On January 9, 2009, the Internal Revenue Service released Private Letter
Rulings 200902008, 200902009, and 200902010 addressing the gift and
generation-skipping transfer tax consequences of the investment in limited
partnerships by generation-skipping transfer (“GST”) tax grandfathered trusts.
In each of these three letter rulings, husband and wife had, prior to
September 25, 1985, created an irrevocable trust for the benefit of a grandson
(the “Trusts”). The grandson is the sole beneficiary of his trust during his
lifetime. The Trustees of the Trusts are a corporate bank and two individuals.
The governing state law gives trustees discretion to invest and reinvest
trust property as they consider proper. State law also provides that a trustee
may exercise any powers necessary or appropriate to carry out the purposes of
the trust. These powers are similar to those granted to a trustee under the
Uniform Trust Code.
Each grandson is also the sole beneficiary of a number of other trusts. The
Trustees of each grandson’s other trusts placed the marketable securities held
in these trusts in a custodian account with Financial Services Corporation (“FSC”)
in order to have integrated reporting of asset performance, both individually
for each trust and in the aggregate for all of the grandson’s trusts.
The Trustees desired to include the marketable securities of the Trusts in
this integrated reporting. However, legal counsel for the corporate trustee
advised that the Comptroller of the Currency requires the trustee to maintain
custody of the trust assets. In order to allow the trust assets to be included
in the FSC reporting, the Trustees formed a wholly-owned LLC. The Trustees
contributed the trust’s marketable securities to a newly-formed limited
partnership in exchange for a 99.9% limited partner interest. The LLC owned a
0.1% general partner interest in the partnership. The partnership then placed
its assets in a custody account with FSC.
The rulings specify that the Partnership Agreement and the LLC Agreement will
be amended to require the partnership to distribute (1) the “net cash from
operations” and (2) amounts sufficient to allow any partner that is a trust to
make any distributions required by the applicable trust instrument of such
trust. Net cash from operations will be treated as being equivalent to net
income under state law.
The parties requested rulings that the formation of the partnership will not
be a taxable gift for gift tax purposes and will not cause the trust to be
subject to GST tax.
The IRS granted each of the requested rulings and concluded that the
operation and management of the trust assets would not result in a shift of any
beneficial interest in the trust to any beneficiary who occupies a generation
lower than the persons holding the beneficial interests prior to the
distribution and would not extend the time for vesting of any beneficial
interest in the trusts beyond the period provided for in the trust agreements.
The IRS further concluded that the operation and management of the trust assets
would not cause the trusts to lose their exempt status for GST tax purposes, and
the receipt of partnership interests by the trusts would not be treated as
additions to the trusts for GST tax purposes.
Finally, the IRS concluded that the operation and management of the trust
assets would not cause any beneficiary of the trusts to have made a taxable gift
for federal gift tax purposes under section 2501.
The IRS has in the past issued similar rulings on the effect of a trust’s
investment in a partnership or LLC. In PLR 200346008, the IRS ruled that the
investment of trust assets in an LLC would not cause the trusts to lose their
GST tax exempt status. The LLC Operating Agreement in PLR 200346008, similar to
the Partnership and LLC Agreements in the three rulings described above, also
required that the LLC distribute at least all of the net income of the LLC, such
amount to be determined as though the LLC were a trust. The rulings do not
explain the inclusion of these LLC or partnership distribution requirements. The
Trustees may have required them in order to avoid a later claim that they
invested in entities that could trap income and prevent the trust beneficiaries
from receiving the income to which they otherwise would have been entitled.
Alternatively, in discussions with the taxpayers, the IRS may have required such
distribution provisions in order to issue the ruling. Similar distribution
requirements can also be found in Private Letter Rulings 200531008, 200531009
and 200531010. In planning, careful attention should always be given to
distribution provisions and the definition of income.
McGuireWoods Fiduciary Advisory Services
Advisory Services assists financial institutions in a wide array of areas in
which questions or concerns may arise. For further information on the private
letter rulings discussed above or our practice, please contact the authors.