IRS Allows Trust Modification Without Forfeiting Exemption

A Recent Private Letter Ruling By The IRS Concluded That A Modification To A Faulty Fiduciary Provision Did Not Result In A Loss Of The Trust’s Grandfathered Generation Skipping Transfer Exempt Status

The taxpayer who submitted the modifications to the inter vivos trust for an IRS private letter ruling found himself bound a set of unfortunate circumstances. Due to the requirements of the successor trustee and appointment provisions and distribution requirements under the terms of trust, future trustees could not be appointed and distributions could not be made to the beneficiaries of the trust. Essentially the terms of the trust had frustrated the purpose of the trust. The beneficiaries were not benefiting from the corpus of the trust and the future of the trust was at risk.

Satisfying Treasury Regulations

Key to the IRS ruling was the satisfaction of the IRS’s two-prong ‘trust modification safe harbor’ found under Treasury Regulations Section 26.2601-1(b)(4)(i)(D). Under this section, a modification will not violate Generation Skipping Transfer tax-exempt status if it

  1.       Does not shift a beneficial interest in the trust to a beneficiary occupying a lower generation than the person holding the interest under the original trust; and
  2.       Does not extend the period for vesting of any beneficial interest in the trust beyond that provided in the original trust.

As the modifications to the trust provisions did not violate the above two prongs and merely fixed a broken trust without changing the interests of the beneficiaries, the changes were allowed.

The Importance of Private Letter Rulings From The IRS

A private letter ruling is a written statement issued to a taxpayer that interprets and applies tax laws to the taxpayer’s represented set of facts. The IRS does this in response to a written request submitted by a taxpayer. While a private letter ruling officially may not be relied on as precedent by other taxpayers or by the IRS in other private letter rulings, the rulings themselves are often interpreted as official IRS policy and are used as guidance by estate planners and financial advisors. Referring above, in this instance, estate planners gain practical insight into what will satisfy IRS standards for fixing faulty trust mechanisms.

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