Using a donors' testamentary limited power of appointment is no longer a foolproof way of guaranteeing that a transfer to a trust will not be a completed gift in the eyes of the Internal Revenue Service, Bessemer Trust officials said Aug. 21 at an American Bar Association Real Property, Trust, and Estate Law Section teleconference.
Until IRS clarifies a Feb. 24 memorandum in which it determined that a gift was complete, even though the grantor had retained a power of appointment exercisable at his or her death, donors are in danger of making gifts that IRS says are taxable, the officials said.
In chief counsel advice memorandum (CCA201208026), IRS said donors made completed gifts of term interests in a trust upon their transfer of property to the trust, and their retained testamentary limited powers of appointment relate only to the trust remainder.
Under the trust agreement, the Settlors retained testamentary limited powers of appointment, presumably with the intent that these retained powers would render contributions to the trust incomplete under Treas. Reg. § 25.2511-2(b), and thus not subject to immediate gift taxation. The Settlors then commenced funding the trust each year with interests in a family entity (the nature of which is not specified in the Memorandum) in amounts equal to the couple's annual gift tax exemption amounts with respect to the trust beneficiaries.
The Memorandum, however, concludes that, under established case law, a testamentary power of appointment relates only to the remainder of the trust and not to the interest held for the benefit of the current beneficiaries. As a result, each gift to the trust has to be thought of as consisting of two parts, a current interest (which is complete for gift tax purposes) and a remainder interest (which is incomplete for gift tax purposes).
In this case, the value of the gift of the current interest is equal to the entire fair market value of the transferred property, for two reasons: (1) since the Trustee of the trust has the power to terminate the trust at any time by distributing all of the principal to one or more of the current beneficiaries, the present value of any remainder interest is negligible and (2) because the incomplete gifts of the remainder interests are not "qualified interests" under the special valuation rules of § 2702, the value of the retained interest is treated as zero.
As a result of this analysis, practitioners wishing to ensure that a gift is incomplete should not rely on a retained testamentary power and should make certain that the grantor is also given an applicable lifetime power, such as a lifetime limited power of appointment or a power to veto trust distributions.
The Memorandum concludes that the beneficiaries have no means of enforcing their withdrawal rights under state law, since the Other Forum is not bound by state law and no beneficiary would be willing to petition the state court for relief at the risk of terminating his or her beneficial interest in the trust. Because these withdrawal rights are therefore deemed unenforceable, the Settlors were not allowed to use their annual gift tax exemption amounts to shield any portion of their
contributions to the trust.
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