QTIP trust division is tax-free, but later modification triggers gifts

Plain-English summary

A trustee divided a QTIP marital trust into two trusts with identical terms. Because the division left the spouse's and daughters' beneficial interests unchanged, the IRS ruled that it did not trigger gift tax under Sections 2511 or 2519. A later court order, however, modified one resulting trust by ending the spouse's income interest and permitting distributions before the spouse's death. The IRS ruled that this modification was a disposition under Section 2519. The spouse was therefore treated as transferring both the remainder interests in that trust and, separately under Section 2511, the qualifying income interest.

Ruling snapshot

• Question: What gift-tax consequences follow from dividing a QTIP trust and then modifying one resulting trust to terminate the spouse's income interest?
• Outcome: Mixed. The identical division caused no taxable transfer, but the later modification caused deemed transfers under Sections 2519 and 2511.
• Key authorities: IRC §§ 2056(b)(7), 2501, 2511, and 2519; Treas. Reg. §§ 25.2511-1 and 25.2519-1

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 202116001 Third Party Communication: None
Release Date: 4/23/2021 Date of Communication: Not Applicable
Index Number: 2519.00-00
Person To Contact:
------------------------------------------- ---------------------, ID No. -----------------
---------------------------------------------------- Telephone Number:
---------------------------- --------------------
------------------------------------- Refer Reply To:
CC:PSI:B4
----------------------------------- PLR-101381-20
Date:
July 09, 2020

Legend

Decedent = --------------------------------

Spouse = -----------------------------------------------------

Daughter 1 = ----------------------------------

Daughter 2 = ---------------------------------------

Qualified Trust = -----------------------------------------------------

Trustee = -------------------------------

State = -------------

State Statute 1 = -----------------------------------------------

State Statute 2 = -----------------------------------------------

Year = -------

Date 1 = ------------------

Date 2 = --------------------------

Date 3 = ------------------

Date 4 = --------------------------

x = -------------------
PLR-101381-20 2

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

  This responds to your letter dated December 20, 2019, and subsequent

correspondence, requesting rulings under § 2519 of the Internal Revenue Code (Code)
regarding the division of a qualified terminable interest trust and distribution of trust
assets as described below.

Facts

    The facts submitted and representations made are as follows.

  Decedent died in Year, survived by Spouse, Daughter 1, and Daughter 2. Part B

of Decedent’s Last Will and Testament created a marital trust, Qualified Trust.

    Part B, Article III, section 3.1 provides that Spouse shall be the income

beneficiary of Qualified Trust for life and, at Spouse’s death, the original and substitute
principal beneficiaries shall become income beneficiaries in proportion to their interests
in principal.

   Section 3.2 provides that the original principal beneficiaries of Qualified Trust

shall be Daughter 1 and Daughter 2. Section 3.2 provides further that should either of
the original principal beneficiaries die both intestate and without decedents, then the
original principal beneficiary who survives her shall become substitute beneficiary of her
interest.

  Article IV provides that the interest of each beneficiary shall be held subject to

the maximum spendthrift restraints permitted by State law.

   Article V provides that Qualified Trust shall terminate upon the death of the last

surviving income beneficiary. However, at any time after Spouse’s death, Qualified
Trust may be terminated as to a beneficiary’s interest and any part of the trust property
representing her interest may be distributed to that beneficiary if the trustee considers
such distribution to be in the best interests of the beneficiary, considering the
demonstrated ability of the beneficiary to handle money and property wisely, her
judgment, prudence and discretion, and any other factors the trustee may consider
relevant. The trustee may exercise the power of termination even if the beneficiary is
restrained from alienating her interest.

   Article VII, section 7.1.2 provides that during Spouse’s lifetime income accruing

to Qualified Trust shall be distributed monthly to Spouse or more frequently should the
trustee see fit. Section 7.2 provides that should the trustee determine that Spouse
needs resources for health, education, maintenance and support, and subject to the
rights of the principal beneficiaries as forced heirs, the trustee is authorized to make one
PLR-101381-20 3

or more distributions first of accumulated income, then principal, if necessary, for her
benefit even though that distribution impairs the interests of the principal beneficiaries.

   It is represented that the terms of Qualified Trust do not contain restrictions on

the trustee’s power to divide the trust.

   On Decedent’s estate tax return, Decedent’s estate elected to treat Qualified

Trust as qualified terminable interest property (QTIP) as provided in § 2056(b)(7) of the
Code.

   State Statute 1 authorizes a trustee to divide a trust into two or more trusts upon

notice to the beneficiaries, provided that such division does not impair the rights of any
beneficiary or adversely affect the accomplishment of the purposes of the trust. State
Statute 1 provides further that a trust instrument may modify these rules, either to
expand or to restrict the trustee's authority to combine or divide a trust. State Statute 2
authorizes Court to order the termination or modification of a trust, in whole or in part, if
the continuance of the trust unchanged would defeat or substantially impair the
purposes of the trust.

   On Date 1, Trustee divided Qualified Trust into two trusts, Qualified Trust-A and

Continuing Qualified Trust, both with terms and provisions identical to those set forth in
Qualified Trust. Trustee placed $x in cash and marketable securities into Qualified
Trust-A and retained all other assets in Continuing Qualified Trust. The assets retained
in Continuing Trust are income producing such that Spouse retains the enjoyment of the
assets. On Date 2, Trustee and the beneficiaries of Qualified Trust-A petitioned Court
for entry of an order with respect to Qualified Trust-A. On Date 3, finding that a
continuation of Qualified Trust-A unchanged would defeat or substantially impair its
purposes, Court entered Order. Order modifies the terms and provisions of Qualified
Trust-A.

    Article V of Qualified Trust-A, as modified by Order, provides that Qualified

Trust-A shall terminate upon the death of the last surviving income beneficiary.
However, at any time, including prior to Spouse’s death, Qualified Trust-A may be
terminated as to a beneficiary’s interest and any part of the trust property representing
her interest may be distributed to that beneficiary if the trustee considers such
distribution to be in the best interests of the beneficiary, considering the demonstrated
ability of the beneficiary to handle money and property wisely, her judgment, prudence
and discretion, and any other factors the trustee may consider relevant. The trustee
may exercise the power of termination even if the beneficiary is restrained from
alienating her interest.

    Article III, section 3.1, as modified by Order, provides that the original and

principal beneficiaries of Qualified Trust-A shall become the income beneficiaries in
proportion to their interests in the principal. Section 7.2, allowing the trustee to make
distributions to Spouse for her health, education, maintenance and support, is deleted in
PLR-101381-20 4

its entirety. Order further provides that, the terms and conditions of Qualified Trust-A
shall be interpreted and applied as if Spouse had died on the date Order is entered, and
that Trustees shall continue to be the trustee of Qualified Trust-A and Continuing
Qualified Trust. Although Order is effective on Date 3, it is expressly conditioned on
receipt of favorable rulings from the Internal Revenue Service prior to Date 4.

Rulings Requested

1. The division of Qualified Trust on Date 1 did not cause the assets remaining in
   Qualified Trust after the division (referred to as Continuing Qualified Trust) to be
   subject to the United States Gift Tax pursuant to § 2519 or 2511.

2. Spouse is deemed to have made a transfer of all of the property in Qualified
   Trust-A under § 2519, other than the value of her qualifying income interest, and
   Spouse is deemed to have made a transfer of her qualifying income interest in
   Qualified Trust-A under § 2511, on Date 3 upon entry of Order approving
   modifications by which the income interest of Spouse in Qualified Trust-A is
   terminated and distributions from Qualified Trust-A are permitted to be made
   prior to death of Spouse.

Law and Analysis

   Section 2501 of the Code imposes a tax on the transfer of property by gift by an

individual.

   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.

   Section 2519(a) provides that any disposition of all or part of a qualifying income

interest for life in any property to which the section applies is treated as a transfer for gift
tax purposes of all interests in the property other than the qualifying income interest.

   Section 2519(b) provides that § 2519(a) applies to any property if a deduction

was allowed with respect to the transfer of such property to the donor under
§ 2056(b)(7).

   Section 25.2511-1(c)(1) of the Gift Tax Regulations provides that the gift tax

applies to gifts indirectly made. Thus, any transaction in which an interest in property is
gratuitously passed or conferred upon another, regardless of the means or device
employed, constitutes a gift subject to tax.

   Section 25.2519-1(a) provides that a transfer of all or a portion of the income

interest of a spouse in QTIP property is a transfer by the spouse under § 2511.
PLR-101381-20 5

   Section 25.2519-1(c)(1) provides that the amount treated as a transfer under

§ 2519 upon a disposition of all or part of a qualifying income interest for life in QTIP
property is equal to the fair market value of the entire property subject to the qualifying
income interest, determined on the date of the disposition (including any accumulated
income and not reduced by any amount excluded from total gifts under § 2503(b) with
respect to the transfer creating the interest), less the value of the qualifying income
interest in the property on the date of the disposition. The gift tax consequences of the
disposition of the qualifying income interest are determined separately under
§ 25.2511-2.

    In the present case, following the division of Qualified Trust on Date 1, the trusts

resulting from the division, Qualified Trust-A and Continuing Qualified Trust, had terms
and provisions identical to those set forth in Qualified Trust. Thus, the division of
Qualified Trust did not change the beneficial interests of Spouse, Daughter 1 or
Daughter 2 in the property originally held in Qualified Trust. Accordingly, based on the
facts submitted and representations made, we rule that the division of Qualified Trust on
Date 1 did not cause the assets remaining in Qualified Trust after the division (referred
to as Continuing Qualified Trust) to be subject to the United States Gift Tax pursuant to
§ 2519 or 2511.

    Order, however, modifies the terms of Qualified Trust-A to change the beneficial

interests of Spouse, Daughter 1, and Daughter 2 in the property of Qualified Trust-A.
Article V of Qualified Trust-A, which continues to provide that Qualified Trust-A shall
terminate upon the death of the last surviving income beneficiary, is modified to provide
that at any time, including prior to Spouse’s death, Qualified Trust-A may be terminated
as to a beneficiary’s interest. In other words, Order terminates Spouse’s income
interest as of Date 3. The term “disposition” as used in § 2519, applies broadly to
circumstances in which the surviving spouse’s right to receive the income is
relinquished or otherwise terminated, by whatever means. See H. Rep. No. 97-201, at
161 (1981). The property in Qualified Trust-A is a portion of the property originally held
by Qualified Trust with respect to which Decedent’s estate was allowed a deduction
under § 2056(b)(7). Thus, for purposes of § 2519, the entry of Order on Date 3 resulted
in a disposition of a qualifying income interest for life in Qualified Trust-A.

    Accordingly, based on the facts submitted and representations made, we rule

that Spouse is deemed to have made a transfer of all of the property in Qualified
Trust-A under § 2519, other than the value of her qualifying income interest, and
Spouse is deemed to have made a transfer of her qualifying income interest in Qualified
Trust-A under § 2511, on Date 3 upon entry of Order approving modifications by which
the income interest of Spouse in Qualified Trust-A is terminated and distributions from
Qualified Trust-A are permitted to be made prior to death of Spouse.

  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-101381-20 6

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

copy of this letter to your authorized representatives.

                                 Sincerely,

                                 Leslie H. Finlow

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

Enclosures (2)

  Copy of this letter
  Copy for § 6110 purposes

cc: