Trust reformation prevents a general power of appointment

Plain-English summary

A trust document mistakenly referred to a beneficiary's testamentary power as a general power of appointment and allowed broad distribution and termination powers. A state court reformed the trust to delete the word “general” and require an independent trustee to exercise the relevant discretion. The IRS found the reformation consistent with applicable state law and the settlors' original intent. It ruled that the beneficiary never possessed a general power of appointment under IRC § 2041 and did not release one under IRC § 2514.

Ruling snapshot

• Question: Did the reformed trust give the beneficiary, or cause the beneficiary to release, a general power of appointment?
• Outcome: Approved, no general power was possessed or released
• Key authorities: IRC §§ 2041 and 2514; Commissioner v. Estate of Bosch, 387 U.S. 456 (1967)

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201634015 Third Party Communication: None
Release Date: 8/19/2016 Date of Communication: Not Applicable
Index Number: 2041.00-00, 2514.00-00
Person To Contact:
------------------------------------ -------------------------, ID No. -----------------
------------------------- -----------------------------------------------------
----------------------------------- Telephone Number:
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Refer Reply To:
CC:PSI:B04
PLR-137978-15
Date:
May 17, 2016

Legend

Settlors = ------------------------------------------------------------------------
Trust = ---------------------------------------------
Taxpayer = --------------------------------
Date 1 = -------------------------
Court = -----------------------------------------------------------
Date 2 = --------------------------
Date 3 = ----------------------
Statute = -------------------------------------------------------------------

Dear --------------------:

This responds to the letter dated November 13, 2015, submitted on behalf of taxpayer,
in which rulings are requested concerning the federal gift and estate tax consequences
under §§ 2041 and 2514 of the Internal Revenue Code of a court order modifying a trust
agreement.

On Date 1, Settlors, husband and wife, executed an irrevocable trust (Trust) for the
primary benefit of their son, Taxpayer. Under the terms of Trust, the trustees may, in
their discretion, pay to or apply for the benefit of Taxpayer such amounts of income and
principal as the trustees deem necessary or desirable for the “support, maintenance,
health, education or other needs” of Taxpayer. Additionally, the trustees may terminate
Trust at any time the trustees determine that the continued administration of Trust is
uneconomical or impractical in view of the small value or extent of trust assets. If this
discretion is exercised, the remaining trust corpus is to be distributed to Taxpayer or
remainder beneficiaries then entitled to discretionary distributions.

Section 3, paragraph (b), of Trust provides that upon the beneficiary’s death, the
Trustees shall pay the entire remaining balance of this Trust to and among the
PLR-137978-15 2

beneficiary’s surviving spouse and surviving issue in such amounts and proportions and
upon such terms, conditions and trusts as the beneficiary, by a provision in his Last Will
and Testament expressly referring to this power of appointment, shall validly direct and
appoint.

Section 3, paragraph (c) of Trust provides in the event or to the extent that the
beneficiary fails to validly exercise the foregoing general testamentary power of
appointment, the trustees shall thereafter hold and administer this Trust for the benefit
of the beneficiary’s surviving children.

Under Section 7 of Trust, Taxpayer has the power, upon reaching age 40, to remove
and replace the trustees of Trust. Taxpayer has not reached age 40.

On Date 2, pursuant to Statute, Settlors petitioned Court for reformation of Trust
because of scrivener’s errors. In support of the petition, Settlors represented that
Section 3, paragraph (c) of Trust contains a reference to the Taxpayer’s “general”
testamentary power of appointment granted in Section 3, paragraph (b) of Trust.
Settlors further represented that such reference is incorrect because the power granted
to Taxpayer in Section 3, paragraph (b) of Trust is not a general power of appointment
as defined in § 2041(b)(1) of the Code, as it is not exercisable in favor of the Taxpayer,
his estate, his creditors or the creditors of his estate. Settlors contended that the terms
of Trust as originally drafted are contrary to the intent of the Settlors to create a trust for
Taxpayer and his issue without transfer tax upon Taxpayer’s death.

On Date 3, Court ordered that only an “independent trustee” (who is not Taxpayer or a
person who is a “related or subordinate party” defined in § 672(c)) may exercise
discretion to make distributions to Taxpayer or terminate Trust. Court further ordered
that the word “general” in Section 3, paragraph (c) be deleted, and that the reformation
be effective as of Date 1.

The following rulings have been requested:

1. As a result of the judicial reformation, Taxpayer never possessed and will not
   possess a general power of appointment with respect to Trust which would cause
   the assets to be includible in Taxpayer’s gross estate under § 2041 for federal
   tax purposes; and

2. As a result of the judicial reformation, Taxpayer will not be treated as having
   released a general power of appointment for federal gift and estate tax purposes
   under § 2514(b) or § 2041(a)(2).

Law and Analysis
PLR-137978-15 3

Under § 2041(a)(2), the value of the gross estate shall include the value of all property
to the extent of any property with respect to which the decedent has at the time of death
a general power of appointment created after October 21, 1942.

Section 2041(b)(1) defines “general power of appointment” as a power which is
exercisable in favor of the decedent, his estate, his creditors, or creditors of his estate.
However, under § 2042(b)(1)(A), 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, support, or maintenance of the decedent is not a general power
of appointment.

Under § 20.2041-1(c)(2) of the Estate Tax regulations, a power is limited by an
ascertainable standard if the extent of the holder's duty to exercise and not to exercise
the power is reasonably measurable in terms of his needs for health, education, or
support (or any combination of them). The words “support” and “maintenance” are
synonymous and their meaning is not limited to the bare necessities of life. A power to
use property for the comfort, welfare, or happiness of the holder of the power is not
limited by the requisite standard. In determining whether a power is limited by an
ascertainable standard, it is immaterial whether the beneficiary is required to exhaust
his other income before the power can be exercised.

Section 2501(a)(1) imposes a tax, for each calendar year, on the transfer of property by
gift by any individual, resident or nonresident. Section 2511 provides that the tax
imposed by § 2501 shall apply whether the transfer is in trust or otherwise, whether the
gift is direct or indirect, and whether the property is real or personal, tangible or
intangible.

Under § 2514(b), the exercise or release of a general power of appointment created
after October 21, 1942, is deemed the transfer of property by the individual possessing
such power. Under § 2514(c), the term “general power of appointment” is defined as a
power which is exercisable in favor of the individual possessing the power (“the
possessor”), his estate, his creditors, or creditors of his estate. However, under
§ 2514(c)(1), a power to consume, invade, or appropriate property for the benefit of the
possessor which is limited by an ascertainable standard relating to the health,
education, support, or maintenance of the possessor is not a general power of
appointment.

Under § 25.2514-1(c)(2) of the Gift Tax Regulations, a power is limited by an
ascertainable standard if the extent of the possessor's duty to exercise and not to
exercise the power is reasonably measurable in terms of his needs for health,
education, or support (or any combination of them). The words “support” and
“maintenance” are synonymous and their meaning is not limited to the bare necessities
of life. A power to use property for the comfort, welfare, or happiness of the holder of
the power is not limited by an ascertainable standard. In determining whether a power
PLR-137978-15 4

is limited by an ascertainable standard, it is immaterial whether the beneficiary is
required to exhaust his other income before the power can be exercised. Powers of
appointment limited by an ascertainable standard are defined in the same way under
§§ 2041 and 2514. Powers of appointment have the same meaning for purposes of
both the gift and estate tax. See Rev. Rul. 76-547, 1976-2 C.B. 302.

In Commissioner v. Estate of Bosch, 387 U.S. 456 (1967), the Court considered
whether a state trial court's characterization of property rights conclusively binds a
federal court or agency in a federal estate tax controversy. The Court concluded that
the decision of a state trial court as to an underlying issue of state law should not be
controlling when applied to a federal statute. Rather, the highest court of the state is the
best authority on the underlying substantive rule of state law to be applied in the federal
matter. If there is no decision by that court, then the federal authority must apply what it
finds to be state law after giving “proper regard” to the state trial court's determination
and to relevant rulings of other courts of the state. In this respect, the federal agency
may be said, in effect, to be sitting as a state court.

Generally, if, due to a mistake in drafting, the instrument does not contain the terms of
the trust that the settlor and the trustee intended, the settlor or other interested party
may maintain a suit in equity to have the instrument reformed so that it will contain the
terms that were actually agreed upon. Bogert & Bogert, The Law of Trusts and
Trustees, § 991 (revised 2d ed. 1983). Based on an analysis of the facts submitted and
the representations made, we conclude that the Court order modifying the instrument
based on scrivener's error is consistent with applicable state law, as it would be applied
by the highest court of the state. Accordingly, we rule as follows:

   1. As a result of the judicial reformation, Taxpayer never possessed and will not
      possess a general power of appointment with respect to the Trust which
      would cause the assets to be includible in Taxpayer’s gross estate under
      § 2041 for federal tax purposes; and

   2. As a result of the judicial reformation, Taxpayer will not be treated as having
      released a general power of appointment for federal gift and estate tax
      purposes under § 2514(b) or § 2041(a)(2).

The rulings contained in this letter are based upon information and representations
submitted by the taxpayer and accompanied by a penalty of perjury statement executed
by an appropriate party. While this office has not verified any of the material submitted
in support of the request for rulings, it is subject to verification on examination.

Except as specifically ruled herein, we express no opinion on the federal tax
consequences of the transaction under the cited provisions or under any other
provisions of the Code.
PLR-137978-15 5

This ruling is directed only to the taxpayer requesting it. Section 6110(k)(3) provides
that it may not be used or cited as precedent.

In accordance with the Power of Attorney on file with this office, a copy of this letter is
being sent to your authorized representative.

                                   Sincerely,


                                   Leslie Finlow
                                   Leslie H. Finlow
                                   Senior Technician Reviewer, Branch 4
                                   Office of the Associate Chief Counsel
                                   (Passthroughs & Special Industries)

Enclosure (2)
Copy for § 6610 purposes
Copy of this letter

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