office_of_chief_counsel internal_revenue_service memorandum number release date cc ita b05 posts-148290-05 uilc date date third party communication none date of communication not applicable to associate area_counsel thousand oaks small_business self-employed from william a jackson chief branch income_tax accounting subject priority of cert and sll deductions this chief_counsel_advice responds to your request for assistance dated date this advice may not be used or cited as precedent legend taxpayer --------------------- target --------------- year ------- year ------- dollar_figurea -------------------- dollar_figureb ------------------- dollar_figurec ------------------- posts-148290-05 dollar_figured -------------------- dollar_figuree ------------------- issues may a taxpayer net_interest_income against interest deductions in determining the amount of allocable_interest deductions under sec_172 in determining which deductions generate a net_operating_loss do allocable_interest deductions or specified_liability_loss deductions take priority conclusions a taxpayer cannot net_interest_income against interest deductions in determining the amount of allocable_interest deductions under sec_172 allocable_interest deductions take priority over specified_liability_loss deductions in determining which of the two types of deductions generate an nol facts in year taxpayer a corporate taxpayer acquired target in a stock acquisition that qualified as a corporate_equity_reduction_transaction cert within the meaning of sec_172 for year taxpayer reported dollar_figurea of allocable_interest deductions as defined in sec_172 the type of deductions that may generate a sec_172 corporate equity reduction interest loss ceril resulting from a cert in determining its allocable_interest deductions taxpayer netted interest_income against interest_expense without allowing an offset against interest_income taxpayer’s allocable_interest deductions would have been dollar_figureb for year taxpayer also claimed dollar_figurec of deductions that could potentially generate a specified_liability_loss sll as defined in sec_172 for year taxpayer claimed a net_operating_loss nol of dollar_figured taxpayer treated dollar_figurec of the nol as a sll taxpayer treated the remainder of the nol that is dollar_figuree as a ceril taxpayer claims that in determining the portion of an nol that is attributable to sll deductions and the portion that is attributable to allocable_interest deductions the sll deductions take priority law and analysis issue section and code references refer to the internal_revenue_code_of_1986 as applicable to the taxable years at issue a the nol for such taxable_year over b the nol for such taxable_year determined without regard to any allocable posts-148290-05 sec_172 prohibits carrying back a ceril to a taxable_year preceding the taxable_year in which the cert occurs sec_172 defines a ceril with respect to any loss limitation_year as the excess if any of -- interest deductions otherwise taken into account in computing such loss sec_172 defines allocable_interest deductions as deductions allowed under chapter of the code for interest on the portion of any indebtedness allocable to a cert sec_163 generally allows as a deduction all interest_paid or accrued within the taxable_year on indebtedness as indicated sec_172 expressly limits allocable_interest deductions to those deductions that are allowed under chapter of the code the provisions of sec_172 do not state nor do they imply that these deductions should be netted in any manner against any income items such as interest_income and nothing else in the code the legislative_history underlying the cert provisions or any other tax authority suggests that a taxpayer should be allowed to offset the interest that it incurs in a cert against its unrelated interest_income for purposes of determining its allocable_interest deductions under sec_172 indeed allowing such an offset could under certain circumstances allow a taxpayer to completely contravene the carryback restrictions in sec_172 despite having engaged in a highly leveraged cert congress obviously did not intend for such a result consequently taxpayer cannot net its interest_income against its interest deductions for purposes of arriving at the allocable_interest deductions from which its ceril is computed issue sec_172 provides a deduction equal to the aggregate of the nol carryovers and carrybacks to the taxable_year sec_172 generally provides an nol_carryback period consisting of each of the taxable years preceding the taxable_year of the loss and an nol_carryover period equal to the taxable years following the taxable_year of the loss sec_172 requires the entire nol to be carried first to the earliest taxable_year to which it may be carried and then to the extent the nol has not been absorbed by modified_taxable_income in taxable years to which it has already been carried to succeeding taxable years in the carryback and carryover periods sec_172 through h provide exceptions to the normal nol_carryback and carryover periods prescribed by sec_172 sec_172 provides a 10-year nol_carryback period for a sll sec_172 provides that a ceril incurred in any loss limitation_year may not be carried back to a taxable_year preceding the taxable_year in which the cert occurs for this purpose a loss limitation_year posts-148290-05 includes the taxable_year in which the cert occurs and the succeeding taxable years with certain modification sec_2 a corporate taxpayer’s nol for a taxable_year equals the excess if any of the deductions allowed to the taxpayer by chapter of the code over the taxpayer’s gross_income for the taxable_year see sec_172 sec_1_172-2 sec_172 defines a sll as the sum of certain deductions to the extent taken into account emphasis supplied in computing the nol for the taxable_year these deductions include certain sec_162 or sec_165 deductions associated with product_liability and certain deductions attributable to the satisfaction of types of liabilities arising under federal or state law a taxpayer’s sll for a taxable_year cannot exceed the taxpayer’s nol for that taxable_year sec_172 for any loss limitation_year sec_172 defines a ceril as the excess if any of the nol for the taxable_year over the nol for such taxable_year determined without regard to any allocable_interest deductions otherwise taken into account in computing the nol for purposes of sec_172 sec_172 provides that allocable_interest deductions are taken into account last in computing the nol if a taxpayer has gross_income and deductions the deductions may either offset gross_income or to the extent they exceed gross_income generate an nol if the sum of a taxpayer’s sll deductions and allocable_interest deductions exceeds the amount of the taxpayer’s nol it is necessary to determine what portion of each type of deduction is taken into account in computing the nol as previously stated the code generally defines an nol as the excess of allowable deductions over gross_income thus if a taxpayer incurs an nol and one ignores the possible effect of the allowance of one deduction on another deduction or item_of_gross_income the marginal effect of removing a single dollar of any type of deduction results in a one dollar reduction in the nol this holds true for every additional dollar of deduction removed until the entire nol is eliminated in the absence of any explicit ordering rule one might argue that each type of deduction should be allocated pro-rata between offsetting gross_income and generating the nol based on the relative amounts of the deductions sec_172 provides that percentage of taxable_income limitations on certain dividends received deductions as well as certain limitations on dividends_paid deductions on certain preferred_stock are to be disregarded in computing the nol of a corporate taxpayer the limitations on dividends received deductions are also disregarded in computing a corporate taxpayer’s taxable_income if to do so would result in an nol if an additional dollar of deduction causes these limitations on dividends received or paid deductions to no longer apply the marginal impact of that additional dollar of deduction on the taxpayer’s taxable_income and nol may be quite substantial to avoid unnecessary complexity and because it is not germane to the points being made the discussion in the text disregards the possible impact of any dividends received or paid deductions on taxable_income or the taxpayer’s nol posts-148290-05 however to determine the amount of a ceril sec_172 explicitly requires that allocable_interest deductions be taken into account last in computing the nol because allocable_interest deductions must be taken into account last in computing the amount of any nol sec_172 treats the nol as first generated by allocable_interest deductions on the other hand sec_172 defines a sll as the sum of certain deductions to the extent taken into account emphasis supplied in computing the nol for the taxable_year in most situations the service has treated sll loss deductions as taken into account last in determining what portion of an nol qualifies as a sll however in contrast to the explicit ordering rule found in sec_172 the vague directive in sec_172does not require that sll deductions always be taken into account last in determining what portion of an nol qualifies as a sll consequently where a taxpayer incurs an nol and has both allocable_interest deductions and sll deductions giving the allocable_interest deductions first priority in characterizing the nature of the nol gives full effect to and harmonizes both statutory provisions the ordering rule_of sec_172 technically only applies for purposes of sec_172 that is for purposes of defining a ceril rather than for purposes of all of sec_172 because of this one might argue that sec_172 does not prevent treating both allocable_interest deductions and specified_liability_loss deductions as taken into account last in generating an nol however doing so would create a conflict between the sll provisions and the provisions dealing with cerils determining the taxable years to which a loss may be carried constitutes the most importance consequence of classifying a loss as either a sll or a ceril whereas a sll may be carried back up to taxable years preceding the taxable_year of the loss a ceril may not be carried back to any taxable_year preceding the taxable_year in which the cert occurs application of the ceril carryback limitations prohibits nol carrybacks to taxable years to which a sll may be carried it is a longstanding rule_of statutory conduction that every part of a statute must be construed in connection with the whole so as to make all the parts harmonize if possible and give meaning to each 101_us_112 w here possible provisions of a statute should be read so as not to create a conflict 476_us_355 because it is impossible to apply the sll and ceril carryback rules to the same loss interpreting the provisions at issue to allow such a characterization would be incorrect moreover even if we were to find a conflict between the two statutes in resolving that conflict the more specific language of sec_172 and sec_172 controls over the general language of sec_172 unless congress has manifested a contrary aim 79_f3d_1348 2d cir cert_denied 519_us_1028 neither the legislative_history to sec_172 nor the legislative_history to any of the acts dealing with slls discuss the interaction of the sll and ceril provisions here the only evidence of intent must be drawn from the statutory language itself posts-148290-05 based on well-established statutory construction principles we conclude that allocable_interest deductions take priority over sll deductions in characterizing the nature of an nol in martin d ginsburg jack s levin mergers acquisitions and buyouts a transactional analysis of the governing tax legal and accounting considerations vol date the authors discuss an argument similar to that set forth above for treating allocable_interest deductions as taking priority over sll deductions in characterizing nols however the authors also present the following two part alternative argument for treating sll loss deductions as having priority over allocable_interest deductions it can be argued that the sll rules should control because the basic cert limitation rule in code sec_172 which was enacted after the sll rules refers only to the regular 2-year carryback period not to the 10-year carryback rule for slls and the 2-year carryback rule_of code sec_172 expressly incorporates the cert carryback limitation by its opening words except as otherwise provided in this paragraph whereas the 10-year sll carryback rule_of code sec_172 does not expressly incorporate the cert carryback limitation both points imply that congress did not intend the cert rules to limit 10-year sll carrybacks id we find these alternative arguments unpersuasive sec_172 provides the general_rule for the taxable years to which an nol may be carried the remainder of the subparagraphs under paragraph of subsection b of sec_172 except as otherwise provided in this paragraph provide exceptions to the general_rule some of these exceptions are based on the nature of the loss some on the nature of the taxpayer and some on a combination of taxpayer status and the nature of the loss included within these exceptions are the special rules for cerils as well as the exceptions for every other special type of loss including slls the statutory structure is simple a general_rule followed by a list of exceptions the first step to determining the taxable years to which an nol may be carried is to characterize the nature of the nol that is as either a garden variety nol a special type of nol such as a sll or ceril or some combination thereof once this has been done with one primary exception3 sec_172 a - h simply provides rules concerning the taxable years to which the nol may be carried to determine if any portion of an nol should be characterized as anything other than a garden variety nol the code provisions which define the special types of nols control not the provisions that indicate the taxable years to which non-garden variety nols may be sec_172 provides rules defining a special type of nol and the taxable years to which it may be carried back posts-148290-05 carried as previously demonstrated the most logical interpretation of the statutory rules defining cerils and those defining slls indicate that allocable_interest deductions take precedence over sll deductions in characterizing an nol the presence or absence of cross references between the provisions of sec_172 a - h has no relevance to the issue of whether allocable_interest deductions or sll deductions take precedence in determining the character of an nol the ceril carryback and carryover rules expressly incorporate part of the general carry back rule and carryover rule_of sec_172 specifically sec_172 provides that a ceril shall be an nol_carryback and carryover to the taxable years described in subparagraph a except that such loss shall not be carried back to a taxable_year preceding the taxable_year in which the cert occurs the taxable years described in subparagraph a are the taxable years preceding the year of the loss and the taxable years following the taxable_year of the loss sec_172 simply provides an exception to the normal carryback period if the carryback would otherwise be to a taxable_year preceding the year of the cert there will be instances in which it will be permissible to carry a ceril back to taxable years provided for by the general_rule for example a ceril may be carried back to the 2d taxable_year preceding the loss if the loss limitation_year in which the ceril is incurred is the 2d succeeding taxable_year following the taxable_year of the cert because a ceril may only be incurred for the taxable_year of the cert and the two succeeding taxable years and a ceril can never be carried back to a taxable_year preceding the taxable_year of the cert it goes without saying that a ceril may not be carried back to the additional preceding_taxable_years to which a sll may be carried contrary to alternative argument the fact that the ceril carryback rule refers to the general carryback rule in sec_172 and not to the 10-year carryback period for slls has no bearing on the question of whether congress intended for the sll rules or the ceril rules to take priority in characterizing an nol the cross reference in sec_172 to the general_rule of sec_172 might be relevant to the priority of deductions issue if the cross-reference incorporated exceptions to the general_rule other than the ceril exception this is not the case sec_172 does not incorporate any of the exceptions to sec_172 sec_172 does not refer to the opening clause of sec_172 except as otherwise provided in this paragraph it simply provides a general_rule subject_to an exception for taxable years preceding the taxable_year of a cert that cerils shall be carried back and carried over to the taxable years described in sec_172 those taxable years are the taxable years preceding the taxable_year of the nol and the taxable years following the taxable_year of the nol moreover even if the language of sec_172 could be interpreted as including a reference to the opening clause of sec_172 this would not provide a basis for giving sll deductions priority over allocable_interest deductions posts-148290-05 except as otherwise provided in this paragraph includes all of the exceptions to sec_172 including the carryback restrictions on cerils regarding alternative argument that the sec_172 special carryback rule for slls makes no reference to the sec_172 ceril carryback rules has no significance in determining which deductions have priority in characterizing an nol likewise whereas the opening clause of sec_172 may be fairly interpreted to refer to the rules for cerils in sec_172 this opening clause except as otherwise provided in this paragraph refers to all the exceptions to the general_rule of sec_172 we fail to see how alternative argument has any bearing on the deduction priority issue for the reasons set forth above we conclude that allocable_interest deductions have priority over sll deductions in determining the character of an nol because taxpayer cannot net its interest_income against its interest deductions to compute allocable_interest deductions for year taxpayer has dollar_figureb of allocable_interest deductions because taxpayer’s nol for year is only dollar_figured the entire nol constitutes a ceril this writing may contain privileged information any unauthorized disclosure of this writing may undermine our ability to protect the privileged information if disclosure is determined to be necessary please contact this office for our views please call if you have any further questions regarding this advice


internal_revenue_service department of the treasury number release date index number washington dc person to contact telephone number refer reply to cc psi plr-148247-01 date date re legend decedent spouse company date date date date date private letter rulings new trusts testamentary trusts will dear sir this is in response to your letter dated date and subsequent correspondence in which you requested rulings regarding the tax consequences of proposed modifications in the method of removing and replacing the trustees of testamentary and new trusts under sec_2601 sec_2041 and sec_2514 of the internal_revenue_code the facts and representations submitted are summarized as follows decedent died on date under the terms of decedent's will nine testamentary trusts were created for the benefit of decedent's two daughters and seven granddaughters article ix of decedent’s will appointed three individual trustees for these testamentary trusts article xii of decedent’s will deals with the selection and removal of trustees decedent’s will provides that the testamentary_trust created for each of decedent's daughters will continue for the life of each daughter and upon a daughter's death the trust corpus is to be distributed equally to the remaining testamentary trusts and or to the beneficiaries of any testamentary_trust that has terminated each of the seven testamentary trusts created for decedent’s granddaughters will continue for the life of each granddaughter upon a granddaughter's death if a granddaughter is survived by descendants under age the trust property is to be held in further trust and distributed to the granddaughter's descendants free of trust upon turning age if a granddaughter dies without issue then the trust is to be divided and distributed in the same manner as the two testamentary trusts for decedent's daughters under the terms of decedent’s will the trustees are to pay or apply for the benefit of each testamentary trust’s beneficiary so much of the net_income deemed adequate to maintain and support such beneficiary in the standard of living to which such beneficiary is accustomed further where the beneficiary is a minor or a student the trustees shall provide for his or her education as well as maintenance and support the trustees are not authorized to distribute the testamentary trusts’ principal after decedent’s death spouse and decedent’s estate formed company each of the nine testamentary trusts held shares of company stock among other assets prior to date on date the beneficiaries of the testamentary trusts obtained a court order that allowed for the formation of nine new trusts new trusts to hold the stock in company that was held in the nine testamentary trusts the stock in company was transferred to the new trusts and the shareholders of company elected to treat company as a subchapter_s_corporation under sec_1361 the new trusts have since elected to be treated as qualified subchapter_s trusts under sec_1361 the current shareholders of company are daughters granddaughters and the new trusts the court order directing the formation of the new trusts provides that the trustees of the new trusts are the same as the trustees of the testamentary trusts and that the procedures for appointing successor trustees for the new trusts are the same as the procedures for appointing successor trustees for the testamentary trusts the court order further provides that the terms of the new trusts are identical to the terms of the testamentary trusts except to the extent necessary to allow the new trusts to be eligible holders of subchapter_s_corporation stock the court order also provides that all of the net_income of a new trust must be distributed to the lifetime beneficiary of that trust at least annually and the trustees are required to invade principal to the extent that the net_income is inadequate to pay the federal and state income taxes payable by the beneficiary as a result of the inclusion in the beneficiary’s gross_income of income attributable to subchapter_s_corporation stock held in the new trust it has been represented that principal has never been invaded to satisfy a beneficiary’s tax obligation on date spouse and new trusts executed a shareholders’ agreement the terms of the shareholders’ agreement provide for the annual distribution of cash dividends in an amount not less than the product of i the highest marginal tax_rate applicable to individual taxpayers under the code and ii the net_income of company for the preceding fiscal_year it has been represented that the shareholders’ agreement has never been modified the shareholders’ agreement contains provisions requiring successive holders of company stock to be subject_to its provisions on date one of decedent’s granddaughters died without issue pursuant to the terms of decedent’s will and the court order the deceased granddaughter’s new trust and testamentary_trust terminated and the assets were added in equal shares to the eight remaining new trusts and the eight remaining testamentary trusts on date the testamentary trusts’ beneficiaries obtained an order clarifying and interpreting the testamentary trusts’ terms the judicial construction was limited to clarifying the issue of excess annual income and modifications related to the administration of the testamentary trusts the service issued private letter rulings to the testamentary trusts ruling in part that the court construction and modifications did not affect the grandfathered status of the testamentary trusts on date the beneficiaries of the testamentary and new trusts filed a petition seeking to modify the terms of the court order establishing the new trusts and restate article xii of decedent’s will dealing with the selection and removal of trustees the modifications set forth in the petition generally provide in pertinent part as follows instead of three trustees acting for all of the testamentary and new trusts each daughter and granddaughter would be required to select one corporate trustee to act as trustee of her testamentary and new trust in addition each daughter and granddaughter would also have the option to select no more than one individual to act as a trustee for her testamentary and new trust during daughters’ lifetimes the corporate trustee and individual trustee if any of their testamentary and new trusts are required to be the same and the daughters are required to act together to remove these trustees and appoint successor trustees a granddaughter however can act independently in appointing and removing a corporate trustee and an individual trustee if desired to act as trustee or trustees for her testamentary and new trust in addition in the event a granddaughter dies leaving descendants under age the granddaughter may designate an individual or individuals to occupy the position of trust appointor who would have the authority to appoint and remove the corporate trustee and the individual trustee if any for any trust established for these descendants daughters granddaughters and trust appointors are not permitted to select a descendant of decedent or a spouse or former spouse of any descendant of decedent to act as trustee for any trust it has been represented that there have been no additions actual or constructive to the testamentary and the new trusts after date the following rulings have been requested the proposed modifications will not cause any of the testamentary or new trusts or distributions from the testamentary or new trusts to be subject_to the generation-skipping_transfer gst tax the proposed modifications of the testamentary and new trusts will not cause any beneficiary of any of the testamentary or new trusts to be treated as having a general_power_of_appointment with respect to the testamentary and new trusts within the meaning of sec_2041 and sec_2514 ruling - law and analysis sec_2601 provides that a tax is imposed on every generation-skipping_transfer sec_2611 provides that the term generation-skipping_transfer means a taxable_termination a taxable_distribution and a direct_skip section b a of the tax_reform_act_of_1986 the act and sec_26_2601-1 of the generation-skipping_transfer_tax regulations provide that the gst tax provisions of chapter will not apply to any generation-skipping_transfer under a_trust that was irrevocable on date however this exemption does not apply if additions actual or constructive are made to the trust after date sec_26_2601-1 provides that any trust in existence on date will be considered an irrevocable_trust except as provided in sec_26_2601-1 or c relating to property includible in a grantor's gross_estate under sec_2038 and sec_2042 sec_26_2601-1 provides that if an addition is made after date to an irrevocable_trust that is otherwise exempt from the application of chapter by section b a of the act a pro_rata portion of subsequent distributions from and terminations of interests in property held in the trust is subject_to the provisions of chapter sec_26_2601-1 describes constructive additions to trusts in certain situations involving powers of appointment and relief from liability sec_26_2601-1 provides rules for determining when a modification judicial construction settlement agreement or trustee action with respect to a_trust that is exempt from the gst tax under sec_26_2601-1 or hereinafter referred to as an exempt trust will not cause the trust to lose its exempt status the rules contained in sec_26_2601-1 are applicable only for purposes of determining whether an exempt trust retains its exempt status for gst tax purposes the rules do not apply in determining for example whether the transaction results in a gift subject_to gift_tax or may cause the trust to be included in the gross_estate of a beneficiary or may result in the realization of capital_gain for purposes of sec_1001 sec_26_2601-1 provides that a modification of the governing instrument of an exempt trust including a trustee distribution settlement or construction that does not satisfy sec_26_2601-1 b or c by judicial reformation or nonjudicial reformation that is valid under applicable state law will not cause an exempt trust to be subject_to the provisions of chapter if the modification does not shift a beneficial_interest in the trust to any beneficiary who occupies a lower generation as defined in sec_2651 than the person or persons who held the beneficial_interest prior to the modification and the modification does not extend the time for vesting of any beneficial_interest in the trust beyond the period provided for in the original trust sec_26_2601-1 provides that for purposes of sec_26_2601-1 a modification of an exempt trust will result in a shift in beneficial_interest to a lower generation beneficiary if the modification can result in either an increase in the amount of a gst transfer or the creation of a new gst transfer to determine whether a modification of an irrevocable_trust will shift a beneficial_interest in a_trust to a beneficiary who occupies a lower generation the effect of the instrument on the date of the modification is measured against the effect of the instrument in existence immediately before the modification if the effect of the modification cannot be immediately determined it is deemed to shift a beneficial_interest in the trust to a beneficiary who occupies a lower generation as defined in sec_2651 than the person or persons who held the beneficial_interest prior to the modification a modification that is administrative in nature that only indirectly increases the amount transferred for example by lowering administrative costs or income taxes will not be considered to shift a beneficial_interest in the trust in the present case the testamentary and new trusts were created and became irrevocable prior to date and you have represented that no additions actual or constructive have been made to the testamentary and new trusts after that date accordingly the testamentary and new trusts are exempt from the gst tax under sec_26_2601-1 based upon the information submitted and the representations made the proposed modifications are administrative in nature and do not shift a beneficial_interest in any testamentary or new trust to a person or persons who occupy a lower generation as defined in sec_2651 than the person or persons who held the beneficial_interest prior to the modification further the modifications will not extend the time for vesting of any beneficial_interest in the testamentary or new trusts beyond the period provided for prior to the modifications accordingly based upon the information submitted and representations made we conclude that the proposed modifications to the testamentary and new trusts will not constitute an addition to the testamentary or new trusts or otherwise subject those trusts or distributions from those trusts to the gst tax further the proposed modifications will not cause the testamentary or the new trusts to lose their gst tax exempt status ruling law and analysis sec_2041 provides that the value of the gross_estate shall include the value of all property with respect to which the decedent has at the time of his death a general_power_of_appointment created after date or with respect to which the decedent has at any time exercised or released such a power_of_appointment by a disposition which is of such nature that if it were a transfer of property owned by the decedent such property would be includible in the decedent's gross_estate under sec_2035 to inclusive a general_power_of_appointment is defined in sec_2041 as a power that is exercisable in favor of the individual possessing the power his estate his creditors or the creditors of his estate under sec_2041 a power to consume invade or appropriate property for the benefit of the decedent relating to the health education support or maintenance of the decedent shall not be considered a general_power_of_appointment sec_20_2041-1 of the estate_tax regulations provides in part that if under the terms of a_trust instrument the trustee or his successor has the power to appoint the principal of the trust for the benefit of individuals including himself and the decedent has the unrestricted power to remove or discharge the trustee at any time and appoint any other person including himself the decedent is considered as having a power_of_appointment sec_20_2041-1 provides in part that the term general_power_of_appointment as defined in sec_2041 means any power_of_appointment exercisable in favor of the decedent his estate his creditors or the creditors of his estate except i joint powers to the extent provided in sec_20_2041-2 and sec_20_2041-3 and ii certain powers limited by an ascertainable_standard to the extent provided in sec_20_2041-1 a power_of_appointment exercisable for the purpose of discharging a legal_obligation of the decedent or for his pecuniary benefit is considered a power_of_appointment exercisable in favor of the decedent or his creditors sec_20_2041-1 provides that a power to consume invade appropriate income or corpus or both for the benefit of the decedent which is limited by an ascertainable_standard relating to the health education support or maintenance of the decedent is by reason of sec_2041 not a general_power_of_appointment a power is limited by such a standard if the extent of the holders duty to exercise and not to exercise the power is reasonably measurable in terms of his needs for health education or support or any combination of them as used in this subparagraph the words support and maintenance are synonymous and their meaning is not limited to the bare necessities of life a power to use property for the comfort welfare or happiness of the holder of the power is not limited by the requisite standard examples of powers which are limited by the requisite standard are powers exercisable for the holders support support in reasonable comfort maintenance in health and reasonable comfort support in his accustomed manner of living education including college and professional education health and medical dental hospital and nursing expenses and expenses of invalidism in determining whether a power is limited by an ascertainable_standard it is immaterial whether the beneficiary is required to exhaust his other income before the power can be exercised sec_2514 provides for a similar definition of a general_power_of_appointment for gift_tax purposes and sec_25_2514-1 of the gift_tax regulations contains provisions similar to sec_20_2041-1 sec_2514 provides that the exercise or release of a general_power_of_appointment created after date shall be deemed a transfer of property by the individual possessing such power with respect to the testamentary trusts the proposed modifications to article xii of decedent’s will will not cause the testamentary trusts’ beneficiaries to have a general_power_of_appointment over the testamentary trusts because the trustees’ power to distribute net_income from each testamentary_trust to a beneficiary is limited by an ascertainable_standard pursuant to sec_20_2041-1 and sec_25_2514-1 in addition the trustees of the testamentary trusts do not have the power to distribute principal to the testamentary trusts’ beneficiaries accordingly the proposed modifications will not cause the testamentary trusts’ beneficiaries to have a general_power_of_appointment over the testamentary trusts within the meaning of sec_2041 and sec_2514 in the present case the trustees of the new trusts are required to distribute all of the net_income of each new trust at least annually to the trust’s beneficiary in addition they are required to invade principal to the extent that the net_income of the new trust is inadequate to pay the federal and state income taxes payable by the beneficiary as a result of the inclusion in the beneficiary’s gross_income of income attributable to any subchapter_s_corporation stock held in the new trust company’s shareholders’ agreement however was executed on the same day that the new trusts were created and generally provides for annual distributions of cash dividends sufficient to cover the beneficiary’s tax_liability attributable to the income of company in this case the trustees of the new trusts have no discretion over the payment of income further company’s shareholders’ agreement provides for distributions sufficient to cover a shareholder’s tax_liability attributable to their share of company’s income distribution provision and you have represented that the principal of the new trusts has never been invaded to satisfy a beneficiary’s tax obligation accordingly the new trust provision requiring the invasion of principal to pay a beneficiary’s taxes attributable to subchapter_s_corporation stock in a year the new trust’s income is insufficient to satisfy the beneficiary’s tax obligation is ineffective and superfluous provided the distribution provision in company’s shareholders’ agreement remains in effect accordingly provided that the distribution provision in company’s shareholders’ agreement remains in effect and is not modified the proposed modifications will not cause the beneficiaries of the new trusts to have a general_power_of_appointment over their new trust within the meaning of sec_2041 and sec_2514 this ruling is expressly limited to the new trusts during the period company stock is the only s_corporation stock held in each new trust except as expressly provided herein no opinion is expressed or implied concerning the tax consequences of any aspect of any transaction or item discussed or referenced in this letter this ruling is directed only to the taxpayer s requesting it sec_6110 provides that it may not be used or cited as precedent the rulings contained in this letter are based upon information and representations submitted by the taxpayer and accompanied by a penalty of perjury statement executed by an appropriate party while this office has not verified any of the material submitted in support of the request for rulings it is subject_to verification on examination in accordance with the power_of_attorney on file with this office a copy of this letter is being sent to your authorized representative sincerely melissa c liquerman branch chief branch office of associate chief_counsel passthroughs and special industries enclosure copy of this letter for sec_6110 purposes cc


number release date id office uilc cca-825121-09 ---------------- from ------------------- sent tuesday date to ------------------------ cc --------------------------------------- subject re façade easement brief date --------- - here is the statement in the training slides that we prepared on façade easements if during the preceding years a rehabilitation_credit under sec_47 was claimed for the building the amount of the charitable_contribution_deduction must be reduced by the ratio of the sum of the credits over the fair_market_value of the building on the date of contribution or using your language in your email i would just revise it as follows under sec_170 the amount of the charitable_contribution_deduction is reduced by an amount which bears the same ratio as the rehabilitation tax_credits allowed for the preceding tax years over the fair_market_value of the building on the date of the contribution one additional reminder as you know we are finalizing new regulations under sec_1_170a-13 when these regulations become final we will need to revise the façade easement brief to reflect those regulations ---------


internal_revenue_service number release date index number --------------- -------------- ------------------------ --------------------- ------------------------------------ ---------------------------- ------------------------------------- department of the treasury washington dc third party communication none date of communication not applicable_person to contact --------------- id no ----------------- telephone number --------------------- refer reply to cc psi plr-131786-10 date date legend date settlor trust date date spouse a b grandchild grandchild grandchild date child date y individual bank state state law citation -------------------------------------------------------------------------------------------------------- ------------------- ---------------------- ------------------------------- ---------------------- --------------------- --------------- ----------------- ---------------- ------------------------ ----------------------- -------------------- --------------------- -------------------------- ------------------ ----------------- -------------- -------------------------------------- ------------ ------------------------------------------------------ ------------------------------------------------------------------------------------------ ---------------------------------------------- citation ----------------------------------------------------------------------------------------- --------------------------------------------------------------------------------------------------------------------- state law -------------------------------------- -------------------------------------------------------- plr-131786-10 state law state law state law year year date date court ------------------------------------------------ -------------------------------------------------- ------------------------------------------------------------------------ ------- ------- ------------------- --------------------------- ---------------------------------------------------------- dear ------------------------------------------------------ this letter responds to your letter of date and prior correspondence in which you request rulings concerning the federal gift and generation-skipping_transfer_tax consequences of a court-approved settlement agreement among the parties of a_trust on date settlor created trust a revocable_living_trust and further amended it on date settlor died on date at which time trust became irrevocable date is prior to date settlor was survived by his wife spouse and two sons a and b spouse and a are currently living a currently has three children grandchild grandchild and grandchild b died on date survived by a child child who is purported to be b’s biological daughter child was born out of wedlock on date to her mother y pursuant to part and sec_2 of trust upon the death of settlor trust was divided into two separate trusts known as the marital trust and the family_trust the current trustees of trust including the family_trust and the marital trust are spouse individual and bank trust is governed by the laws of state part provides that spouse is to receive the entire net_income of the marital trust at least quarter-annually during her lifetime pursuant to part distributions of principal from the marital trust may be made to spouse in the sole discretion of the trustees other than spouse other trustees to permit spouse to maintain spouse’s standard of living or to relieve any condition of emergency hardship or special need the other trustees may invade the principal of the family_trust if they determine that a distribution to spouse from the marital trust would be impracticable part provides that upon the death of spouse the entire remaining principal of the marital trust is to be distributed to or in favor of such persons including the estate of spouse in such manner and in such proportions in trust or otherwise as spouse may appoint by specific reference to this power in her will any unappointed portion of the principal of plr-131786-10 the marital trust is to be divided and distributed to or held in trust for the benefit of the beneficiaries of family_trust part dollar_figure provides that during spouse’s life payments of income and or principal from the family_trust are to be made to settlor’s grandmother settlor’s mother-in-law and settlor’s sister and the balance of income if any to spouse at least quarter- annually settlor’s grandmother settlor’s mother-in-law and settlor’s sister are deceased accordingly spouse currently receives the net_income quarter-annually from the family_trust upon the death of spouse the trustees are to hold or distribute the entire remaining principal of the family_trust including any amounts distributable to them by reason of spouse’s will and any unappointed portion of the marital trust as follows the trustees are to pay a charity and named individuals amounts as specified in part the remainder is to be divided per stirpes into separate shares for settlor’s issue living on spouse’s date of death each share for a child of settlor is held in a primary trust each share for issue of settlor who is not a child of settlor is held in a secondary trust the beneficiary for whom each trust is created is called the primary beneficiary of his or her respective trust until termination of a primary trust the trustees are to pay the net_income in convenient installments to the primary beneficiary payments of principal may be made to the primary beneficiary at the uncontrolled discretion of the trustees in the event of a condition of hardship emergency or special need upon a primary beneficiary’s death income may be distributed to the primary beneficiary’s surviving_spouse and issue each primary trust is to terminate upon the death of the survivor of the primary beneficiary settlor’s grandmother settlor’s mother-in-law and settlor’s sister upon termination the trustees are to deliver the principal to a class composed of the primary beneficiary’s surviving_spouse and issue as appointed in the primary beneficiary’s will any unappointed portion is to be delivered per stirpes to the issue of the primary beneficiary who survive the primary beneficiary if there are none then the trust estate is to be delivered to the issue of the settlor per stirpes until termination of a secondary trust the trustees are to pay the net_income to the primary beneficiary when a primary beneficiary reaches age the trustees are to distribute one-third of the secondary trust principal to the primary beneficiary at age the trustees are to distribute one-half of the secondary trust principal to the primary beneficiary at age the trustees are to distribute the principal of the secondary trust to the primary beneficiary each secondary trust is to terminate upon the death of the primary beneficiary upon termination the trustees are to deliver the corpus to a class composed of the primary beneficiary’s surviving_spouse and issue as appointed in the primary beneficiary’s will any unappointed portion is to be delivered per stirpes to the issue of the primary beneficiary who survive the primary beneficiary if there are none then the trust estate is to be delivered to the issue of the settlor per stirpes plr-131786-10 part of trust provides that no trust created shall continue for longer than years after the death of the last to die of a class composed of settlor spouse settlor’s children living on date settlor’s grandmother settlor’s mother-in-law and settlor’s sister it is represented that no amendments were made to trust after date and no additions have been made to either the family_trust or marital trust since that date part provides that the trustees have the power in dividing any property into shares or in distributing such shares to divide or distribute in cash in_kind or partly in cash and partly in_kind in such manner as the trustees believe proper and for the purposes of division or distribution to resolve all doubtful questions as to the value of property and to allocate assets among trusts or beneficiaries when an exact division or the distribution or allocation of undivided interests is not practicable or desirable state law defines issue as an individual’s descendant part of trust provides that the term issue shall include any adopted_child of settlor and any person legally adopted by any of settlor’s issue shall be deemed for purposes of the trust agreement to be the issue of his adopting parent including without limitation on the generality of the foregoing for the purpose of determining i the adopted person is the issue or lineal descendant of any other person and ii the issue or lineal_descendants of such adopted person are the issue or lineal_descendants of any other persons a controversy exists between the parties as to whether the term issue includes child for purposes of determining the remainder beneficiaries of trust under state law where an interest vests at the time of the testator’s death the law at the testator’s death applies but the intention of the settlor is paramount in construing a document see citation in cases where the interest is to take effect upon a later event the law at such later time or event is applied see citation trust is silent as to the inclusion of child as settlor’s descendant the trustees assert that the remainder interests of settlor’s issue are all vested interests and that such interests vested upon settlor’s death child was born in state and trust is a state trust so state law applies to determine the legitimacy of child under state law a specific statutory test determines the legal acknowledgment of an illegitimate child this statutory test however has changed over the years since trust was established on date it remains unclear as to which test applies to determine the legitimacy of child the law in effect at the time of settlor’s execution of trust at the time of settlor’s death at the time of the birth of child at the time of b’s death or at some future time eg the death of beneficiaries with intervening life estates plr-131786-10 state law at the time of trust’s execution and at the time of settlor’s death provided for paternity only through a signed and recorded acknowledgement by the man and joined by the mother state law state law in effect at the time of child’s birth provides that a man is considered the natural father of a child born out of wedlock for all purposes of intestate_succession if any of the following occurs a a signed and recorded acknowledgement by the man with the mother b a written request for a correction of certificate of birth or c the man and the child has a mutually acknowledged relationship of parent and child which began before the child became and continued until terminated by the death of either state law in effect at the time of b’s death provides for the same tests under state law but also adds that parentage for purposes of intestate_succession may also be proven by an order of filiation entered by the court or a probate_court determination that the man is the child’s father using the standards and procedures established under the paternity act state law child was born out of wedlock to y b and child submitted to a dna test which concluded that b was the biological father of child b acknowledged child as his child and was involved in child’s life settlor’s spouse cares for child as a grandmother as she does for her other grandchildren b however was not listed on child’s birth certificate and while b joined with y to complete an application_for correction of a certificate of birth for child there is no evidence that the application was submitted for processing nor was a substituted certificate of birth ever issued b is purported to have signed an affidavit of parentage for child affidavit but such affidavit was not dated not notarized and never filed or recorded as required under state law while b and child may have borne a mutually acknowledged relationship of parent and child as set forth under state law it has not been proven by the judicial process b filed a petition for filiation in year but it was dismissed for lack of progress therefore no order of filiation was ever entered b died on date accordingly the legal status of child as b’s child has not been resolved by a court of proper jurisdiction if child is determined to be a descendant of settlor upon the death of spouse child and a would each receive one-half of the remainder of trust per stirpes as set forth in sec_2 of trust a’s children grandchild grandchild and grandchild would each receive a one-sixth share of the remainder after the death of spouse and a if child is determined not to be a descendant of settlor she would receive no interest a would receive the entire remainder for his life and a’s children grandchild grandchild and grandchild would each receive a one-third remainder_interest upon a’s subsequent death child through her counsel has considered the pursuit of litigation to obtain a binding judicially enforceable determination of her paternity because of the sensitive family concerns and spouse’s urging that all parties amicably resolve the disputed issues the parties entered into settlement negotiations in year each of the plr-131786-10 interested parties is represented by legal counsel including any unborn unknown or unascertainable beneficiaries through their guardian ad litem several years later on date the parties reached an agreement settlement agreement concerning the provisions of trust settlement agreement provides that child shall be recognized as the issue of settlor and the issue of b for purposes of trust specifically part of trust is modified as follows descendants of settlor are defined to include his son a the sons of a grandchild grandchild and grandchild collectively a ’s children and individually as a ’s child the daughter of b child all four grandchildren are collectively grandchildren and individually grandchild and the descendants of settlor’s grandchildren all others if any are excluded the settlement agreement also provides that upon the death of spouse the balance of the family_trust not specifically bequeathed to a named charity and certain individuals shall be divided as follows if a and child survive spouse the trustees shall allocate three-fourths of the remainder of the principal to the trust for a and one-fourth of the remainder of the principal to the trust for child if a fails to survive spouse and child survives spouse the trustees shall divide the assets into a sufficient number of shares of equal value to provide one share for each of settlor’s grandchildren who then survive and one share for each of settlor’s grandchildren who has died leaving descendants then living the shares shall be allocated to the trust for child and to the trust for a’s descendants as the case may be if a survives and child fails to survive spouse the trustees shall allocate three-fourths of the remainder of the principal to the trust for a and one-fourth of the remainder of the principal to the trust for child if any descendants of child then survive if none the trustees shall allocate all of the remainder of the principal to the trust for a if neither a nor child survive spouse the trustees shall divide the assets into a sufficient number of shares of equal value to provide one share for each of settlor’s grandchildren who then survive and one share for each of settlor’s grandchildren who has died leaving descendants then living the shares shall be allocated to the trust for child and to the trust for a’s descendants as the case may be moreover under the modifications of trust settlor’s grandchildren will each be entitled to one-third of his or her respective trust at age one-half of the trust at age and the balance of the trust at age as to child’s trust child will receive plr-131786-10 discretionary distributions of income based on a standard defined in the settlement agreement any undistributed_income will be added to principal trust will bear each of the parties’ costs and attorneys fees through the time of the entry of order approving settlement agreement it is represented that settlement agreement is the result of arm’s length negotiations and is intended to avoid further conflicts among the beneficiaries of trust on date state court approved the settlement agreement and issued an interlocutory_order order pending the issuance of a favorable private_letter_ruling from the internal_revenue_service it is represented that an amended settlement agreement will be executed by the parties providing that each of settlor’s grandchildren will have a testamentary general power to appoint the principal of his or her respective trust you have asked for the following rulings the i recognition and treatment of child as lawful issue of settlor for purposes of trust and order ii the exchange of mutual general releases iii the trustees’ use of trust funds from income and principal to pay and reimburse or advance the parties for reasonable and necessary attorneys’ fees and related expenses_incurred and paid to effect the settlement agreement and iv the modified provisions of trust together the proposed modification will not cause trust or family_trust to be subject_to the generation-skipping_transfer gst tax under sec_2601 and family_trust will continue to be exempt from gst tax the proposed modification will not be deemed to result in additions or constructive additions to trust the proposed modification will not give rise to a gift under sec_2501 by the parties to the settlement agreement ruling sec_1 and sec_2601 of the internal_revenue_code imposes a tax on every generation- skipping transfer gst made after date sec_2611 defines the term generation-skipping_transfer as a taxable_distribution a taxable_termination and a direct_skip under a of the tax_reform_act_of_1986 act and sec_26_2601-1 of the generation-skipping_transfer_tax regulations the gst tax is generally applicable to generation-skipping transfers made after date however under b a of the act and sec_26_2601-1 the tax does not apply to a transfer under a_trust as defined in sec_2652 that was irrevocable on date but only to the extent that such transfer is not made out of corpus added to the trust after plr-131786-10 date or out of income attributable to corpus so added sec_26_2601-1 provides rules for determining when a modification judicial construction settlement agreement or trustee action with respect to a_trust that is exempt from the gst tax under sec_26_2601-1 b or b will not cause the trust to lose its exempt status the rules of sec_26_2601-1 are applicable only for purposes of determining whether an exempt trust retains its exempt status for gst tax purposes they do not apply in determining for example whether the transaction results in a gift subject_to gift_tax or may cause the trust to be included in the gross_estate of a beneficiary or may result in the realization of capital_gain for purposes of sec_1001 sec_26_2601-1 provides that a court-approved settlement of a bona_fide issue regarding the administration of a_trust or the construction of terms of the governing instrument will not cause an exempt trust to be subject_to the provisions of chapter if -- the settlement is the product of arm’s length negotiations and the settlement is within the range of reasonable outcomes under the governing instrument and applicable state law addressing the issues resolved by the settlement a settlement that results in a compromise between the positions of the litigating parties and reflects the parties’ assessments of the relative strengths of their positions is a settlement that is within the range of reasonable outcomes sec_26_2601-1 provides that a modification of the governing instrument of an exempt trust including a trustee distribution settlement or construction that does not satisfy sec_26_2601-1 b or c of this subsection by judicial reformation or nonjudicial reformation that is valid under applicable state law will not cause an exempt trust to be subject_to the provisions of chapter but only if the modification does not shift a beneficial_interest in the trust to any beneficiary who occupies a lower generation as defined in sec_2651 than the person or persons who held the beneficial_interest prior to the modification and the modification does not extend the time for vesting of any beneficial_interest in the trust beyond the period provided for in the original trust trust was created and irrevocable before date it is represented that no additions constructive or actual have been made to trust after that date consequently trust is currently exempt from gst tax in this case each party was represented by legal counsel the prospective beneficiaries had distinct and adverse economic and administrative interests some of the parties wanted to pursue litigation to resolve the issues settlement negotiations were carried out over several years until settlement agreement was reached the parties have obtained court approval of settlement agreement pending the issuance of this private_letter_ruling plr-131786-10 we conclude that settlement agreement constitutes a settlement of bona_fide issues regarding the administration of trust or the construction of the terms of trust we also conclude that the terms of settlement agreement are the product of arm’s length negotiations and represent a compromise that reflects the parties’ assessments of the relative strengths of the positions of the family lines of a and b further the terms of settlement agreement are within the range of reasonable outcomes under the governing instrument and the applicable state law addressing the issues resolved by settlement agreement in the instant case the modification of trust provides that the trust principal of a_trust for the benefit of grandchild grandchild grandchild or child that would otherwise pass down to his or her respective descendants by representation on termination prior to a primary beneficiary’s receipt of the entire principal will be subject_to a testamentary general power to appoint the principal of his or her trust accordingly the assets of a_trust for the benefit of grandchild grandchild grandchild or child will be included in the respective primary beneficiary’s gross_estate for estate_tax purposes under sec_2041 further grandchild grandchild grandchild and child will each be treated as the transferor of the trust principal for gst tax purposes under sec_2652 accordingly based on the facts submitted and the representations made we rule as follows the i recognition and treatment of child as lawful issue of settlor for purposes of trust and order ii the exchange of mutual general releases iii the trustees’ use of trust funds from income and principal to pay and reimburse or advance the parties for reasonable and necessary attorneys’ fees and related expenses_incurred and paid to effect the settlement agreement and iv the modified provisions of trust together the proposed modification will not cause trust or family_trust to be subject_to the generation-skipping_transfer gst tax under sec_2601 and family_trust will continue to be exempt from gst tax the proposed modification described in the settlement agreement as amended will not be deemed to result in additions or constructive additions to trust ruling sec_2501 imposes a tax for each calendar_year on the transfer of property by gift during such calendar_year by any individual sec_2511 provides that the tax imposed by sec_2501 applies whether the transfer is in trust or otherwise direct or indirect and whether the property transferred is real or personal tangible or intangible sec_25_2511-1 of the gift_tax regulations provides that as to any property or part thereof or interest therein of which the donor has so parted with plr-131786-10 dominion and control as to leave in him or her no power to change its disposition whether for his or her own benefit or for the benefit of another the gift is complete but if upon a transfer a donor reserves any power over its disposition the gift may be wholly incomplete or may be partially complete and partially incomplete depending upon all the facts in the particular case sec_25_2511-1 provides that any transaction in which an interest in property is gratuitously passed or conferred upon another regardless of the means or device employed constitutes a gift subject_to tax whether an agreement settling a dispute is effective for gift_tax purposes depends on whether the settlement is based on a valid enforceable claim asserted by the parties and to the extent feasible produces an economically fair result see 674_f2d_761 9th cir thus state law must be examined to ascertain the legitimacy of each party’s claim a settlement that fairly reflects the relative merits and economic values of the various claims asserted by the parties and reaches a settlement that is within a range of reasonable settlements will not result in a transfer for gift_tax purposes as discussed above settlement agreement represents the resolution of a bona_fide controversy between the family lines of a and b all interested parties who hold or may hold an interest in trust including any minors and any unborn unknown or unascertained heirs have been represented in the proceedings that culminated in the date court order approving settlement agreement further based on the facts as presented the terms of settlement agreement are the product of arm’s length negotiations among all the interested parties we conclude that settlement agreement as amended to grant each of settlor’s grandchildren a testamentary general power to appoint his or her respective trust property reflects the rights of the parties under the applicable law of state that would be applied by the highest court of state accordingly based on the facts submitted and representations made we rule that implementation of settlement agreement as amended will not result in a gift under sec_2501 by the parties to the settlement agreement further under the circumstances grandchild grandchild grandchild and child will not be treated as making a gift_for purposes of sec_2501 if on termination of a primary beneficiary’s trust the primary beneficiary holds a testamentary general power to appoint trust property from his or her respective trust except as expressly provided herein no opinion is expressed or implied concerning the tax consequences of any aspect of any transaction or item discussed or referenced in this letter this ruling is directed only to the taxpayer requesting it sec_6110 of the code provides that it may not be used or cited as precedent plr-131786-10 in accordance with the power_of_attorney on file with this office a copy of this letter is being sent to your authorized representative the rulings contained in this letter are based upon information and representations submitted by the taxpayer and accompanied by a penalty of perjury statement executed by an appropriate party while this office has not verified any of the material submitted in support of the request for rulings it is subject_to verification on examination sincerely james f hogan chief branch office of associate chief_counsel passthroughs and special industries enclosures