Court-approved trust termination preserves GST exemption

Plain-English summary

A trust created before September 25, 1985, provided lifetime income to a daughter and then benefits and principal to a granddaughter. The adult granddaughter had severe medical needs, so a state court approved terminating the trust and dividing its assets between the daughter and the granddaughter according to the actuarial value of their interests. No additions had been made to the grandfathered trust. The IRS ruled that the termination neither shifted a beneficial interest to a lower-generation beneficiary nor extended the time for vesting beyond the original trust terms. The trust and its terminating distributions therefore remained exempt from generation-skipping transfer tax.

Ruling snapshot

• Question: Will a court-approved early termination cause a grandfathered trust or its final distributions to become subject to GST tax?
• Outcome: Approved. The termination preserves the trust's exemption from GST tax.
• Key authorities: IRC §§ 2601, 2611, 2651; Treas. Reg. § 26.2601-1(b)(4)(i)(D)

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201719008 Third Party Communication: None
Release Date: 5/12/2017 Date of Communication: Not Applicable
Index Number: 2601.00-00
Person To Contact:
------------------------------------- ---------------, ID No. -----------------
------------------------------------------- Telephone Number:
--------------------------- --------------------
Refer Reply To:
CC:PSI:04
RE: --------------------------------------------- PLR-125593-16
------------------------------------------------------------ Date:
----------------------------- February 1, 2017

Legend

Date 1 = --------------------------
Grantor = ----------------
Trust = ---------------------------------------------------------------------------------
Date 2 = --------------------------
Daughter = ----------------------------------------------------------------
Granddaughter = ------------------------------------------------------------
Sibling 1 = -------------
Sibling 2 = ---------------
State Court = --------------------------------------------------------------------------------

Date 3 = -------------------
Statute = --------------------------------------------------------
Date 4 = --------------------------

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

This letter responds to your authorized representative’s letter of July 10, 2016,
regarding the generation-skipping transfer (GST) tax consequences of a court-approved
termination of Trust.

FACTS

The facts and representations submitted are as follows.
PLR-125593-16 2

On Date 1, a date prior to September 25, 1985, Grantor created an irrevocable trust,
Trust. Trust was created for the primary benefit of Daughter, for her lifetime, and then
to Granddaughter.

Paragraph 1 of Trust provides that trustee shall distribute the net income to or for the
benefit of Daughter for her lifetime and, at her death, the trustee shall pay over so much
of the income as the trustee may determine, in the trustee’s sole discretion, to or for the
benefit of Granddaughter until Granddaughter attains age 30. At such time as
Granddaughter has attained age 30, but in no event prior to the death of Daughter,
trustee shall pay over all corpus and income to Granddaughter, if living, and, if not
living, to Granddaughter’s issue, per stirpes, or if Granddaughter has no issue, to
Granddaughter’s siblings, per stirpes.

Grantor died on Date 2, survived by Daughter, Granddaughter, and two siblings of
Granddaughter, Sibling 1 and Sibling 2.

Currently, Granddaughter is under a conservatorship due to severe medical issues
which require constant attention and medical care. Granddaughter is an adult and over
the age of 30. Granddaughter has no children. To address the issue of
Granddaughter’s immediate medical needs, Daughter and Granddaughter’s conservator
petitioned State Court on Date 3 to terminate Trust and distribute the trust estate, as
permitted by Statute.

Under Statute, following the settlor's death, a noncharitable irrevocable trust may be
terminated upon consent of all of the qualified beneficiaries if the court concludes that
continuance of the trust is not necessary to achieve any material purpose of the trust.
Upon termination of a trust, the trustee shall distribute the trust property as agreed by
the qualified beneficiaries.

On Date 4, State Court issued an order terminating Trust. State Court determined that
Daughter and Granddaughter were the “qualified beneficiaries” of Trust under state law
and, as such, were the only parties necessary to consent to the termination of Trust.
State Court further determined that the material purpose of Trust would in fact be
fulfilled by terminating the trust. Under the order, the trust estate will be distributed to
Daughter and Granddaughter, via her conservator, in accordance with the actuarial
value of their respective interests in the trust estate, determined under § 7520 of the
Internal Revenue Code (Code). The termination and final distribution are contingent on
obtaining a favorable ruling from the Internal Revenue Service on the GST tax
consequences of the termination and distribution of Trust.

You request a ruling that the termination of Trust and distribution of the trust estate
pursuant to State Court’s Date 4 order will not cause Trust, or any distributions from
Trust, to become subject to GST tax under chapter 13 of the Code.
PLR-125593-16 3

LAW AND ANALYSIS

Section 2601 imposes a tax on every GST, which is defined under § 2611 as a taxable
distribution, a taxable termination, and a direct skip.

Under § 1433(a) of the Tax Reform Act of 1986 (Act) and § 26.2601-1(a) of the
Generation-Skipping Transfer 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) of the regulations, the tax does not
apply to a transfer under a trust that was 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).

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 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) provides that a modification of the governing instrument of
an exempt trust (including a trustee distribution, settlement, or construction that does
not satisfy § 26.2601-1(b)(4)(i)(A), (B), or (C)) 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 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. 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 or
the creation of a new GST.

In the present case, Trust was irrevocable on September 25, 1985, and it is represented
that no additions (constructive or actual) have been made to Trust.

Based upon the facts submitted and the representations made, we conclude that the
court-approved termination of Trust will neither cause a beneficial interest to be shifted
to a beneficiary who occupies a generation lower than the beneficiaries who held the
interests prior to the termination, nor extend the time for vesting of any beneficial
interest in Trust beyond the period provided for in the original Trust. Accordingly, we
PLR-125593-16 4

rule that the court-approved termination of Trust will not cause Trust, or any terminating
distributions from Trust, to become subject to GST tax under chapter 13 of the Code.

Except as expressly provided herein, no opinion is expressed or implied concerning the
tax consequences of any aspect of any transaction or item discussed or referenced in
this letter.

This ruling is directed only to the taxpayer requesting it. Section 6110(k)(3) of the Code
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.

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.

                                   Sincerely,


                                   Karlene M. Lesho
                                   Karlene M. Lesho
                                   Senior Technician Reviewer, Branch 4
                                   Office of the Associate Chief Counsel
                                   (Passthroughs & Special Industries)

Enclosures (2)
Copy of this letter
Copy for § 6110 purposes

cc: