Court fix of a botched Crummey clause carries no estate, gift, or GST tax

Plain-English summary

A grandfather set up an irrevocable trust split into three shares, one for each grandchild, meant to keep the trust assets out of the grandchildren's taxable estates and to use up his and his wife's generation-skipping (GST) tax exemptions. The lawyer who drafted it made two mistakes in the withdrawal ("Crummey") clause: it let each grandchild pull out the entire yearly contribution instead of just the gift-tax annual exclusion amount, and it let that withdrawal right lapse each year without the usual "5-and-5" ($5,000-or-5%) safe harbor. Left uncorrected, those errors would have given each grandchild a general power of appointment, pulling the trust into their estates and treating each annual lapse as a taxable gift. A state court reformed the trust to fix the scrivener's error retroactively. The IRS ruled that after the reformation the grandchildren have no general power of appointment beyond the corrected annual-exclusion withdrawal right, the reformation itself is not a taxable exercise or release of a power, the lapses caused no gift, the trust assets stay out of the grandchildren's estates, and the couple substantially complied with the rules to allocate their GST exemption even though they mis-reported the gift on Form 709. Families who discover a drafting error in an old trust would care: a retroactive court reformation for a genuine scrivener's error can preserve the intended tax treatment.

Ruling snapshot

• Question: After a court reforms a trust to fix a defective Crummey withdrawal clause, do the grandchildren hold general powers of appointment, and did the couple validly allocate their GST exemption despite a Form 709 reporting error?
• Outcome: approved (all five rulings favorable to the taxpayer)
• Key authorities: IRC §§ 2041, 2514 (general powers of appointment and lapses); IRC § 2632 and § 2513 (GST exemption allocation, gift-splitting); 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: 201837006                                             Third Party Communication: None
Release Date: 9/14/2018                                       Date of Communication: Not Applicable
Index Number: 2036.00-00, 2038.00-00,
              2041.00-00, 2501.00-00,                         Person To Contact:
              2511.00-00, 2514.00-00                          [redacted]
                                                              Telephone Number:
[redacted]                        [redacted]
[redacted]                                              Refer Reply To:
[redacted]                    CC:PSI:B04
[redacted]              PLR-135731-17

                                                              Date:
                                                              May 24, 2018




         [redacted]




Legend

Settlor                             = [redacted]
Spouse                              = [redacted]
Son                                 = [redacted]
Grandchild 1                        = [redacted]
Grandchild 2                        = [redacted]
Grandchild 3                        = [redacted]
Attorney 1                          = [redacted]
Attorney 2                          = [redacted]
Trust                               = [redacted]
Date 1                              = [redacted]
Date 2                              = [redacted]
Year 1                              = [redacted]
Year 2                              =[redacted]
Court                               = [redacted]
                                    [redacted]
Court Order                         = [redacted]
[redacted]
State                               = [redacted]
State Statute 1                     = [redacted]
State Statute 2                     = [redacted]

Dear [redacted] [redacted]:

This letter responds to your authorized representative's letter dated November 27, 2017,
requesting rulings on the gift, estate and generation-skipping (GST) tax consequences of
the reformation of an irrevocable trust.

The facts and representations submitted are summarized as follows:

Settlor executed an irrevocable trust (Trust) on Date 1 for the benefit of Settlor's
grandchildren and their descendants. Trust was funded in Year 1 and Spouse made a
second gift to Trust in Year 2. No additional gifts have been made to Trust. Trust is
governed by the laws of State. The current beneficiaries of Trust are Grandchild 1,
Grandchild 2, and Grandchild 3.

Article SECOND provides that the trustee will divide the trust property into three equal
shares. Each share is to be named for one of Settlor's grandchildren. Each grandchild is
a beneficiary of an independent share of Trust.

Article THIRD paragraph (B) provides that the trustee may from time to time pay to or for
the benefit of such grandchild or his or her issue, such part of the net income and principal
as the trustee deems advisable and in their respective best interests; provided, however,
that in all but extraordinary emergency situations, distributions to the grandchild and his or
her issue shall be limited to their medical and educational needs. Any net income not so
paid may be added to principal.

Article THIRD paragraph (C) provides that upon the death of a grandchild, the trustee shall
distribute the remaining principal and all accrued and accumulated income to or for such
one or more appointees as the grandchild appoints by will (other than the grandchild, the
grandchild's estate, the grandchild's creditors or creditors of the grandchild's estate).

Article THIRD paragraph (D) provides that any property not appointed by a grandchild shall
be distributed to grandchild's then living issue by right of representation. Any distribution
to an issue of grandchild under the age of 30 will be held in further trust. If there are no
issue of grandchild the unappointed property shall be distributed to the Settlor's then living
issue, if none, too Settlor's son, Son, if living, otherwise to Settlor's issue by right of
representation.

Article THIRD paragraph (A) provides, generally, for withdrawal rights for the beneficiaries,
specifically, that during the calendar year, the grandchild may make withdrawals from any
additions to the principal of the share during such year. This right of withdrawal may be
exercised from time to time by written request signed by the grandchild (or, during any
period when the grandchild is legally incompetent, by his or her legal representative other
than Settlor or Spouse) and delivered to the Trustee. For the purpose of this paragraph,
any withdrawal right with respect to any addition extends to the property, if any, in which

such addition is invested. The trustee immediately shall notify the grandchild in writing as
to any addition, the existence of such right and the property to which it pertains.
Notwithstanding the foregoing, if any addition is added to the share after December 1st of
any given calendar year, the grandchild's withdrawal right with respect to such addition
shall lapse on the thirty-first day after his or her receipt of the notice from the trustee. This
withdrawal right is non-cumulative.

Attorney 1 drafted Trust. Settlor created and funded Trust in reliance on the advice of
Attorney 1. Based on affidavits of Spouse and Attorney 1, Settlor created Trust to provide
for his descendants of all generations, and to reduce the overall transfer taxes payable on
Trust assets by ensuring that the assets held in Trust would not be includible in the
grandchild's gross estate upon the grandchild's death, and to minimize the amount subject
GST tax by utilizing Settlor's and Spouse's GST exemption.

The withdrawal provision in Article THIRD paragraph (A) contains two drafting errors.
First, Trust grants each grandchild the right to withdraw the entire amount of any
contribution to that grandchild's separate share of the trust and fails to limit the withdrawal
right to the gift tax annual exclusion amount, causing the grandchild to possess general
powers of appointment (within the meaning of §§ 2514 and 2041) over the entire amount
of the contribution to that grandchild's separate share of Trust. Second, each grandchild's
withdrawal right over the assets contributed to Trust in any given year is non-cumulative
and lapses in its entirety on an annual basis. Since the lapse is not limited to the greater
of $5,000 or 5 percent of the value of the trust assets, any lapse of a grandchild's
withdrawal right would be treated as a taxable transfer by that grandchild under § 2514 to
the extent that the property that could have been withdrawn exceeds in value the greater
of $5,000 or 5 percent of the aggregate value of the assets subject to withdrawal.

Settlor and Spouse each timely filed a Year 1 Form 709, United States Gift (and
Generation-Skipping Transfer) Tax Return and elected to gift-split. Settlor and Spouse
incorrectly reported the Year 1 gift to Trust as an indirect skip. However, Settlor and
Spouse each allocated his or her GST exemption to Trust. Spouse timely filed a Form 709
for Year 2 and allocated her remaining GST exemption to Trust. No GST transfers have
been made from Trust.

The errors were discovered when Son retained a new attorney, Attorney 2, to represent
him in estate planning matters. Attorney 2 informed Son of the drafting errors that
defeated the intent of the Settlor in establishing Trust. Trustee filed a petition in State
Court requesting judicial reformation of the erroneous provision of Article THIRD,
paragraph (A), effective as of the date Trust was originally created. On Date 2, Court
allowed the petition and, in Court Order, reformed Trust to eliminate the scrivener's error
retroactive to the date of Trust's creation.

As reformed, Trust limits the beneficiaries' withdrawal rights to the gift tax annual exclusion
amount, and it limits the annual lapse of the withdrawal rights to the greater of $5,000 or
5% of the value of the trust assets.
You have requested the following rulings:

1. As a result of the judicial reformation of Trust, Settlor's grandchildren, Grandchild 1,
Grandchild 2, and Grandchild 3, do not possess general powers of appointment (within the
meaning of §§ 2514 and 2041) over their respective shares of Trust, except to the extent
of each grandchild's withdrawal rights under the reformed trust instrument.

2. The judicial reformation of Trust does not constitute, for federal gift and estate tax
purposes, the exercise or release by any grandchild of Settlor of a general power of
appointment.

3. The lapse of any grandchild's withdrawal right over Trust did not result in a gift for
federal gift tax purposes.

4. No part of Trust property will be included in the gross estates of the Settlor's
grandchildren for federal estate tax purposes, except to the extent of each grandchild's
withdrawal rights under the reformed trust instrument exercisable at the grandchild's death.

5. Settlor and Spouse substantially complied with the requirements of § 2632(a) to
allocate their available GST exemption to the Year 1 gift to Trust.

Rulings 1-4

Section 2001(a) provides that a tax is imposed on the transfer of the taxable estate of
every decedent who is a citizen or resident of the United States.

Section 2033 provides, generally, that the value of the gross estate shall include the extent
the value of all property to the extent of the interest therein of the decedent at the time of
his death.

Section 2041(a)(2) provides that the value of the gross estate includes 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 such a power of appointment
by a disposition which is of such nature that if it were a transfer of property owned by the
decedent, such property would be includible in the decedent's gross estate under §§ 2035
to 2038, inclusive. For purposes of § 2041(a)(2), the power of appointment shall be
considered to exist on the date of the decedent's death even though the exercise of the
power is subject to a precedent giving of notice or even though the exercise of the power
takes effect only on the expiration of a stated period after its exercise, whether or not on or

before the date of the decedent's death notice has been given or the power has been
exercised.

Section 2041(b)(1) provides that for purposes of § 2041(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.

Section 2041(b)(2) provides that the lapse of a power of appointment created after October
21, 1942, during the life of the individual possessing the power shall be considered a
release of such power. The preceding sentence shall apply with respect to the lapse of
powers during any calendar year only to the extent that the property, which could have
been appointed by exercise of such lapsed powers, exceeded in value, at the time of such
lapse, the greater of the following amounts: (A) $5,000, or (B) 5 percent of the aggregate
value, at the time of such lapse, of the assets out of which, or the proceeds of which, the
exercise of the lapsed powers could have been satisfied.

Section 2501(a)(1) provides, generally, that a tax is imposed for each calendar year on the
transfer of property by gift by any individual, resident or nonresident. Section 2511(a)
provides that the gift tax 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.

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 for purposes of § 2514, the term "general power of
appointment" means a power which is exercisable in favor of the individual possessing the
power, his estate, his creditors, or the creditors of his estate.

Section 2514(e) provides that the lapse of a power of appointment created after October
21, 1942, during the life of the individual possessing the power shall be considered a
release of such power. The rule of the preceding sentence shall apply with respect to the
lapse of powers during any calendar year only to the extent that the property which could
have been appointed by exercise of such lapsed powers exceeds in value the greater of
the following amounts: (1) $5,000, or (2) 5 percent of the aggregate value of the assets out
of which, or the proceeds of which, the exercise of the lapsed powers could be satisfied.

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.

State Statute 1 provides, in part, that a proceeding to approve or disapprove a proposed
modification of termination of a trust, may be commenced by a trustee or a beneficiary.

State Statute 2 provides, in part, that the court may reform the terms of a trust, even if
unambiguous, to conform the terms to the settlor's intention if it is proved by clear and
convincing evidence that the settlor's intent or the terms of the trust were affected by a
mistake of fact or law.

In this case, an examination of the relevant trust instruments, affidavits, and
representations of the parties indicate that the original terms of Article THIRD paragraph
(A), resulting from scrivener's error, are contrary to the intent of Settlor. The purpose of
the reformation is to correct the scrivener's error, not to alter or modify the trust instrument.
Accordingly, based on the facts presented and the representations made, we conclude
that as a result of the reformation of Trust, Settlor's grandchildren do not possess general
powers of appointment over the assets of Trust, except to the extent of each grandchild's
withdrawal rights under the reformed trust instrument. Further, we conclude that the
judicial reformation of Trust does not constitute, for federal gift and estate tax purpose, the
exercise or release by any grandchild of Settlor of a general power of appointment. We
also conclude that the lapse of Grandchild 1, Grandchild 2, or Grandchild 3's withdrawal
rights did not result in a gift for federal gift tax purposes. Finally, we conclude that upon
the death of Grandchild 1, Grandchild 2 or Grandchild 3, the assets of each Grandchild's
portion of Trust will not be includible in that grandchild's gross estate under § 2041.

Ruling 5

Section 2513(a)(1) provides, generally, that a gift made by one spouse to any person other
than the donor's spouse is considered for purposes of the gift tax as made one-half by the
donor and one-half by the donor's spouse, but only if at the time of the gift each spouse is
a citizen or resident of the United States.

Section 25.2513-1(b)(4) of the Gift Tax Regulations provides that the consent is effective
only if both spouses signify their consent to treat all gifts made to third parties during that
calendar period by both spouses while married to each other as having been made one-
half by each spouse. Such consent, if signified with respect to any calendar period, is
effective with respect to all gifts made to third parties during such calendar period except,
in part, if one spouse transferred property in part to his or her spouse and in part to third
parties, the consent is effective with respect to the interest transferred to third parties only
insofar as such interest is ascertainable at the time of the gift and severable from the
interest transferred to his spouse.


Section 25.2513-1(b)(5) provides that the consent applies alike to gifts made by one
spouse alone and to gifts made partly by each spouse, provided such gifts were to third
parties and do not fall within any of the exceptions set forth in § 25.2513-1(b)(1) through
(b)(4). The consent may not be applied only to a portion of the property interest
constituting such gifts. If the consent is effectively signified on either the husband's return
or the wife's return, all gifts made by the spouses to third parties (except as described in
subparagraphs (1) through (4) of this paragraph), during the calendar period will be treated
as having been made one-half by each spouse.

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

Section 2602 provides that the amount of the GST tax is determined by multiplying the
taxable amount by the applicable rate. Section 2641(a) provides that the term "applicable
rate" means, with respect to any GST, the product of the maximum federal estate tax rate
and the inclusion ratio with respect to the transfer.

Section 2641(a) defines the applicable rate as the product of the maximum federal estate
tax rate and the inclusion ratio with respect to the transfer.

Under § 2642(a)(1), the inclusion ratio with respect to any property transferred in a
generation-skipping transfer is generally defined as the excess of 1 over the "applicable
fraction." The applicable fraction, as defined in § 2642(a)(2), is a fraction, the numerator of
which is the amount of GST exemption under § 2631 allocated to the trust (or to property
transferred in a direct skip), and the denominator of which is the value of the property
transferred to the trust or involved in the direct skip.

Section 2631(a) provides that, for purposes of determining the inclusion ratio, every
individual shall be allowed a GST exemption amount which may be allocated by such
individual (or his executor) to any property with respect to which such individual is the
transferor. Section 2631(b) provides that any allocation under § 2631(a), once made, shall
be irrevocable.

Section 2632(a)(1) provides that any allocation by an individual of his or her GST
exemption under § 2631(a) may be made at any time on or before the date prescribed for
filing the estate tax return for such individual's estate (determined with regard to
extensions), regardless of whether such a return is required to be filed.

Under § 2652(a)(1), for purposes of chapter 13, the term "transferor" means the decedent,
in the case of any property subject to tax imposed by chapter 11 and, the donor, in the
case of any property subject to tax imposed by chapter 12.

Section 26.2652-1(a)(1) of the Generation-Skipping Transfer Regulations provides that the
individual with respect to whom property was most recently subject to federal estate or gift
tax is the transferor of that property for purposes of chapter 13.

In this case, Settlor and Spouse elected to gift-split on their timely filed Form 709 in Year 1.
Thus, we conclude that Settlor and Spouse are each treated as the transferor of one-half
of the assets gifted to Trust in Year 1. Spouse timely filed Form 709 for Year 2. For GST
purposes, Spouse is the transferor of the assets gifted to Trust in Year 2.

Settlor and Spouse incorrectly reported the Year 1 gift to Trust as an indirect skip.
However, Settlor and Spouse allocated their GST exemption to the Year 1 gift to Trust.
Settlor and Spouse did not literally comply with the instructions to Form 709 to properly
allocated their remaining GST exemption to the Year 1 gift to Trust. However, literal
compliance with the procedural instructions to make an election is not always required.
Elections may be treated as effective where the taxpayer complied with the essential
requirements of a regulation (or the instructions to the applicable form) even though the
taxpayer failed to comply with certain procedural directions therein. See Hewlett-Packard
Company v. Commissioner, 67 T.C. 736, 748 (1977), acq. In result, 1979-1 C.B. 1. Thus,
an allocation that does not strictly comply with the instructions on Form 709 or the
applicable regulations, will be deemed valid if the information on the return is sufficient to
indicate that the donor intended to make the allocation. Based upon the facts submitted
and representations made, we conclude that Year 1 Forms 709 contain sufficient
information and, therefore, we further conclude that Settlor and Spouse substantially
complied with the requirements of § 2632(a) to allocate their respective GST exemption to
the Year 1 gift to Trust. Spouse allocated her available GST exemption to the Year 2 gift
to Trust on a timely filed Form 709.

A copy of this letter should be attached to any gift, estate, or generation-skipping transfer
tax returns that you may file relating to these matters.

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 rules herein, we do not express or imply any opinion concerning the
federal tax consequences of any aspect of the transaction or subsequent transaction to
Trust under the cited provisions or under any other provisions of the Code.

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,

                                          Associate Chief Counsel
                                          Passthroughs & Special Industries

                                         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



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