Private Trust Companies

Proposed revenue ruling gives green light to use of private trust companies Notice 2008-63, 2008-31 IRB

Mike Habib, EA

A new notice contains a proposed revenue ruling that would allow families to use private trust companies (PTCs) in their estate planning without adverse income, estate, gift or generation-skipping transfer (GST) tax consequences for the trust creators or beneficiaries in carefully defined situations. IRS requests comments on the proposed ruling.

Background. Under Code Sec. 2036, a decedent’s gross estate includes transfers under which he retained the possession or enjoyment of, or the right to the income from, the transferred property. The decedent need not have a legally enforceable right, but there must be an agreement, either expressed or implied, that the decedent will retain the benefit. Under Code Sec. 2038 , a decedent’s gross estate includes a lifetime transfer if the enjoyment of the transferred property was subject at his death to any change through the exercise by him of a power to alter, amend, revoke or terminate. This includes any power affecting the time or manner of enjoyment of property or its income. Inclusion is not required under Code Sec. 2036 or Code Sec. 2038 if the transfer was a bona fide sale for full and adequate consideration.

Under the grantor trust rules of Code Sec. 671 to Code Sec. 679, the grantor, or another person, such as a beneficiary, is treated as the “owner” of all or part of the trust and taxed directly on the income of the trust to the extent of that “ownership” so long as the grantor or other person is not a foreign person.

Property subject to a general power of appointment created after Oct. 21, ’42, is includible in the gross estate of the holder of the power if the decedent either: (1) has the power at the time of his death, and the interest subject to the power exists at the time of his death, or (2) exercised or released the power, in a testamentary manner, or the power lapsed. (Code Sec. 2041(a))

Detailed facts in the proposed ruling. The proposed ruling includes a set of fairly substantial general facts followed by even more detailed specific facts in each of two situations. Basically, a married couple, A and B, established separate irrevocable trusts for each of their three children, C, D and E, all of whom are married and have their own children. These individuals are collectively referred to as Family. The trustee of each trust has discretionary authority to distribute income and/or principal to the primary beneficiary during his lifetime and the primary beneficiary has a testamentary power to appoint the trust corpus to or for the benefit of one or more Family members and/or charities. Each trust also provides that the grantor, or the primary beneficiary if the grantor is not living, may appoint a successor trustee other than himself or herself if the current trustee either resigns or is no longer able to fulfill the duties of trustee.

In Situation 1, the trust is governed by the laws of State 1, a state that has enacted a PTC statute (Statute). Any PTC formed under Statute must create a Discretionary Distribution Committee (DDC) and delegate to the DDC the exclusive authority to make all decisions regarding discretionary distributions from each trust for which it serves as trustee. Statute does not restrict who may serve on the DDC, but provides that no member of the DDC may participate in the activities of the DDC with regard to any trust of which that DDC member or his or her spouse is a grantor, or any trust of which that DDC member or his or her spouse is a beneficiary. In addition, Statute provides that a DDC member may not participate in the activities of the DDC with respect to any trust with a beneficiary to whom that DDC member or his or her spouse owes a legal obligation of support.

In 2008, Family formed a PTC with governing documents creating a DDC that will make all decisions with respect to discretionary distributions from all trusts for which it serves as trustee, consistent with Statute. PTC becomes trustee of the above trusts and additional trusts created by A for his children.

In Situation 2, the facts are the same as in Situation 1, except that the PTC is formed in State 2, a state that has not enacted specific legislation governing the formation or operation of a PTC. PTC is established for the specific purpose of acting as the trustee for the various trusts established by members of Family. In each situation, Family owns all of the stock in PTC, either outright or through trusts and/or other entities. Each situation provides extremely detailed information concerning the DDC’s powers and restrictions or lack thereof on who may serve as DDC.

Favorable rulings. The proposed revenue ruling concludes that neither the appointment nor the service of PTC as the trustee of a Family trust described in Situation 1 or Situation 2 will by itself:

  • cause the value of the trust assets to be included in a grantor’s gross estate under Code Sec. 2036(a) or Code Sec. 2038(a).
  • cause the value of the trust assets to be included in a beneficiary’s estate under Code Sec. 2041
  • affect the exempt status of that trust if the trust is otherwise exempt from the GST tax under Reg. ยง 26.2601-1(b)(1)(i) (grandfather exception for trusts in existence on Sept. 25, ’85), or change the inclusion ratio of a trust.
  • cause any grantor or beneficiary of that trust to be treated as the owner of that trust or any portion thereof under Code Sec. 673, Code Sec. 676, Code Sec. 677, or Code Sec. 678. Whether any grantor is treated as an owner of the trust or any portion of it under Code Sec. 675 is a question of fact. Whether any grantor is treated as an owner of the trust or any portion thereof under Code Sec. 674 will depend upon the particular powers of the trustee and may depend upon the proportion of the members of the DDC with authority to act with regard to that trust who are related or subordinate to the grantor.

In addition, the proposed revenue ruling concludes that neither the appointment nor the service of PTC as the trustee of the trusts in which the trustee has the discretionary power to distribute income and/or principal to the grantor’s child or descendants in Situation 1 or Situation 2 will by itself cause the grantor’s transfer to that trust to be deemed to be an incomplete gift under Code Sec. 2511, or any distribution from the trust to be a gift by any DDC member.