Source: https://www.bna.com/plr-sale-remainder-n17179925520/
Timestamp: 2016-12-09 09:45:08
Document Index: 633509466

Matched Legal Cases: ['§2642', '§2642', '§2642', '§7520', '§7520', '§2642', '§2652', '§1361', '§1361', '§1361', '§1015', '§1012', '§1361', '§2511', '§2036', '§ 2036', '§6163']

PLR Sale of Remainder Interest in a Grantor Trust to Another Grantor Trust Will Not Affect Purchasing Trust's ESBT Status; Ruling is Silent on GST Result | Bloomberg BNA
By reason of Internal Revenue Code §2642(e) and §2642(f), it is
difficult to allocate GST exemption either to a charitable lead annuity trust
(CLAT) or a grantor retained annuity trust (GRAT) effectively at the inception
of those trusts.
In the case of a CLAT, §2642(e) states that the percentage of a CLAT
that will be subject to the GST (the "inclusion ration") is equal to
a fraction, the numerator of which is the amount of the GST exemption allocated
to the trust, plus the assumed appreciation under §7520, (currently 1.8%) in
the value of that exemption over the trust term, and the denominator of which
is the actual value of the trust assets at the end of the term. As a result, if
the assets in the CLAT appreciate at a rate significantly in excess of the §7520
rate (which is the objective of almost all CLATs) that appreciation will be
subject to GST tax on the termination of the trust.
Similarly, under §2642(f), GST exemption may not be allocated to a
GRAT1 until the end of the estate tax
inclusion period – or ETIP. Any allocation made at that time must be at the
values in effect at the close of the ETIP, again negating any attempt to
leverage the GST exemption.
Practitioners have suggested various "fixes" for the above
problem, some of which may be summarized as follows:
problem is avoided if the grantor names only his/her children (or their
estates) as the remainder beneficiaries of the CLAT or GRAT. The assets of the trust will be includible in
the child's estate when the child dies.2
A similar result obtains if the child is given a general power of appointment
over the assets in the trust, in default of the exercise of which the assets
will pass to or for the benefit of grandchildren.
less common, and more risky, technique involves planning for a sale by the
child/remainder beneficiary of his or her remainder interests in the CLAT or
GRAT to a generation-skipping trust shortly after the transfer to the CLAT or
GRAT. The actuarially determined value of that remainder interest in the early
years of the trust term should be very low, particularly if the remainder
interest was "zeroed out" for gift tax purposes. When the CLAT or
GRAT terminates, it will distribute its assets to a GST-exempt dynasty trust,
which, by reason of the sale, will be the new remainder beneficiary. There can
be many variations on this technique. For example, the purchasing trust(s)
could be established by the grantor's children for the benefit of the grantor's
grandchildren.3
The problem with the second option, above, is that the IRS has
indicated,4 in a situation in which the remainder
interest was given away to a dynasty trust, rather than sold, that it will not
respect the form of the transaction and will deem that the original transferor,
under §2652, to the CLAT (in that case) will not be changed, except to the
extent of the sales price of the interest, which, as noted above, is likely to
be negligible. Many practitioners believe that the IRS's position is wrong,5 but the cost to the taxpayer of
guessing wrong would be a GST tax due – payable by the trustee from the trust
assets - on termination of (or upon a distribution to skip persons from) the
CLAT or GRAT.
It is clear, however, from the description of the facts and findings
of PLR 201436007, that some taxpayers may be moving forward with the remainder
interest sale technique.
PLR 201436007:
In PLR 201436007, Grantor created TRUST 1 as a wholly owned grantor
trust on an unspecified date. Although it is not stated in the ruling, it is
likely that TRUST 1 was an intentionally-defective grantor trust, and also
likely that TRUST 1 was exempt, by reason of an allocation of the Grantor's GST
exemption, from the generation-skipping transfer tax.
Grantor proposed to create TRUST 2, which also will be a
wholly-owned grantor trust. Grantor proposed to fund TRUST 2 with a
contribution of S corporation stock to TRUST 2 and sell the TRUST 2 remainder
interest to TRUST 1. TRUST 2 will elect to be an electing small business trust
(ESBT) under 1361(e) upon creation. Again, although it is not stated in the ruling, the fact that the
remainder will be sold to TRUST 1 probably indicates that TRUST 2 is a GRAT.
Since both trusts are grantor trusts, there would be no gain on the sale.
Grantor requested and got two rulings regarding the effect of the
sale on TRUST 2's ESBT status:
1. The sale of the TRUST 2
remainder interest to TRUST 1 will not disqualify TRUST 2 from being an ESBT
under §1361(e) during the period when TRUST 1 is a grantor trust as to X
because the sale of the remainder interest is not a "purchase" within
the meaning of §1361(e). [Note that
§1361(e)(1)(A)(ii) states that no interest in an ESBT may be acquired by
purchase.] The sale is not a purchase because a purported sale from one grantor
trust to another is ignored for federal income tax purposes. (Rev. Rul. 85-13,
1985-1 C.B. 184), and because the basis of property acquired by gift is a
carryover basis under §1015(a), and is not governed by §1012(a); and
2. TRUST 2 will not cease to be or fail to qualify as an ESBT after the
termination of TRUST 1's grantor trust status because TRUST 1's acquisition of
the remainder is not a purchase within the meaning of §1361(e).
The PLR does not discuss (and probably was not asked to rule
on) the potential GST implications of the ruling, as described above. However,
the PLR notes, in the customary caveat section, that:* * * Specifically, we
express no opinion regarding the identity of the transferor of the remainder
interest in the S corporation stock to TRUST 2 for purposes of §§2511 and 2652
or the tax consequences of that transfer. In addition, we express no opinion on
whether the S corporation stock will be includible in the gross estate of any
transferor under §2036 or any other provision of the Code.
This indicates that the IRS was at least aware of the probably purpose
of, and the potential for avoidance of the GST tax on termination of TRUST 2
through, the use of the remainder interest sale.
PLR 201436007 does not answer the question of whether the remainder
interest sale technique works to avoid the consequences of Section 2642(e) and
(f). It does, however, indicate that taxpayers are using this technique in a
situation that it would appear to make sense to do so despite the IRS's clear
reluctance to bless it. Because of the risks involved, however, practitioners
and their clients who are inclined to assume them would be well advised to take
To avoid any step transaction assertions, or attempt to collapse the
transaction and treat the grantor of the GRAT as the transferor of the entire value
of the assets in the GRAT, the purchasing trust (the GST-exempt grantor trust)
ideally should be in existence well in advance of any sale to it by the GRAT.
Second, the remainder interest should be transferred by sale, as opposed to
gift, for whatever protection may be achieved via the "bona fide
sale" exception in § 2036 and also to avert an attempt to conflate the
gift to the GRAT and the gift of the remainder interest. The GRAT's spendthrift clause, if any, should
not prevent the assignment of an interest in the trust.
However, even if the technique fails, the tax consequences may not
be disastrous, since the downside risk is the imposition of a GST tax on the
termination of the GRAT (or perhaps on future distributions from the GRAT to
skip persons) vs. an almost certain imposition of an estate tax upon the death
of the grantor's children if they are the remainder beneficiaries. Depending on
(i) the term of the GRAT (or CLAT), (ii) the availability of estate tax
exemption to the child's estate, (iv) the applicability, if any of a state
estate tax (few states imposed GST taxes), and (iii) the age difference of the
grantor and his or her children, and given that there is no longer any
difference in the tax rates for the GST and estate taxes, this may be a
question of timing more than dollar amounts, so what is really at risk may be
Harrington, 850 T.M., Generation-Skipping Transfer Tax, and in Tax Practice Series, see ¶6340,
1 A similar rule would
apply in the case of a gift of a remainder interest in a residence to a
qualified personal residence trust (QPRT) due to the ETIP that applies to those
2 If a child dies during
the trust term, the then value of his or her remainder interest (actuarially
determined) would be includible in the child's estate, although the tax on the
value of that remainder interest could be deferred until the end of the trust
term. §6163.
3 A third option might
be to make sure that there is always a non-skip person (including, perhaps a
charity with a substantial, present, and nondiscretionary right to receive
income or corpus from the trust) as a significant beneficiary of the trust.
See PLR
200107015.
Gopman, Steinberg & Oshins, Ruling on Assignment of Vested Remainder
Interest May Have Reached Wrong Conclusion, 26 Estates, Gifts and Trusts J.
203 (Sept. 14, 2001).