Content area
Full Text
Grantor trusts are extremely popular devices for family wealth transfers, but a grantor may not always recognize the appeal of paying taxes on trust income that he or she does not receive. This raises the question of how to change a regular trust into a grantor trust after the trust has been executed and is irrevocable and unamendable. The answer is illustrated in Ltr. Rul. 200848017.
Background
In the letter ruling, the grantor created and funded an irrevocable trust for the benefit of the grantor's children. The trust was not a grantor trust.
In accordance with applicable state law, the grantor and all the beneficiaries of the trust proposed to execute a modification of the trust instrument, giving the grantor the nonfiduciary power to reacquire any property contained in the trust by substituting other property of equivalent value. This, the grantor contended, should cause the trust to become a grantor trust, under Section 675(4)(C).
IRS approves conversion to grantor trust
The IRS explained that the power to substitute trust assets for other assets of equivalent value is a grantor trust power under Section 675(4)(C), if exercisable in a nonfiduciary capacity. Whether a power is exercisable in a fiduciary capacity is a factual question to be determined from an examination of all relevant facts and circumstances, and the IRS does not rule on such questions.1 The IRS stated that this modification would create a grantor trust if the facts and circumstances established that the grantor's new power was actually exercisable in a nonfiduciary manner.
The IRS declined to rule on the gift tax consequences of the proposed transaction or of the future exercise of the substitution power. This caveat, however, should cause practitioners little concern, as the creation and exercise of the substitution power would not normally have gift tax consequences, because the exercise of that power does not affect the value of the interests of any of the beneficiaries.
The only situation in which the exercise of the substitution power would create adverse gift tax results involves a beneficiary entitled only to an income or remainder interest. If the trust does not permit the...