PLR 201207001 - Adding the Power to Remove Trustees, After-the-Fact

February 20, 2012

Highlights

Summary

In PLR 201207001, the Service ruled favorably on the proposed modification of a GST-exempt trust to allow the primary beneficiary, the settlor's son, authority to appoint and replace independent trustees and investment advisors.

Extended Summary

The trust was created prior to September 25, 1985, the effective date of the present generation-skipping transfer tax.

The independent co-trustees had discretion to accumulate income or to distribute income or principal among a class of beneficiaries comprised of the settlor's son, the son's spouse, and the son's descendants. The son had a limited power to appoint the remainder at his death among his descendants. In default of the exercise of that power, the trust was to continue for the benefit of the son's spouse and his descendants until the expiration of a perpetuities period measured from the date the trust was created.

If at any time there were no surviving descendants of the son, then the trust was to continue for the benefit of the settlor's other descendants. At the expiration of the perpetuities period, the remainder was to be distributed per stirpes to the son's descendants, otherwise one-half per stirpes to the descendants of the settlor's other two children.

The trust document provided the son, or if he had died the settlor's surviving children, could appoint a successor trustee if either of the co-trustees resigned. The text of the ruling does not clearly indicate whether the trust document required successor co-trustees be independent of the settlor and of any of the beneficiaries.

The primary asset of the trust was stock in a closely held corporation. The trust document provided that in the event the trustees determined to sell the stock, the corporation would have a right of first refusal to redeem the stock at "net book value."

The son proposed to bring an action in state court to modify the trust in a number of ways:

The situs of the trust would be changed to the state in which the then-acting corporate co-trustee was based, for administrative purposes only. The law of the state in which the trust had been created would continue to control for purposes of determining the validity, construction, and duration of the trust.
A "distribution advisor" would be appointed to advise the trustees on the exercise of their discretion to distribute income or principal, and an "investment advisor" would be appointed to advise the trustees on the exercise of their investment responsibilities. A "trust protector" would be appointed to make administrative changes to the trust from time to time, within stated limits. The settlor's son would be the initial investment advisor and the initial trust protector.
The settlor, the settlor's spouse, the descendants of the settlor, and any "related or subordinate party" with respect to any of these, would not be permitted to act as a trustee or as the "distribution advisor."
Subject to that limitation, the son was given authority to remove and replace any trustee or advisor. If the son died, this authority would be exercised by those individuals in the oldest generation of his descendants who had attained age 25.
The trust definition of "book value" for the purpose of the closely held corporation's right of first refusal was clarified.

The trustees sought rulings and received favorable rulings that the proposed changes would not cause:

the trust to lose its "grandfathered" GST exempt status;
any beneficiary to be treated as having made a taxable gift;
any portion of the trust to be included in the gross estate of any beneficiary for estate tax purposes; and
the trust or any beneficiary to recognize any gain or loss.

With respect to the first of these rulings, the Service determined that the case fell squarely within two examples in Reg. Sec. 26.2601-1(b)(4)(i)(E); Example 4 with respect to the change in situs and Example 10 with respect to purely administrative changes. With respect to the second ruling, the Service determined that the proposed modifications would not affect the beneficial interest of any beneficiary. With respect to the fourth ruling, the Service determined that therefore Cottage Savings would not apply to cause recognition of gain or loss.

With respect to the third ruling, the Service discussed at some length Rev. Rul. 95-58. In that ruling, the IRS yielded to a number of court decisions, which determined a settlor's retained power to remove a trustee and appoint a successor who was not "related or subordinate" to the settlor within the meaning of Section 672(c) would not itself cause trust assets to be includible in the settlor's gross estate under Sections 2036 (retained beneficial interest) or 2038 (retained power to control distributions).

CPC Commentary

The ruling did not specifically state why the son should be treated as the trust settlor for purposes of the Rev. Rul. 95-58 analysis. Presumably, one could argue the son's control through a "related or subordinate" trustee over discretionary distributions to himself might be treated as if he had, in effect, contributed assets to the trust by not receiving distributions. This, however, is stretching the law, as we know it.

Omitted from the discussion, possibly because the trustees did not seek a ruling on the matter, were the questions:

whether the trust document as drafted, prior to the proposed modifications, would have allowed the appointment of a "related or subordinate" successor trustee, thereby possibly causing the trust assets to be includible in the settlor's gross estate under Section 2038; and
whether the proposed modification requiring that a successor trustee not be "related or subordinate" therefore had the effect of terminating a reserved Section 2038 power, possibly triggering a taxable gift by the trust settlor, who was apparently still alive.

We consider this ruling to be important to charitable planners, since it opens the door to add this critical provision at a later point in time, without having adverse income, estate, gift, and GST taxes.