IRS Permits Trust Division Without Adverse Federal Tax Consequences

In Private Letter Rulings 201702005 and 201702006, the IRS favorably ruled on federal tax consequences of a proposed trust division. But for a minor change in facts, the two rulings are identical, so we will focus only on 201702005. Two trusts are involved in the rulng – with each trust to be divided pursuant to state statute and court approval. The trusts involved are irrevocable trusts established for the benefit of the descendants of a child of the settlor (A). A has three adult children (B, C & D) and four minor grandchildren. Income is distributable to A’s children and the descendants of any deceased child of A (although in one trust such descendants are not included). The trustee has authority to withhold income and accumulate it or later pay it out. The trustee may also distribute principal if needed for care, eduation and support beyond what is being satisfied by income distributions. One year after A’s death the trust principal and accumulated income is to be distributed to A’s lineal descendants per stirpes. Proposed new subtrusts will be funded by fractionally dividing the existing trust assets of each trust into 3 new subtrusts, one for each of B, C & D. Trust provisions for the subjtrusts are similar, but not identical to the existing trusts, subject to the siloing of the interests of B, C & D and their descendants into separate trusts so as not to be directly impacted by the exercise of trustee discretion outside of their respective silo. The PLR sought rulings to the effect that (a) the new subtrusts will maintain the “grandfathered” trust status of the predecessor trust for GST purposes, (b) each subtrust will be treated as a separate trust for federal income tax purposes, (c) the division will not cause the predecessor trusts nor any new subtrust to recognize gain or loss from a sale or other disposition of property under Code §§61, 662, or 1001, (d) the subtrusts will inherit the tax basis and holding periods of the predecessor trust as to assets received, (e) the division will not result in any assets of the subtrusts being included in the gross estate of their beneficiaries, and (f) the divisions will not result in transfers subject to gift tax. The IRS favorably ruled on all of the requested rulings…

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