Successor-trustee revisions preserve GST exemption

Plain-English summary

A separate trust created under a pre-1985 irrevocable trust instrument needed revised successor-trustee rules after the designated law firm dissolved. The settlement would require an independent trustee, permit the beneficiary son to remove a trustee only if the replacement was independent, and continue preventing family trustees from participating in discretionary distribution decisions. The IRS ruled that the son's restricted removal and replacement power was not a general power of appointment under sections 2041 or 2514. Because the changes were administrative, did not shift beneficial interests to a lower generation, and did not extend vesting, they would not create a constructive addition or end the trust's GST exemption. Distributions and terminations under the modified trust also would not become subject to GST tax.

Ruling snapshot

• Question: Do the proposed successor-trustee changes create a general power of appointment or disturb the trust's GST-exempt status?
• Outcome: approved; estate, gift, and GST treatment was preserved
• Key authorities: IRC §§ 2041, 2514, 2601; Treas. Reg. §§ 20.2041-1, 25.2514-1, 26.2601-1; Rev. Rul. 95-58

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201702017 Third Party Communication: None
Release Date: 1/13/2017 Date of Communication: Not Applicable
Index Number: 2601.03-01, 2041.03-00,
2514.00-00 Person To Contact:
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---------------------- Telephone Number:
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----------------------------------------- Refer Reply To:
------------------------------- CC:PSI:B04
PLR-115975-16
In Re: -------------------------------------- Date:
September 19, 2016

Legend

Settlor --------------------------
Spouse -------------------------
Son --------------------------
Trust A -------------------------------------------------------------------------------------
--------------------------------------------------------------------
Trust 1 -------------------------------------------------------------------------------------
-----------------------------------
Date 1 -----------------------
Date 2 ------------------------
Date 3 ------------------
Date 4 ---------------------
Date 5 ----------------
Date 6 ------------------
Individual 1 ---------------------
Individual 2 ----------------
Attorney 1 ------------------------
Attorney 2 ------------------
Law Firm ------------------------------------------------
State Statute 1 ---------------------------------------------------
State Statute 2 -----------------------------------------------
State Court -------------------------------------------------------------------------------------
--------------------------
x ---
PLR-115975-16 2

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

   This letter responds to your authorized representative’s letter dated

May 12, 2016, requesting gift, estate, and generation-skipping transfer (GST) tax rulings
with respect to the proposed modifications of a trust.

   The facts and representations submitted are summarized as follows:

   On Date 1, Settlor created Trust A. On Date 2, Trust A was amended and

restated, at which point it became irrevocable. Date 1 and Date 2 are prior to
September 25, 1985.

    Pursuant to Article III of Trust A, three separate trusts have been established with

identical terms, one for each of Settlor's three sons. One of those separate trusts,
Trust 1, was established for the benefit of Son. Article III provides that the trustees
(other than Settlor’s spouse (Spouse)) may distribute net income among the son and his
issue at the trustees' discretion. Any net income not distributed is to be accumulated
and added to principal. The trustees (other than Spouse) also have the discretion to
distribute principal for the son or his issue for their “health, maintenance, support and
education or to assist any of them in the purchase of a home or in a business or
profession.”

    If the son is living at the death of the survivor of Settlor and Spouse, the trustees

are directed to distribute to the son one-tenth of the principal of the trust when he
reaches thirty years of age and four-ninths when he reaches thirty-five years of age. If
at the death of the survivor of Settlor or Spouse the son has already attained these
ages, the trustees are at that time to make the required distributions to the son. The
balance of the trust will continue on the same terms for income and principal
distributions.

    Upon the death of the son, the balance of principal and any undistributed income

is to be distributed to the persons specified by the son in the exercise of a limited power
of appointment. If the power of appointment is not exercised, the balance of the trust is
to be distributed to the son's issue per stirpes.

    If the son is deceased at the death of the survivor of Settlor and Spouse, the

balance of the principal and undistributed income will be distributed to the son's issue
per stirpes. If the son and all his issue die, the entire balance of his trust shall be added
to the trusts for the other sons of Settlor.

   Article VI, Paragraph B, provides, in relevant part, that all real estate decisions

are to be made, during Settlor’s lifetime, by Spouse, while she is trustee. All other
decisions (including real estate decisions made after Settlor’s death or while Settlor is
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alive and Spouse is not serving as trustee) are to be made by a majority of trustees
entitled to act in any specific instance.

   Under Article X, Paragraph A, Settlor appoints Spouse and Attorney 1 as the

original trustees. Upon the death, resignation, or inability of Spouse to serve as trustee,
Settlor appoints Individual 1 as successor trustee and upon Individual 1’s death,
resignation, or inability to serve, the vacancy is to be filled by such individual or series of
individuals, other than Settlor, as the last to serve of Spouse and Individual may
designate in writing.

   Under Article X, Paragraph B, upon Settlor’s death, Spouse, Individual 1, and

Attorney 1 are to serve as co-trustees. Upon the death, resignation, or inability of either
Individual 1 or Spouse to serve as trustee, Individual 2 is appointed as trustee. As each
son attains the age of twenty-five, he will become a trustee of his trust.

   Article X, Paragraph C, provides that upon the death, resignation, or inability of

Attorney 1 to serve as co-trustee, the vacancy will be filled by a member of Law Firm
that Attorney 1 may designate in his will, but in the event that he fails to designate, or if
his designee dies, resigns or is unable to serve, said vacancy shall be filled, and shall
continue to be filled, by a member of Law Firm as shall be designated by that firm, from
time to time.

  Article X, Paragraph D, provides that as each trustee attains the age of x, he or

she shall resign and be succeeded in accordance with Paragraphs A, B, and C.

   Article X, Paragraph E, provides, in relevant part, that a son or other issue of

Settlor, who is serving as a trustee, is prohibited from participating in any decision
relating to discretionary distributions of income or principal.

   On Date 3, the three sons of Settlor signed a statement that acknowledges that

each individual trustee (other than a son of Settlor) shall have one vote with respect to
all business decisions to be made by the trustees. The sons of Settlor shall collectively
have one vote with respect to all business decisions to be made by the trustees. The
term “business decisions” is defined to mean any decision that pertains to or affects an
interest in a closely held investment, including any decision to acquire additional
interests in an existing closely held investment. On Date 4, State Court issued a decree
that appointed each son as a co-trustee of his separate trust. On Date 5, Attorney 2
was appointed as a co-trustee of each separate trust.

   Law Firm delivered a letter, dated Date 6, to Spouse stating that (i) Attorney 2

was serving as co-trustee with Attorney 1; (ii) Attorney 2 would serve as successor
trustee to Attorney 1 upon Attorney 1’s resignation; (iii) after the termination of service
as trustee by both Attorney 1 and Attorney 2, Law Firm would designate as successor
trustee a partner of Law Firm who is acceptable to Spouse, if she is living, or the sons of
PLR-115975-16 4

Spouse, if Spouse is not living; (iv) such procedure would be repeated each time a
partner of Law Firm terminated his service as trustee; (v) if such procedure to appoint a
successor trustee by Law Firm did not result in the appointment of a trustee who is
acceptable to Spouse, if she is living, or the sons of Spouse, if Spouse is not living, then
Law Firm would assist and cooperate with any court proceeding to appoint a trustee
who is not related or subordinate to any of the beneficiaries, within the meaning of
§ 672(c) of the Internal Revenue Code, to fill such vacancy.

   Attorney 1 and Spouse resigned as trustees when they reached the age of x.

Individual 1 was already more than x years old when Spouse resigned, so Individual 1
never served as trustee. Currently, Son and Attorney 2 are the only co-trustees of
Trust 1.

    State Statute 1 provides, in relevant part, that a noncharitable irrevocable trust

may be modified or terminated upon consent of the settlor and all beneficiaries even if
the modification or termination is inconsistent with a material purpose of the trust. A
settlor's power to consent to a trust's modification or termination may be exercised by a
guardian, an agent under the settlor's general power of attorney or an agent under the
settlor's limited power of attorney that specifically authorizes that action.

   State Statute 2 provides, in relevant part, that all beneficiaries and trustees of a

trust may enter into a binding nonjudicial settlement agreement with respect to any
matter involving the trust. A nonjudicial settlement agreement is valid only to the extent
it does not violate a material purpose of the trust and includes terms and conditions that
could be properly approved by the court under this chapter or other applicable law.

    Under the authority of State Statute 2, the beneficiaries, which include Son and

Son’s children, and trustees of Trust 1 propose to enter into a nonjudicial settlement
agreement to amend certain administrative provisions of Trust A. The settlement
agreement will provide for successor trustee provisions in light of the fact that Law Firm
dissolved. Under the settlement agreement, the Date 3 statement, Paragraph B of
Article VI, and Article X in its entirety are revoked. Each son of Settlor is to serve as co-
trustee of his separate trust with Attorney 2.

   The settlement agreement also provides that a new Article X is to be added to

Trust A. The new Article X provides, in relevant part, that at least one Independent
Trustee is to serve each separate trust. Each son is to have the right, at any time, to
remove any trustee, including an Independent Trustee, then serving his separate trust
and to appoint a substitute trustee who is an Independent Trustee. Each son may
appoint an individual or individuals to exercise such powers, known as an Appointment
Person, to appoint a new Independent Trustee, in the case of son’s death or disability.

  The settlement further provides that the individual trustees, by majority vote, may

appoint individuals to serve as additional trustees, provided that only Independent
PLR-115975-16 5

Trustees are eligible to elect additional trustees who are not Independent Trustees.
Each individual trustee may appoint one or more individuals to serve concurrently or
consecutively, as his or her successor. If at any time there is no Independent Trustee
serving, the vacancy in the position is to be filled by the son of Settlor, or if none, by a
majority of the income beneficiaries of such trust who are of age and able to give or
withhold consent. No son or other issue of Settlor, who may at any time be serving as
trustee, may participate in any decision relating to the discretionary distributions of
income or principal. An Independent Trustee is defined as a trustee who is not a related
or subordinate party, as defined in § 672(c) to Settlor, Spouse, or any of Settlor’s issue.

   You have requested the following rulings:

1. The proposed modifications to Trust 1 will not constitute the grant of a general
   power of appointment under §§ 2041 and 2514 and, thus, the assets of Trust 1
   will not be includible in Son’s gross estate at death and will not be deemed to
   be transferred by Son for gift tax purposes.

2. The proposed modifications to Trust 1 will not constitute a constructive
   addition to Trust 1 under § 2601 and will not affect the exempt status of Trust 1
   for GST tax purposes.

3. The proposed modifications to Trust 1 will not cause distributions from or the
   termination of any interest in Trust 1 to be subject to GST tax.

LAW AND ANALYSIS

Ruling 1

   Section 2041(a)(2) provides that 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 his death, a general power of appointment created after October 21,
1942, or with respect to which the decedent has at any time exercised or released a
power of appointment by a disposition that is of such nature that if it were a transfer of
property owned by the decedent the property would be includible in the decedent's
gross estate under §§ 2035 to 2038, inclusive.

   Section 2041(b)(1) provides that a general power of appointment is a power that

is exercisable in favor of the decedent, the decedent's estate, the decedent's creditors,
or the creditors of the decedent's estate. However, a power to consume, invade, or
appropriate property for the benefit of the decedent that is limited by an ascertainable
standard relating to the health, education, support, or maintenance of the decedent shall
not be deemed a general power of appointment.

   Section 20.2041-1(b)(1) of the Estate Tax Regulations provides, in part, that a

PLR-115975-16 6

donee may have a power of appointment if he has the power to remove or discharge a
trustee and appoint himself. For example, if under the terms of the 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, the mere power of
management, investment, custody of assets, or the power to allocate receipts and
disbursements as between income and principal, exercisable in a fiduciary capacity,
whereby the holder has no power to enlarge or shift any of the beneficial interests
therein except as an incidental consequence of the discharge of the fiduciary duties is
not a power of appointment.

   Section 2514(b) provides that the exercise or release of a general power of

appointment created after October 21, 1942, shall be deemed a transfer of property by
the individual possessing such power.

   Section 2514(c) provides that a general power of appointment is a power that is

exercisable in favor of the individual possessing the power (the possessor), his estate,
his creditors, or the creditors of his estate. However, a power to consume, invade, or
appropriate property for the benefit of the posessor that is limited by an ascertainable
standard relating to the health, education, support, or maintenance of the decedent shall
not be deemed a general power of appointment.

    Section 25.2514-1(b)(1) of the Gift Tax Regulations provides, in part, that a

donee may have a power of appointment if he has the power to remove or discharge a
trustee and appoint himself. For example, if under the terms of the instrument, the
trustee or his successor has the power to appoint the principal of the trust for the benefit
of individuals including himself, and A has the unrestricted power to remove or
discharge the trustee at any time and appoint any other person including himself, A is
considered as having a power of appointment. However, the mere power of
management, investment, custody of assets, or the power to allocate receipts and
disbursements as between income and principal, exercisable in a fiduciary capacity,
whereby the holder has no power to enlarge or shift any of the beneficial interests
therein except as an incidental consequence of the discharge of the fiduciary duties is
not a power of appointment.

  In Rev. Rul. 95-58, 1995-2 C.B. 191, the Service 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(c), is not considered a reservation of the trustee's discretionary
powers of distribution over the property transferred by the decedent/grantor to the trust.
Accordingly, the trust corpus is not included in the decedent's gross estate under
§ 2036 or 2038.
PLR-115975-16 7

    Section 672(c) defines the term "related or subordinate party" to mean any

nonadverse party who is (1) the grantor's spouse if living with the grantor; or (2) any one
of the following: the grantor's father, mother, issue, brother or sister; an employee of
the grantor; a corporation or any employee of a corporation in which the stock holdings
of the grantor and the trust are significant from the viewpoint of voting control; a
subordinate employee of a corporation in which the grantor is an executive.

    In this case, none of the proposed modifications affect the dispositive provisions

of Trust 1. At all times, both before and after the proposed modifications, no son or
other issue of Settlor, who may at any time be serving as trustee, may participate in any
decision relating to the discretionary distributions of income or principal. Under the
proposed modification, at all times there is to be an Independent Trustee of each
separate trust. A son of Settlor may remove a trustee and must replace that trustee
with an Independent Trustee. The son of Settlor may not participate in any way with the
selection of a non-Independent Trustee. Furthermore, in the case of the son’s death or
disability, only the Appointment Person may appoint an Independent Trustee. Son’s
power to remove and replace a trustee is equivalent to the power referenced in
Rev. Rul. 95-58 where a replacement trustee may not be related or subordinate to the
powerholder within the meaning of § 672(c). Accordingly, based on the facts submitted
and the representations made, we conclude that the proposed modifications to Trust 1
will not constitute the grant of a general power of appointment under §§ 2041 and 2514
and, thus, the assets of Trust 1 will not be includible in Son’s gross estate at death and
will not be deemed to be transferred by Son for gift tax purposes.

Rulings 2 and 3

    Section 2601 imposes a tax on every GST made after October 26, 1986. A GST

is defined under § 2611(a) as (1) a taxable distribution, (2) a taxable termination, and
(3) a direct skip.

    Section 2612(a) provides that the term “taxable termination” means a termination

(by death, lapse of time, release of a power, or otherwise) of an interest in property held
in a trust unless (A) immediately after such termination, a non-skip person has an
interest in such property, or (B) at no time after such termination may a distribution
(including distributions on termination) be made from such trust to a skip person.

    Section 2612(b) provides that the term “taxable distribution” means any

distribution from a trust to a skip person (other than a taxable termination or a direct
skip).

   Under § 1433(a) of the Tax Reform Act of 1986 (Act) and § 26.2601-1(a) of the

GST Tax Regulations, the GST tax is generally applicable to generation-skipping
transfers made after October 22, 1986. However, under § 1433(b)(2)(A) of the Act and
§ 26.2601-1(b)(1)(i), the GST tax does not apply to a transfer under a trust that was
PLR-115975-16 8

irrevocable on September 25, 1985, but only to the extent that such transfer is not made
out of corpus added to the trust after September 25, 1985 (or out of income attributable
to corpus so added). Under § 26.2601-1(b)(1)(ii), any trust in existence on September
25, 1985, will be considered irrevocable unless the settlor had a power that would have
caused inclusion of the trust in his or her gross estate under § 2038 or 2042, if the
settlor had died on September 25, 1985.

    Section 26.2601-1(b)(1)(iv) provides, in relevant part, that for purposes of

chapter 13, a constructive addition under § 26.2601-1(b)(1)(v) is treated as an addition
to a trust.

   Section 26.2601-1(b)(1)(v)(A) provides, in relevant part, that, except as provided

under § 26.2601-1(b)(1)(v)(B), where any portion of a trust remains in the trust after the
post September 25, 1985, release, exercise, or lapse of a power of appointment over
that portion of the trust, and the release, exercise, or lapse is treated to any extent as a
taxable transfer under chapter 11 or chapter 12, the value of the entire portion of the
trust subject to the power that was released, exercised, or lapsed is treated as if that
portion had been withdrawn and immediately retransferred to the trust at the time of the
release, exercise, or lapse.

   Section 26.2601-1(b)(1)(v)(B) provides, in relevant part, that the release,

exercise, or lapse of a power of appointment (other than a general power of
appointment as defined in § 2041(b)) will not be treated as an addition to a trust if the
power of appointment was created in an irrevocable trust that is not subject to
chapter 13 under § 26.2601-1(b)(1).

    Section 26.2601-1(b)(4)(i) provides rules for determining when a modification,

judicial construction, settlement agreement, or trustee action with respect to a trust that
is exempt from the GST tax under paragraph (b)(1), (2), or (3) of this section
(hereinafter referred to as an exempt trust) will not cause the trust to lose its exempt
status. In general, unless specifically provided otherwise, the rules contained in this
paragraph are applicable only for purposes of determining whether an exempt trust
retains its exempt status for GST tax purposes. Thus (unless specifically noted), the
rules do not apply in determining, for example, whether the transaction results in a gift
subject to gift tax, or may cause the trust to be included in the gross estate of a
beneficiary, or may result in the realization of gain for purposes of § 1001.

    Section 26.2601-1(b)(4)(i)(D)(1) provides that a modification of the governing

instrument of an exempt trust (including a trustee distribution, settlement, or
construction that does not satisfy paragraph (b)(4)(i)(A), (B), or (C) of this section) by
judicial reformation, or nonjudicial reformation that is valid under applicable state law,
will not cause an exempt trust to be subject to the provisions of chapter 13, if the
modification does not shift a beneficial interest in the trust to any beneficiary who
occupies a lower generation (as defined in § 2651) than the person or persons who held
PLR-115975-16 9

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 provided for in
the original trust.

    Section 26.2601-1(b)(4)(i)(D)(2) provides that for purposes of this section, a

modification of an exempt trust will result in a shift in beneficial interest to a lower
generation beneficiary if the modification can result in either an increase in the amount
of a GST transfer or the creation of a new GST transfer. To determine whether a
modification of an irrevocable trust will shift a beneficial interest in a trust to a
beneficiary who occupies a lower generation, the effect of the instrument on the date of
the modification is measured against the effect of the instrument in existence
immediately before the modification. If the effect of the modification cannot be
immediately determined, it is deemed to shift a beneficial interest in the trust to a
beneficiary who occupies a lower generation (as defined in § 2651) than the person or
persons who held the beneficial interest prior to the modification. A modification that is
administrative in nature that only indirectly increases the amount transferred (for
example, by lowering administrative costs or income taxes) will not be considered to
shift a beneficial interest in the trust.

   In § 26.2601-1(b)(4)(i)(E), Example 10 considers the following situation. In 1980,

Settlor established an irrevocable trust for the benefit of Settlor's issue, naming a bank
and five other individuals as trustees. In 2002, the appropriate local court approves a
modification of the trust that decreases the number of trustees which results in lower
administrative costs. The modification pertains to the administration of the trust and
does not shift a beneficial interest in the trust to any beneficiary who occupies a lower
generation (as defined in § 2651) than the person or persons who held the beneficial
interest prior to the modification. In addition, the modification does not extend the time
for vesting of any beneficial interest in the trust beyond the period provided for in the
original trust. Therefore, the trust will not be subject to the provisions of chapter 13.

    In this case, Trust 1 was created, funded, and became irrevocable prior to

September 25, 1985. It is represented that there have been no additions, actual or
constructive, since that date. Son’s rights under the proposed modification to remove
any Trustee and to appoint a successor to such Trustee, provided that any Trustee so
appointed shall be an Independent Trustee, should not be considered a constructive
addition to any trust because such rights do not constitute a general power of
appointment within the meaning of §§ 2041(b) and 2514(c). The changes are
administrative in nature under § 26.2601-1(b)(4)(i)(D)(2), and will not be considered to
shift a beneficial interest to a lower generation in the trust. See Example 10 of
§ 26.2601-1(b)(4)(i)(E). The changes will not result in a shift in any beneficial interest to
a lower generation nor do the changes extend the time for vesting of any beneficial
interest in Trust. Accordingly, based upon the facts submitted and the representations
made, we conclude that the proposed modifications to Trust 1 will not constitute a
constructive addition to Trust 1 under § 2601 and will not affect the exempt status of
PLR-115975-16 10

Trust 1 for GST tax purposes. We also conclude that the proposed modifications to
Trust 1 will not cause distributions from or the termination of any interest in Trust 1 to be
subject to GST tax.

  In accordance with the Power of Attorney on file with this office, we have sent a

copy of this letter to your authorized representatives.

   Except as expressly provided herein, we neither express nor imply any opinion

concerning the tax consequences of any aspect of any transaction or item discussed or
referenced in this letter.

  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.

  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.

                                       Sincerely,



                                       Lorraine E. Gardner
                                       Lorraine E. Gardner
                                       Senior Counsel, Branch 4
                                       Office of the Associate Chief Counsel
                                       (Passthroughs and Special Industries)



   Enclosures
         Copy for § 6110 purposes
         Copy of this letter