PLR 200944002 (Oct. 30, 2009) is an interesting development at the intersection of estate planning and asset protection planning. The widely accepted back story to the Letter Ruling is that it relates to Alaska asset protection trusts, a topic dear to the hearts of renowned T&E leader Jonathan Blattmachr and his brother Doug, who just so happens to have a Alaska trust company, in case you needed one.
The facts submitted to the IRS were as follows: a Grantor proposed to create a self-settled irrevocable asset protection trust for the benefit of himself, his spouse, and his descendants. A trust company would serve as trustee. The trust provides for distributions of principal and income among the grantor, grantor’s spouse, and grantor’s descendants at the trustee’s “sole and absolute discretion”. Income that is not distributed will be added to principal.
The trust is structured so that the grantor does not have a general power of appointment over trust assets, whether inter vivos or testamentary. At the later of the grantor’s death or the death of the grantor’s spouse, the trust divides into separate trusts for the benefit of grantor’s descendants. The default distribution is to one or more charitable organizations.
The trust provides that neither the grantor, the grantor’s spouse, any beneficiary, any spouse of a beneficiary, nor anyone related or subordinate to the grantor under section 672(c) may be trustee.
The trust is intended to be taxed as a grantor trust, because the trustee is given the power, exercisable in a non-fiduciary capacity, to acquire trust property by substituting assets of equivalent value. The power to substitute assets cannot be exercised in a manner that can shift benefits among the trust beneficiaries.
The trust also contains provisions prohibiting the grantor from serving as trustee, or removing any trustee. The trustee may not pay any income in discharge of grantor’s income tax liability.
The state has an asset protection statute that provides substantially as follows:
…a person who in writing transfers property in trust may provide that the interest of a beneficiary of the trust, including a beneficiary who is the settlor of the trust, may not be either voluntarily or involuntarily transferred before payment or delivery of the interest to the beneficiary by the trustee…if the trust instrument contains this transfer restriction, it prevents a creditor existing when the trust is created or a person who subsequently becomes a creditor…from satisfying a claim out of the beneficiary’s interest in the trust unless …(1) the trust provides that the settlor may revoke or terminate all or part of the trust without the consent of a person who has a substantial beneficial interest in the trust and the interest would be adversely affected by the exercise of the power held by the settlor to revoke or terminate all or part of the trust; (2) the settlor intends to defraud a creditor by transferring the assets to the trust; [or] (3) the settlor is currently in default of a child support obligation by more than 30 days….
(The applicable Alaska statute is here.)
The taxpayer requested two rulings: (1) a completed taxable gift will occur when the grantor makes a contribution to the trust; and (2) no portion of the trust assets will be includible in Grantor’s gross estate.
With respect to the first ruling, the IRS noted Treas. Reg. Sec. 25.2511-2(b), which provides that:
…as to any property, or part thereof, of which the donor has so parted with dominion and control as to leave in him no power to change its disposition, whether for the donor’s own benefit or for the benefit of another, the gift is complete.
It also noted Treas. Reg. Sec. 25.2511-2(c), which provides, in part, that:
…a gift is incomplete in every instance in which a donor reserves the power to revest the beneficial title to the property in himself. 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.
Under the facts of the ruling request, the grantor retained no power to revest beneficial title, and had not reserved any interest to name new beneficiaries or change the interests of the beneficiaries. The IRS ruled, accordingly, that transfers to the trust would be completed gifts.
(So far, so good, right? Step 1 to removing something from the taxpayer’s estate is to get rid of it. The completed gift ruling means the taxpayer is halfway home….)
The IRS then evaluated the question of inclusion under section 2036. The IRS noted Treas. Reg. Sec. 20.2036-1(b)(2), providing that:
…the use, possession, right to income, or other enjoyment of transferred property is treated as having been retained by the decedent to the extent that the transferred property is to be applied towards the discharge of a legal obligation of the decedent
It then discussed Rev. Rul. 2008-16, 2008 I.R.B. 796, which provides that a power to substitute assets in a nonfiduciary capacity will not, by itself, cause inclusion under section 2036 or section 2038, as long as the trustee has a fiduciary obligation under local law to ensure that the substituted assets are in fact of equivalent value, and that the substitution will not shift benefits among trust beneficiaries.
Based on Rev. Rul. 2008-16, the IRS concluded that the trust’s substitution power [i.e., the basis for the trust being taxed as a grantor trust] will not, by itself, cause the value of the trust’s corpus to be includible in the grantor’s gross estate.
The IRS then noted Rev. Rul. 2004-64, which provides that when the grantor pays income tax attributable to the inclusion of the trust’s income in the grantor’s taxable income, the grantor is not treated as making a gift of the amount of the tax to the trust beneficiaries. It cautioned, however, that:
If, pursuant to the trust’s governing instrument or applicable local law, the grantor had to be reimbursed by the trust for the income tax payable by the grantor that was attributable to the trust’s income, the full value of the trust’s assets would be includible in the grantor’s gross estate under § 2036.
If, however, the trust’s governing instrument or applicable local law gave the trustee the discretion to reimburse the grantor for that portion of the grantor’s income tax liability, the existence of that discretion, by itself, whether or not exercised, would not cause the value of the trust’s assets to be includible in the grantor’s gross estate.
Applying these rules to the facts before it, the IRS concluded that “because the trustee is prohibited from reimbursing Grantor for taxes Grantor paid, that Grantor has not retained a reimbursement right that would cause [the trust’s] corpus to be includible in Grantor’s gross estate under [section 2036]….In addition, the trustee’s discretionary authority to distribute income and/or principal to Grantor, does not, by itself, cause [the trust’s] corpus to be includible in Grantor’s gross estate under [section 2036].”
The IRS cautioned that it was “specifically not ruling” on whether the trust was a grantor trust, or whether trustee’s discretion to distribute income and principal (combined with other facts, if any, regarding an understanding or pre-existing arrangement between Grantor and trustee regarding exercise of trustee’s discretion) might cause inclusion under section 2036.
PLR 200944002 is good news for taxpayers and for asset protection planning, because it provides guidance (albeit non-binding) that the corpus of appropriately structured self-settled asset protection trusts will not be per se includible in the settlor’s taxable estate. The letter ruling should not be read too broadly, however, because the IRS left open the possibility that facts and circumstances in any particular situation relating to a self-settled asset protection trust may warrant estate inclusion.