Two recent private letter rulings issued by the IRS provide guidance on when changes made to a "grandfathered" trust will cause that trust to lose its exempt status.
Trusts that became irrevocable before Sept. 25, 1985, are exempt from the generation-skipping transfer (GST) tax. These trusts are said to be "grandfathered." Because a trust's exempt status can be very valuable to its beneficiaries, taxpayers are naturally concerned about what changes may be made without causing a loss of the trust's exempt status.
PLR 201422005 involved a testamentary trust established before Sept. 25, 1985. Under the terms of the decedent's will, the trust was to terminate upon the death of the decedent's last living child. Upon termination, the trust was to be distributed equally to each of the decedent's grandchildren who were then living. The trust had been the subject of litigation for many years. The lone surviving child petitioned the state court to dissolve the trust, while some of the grandchildren and great-grandchildren objected. After a series of discussions, negotiations and pleadings, a tentative settlement was reached. The court approved the termination of the trust, with the trust assets being paid to each income beneficiary (including great-grandchildren, who would have received nothing out of the trust's remaining assets under the terms of the will) based on the income beneficiary's actuarial interest in the trust.
The IRS ruled that this modification to the trust's distribution scheme (terminating it early and making distributions out of the residue to the great-grandchildren) would not cause any distributions to be subject to the GST tax. The IRS ruled that the modification fell within the safe harbor of Treas. Reg. Sec. 26.2601-1(b)(4)(i)(B) because the termination agreement represented a good faith compromise between litigating parties.
PLR 201422011 involved a revocable trust that became irrevocable upon the death of the trust's settlor before Sept. 25, 1985. Under the terms of the trust, income was to be distributed equally among the settlor's children and their issue on the principle of representation. Since the settlor's death, a trust company had served as trustee.
The beneficiaries desired greater control over the trust's investments and petitioned the court to modify the trust to establish an investment committee to control the trust's investments. The committee, to be made up of one beneficiary from each of the family's five branches, would have the power to remove and replace the trustee.
The beneficiaries asked the court to modify the trust to allow the trustee to move the trust's situs to another state. The trustee could then elect to have the trust administered under the laws of that state. The proposed modification provided that in no event would the term of the trust continue beyond what would have been permitted had no modification been made.
The IRS ruled that the proposed modifications would not cause the trust to lose its grandfathered status. The modifications were administrative in nature and therefore fell within the safe harbor found in Treas. Reg. Sec. 26.2601-1(b)(4)(i)(D).
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