Tax & Accounting Blog

IRS Requests Comments on the Tax Consequences of a Decanting Trust

ONESOURCE, Tax Information Reporting, Trust Tax March 15, 2012

In a Notice, the IRS has requested comments on when and under what circumstances transfers by a trustee of all or a part of the principal of an irrevocable trust (Distributing Trust) to another irrevocable trust (Receiving Trust), sometimes called decanting, that result in a change in the beneficial interests in the trust aren’t subject to income, estate and gift (E&G), and/or generation-skipping transfer (GST) taxes. In such transfers, the interests of one or more of the beneficiaries may be changed or terminated while another beneficiary, who didn’t previously have an interest in the Distributing Trust, may receive an interest in the Receiving Trust.

Background. The IRS is studying the tax implications of transfers when there is a change in the beneficial interests in the trust and is considering approaches to addressing some or all of the relevant tax issues in published guidance. While these issues are under study, the IRS won’t issue private letter rulings (PLRs) on such transfers that result in a change in beneficial interests. However, the IRS will generally continue to issue PLRs on such transfers that do not result in a change to any beneficial interests and do not result in a change in the applicable Rule Against Perpetuities period.

Request for comments. IRS invites public comment on the income, E&G, and GST tax issues and consequences arising from transfers by a trustee of all or a portion of the principal of a Distributing Trust to a Receiving Trust that change beneficial interests.

The facts and circumstances that IRS has identified as potentially affecting one or more tax consequences include the following:

  • a beneficiary’s right to or interest in trust principal or income is changed (including the right or interest of a charitable beneficiary);
  • trust principal and/or income may be used to benefit new (additional) beneficiaries;
  • a beneficial interest (including any power to appoint income or corpus, whether general or limited, or other power) is added, deleted, or changed;
  • the transfer takes place from a trust treated as partially or wholly owned by a person under Code Sec. 671 through Code Sec. 678 (grantor trust) to one which isn’t a grantor trust, or vice versa;
  • the situs or governing law of the Receiving Trust differs from that of the Distributing Trust, resulting in a termination date of the Receiving Trust that is later than the termination date of the Distributing Trust;
  • a court order and/or approval of the state Attorney General is required for the transfer by the terms of the Distributing Trust and/or applicable law;
  • the beneficiaries are or aren’t required to consent to the transfer by the terms of the Distributing Trust and/or applicable local law;
  • consent of the beneficiaries and/or a court order (or approval of the state Attorney General) is not required but is obtained;
  • the effect of state law or the silence of state law on any of the above scenarios;
  • a change in the identity of a donor or transfer or for gift and/or GST tax purposes;
  • the Distributing Trust is exempt from GST tax under Reg. §26.2601-1, has an inclusion ratio of zero under Code Sec. 2632, or is exempt from GST tax under Code Sec. 2663 ; and
  • none of the above changes are made, but a future power to make any such changes is created.