayer, or the creditors of Taxpayer's estate. Any portion of the trust estate not effectively appointed will be distributed to Taxpayer's issue, or if none of Taxpayer's issue is then living, to Trustor's issue, or if none of Trustor's issue is then living, to Taxpayer's heirs-at-law.

Any discretionary distribution to be made to or for the benefit of any beneficiary-trustee (including distributions to such beneficiary-trustee's spouse and distributions in discharge of any legal obligation of such beneficiary-trustee) must be made in the discretion of a non-beneficiary trustee. If no non-beneficiary trustee is then acting, such distribution cannot be made.

Trustee Resignations. Over a period of time, A, B and Bank either resigned or declined to serve as trustees or successor trustees. Trustor appointed Taxpayer as a successor co-trustee to serve with C. For so long as Taxpayer and C continue to serve, no additional co-trustee may be appointed to serve with them, and furthermore, no successor trustee can be appointed for or by Taxpayer or C. Only a corporate trustee may appoint a co-trustee in the event that no individual trustee is then serving and only a sole trustee may appoint one or more successor trustees with no provision for the appointment of a co-trustee. In addition, if any beneficiary of Trust (including Taxpayer) serves as a sole trustee of Trust, that beneficiary will be unable to make distributions to him or herself.

Court Modifications. Subsequently, Taxpayer, in his capacity as co-trustee of Trust, petitioned State court for an order approving modifications to the successor trustee and distribution provisions of Trust. These modifications were approved by State court, contingent upon receipt of a favorable ruling from the IRS. The successor trustee modifications provided that:

  •  Each of the current co-trustees may appoint a successor at any time and may revoke the appointment, with or without cause, at any time until the appointment becomes effective;
  •  Once a successor trustee's appointment becomes effective, the successor trustee may appoint his or her successor only if authorized to do so in the appointment made by his or her predecessor;
  •  The trustee or co-trustees may appoint as a co-trustee any person or entity, may remove that co-trustee, with or without cause and without appointing a successor, and may restrict the powers of that co-trustee; and
  •  Taxpayer may remove any trustee or co-trustee, provided Taxpayer simultaneously appoints another trustee, who must be an Independent Trustee, to succeed the removed trustee or co-trustee; and Taxpayer may transfer Taxpayer's removal and appointment power, as well as Taxpayer's power to transfer these powers, to any one or more of Trustor's issue.
The distribution modifications provided that:
  •  A beneficiary serving as a sole trustee may make discretionary distributions of trust income and principal, subject to a standard of health, education, maintenance and support, to or for the beneficiary's own benefit;
  •  Such distributions cannot be in discharge of any legal obligation of the beneficiary;
  •  No trustee can make a distribution in satisfaction of any legal obligation of such trustee (or in satisfaction of any legal obligation of a person who appointed the trustee); and
  •  A trustee or co-trustee appointed by a beneficiary cannot make distributions to the beneficiary appointing the trustee or co-trustee unless the distributions are subject to a standard of health, education, maintenance and support, or unless the trustee qualifies as an independent trustee. The term independent trustee means any trustee who is not Trustor, a descendant of Trustor, any beneficiary or possible distributee of Trust, any parent or spouse of any such person, or any related or subordinate party to any of such persons or entities, as such terms are used in §672(c).

 

Rulings

On the above facts, and applying Reg. §26.2601-1(b)(4)(i)(D), the IRS ruled as follows:

  • 1. The trustee succession modifications will not cause a beneficial interest in Trust to be shifted to a beneficiary who occupies a lower generation than the beneficiaries who held the interests prior to the modifications and will not extend the time for vesting of any beneficial interest in Trust beyond the period provided for in the original trust agreement. Accordingly, Trust will remain exempt from the GST tax under §2601.
  • 2. The distribution modifications will not cause a beneficial interest in Trust to be shifted to a beneficiary who occupies a lower generation than the beneficiaries who held the interests prior to the modifications and will not extend the time for vesting of any beneficial interest in Trust beyond the period provided for in the original trust agreement. Accordingly, Trust will remain exempt from the GST tax under §2601.

 

Additionally, the IRS ruled that the powers given to Taxpayer under the trustee succession modifications and the distribution modifications do not result in Taxpayer having a general power of appointment under §2041(b)(1) or §2514(c). Under §2041(b)(1)(A), the term “general power of appointment” means a power which is exercisable in favor of the decedent, his estate, his creditors, or the creditors of his estate; except that a power to consume, invade, or appropriate property for the benefit of the decedent which is limited by an ascertainable standard relating to the health, education, maintenance, or support of the decedent shall not be deemed a general power of appointment.

A power in a donee to remove or discharge a trustee and appoint himself may be a power of appointment. For example, if under the terms of a trust instrument, the trustee or his successor has the power to appoint the principal of the trust for the benefit of individuals including himself, and the decedent has the unrestricted power to remove or discharge the trustee at any time and appoint any other person including himself, the decedent is considered as having a power of appointment. However, in Rev. Rul. 95-58, the IRS ruled that a decedent/grantor's reservation of an unqualified power to remove a trustee and to appoint an individual or corporate successor trustee that is not “related or subordinate” to the decedent within the meaning of §672, is not considered a reservation of the trustee's discretionary powers of distribution over the property transferred by the decedent/grantor to the trust.

In the PLRs, the power of Taxpayer (if and when serving as trustee of Trust) to make distributions to, or for the benefit of, Taxpayer is limited by an ascertainable standard relating to the health, education, maintenance and support of Taxpayer. In addition, although Taxpayer may remove and replace a trustee or co-trustee, any trustee or co-trustee appointed by Taxpayer pursuant to the removal and replacement power cannot be related or subordinate to Taxpayer within the meaning of §672(c).

Comment

Many older trusts contain provisions that become problematic over time. Judicial and non-judicial modifications are important tools for correcting these problematic provisions. However, PLR 201634016 and PLR 201634017 serve as useful reminders of the advisability of obtaining a private letter ruling when making changes to a grandfathered GST trust. The potential to cause an inadvertent GST event is too great to risk an unapproved amendment.

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