Selecting A Trustee

Posted by McCullough

If you are choosing a trustee for a dynasty trust, an asset protection trust, or a trust used to establish residency in a certain jurisdiction, then you better pick a corporate trustee or a professional trustee. Even if they don’t provide a lot of services, their fees are justified by their credibility if the trust is attacked, by their independent approval of related party transactions, and by the cost of their malpractice insurance. The IRS and the courts have busted many a trust by proving that the trustee was a straw man and the trust was a sham. (See Sparkman v. Commissioner, 509 F. 3d 1149 (C.A. 9, Dec. 10, 2007)).

If you are selecting a trustee to administer your family living trust, the analysis is different. You have the option of picking a family member, friend, CPA, or a professional trustee. I usually recommend a professional trustee because they are qualified, experienced, capable, unbiased, and they have the time and energy to get the work done. But most people ignore my advice and appoint a family member who has no qualifications, no experience, no independence, no time, and no desire to serve in that capacity. Most people pick a family member in order to save money, failing to factor in the cost of probate litigation, restraining orders, and strategic warfare among their heirs when the estate is administered by a family member.

Being chosen as an executor or trustee is a lot like being asked to referee a church basketball game. You have little to gain, and no matter how hard you try, you will probably be disliked, accused of being unfair and incompetent, and you will probably find yourself in the middle of a melee. I have personally played in a game that involved six technical fouls, two ejections, and a chipped tooth. The referees were atrocious, but, most importantly, we won the game.

These are some factors to consider in selecting a trustee:

Someone who is honest and trustworthy. If they have deep pockets, you have greater assurance they won’t steal or your money and leave you without recourse.
Someone who is qualified and capable. It helps if they have accounting skills, investment experience, and some business savvy.
Someone who is organized, responsible, and capable of decent record keeping.
Someone who is fair, unbiased, and a good communicator.
Someone in your geographic vicinity.

The Case for Specialization (and deep powder)

Posted by McCullough

Last Saturday I went snowcat skiing with my dad and my brother. We had a marvelous time. But the most impressive part of the day was watching the guides who led us to the steepest and deepest powder runs while avoiding the dangers all around us. The guides have years of experience on the same mountains and they know exactly where the best powder is found and how to avoid the avalanches and other dangers which were apparent all around us. All day the snowcat climbed up ridges no wider than the snowcat itself with thousand foot drops on both sides. We skied along narrow ridges where the guides insisted that we stay directly on their tracks to avoid collapsing the rims on either side. In one large bowl thousands of yards across, the guides showed us how there was avalanche danger on the right, icy crusty snow on the left, and one perfect powder run down the middle. They had us ski between the tracks of one guide on the right and the tracks of another on the left so we could take advantage of the lightest and deepest powder the mountain had to offer.

asset protection ski — Powder skiing photography by John Dougall

These guides did not rely on generalized weather reports or general backcountry experience. They were focused on the specific conditions of each particular hillside at each specific moment in time. They knew which slopes got the most sun, which got most wind, which got the most snow, and how this would affect the safety and enjoyment of the skiers at any particular time. Because of their specific knowledge, they were able to provide a safer and better experience than we could ever do for ourselves.

This same principal applies equally well in many fields. I keep a specialist file in my office with the name and contact information of people who are the very best in their field of specialization. So if you ever need an expert in municipal bonds, or the taxation of stock options, or mediation, or bankruptcy (hopefully not), let me refer you to a specialist. By focusing on one specific area, a specialist can stay up on the latest developments, dangers, strategies and ideas. Just like the ski guides, we can show you where the dangers are, and where the good stuff can be found.

Living on the Edge

Posted by McCullough

Gooseberry Mesa is the greatest mountain bike trail on earth The trail involves sweet single track, endless slick rock playground, and breathtaking views. If you look east, you see the imposing cliffs of Zion National Park If you ride along the south or north edges of the mesa, the trail skirts sheer cliffs dropping hundreds if not thousands of feet to the valley floor At the end of the mesa is a narrow neck of rock, forty feet wide with a trail down the middle and cliffs on both sides Finally, the rock ends with sheer cliffs dropping off in front of you and on both sides A trip to Gooseberry Mesa is exhilarating, and refreshing to the soul.

The trail keeps you close enough to enjoy the view, but never puts you in danger of falling off the edge This is a good analogy for those of you who like to live on the edge I have many clients who get involved in aggressive tax planning, speculative investments, or high risk businesses Some push the limits too far and get burned; others live to play another day Sometimes it is luck that makes the difference; other times, a person is protected by taking precautionary measures that limit their exposure I recommend the following precautionary measures:

First, “Where no counsel is, the people fall: but in the multitude of counsellors there is safety” (Proverbs 11:14) A really good CPA not only helps you take advantage of every opportunity, but he also knows where to draw the line and when to push back when you get too greedy Before taking the plunge on a risky deal, I suggest you get several independent opinions from well qualified counselors.

Second, “He that maketh haste to be rich shall not be innocent” (Proverbs 28:20) If it sounds too good to be true, it probably is If it is that good, it is worth taking the time for some advance planning and due diligence.

Third, “He that walketh with wise men shall be wise: but a companion of fools shall be destroyed” (Proverbs 13:20) More important than any legal documents, tax opinions, or pro forma projections, is the character of the promoters.

Remember, a fine day at Gooseberry Mesa is made better by the fact that you are likely to survive, to do it again.

Death Hollow and Doing Difficult Things

Posted by McCullough

My dad has been a scoutmaster all his adult life. He has done 7 or 8 camping trips every year for over thirty years. I asked him once, “What is the most memorable scout trip you ever did?” He said the most memorable trip was Death Hollow because it was the most difficult. He said that those who went will never forget it as long as they live.

And so it was, in June of 2007, that I took 22 boys and 9 men to a place called Death Hollow. This is a deep, beautiful canyon, 33 miles long, and filled with obstacles of every kind. Can you imagine hiking through thick forest with no trail, sandy riverbeds, endless cactus fields, deep narrows full of choke stones, beaver dams, swimming holes, waterslides, and lots of poison ivy, all in one trip?

The canyon changes every year depending on the water flows. We took plenty of water for the first 11 miles, expecting to refill at a well marked spring. But in June of 2007, the canyon was burning hot, and the spring was dry. We all suffered from severe dehydration, but most of the boys made it to flowing water at the 13 mile mark. I was with a small group that collapsed from dehydration. We found a small pool of dirty water with a dead bird in it. We filtered the water many times and attempted to drink. But my body was so dehydrated I threw it up. Six times I tried to drink and threw it up. I knew I desperately needed water, but my body wouldn’t take it. I thought I was going to die. I prayed with a desperation and sincerity I never felt before in my life. It was a long night, but I did finally keep the water down and recover my strength.

deathhollow-1 deathhollow-2

In the morning we joyfully reunited with our friends and continued on our way. The rest of the trip was challenging, adventurous, and thoroughly enjoyable. We cherish the memories of Death Hollow the same way my dad’s troop did. In fact, we came up with a new motto for our troop, “We do difficult things.”

It is no coincidence that the most difficult things in life are often the most rewarding. The best business advice I ever heard is to find the thing that is so difficult that no one else wants to do it, and master that thing, and this will make you valuable.

My accounting professors at college said that the most complicated parts of the Internal Revenue Code are partnership special allocations and the generation-skipping transfer tax. I made a special effort to learn these provisions and I found that this made me valuable at work because I knew things that were useful, but very few were willing to learn.

If I stay in my comfort zone, I am no more valuable to others tomorrow than I am today. But if I take on the difficult process of continual education and improvement, I increase my ability to help myself and others. I believe this applies in many fields of endeavor. I suggest that you adopt our troop motto, “We do difficult things.” Look around for difficult challenges that will stretch your capacity, and then do it and see what it does for you. If you are unable to find a difficult challenge, we are planning another trip to Death Hollow this year, and you are welcome to come along!

deathhollow-3 deathhollow-4

How to Avoid a Piercing of Your Corporate Veil

Posted by McCullough

If you have one or more corporations or LLCs, this subject should be of importance to you. The general rule in every state is that a creditor of a corporation or LLC cannot reach the assets of the owners unless the owners have signed a personal guarantee, or unless the creditor can pierce the corporate veil.

Courts in every state generally uphold the liability protection offered by a corporation or LLC, and they rarely are willing to pierce the corporate veil. A two-part test has been developed by the Utah Supreme Court to assist in determining when to disregard a corporation or LLC.　”[I]n order to disregard the corporate entity, there must be a concurrence of two circumstances: (1) there must be such unity of interest and ownership that the separate personalities of the corporation and the individual no longer exist, viz., the corporation is, in fact, the alter ego of one or a few individuals; and (2) the observance of the corporate form would sanction a fraud, promote injustice, or an inequitable result would follow.” (Envirotech Corp. v. Callahan, 872 P.2d 487, 499 (Utah App. 1994)).

There are slight differences from state to state, but courts will typically look at the following factors to determine if a corporate veil can be pierced: (1) is there commingling of funds between the entities, (2) is the management the same, (3) is the ownership the same, (4) do the entities have separate bank accounts and accounting records, (5) do the entities have their own operating agreements, (6) is their a unity of purposes, assets, or operations, (7) does one entity exert dominion over the other, (8) is the entity undercapitalized for its operating needs, (9) is there a failure to fulfill corporate formalities, etc.

After reviewing applicable case law, the following are my tips to avoiding a piercing of your corporate veil:

Each entity should have its own bank account, keep its own accounting records, collect its own income, and pay its own bills. It is possible to have another entity provide management services (such as collecting income and paying bills) if a written management agreement is in place and if proper allocations and reimbursements are made.
Corporations should have an updated corporate book with bylaws, organizational meeting minutes, a stock ledger, updated stock certificates, and minutes of annual meetings of shareholders and directors. LLCs should have an operating agreement and they may strengthen their position by having resolutions or minutes of manager meetings although these are not required. Entities must be operated in accordance with the rules set forth in the bylaws or operating agreement.
Related party transactions should be documented with written leases, promissory notes, purchase agreements, etc, and the terms should be typical of an arms-length transaction.
Different entities should have differences in the identify of their officers, directors or managers. In a family setting, you could have one spouse manage one entity and another spouse manage another entity. After all, who could argue that a husband and wife have such a unity of interest that the separate personalities no longer exist and one is the alter ego of the other?
Any use of assets, employers or resources of one entity by another entity should be compensated or reimbursed.
Each entity should have sufficient capital to meet its operating needs.
Each entity should have its own assets and resources which are allocated to its independent purposes.
Most entities should have an annual meeting with an outside CPA and attorney to discuss tax and business planning issues, update corporate documents, review buy sell agreements and leases, check on asset titles and corporate renewals, and review the factors necessary to avoid a piercing of the corporate veil.

How to Protect Your Home

Posted by McCullough

For most of us, protecting our home is paramount. We do this through the acquisition of homeowners insurance, fire insurance, flood insurance, personal liability insurance, burglar alarms, fire alarms, frightening dogs, and an assortment of high powered weapons. In addition to all the above, you should consider legal asset protection planning for your home.

I have a client who works in a high risk occupation. My client has a recurring nightmare that he will incur serious personal liability and have a sheriff come to his house with a judgment in hand, kick his family out, and attempt to take furnishings or other personal items from the house to satisfy the judgment. He wants to be sure that his wife and children don’t experience this kind of invasion of their peace, privacy and personal belongings, but what are his options?

These are a few of the common strategies for protecting a home:

Using Mortgages and Liens

Some people keep enough debt on the home so there isn’t much equity for a creditor to attack. A lack of equity may deter a creditor, but it results in a significant interest expense Others sign up for a home equity loan that results in a lien for the full amount of the credit line even if they don’t borrow any money. This gives the appearance of low equity, but it is only a smokescreen It may deter a lazy creditor, but it also may fail if a creditor discovers that no funds have been borrowed and there is equity in the home.

Separate Property Ownership for a Safer Spouse

If a couple has a safer spouse who is not likely to be sued, it is possible for the couple to sign a legal agreement whereby they agree to own property separately. If the couple has signed a prenuptial agreement, or a post-marital separate property agreement, the creditors of one spouse should not be able to reach the separate property of the other spouse (see Lakeside Lumber Products vs. Evans under “Important Articles, Cases and Rulings” on my website). This can be a safe and convenient strategy, and it allows a couple to retain all the tax advantages of home ownership. The only disadvantages are the risk of a suit against the safer spouse, and the risk in some states that you could be left at a disadvantage in the event of a divorce.

Using an Irrevocable Trust

The advantages of transferring a home to an irrevocable trust are: (1) the assets can be protected from the creditors of both spouses, (2) the couple can retain the tax advantages of home ownership, (3) the trust can serve other important purposes such as avoiding probate, avoiding estate taxes, and transferring assets to heirs according to your wishes. The disadvantages of an irrevocable trust include: (1) cost and complexity, (2) possible difficulty in later refinancing the home, and (3) the transfer must occur far before trouble occurs so it is not deemed to be a fraudulent transfer.

Renting from a Safer Entity

If you don’t own something, your creditors can’t take it away from you. I have some clients who rent their furnished house from a friendly landlord to ensure that the assets are protected from creditors. The obvious risk is that the landlord could kick you out, or he could jeopardize the home due to his own liabilities. It is best to structure a protected entity to own the home and collect rent from you for your future benefit. By paying full rental value for your home and personal property, you can transfer additional funds into a protected entity This option requires some cost, complexity, and tax planning, but if properly designed and managed, it can provide phenomenal peace of mind.

Tax Planning for Business Opportunities

Posted by McCullough

I am an amateur outdoor photographer. To me, photography is all about capturing the opportunities when they come and before they leave To get the perfect photo, you simply have to be in the right place at the right time Consider the following photos:

I have been to these places many times when the colors weren’t as brilliant, or the water wasn’t flowing, or the light wasn’t just right These photos are as good as they are because I was lucky to be in the right place at the right time.

Business opportunity planning is similar, in that you try to transfer a business to a Dynasty Trust or a Roth IRA at just the right time.

Consider these examples:

1. A young software developer established and funded a Self-Directed Roth IRA when his income was low enough for him to qualify, and at a time when he had an opportunity to purchase stock in his company for a very low price The Roth IRA bought the stock, the value grew exponentially, the company was sold, and the young guy walked away with $700,000 in a Roth IRA, never to be subject to income tax! That is what we call business opportunity planning.
2. One of my clients owned a huge commercial real estate center At a perfect time when values and interest rates were low, he sold the real estate to a Dynasty Trust Now he is 85 years old and he has $200,000,000 in a Dynasty Trust that can pass to future generations without estate tax.

Neither of these examples required a bending of the rules Both were made possible by a convergence of good timing, good thinking, and a quick and decisive response Both are very applicable to current conditions Right now we have historically low market values, historically low interest rates, and the opportunity for people of any income level to convert to a Roth IRA Now all you need is a legitimate and reliable once-in-a-lifetime business opportunity!

Advance Planning for the Sale of a Business

Posted by McCullough

The best way to prepare for the sale of your business is to sell your stock to a grantor trust (often called a Dynasty Trust) In addition to other benefits, this will protect the appreciation of your stock from estate taxes as well as other potential creditors

If you want to provide incentive to key employees by promising them a portion of the proceeds from a sale of the business, a “profits interest” may be the most tax efficient way to do it A “profits interest” is simply an interest in the future profits of a partnership without any current equity or liquidation rights A profits interest can be granted without any income tax affect and it can allow an employee to receive long-term capital gains from the proceeds of a sale A profits interest can be designed with any kind of limits, restrictions, adjustments, vesting schedules or other specific features.

If you give an employee a bonus plan, this will result in ordinary income and employment taxes to the employee If you give an employee stock, this is ordinary income to the employee when it is received If you give an employee stock options, this will create ordinary income to the employee when the options are granted, or when they vest Incentive stock options result in AMT income instead of ordinary income, but the end result is almost equally negative Also, most of these options can’t be undone if the employee is terminated.

Consider this example of a profits interest Assume that you give your key employee a profits interest defined as 10% of the proceeds from the sale of the business, but only to the extent the proceeds exceed the current business value of $10,000,000, and only if the employee is not terminated for cause before the sale If the business sells for $15,000,000, the employee will receive $500,000 as a long term capital gain and pay $75,000 in taxes (using the current 15% federal rate) If the employee had received the same $500,000 as ordinary income, the employee would have paid $175,000 in taxes (assuming a 35% federal rate).

On the other hand, a sale to a grantor trust for an employee can accomplish the same result as a profits interest, with even greater control and flexibility And a sale to a grantor trust works just as well with a corporation as it does with a partnership or LLC If you are starting to get the impression that I attempt to solve all of life’s problems with a grantor trust, you may be on to something I haven’t found too many problems that can’t be solved with fresh air, duct tape, or a grantor trust!

Tax Planning for Loans to Children

Posted by McCullough

Many of my clients make occasional loans to their children. A few of these loans have actually been repaid, or at least partially repaid.

The problem is that if you make a loan to your child for his new business, and the child’s new business experiences temporary or permanent financial losses, the child can’t take a deduction for the loss because the child has no basis and no income, and you only get a capital loss that can only be offset against capital gains.

A better approach may be to establish a partnership with your child and file it as an LLC. Then you contribute cash to the LLC instead of loaning the money to your child. If you include special allocations language in the LLC providing that all losses are allocated to the partners according to their tax basis, then you get to take 100% of the losses as a business loss which you can offset against ordinary income (subject to passive activity limitations).

If you loan $200,000 to your child and suffer a total loss, the difference between a capital gain and ordinary income could be 20%, or $40,000.

So before you plow ahead with a loan to your child, you should consult with your tax advisors and see if a better structure will give you additional tax benefits. Who knows, maybe you will be lucky and your tax advisor will talk you out of making the loan altogether!

Self Settled Trust not Included in Taxable Estate

Posted by McCullough

PLR 200944002

PLR 200944002 Completed Gift Not in Estate

Dear * * *:

This responds to your authorized representative’s letter of January 15, 2009, requesting gift and estate tax rulings with respect to a trust.

The facts and representations submitted are as follows: Grantor proposes to create an irrevocable trust (Trust) for the benefit Grantor, his spouse and descendents. Trust will be initially funded with $X. Trust Company will serve as trustee.

Article Second, paragraph A of Trust provides, in part, that trustee will pay over the income and principal of Trust in such amounts and proportions as trustee in its sole and absolute discretion may determine for the benefit of one or more members of the class consisting of Grantor, Grantor’s spouse and Grantor’s descendants. Any income not paid will be accumulated and added to principal.

Under the terms of Article Second, paragraph B, upon termination of trust, no part of the income or principal of Trust may be transferred or paid to Grantor, Grantor’s estate, Grantor’s creditors or the creditors of Grantor’s estate. Article Second, paragraph B, also provides that upon the death of Grantor and Grantor’s spouse, the entire principal together with any accrued income shall be distributed to any descendant of Grantor then living to be held in separate trusts. If there is no descendant then living, the principal and income shall be disposed of in accordance with the terms and conditions of Article Fourth, which provides that the property shall be transferred, conveyed and paid over to one or more organizations described in §§ 170, 2055 and 2522 of the Internal Revenue Code.

Article Eighth, paragraph B, provides that the following persons may not be a trustee of Trust or any other trust created under trust: (1) Grantor; (2) the spouse or a former spouse of Grantor; (3) any individual who is a beneficiary of Trust or a trust created under Trust; (4) the spouse or a former spouse of a beneficiary of any trust hereunder; (5) anyone who is related or subordinate to Grantor within the meaning of § 672(c).

Article Eleventh, paragraph B, provides Grantor with the power, exercisable in a nonfiduciary capacity, without the approval or consent of any person in a fiduciary capacity, to acquire property held in the trust by substituting other property of an equivalent value. Grantor will exercise the power by certifying in writing that the substituted property and the trust property for which it is substituted are of equivalent value and Trustee shall have a fiduciary obligation to ensure Grantor’s compliance with the terms of the power to substitute property. Before the substitution of property is completed, the trustee must be satisfied that the properties acquired and substituted are in fact of equivalent value. In addition, the power can not be exercised in a manner that can shift benefits among the trust beneficiaries.

Article Twelfth, paragraph B, provides that Grantor may not be a trustee of Trust or remove any trustee of trust. Article Twelfth, paragraph D, provides that trustee shall not pay Grantor or Grantor’s executors any income or principal of Trust in discharge of Grantor’s income tax liability. Trustee is not a related or subordinate party within the meaning of § 672(c).

Grantor is a resident of State and the situs of Trust is State. State Statute provides that 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. Under State Statute, 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; (3) the settlor is currently in default of a child support obligation by more than 30 days; or (4) the trust requires that all or a part of the trust’s income or principal, or both, must be distributed to the settlor.

You have requested the following rulings:

1. A completed taxable gift will occur when Grantor makes a contribution to Trust.

2. No portion of Trust’s assets will be includible in Grantor’s gross estate.

RULING 1

Section 2501 provides that a tax, computed as provided in § 2502, is imposed for each calendar year on the transfer of property by gift during such calendar year by any individual, resident or nonresident.

Section 2511(a) provides, in part, that subject to limitations contained in chapter 12, the tax imposed by § 2501 shall apply whether the transfer is in trust or otherwise, whether the gift is direct or indirect, and whether the property is real or personal, tangible or intangible.

Section 25.2511-2(b) of the Gift Tax Regulations 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.

Section 25.2511-2(c) 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.

In this case, Grantor has retained no power to revest beneficial title or reserved any interest to name new beneficiaries or change the interests of the beneficiaries. Consequently, we conclude that Grantor’s transfer of $X to trust will be a completed gift of $X.

RULING 2

Section 2036(a)(1) provides that the value of the gross estate shall include the value of all property to the extent of any interest therein of which the decedent has at any time made a transfer (except in the case of a bona fide sale for an adequate and full consideration in money or money’s worth), by trust or otherwise, under which the decedent has retained for life or for any period not ascertainable without reference to the decedent’s death or for any period that does not in fact end before death the possession or enjoyment of, or the right to the income from, the property.

Section 20.2036-1(b)(2) of the Estate Tax Regulations provides 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.

Rev. Rul. 2008-16, 2008 I.R.B. 796, provides guidance regarding whether the corpus of an inter vivos trust is includible in the grantor’s gross estate under § 2036 or § 2038 if the grantor retained the power, exercisable in a nonfiduciary capacity, to acquire property held in the trust by substituting other property of equivalent value. The ruling provides that, for estate tax purposes, the substitution power will not, by itself, cause the value of the trust corpus to be includible in the grantor’s gross estate, provided the trustee has a fiduciary obligation (under local law) to ensure the grantor’s compliance with the terms of this power by satisfying itself that the properties acquired and substituted by the grantor are in fact of equivalent value and further provided that the substitution power cannot be exercised in a manner that can shift benefits among the trust beneficiaries.

Based on Rev. Rul. 2008-16, we conclude that in this case the substitution power, by itself, will not cause the value of the trust corpus to be includible in Grantor’s gross estate.

Rev. Rul. 2004-64, 2004-2 C.B. 7, considers situations in which the trustee reimburses the grantor for taxes paid by the grantor attributable to the inclusion of all or part of the trust’s income in the grantor’s income. In Rev. Rul. 2004-64, a grantor created an irrevocable inter vivos trust for the benefit of the grantor’s descendants. The grantor retained sufficient powers with respect to the trust so that the grantor is treated as the owner of the trust under subpart E, part I, subchapter J, of chapter 1 of the Code. When the grantor of a trust, who is treated as the owner of the trust under subpart E, pays the 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. 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. However, such discretion combined with other facts (including but not limited to: an understanding or pre-existing arrangement between grantor and the trustee regarding the trustee’s exercise of this discretion; a power retained by Grantor to remove the trustee and name grantor as successor trustee; or applicable local law subjecting the trust assets to the claims of grantor’s creditors) may cause inclusion of Trust’s assets in grantor’s gross estate for federal estate tax purposes.

In this case, under the terms of Article Twelfth, paragraph D, the trustee is prohibited from paying Grantor or Grantor’s executors any income or principal of Trust in discharge of Grantor’s income tax liability. Although, Rev. Rul. 2004-64 does not consider this situation, it is clear from the analysis, that because the trustee is prohibited from reimbursing Grantor for taxes Grantor paid, that Grantor has not retained a reimbursement right that would cause Trust corpus to be includible in Grantor’s gross estate under § 2036. See Rev. Rul. 2004-64. In addition, the trustee’s discretionary authority to distribute income and/or principal to Grantor, does not, by itself, cause the Trust corpus to be includible in Grantor’s gross estate under § 2036.

We are specifically not ruling on whether Trustee’s discretion to distribute income and principal of Trust to Grantor combined with other facts (such as, but not limited to, an understanding or pre-existing arrangement between Grantor and trustee regarding the exercise of this discretion) may cause inclusion of Trust’s assets in Grantor’s gross estate for federal estate tax purposes under § 2036.

We are specifically not ruling on whether or not Trust is a trust described in subpart E, part I, subchapter J, of chapter 1 of the Code.

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. Section 6110(k)(3) provides that it may not be used or cited as precedent.

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
Senior Technician Reviewer
Branch 4
Associate Chief Counsel
(Passthroughs and Special Industries)