In the only private letter ruling addressing incomplete gift, non-grantor trusts (“INGs”) in 2020, the IRS ruled that the subject trust was a non-grantor trust under section 671 of the internal revenue code, and that transfers to the trust would be incomplete gifts for federal gift tax purposes under section 2511.
The subject trust has the following characteristics:
- Grantor created a domestic trust in a state that presumably does not impose an income tax on transactions within the trust.
- The trust is irrevocable for the benefit of Grantor, Grantor’s Spouse, Grantor’s issue, Grantor’s Parents, and the other issue of Grantor’s Parents (collectively, the “Beneficiaries”). Grantor had no power to alter or amend the trust.
- A corporate trustee (Trustee) is the sole trustee of the Trust.
- While Grantor is alive, the Distribution Committee is to be in existence. The Distribution Committee is initially composed of Grantor, Grantor’s parents and Grantor’s sister. Until the death of Grantor, the Distribution Committee must have at least two members, other than Grantor or Grantor’s Spouse. If there are less than two remaining members, other than Grantor or Grantor’s Spouse, the Trust Protector will appoint any one or more of the Beneficiaries other than Grantor’s Spouse to the Distribution Committee, provided that the number of members does not exceed four and that any member of the Distribution Committee is an adult, competent person.
- While Grantor is alive, Trustee must distribute income and principal of the trust estate as directed in writing by the Distribution Committee, Grantor, or both, as follows: (A) Income or principal to any Beneficiary (other than Grantor’s Spouse) as determined by a majority of the Distribution Committee, other than Grantor or Grantor’s Spouse, acting in a non-fiduciary capacity, with the written consent of Grantor (“Grantor’s Consent Power”); (B) Income or principal to any Beneficiary as determined by unanimous decision of the Distribution Committee, other than Grantor or Grantor’s Spouse, acting in a non-fiduciary capacity (“Unanimous Committee Power”); and, (C) Principal to any Beneficiary (other than Grantor or Grantor’s Spouse) as determined by Grantor, acting in a non-fiduciary capacity, for any one or more of such Beneficiary’s support, health, or education (“Grantor’s Sole Power“).
- Grantor may appoint all or any part of the principal of Trust, outright or in trust, at his death in favor of the issue of Grantor’s parents (other than Grantor, his estate, his creditors, or the creditors of his estate), Grantor’s Spouse, or any one or more charitable organizations as Grantor designates (“Grantor’s Testamentary Power”). Any part of the principal of Trust not effectively appointed by Grantor upon his death will be distributed to a designated trust.
INCOME TAX RULING
The IRS held that during the period the Distribution Committee is serving, no portion of the items of income, deductions, and credits against tax of Trust will be included in computing the Grantor’s taxable income, deductions, and credits under § 671.
Based solely on the facts and representations submitted, the IRS concluded an examination of Trust reveals none of the circumstances that would cause Grantor or any member of the Distribution Committee to be treated as the owner of any portion of Trust under sections 673, 674, 676, 677, 678, or 679 as long as the Distribution Committee remains in existence and serving and Trust remains a domestic trust. Furthermore, the IRS concluded that an examination of Trust reveals none of the circumstances that would cause administrative controls to be considered exercisable primarily for the benefit of Grantor under section 675.
This means that Trust would be considered its own Taxpayer and be required to report and pay its own federal and state income taxes.
GIFT TAX RULING
Section 25.2511-2(c) provides that a gift is incomplete in every instance in which a donor reserves the power to revest the beneficial title in himself or herself. A gift is also incomplete if and to the extent that a reserved power gives the donor the power to name new beneficiaries or to change the interests of the beneficiaries as between themselves unless the power is a fiduciary power limited by a fixed or ascertainable standard.
Under § 25.2511-2(c), a gift is incomplete if and to the extent that a reserved power gives the donor the power to name new beneficiaries or to change the interests of the beneficiaries as between themselves unless the power is a fiduciary power limited by a fixed or ascertainable standard. In this case, Grantor’s Sole Power gives Grantor the power to change the interests of the beneficiaries. Grantor’s Sole Power is a non-fiduciary power. Accordingly, the retention of Grantor’s Sole Power causes the transfer of property to Trust to be wholly incomplete for federal gift tax purposes.
This means that transfers to Trust by Grantor would not be taxable gifts and would not reduce Grantor’s lifetime gift tax exemption (which in 2020 was $11.58 million).
ESTATE TAX RULING
A Distribution Committee member’s gross estate for federal estate tax purposes won’t include the value of any trust property.
The IRS concluded that the powers held by the Distribution Committee are not general powers of appointment for purposes of section 2041(a)(2) and, accordingly, no member of the Distribution Committee upon his or her death will include in his or her estate any property held in Trust because such member is deemed to have a general power within the meaning of section 2041 over property held in Trust.
WHAT’S THE POINT? — Tax Savings!
The Grantor spent a lot of time, effort, and money setting up this trust, modifying it to run a gauntlet of sophisticated income, estate, and gift tax requirements, and then obtaining a favorable ruling from the IRS.
While the underlying transaction is unknown, let’s say the Grantor owned an asset worth $10,000,000 but with an adjusted tax basis of $1,000,000. If the Grantor were to sell the asset, the Grantor would realize $9,000,000 of gain and that gain would be subject to both state and federal taxes.
Let’s assume the plan was to transfer the asset to the trust and to have the trust sell the asset. Since the trust is a non-grantor trust, the trust then, and not the Grantor would be taxed on the gain. In many states, this structure would avoid state income taxes on the gain. The Distribution Committee could then direct any number of distributions to either return the proceeds to the Grantor, or to make gifts to the other Beneficiaries, or to continue holding the proceeds in trust. These decisions could further reduce income taxes, offer increased creditor protection, and otherwise provide for continued long-term management of the trust. The flexibility this structure provided, coupled with the tax savings, was the advantage sought by the Grantor.