A transfer between two trusts owned by the same beneficiary is not recognized as a sale

Plain-English summary

An irrevocable family trust contributed stock to an LLC taxed as a partnership and later transferred part of its LLC interest to a subtrust for one beneficiary. The subtrust proposed selling part of that LLC interest to another trust in exchange for cash and a promissory note. The beneficiary could withdraw the sale proceeds from the subtrust, and the purchasing trust was represented to be a grantor trust owned by the same beneficiary. The IRS concluded that the withdrawal power caused the beneficiary to be treated as the owner of the subtrust under section 678. Because the beneficiary was treated as owning both trusts, the transfer was not recognized as a sale for federal income tax purposes. The ruling was conditioned on the purchasing trust's grantor-trust status and the beneficiary's authority to withdraw the note.

Ruling snapshot

• Question: Is gain recognized when a subtrust sells an LLC interest to another trust if the same beneficiary is treated as owning both trusts?
• Outcome: approved (the transfer is not recognized as a sale, subject to the stated ownership conditions)
• Key authorities: IRC §§ 671, 678; Rev. Rul. 85-13; Dobson v. Commissioner

Full text (IRS public release)

 Internal Revenue Service                                          Department of the Treasury
                                                                   Washington, DC 20224

 Number: 202022002                                                 Third Party Communication: None
 Release Date: 5/29/2020                                           Date of Communication: Not Applicable
 Index Numbers: 671.00-00, 671.02-00,                              Person To Contact:
               678.00-00                                           ---------------------, ID No. ---------------
                                                                   Telephone Number:
 -------------------------------------------------------------     --------------------
 --------------------------                                        Refer Reply To:
 ----------------------------------------------------------        CC:PSI:B03
 ---------------------------------                                 PLR-111315-19
 -----------------------------------------                         Date:
 ----------------------------------                                February 25, 2020




Legend

Trust 1:        -------------------------------------------
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Subtrust: -------------------------------------------
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Grantors:       --------------------------

Shares:         ----------------------------------------
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LLC:            ------------------------------------------------
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----------------------------------------

Trust 2:        ------------------------------------------
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A:              ----------------------------
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Date 1:       --------------------------

Date 2:       -------------------------

Date 3:       ---------------------

PLR-111315-19                                 2


Date 4:      ------------------

Date 5:      ---------------------

$a:          ---------------

$b:          -----------------

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

       This letter responds to a letter dated April 16, 2019, submitted on behalf of Trust
1, requesting a ruling as to whether gain is recognized on the sale of a partnership
interest by Subtrust to Trust 2.

                                          FACTS

       According to the representations submitted, Grantors created Trust 1, an
irrevocable trust for the benefit of Grantors’ children and grandchildren. Grantors
transferred Shares to Trust 1. Pursuant to the Trust 1 indenture dated Date 1, Trust 1
was divided into separate trusts for each of Grantors’ children and grandchildren.

         The Trust 1 indenture prohibits a distribution of the Shares, but allows for
distribution of the proceeds from the sale of the Shares. On Date 2, Trust 1 contributed
all of its Shares to LLC, a newly formed entity classified as a partnership for federal tax
purposes, in exchange for membership interests in LLC. Trust 1 represents that the
same restriction placed on the distribution of Shares also restricts the distribution of the
LLC interests. Effective Date 3, Trust 1 transferred a portion of its LLC interests to
Subtrust. LLC’s assets include cash and the Shares. A is the sole beneficiary of
Subtrust.

      Trust 1 represents that A has the authority to withdraw all of Subtrust’s assets
when A reaches age 40 except the LLC interests. Pursuant to her withdrawal right, on
Date 4, A withdrew all of Subtrust’s assets except the LLC interests.

       On Date 5, the trustees of Subtrust agreed to sell a portion of the LLC interests
held in Subtrust to Trust 2 in exchange for $a cash and a $b promissory note. Trust 1
represents that Trust 2 is a grantor trust with respect to A under subpart E of part I of
subchapter J of the Code. Trust 1 further represents that A has the authority to withdraw
the cash and promissory note from Subtrust after the proposed sale.

PLR-111315-19                                 3

                                           LAW

        Section 671 of the Code provides that where it is specified in subpart E of part I
of subchapter J (sections 673 through 679 of the Code) that the grantor or another
person shall be treated as the owner of any portion of a trust, there shall then be
included in computing the taxable income and credits of the grantor or the other person
those items of income, deductions, and credits against tax of the trust which are
attributable to that portion of the trust to the extent that such items would be taken into
account under chapter 1 in computing taxable income or credits against the tax of an
individual.

       Section 678(a) of the Code provides that a person other than the grantor shall be
treated as the owner of any portion of a trust with respect to which: (1) such person has
a power exercisable solely by himself to vest the corpus or the income therefrom in
himself, or (2) such person has previously partially released or otherwise modified such
a power and after the release or modification retains such control as would, within the
principles of §§ 671 to 677, inclusive, subject a grantor of a trust to treatment as the
owner thereof.

         In Rev. Rul. 85-13, 1985-1 C.B. 184, A created T, an irrevocable trust, and
funded it with Corporation Z shares. W, A’s spouse was trustee of T. Neither A nor any
other person had a power over, or an interest, in T that would cause A to be treated as
the owner of T under subpart E of part I of subchapter J. When the fair market value of
the shares had increased, W, as trustee, transferred the Corporation Z shares to A. In
exchange, A gave W A’s unsecured promissory note with a face amount equal to the
fair market of the shares bearing an adequate annual rate of interest. Principal
payments on the note were scheduled to be paid in 10 equal annual installments, the
first installment due three years following the date the shares were transferred to A.
Less than three years later, A sold the shares to an unrelated party. Corporation Z did
not make any distributions with respect to the shares exchanged for A’s promissory note
at any time before the sale of the shares to the unrelated party.

        The Service held that the owner of a grantor trust is not merely taxable on a
trust’s income, but is treated as the owner of the trust’s assets for federal income tax
purposes, citing Ringwalt v. United States, 549 F.2d 89 (8th Cir. 1977), cert. denied,
432 U.S. 906 (1977); Estate of O’Connor v. Commissioner, 69 T.C. 165 (1977); Treas.
Reg. § 1.1001-2(c), Example 5; Rev. Rul. 81-98, 1981-1 C.B. 40; Rev. Rul. 78-175,
1978-1 C.B. 144; Rev. Rul. 77-402,1977-2 C.B. 222; Rev. Rul. 74-613, 1974-2 C.B.
153; Rev. Rul. 72-471, 1972-2 C.B. 201; Rev. Rul. 70-376, 1970-2 C.B. 164; and Rev.
Rul. 66-159, 1966-1 C.B. 162; but cf. Rev. Rul. 74-243, 1974-1 C.B. 107.

      Rev. Rul. 85-13 states that although A did not engage in a direct borrowing of the
Corporation Z shares, A’s acquisition of the T corpus in exchange for the unsecured
note was, in substance, the economic equivalent of borrowing trust corpus. Accordingly,
under § 675(3), A was treated as owner of the portion of T represented by A’s

PLR-111315-19                                4

promissory note. Further, because the promissory note was T’s only asset, A was
treated as owner of the entire trust. Moreover, because A was considered owner of the
promissory note held by the trust, the transfer of the Corporation Z shares by T to A was
not recognized as a sale for federal income tax purposes because A was both the
maker and owner of the promissory note. Citing Dobson v. Commissioner, 1 B.T.A.
1082 (1925), the ruling states that a transaction cannot be recognized as a sale for
federal income tax purposes if the same person is treated as owning the purported
consideration both before and after the transaction.

                                     CONCLUSION

        Based solely on the facts submitted and representations made, we conclude that
because A has a power exercisable by herself to vest the proceeds from the sale of
Subtrust’s LLC interests in herself and that those proceeds are Subtrust’s only asset, A
will be treated as the owner of Subtrust under § 678. Consequently, the transfer of the
LLC interests to Trust 2 is not recognized as a sale for federal income tax purposes
because Trust 2 and Subtrust are both wholly owned by A.

       Except as specifically set forth above, no opinion is expressed or implied
concerning the federal tax consequences of the transaction described above under any
other provision of the Code. Specifically, this ruling is conditioned upon Trust 2 being a
grantor trust as to A and A having the authority to withdraw the promissory note from
Subtrust. If these facts are not as represented by Trust 1, then this ruling is null and
void.

       The ruling contained in this letter is 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 ruling request, it is subject to verification on examination.

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.

PLR-111315-19                                            5

        A copy of this letter must be attached to any income tax return to which it is
relevant. Alternatively, taxpayers filing their returns electronically may satisfy this
requirement by attaching a statement to their return that provides the date and control
number of the letter ruling. 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,



                                                Adrienne M. Mikolashek
                                                Branch Chief, Branch 3
                                                (Passthroughs & Special Industries)

Enclosure (2):

Copy of this letter
Copy of this letter for § 6110 purposes



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