The Not-So Irrevocable Trust

Sy STEPHEN M. MARGOUN

Reprinted frí'lI the .\ugu:;t, 19ïJ issue oiT.\xEs-Tl:e Tax ;\aya::ilil!

Puhlished anil Copyrighted 19ï3 byj~I,Jiiinerce Clearing" House, I nc., Chicago, Illinois 606.l

.\11 Rig-Iits Reserveil

The Not-So Irrevocable TrustBy STEPHEN M. MARGOUN

The author shows how the irrevocable trust may be structured toIJvoid toxes on trust property passing at grantor's death, evenupon the demise of his spouse and descendants.

 LEGITBIATE OBJECT of estate planning is to provide for themost effcient disposition of property- after death. This encom-passes transferring- property to beneficiaries with the least amount ofg-rief and expense to them. This paper discusses transferring insuranceproceeds and other property to beneficiaries through a trust.

The objects of this trust are: (1) to pass property to beneficiaries

without imposition of ,leath taxes; (2) to use this property (throughloans i)r purchase 1)£ estate assets) to pay death taxes on property inestate of the trust grantor; and (3) to assure grantor of the immediateavailability of this property for distribution to family members. (bene-ficiaries) in event of need.

Death Tax on Life InsuranceProceeds of life insurance owned hy a decedent at neath are in-

cludible in his g-ross estate for federal estate tax purposes.! It is worthconsideration, therefore, for an insured to transfer all policy incidentsi)f ownership:! during his lifetime and avoicl this tax:. If all incidentsof ownership are transferred to insured's wife and he predeceases her,she will collect all insurance proceeds at his death. The insured mayobject to entrusting- a larg-e sum of money to his surviving spouse,particularly if there are minor children involved. Also, the insuranceproceeds remaining at wife"s death are added to her gross estate. Ifbnre enough, this would attract more fecleral estate tax than in in-sured's estate if he owneti the policies-this hecause the marital de-duction is available to him, but not to the wife after husband's death.3

The Irrevocable Trust

To avoid this tax on both husband's and wife's estates, an insuredmight consider an irrevocable trust. An irrevocable trust is a person

1 Sec. 2032. All section references are to the I nteral Revenue Code of 1954.i Reg. Sec. 20.2042-1 (c) (2) states "incidents of ownership":

". . . includes the power to chan¡:e the beneficiary, to surrender or cancelthe policy, to assign the policy, to revoke an assignment, to pledge the policyfor a loan, or to obtain from the insurer a loan against the surrender value of

the policy, etc."l Sec. 2056. Bush, 'I Husband and Wife Transiers," 20 New 17 ùrk UiiiversityAiimtal ll1~.tit"te vn Federal Ta.ratimi 1)95, 721-i24.

The Not-So Irrevocable Trust 477

separate from its grantor.. It istrea ted for tax purpses similar to anindependent individual.5

..\n insured, therefore, as grantorcould establish an inter 'zJivos, irrv-ocable trust and transfer all insur-anc~ policy incidents of ownership tothat trust. The usual beneficiaries of

this trust are grantor-insured's wife

for her life and remainder to de-scendants and others selected by him.

Lessening Federal Estte Tax

Burden: Generaion SkippingTransferring insurance to an irrev-

ocable trust avoids federal estatetaxation on insurance proceeds at in-sured's death. This is simply because

at death he owns no interest in theinsurance policy or proceeds. (Seediscussion on gifts in contemplation

of death, however, below.) 'The pro-ceeds could escape such tax at hiswife's death too since she owns nosuch interest. In fact, if the trust in-strumcnt carefully provided, and sub-jcct to the statute of limitation, the

proceeds could be passed to his greatgrandchildren free of estate tax.S

Stephen M. Margolin is a parter

in the law firm of Margolin, Levin

and Brandwein, ltd., in Chicago.

The disadvantage of transferring an

insurance policy (or any other prop-erty) to an irrevocable trust is im-

metjiate subjection to gift tax laws.1

The gift ta la ws are designedto supplement the estate tax laws.sIf one does not apply, the other does.

Sometimes both apply. a

Gift tax laws pertain to transfersin trust. The following discussion,

however, suggests their relatively in-significant tax effect when comparedto the advantageous estate tax effect.Specifically, the value of the policyis slight when transferred by giftcompared to the full face value of thepolicy, includible in insured's estate,if not so transferred.1o Further, notethat the gift tax rate is merely 75

per cent of the estate tax rate in thecorresponding bracket. The gift taxstarts in the 2.25 per cent bracket.

The Gift Tax Laws

An insurance premium is a gift.llA gift is subject to gift tax based onits value 12 at the gift date. A donor,however, is entitled to a lifetime ex-

· It may be treated, however, as a "gran-tor trust" under Section 6i1 for incometa.ic purposes. See discussion below.· Reg. Sec. 1.641(a)-1 and Reg. Sec.

301.7701-1.· Littenberg, "How to Use Trusts and

Powers of Appointment to Skip SuccessiveEstate Taxes," P-H, .'I'I£ccessfiiJ Estate Plan-ning Id.:as and J1 ethods, 11 608.

1 Secs. 2501-2524.

· See Lowndes and Kramer, Ff!deraJ Es-tate arid Gift Taxes 11 28.2 (2nd ed. 1962).

478

· For example, a gift in contemplation of

death. Also, see Lowniles and Kramer,cited at footnote 8.

"Rocco, "How to Handle Gifts of LifeInsurance Outright or in T,rust," P-H,Slicces.rfuJ Estate Planning Ideas and M /!h-eii/s, 1l 5503.

11 1 CCH FEDERAL ESTATE AND GIFT TAx

REPORTS 1l 3020.40, citing Bureau ReleaeMarch 6, 1933.

,. Sec. 2512(a).

August: 1973 . T A XES - The Tax Magazine

\.mption of $30,00 13 and may be en-titled to a $3,00 annual exclusion. H

The annual exclusion obtains only if thetrust beneficiary has a "present interest"in the trust. is Although not a largesum, generally gifts valued under$3,00 may be made in any year with-out the necessity of preparing a gifttax return.18 Also, importantly, with-

out that exclusion; the value of any

gift diminishes the $30,00 lifetimeexemption.

If the instrument provided the wife

to receive "an unrestricted right to

the immediate use, posession or en-

joyment of property," under the Reg-ulations,17 the donor could excludethe fist $3,00 of premiums paideach year.

Language granting the wife a non-cumulative, annual power to invade,commencing at trust inception, forher life of $5,00 or 5 per cent ofprincipal, whichever is greater, ap-pears to satisfy the above presentinterest regulatory test.18

It has been suggested that the wifepay the premiums for the trust andutilize her lifetime exemption andlow gift tax bracket. This raises other,theoretically more serious, problems.Since she is nornlly the life bene-ficiary, a transfer (payment of pre-

II Sec. 2521.

.. Sec. 250J(b).i. Reg. Sec. 25.250J-3(b) states:.. An unrestricted right to the immediate

use, possession or enjoyment of propertyor the income from property . . . is apresent interest in property. An exclusionis allowable with respect to a. gift of suchan interest. . . ."

"Sec. 6019(a).1T Reg. Sec. 25.250J-3(b), above.

II Yohlin, "Ownership a.nd Transfer ofLife Insurance," 28 Nt'W York Unii'ersity.-liiiiiial Institute of F~deral Taxation ì6S,792. See also Cmmmey v. C vmmissioller, 68-2USTC 11 12,541, 397 F. 2d 82 (CA-9).

,. Eiia M. Miller, CCH Dec. Jl,'l75, 38TC 1)9 (1972).

20 The greater of 5 per cent of trust value

or $5,00 is includible in wife's estate at

The Not-So Irrevocable Trust

miums) by her could activate Section2036 (Transfers with Retained LifeEstate).19 This mig-ht result at her

death in the inclusion in her estate

()f the insurance proceeds attrbutale

to her premium payments.In short, in many instances the

grantor-insured is the most logicaland practical candidate to pay thepremiums. He may, therefore, wishto utilize language along the abovelines to obtain the annual exclusion.

Federal Estte Tax Consequences

of Wife's Power of Invasion

Under Section 2041, this $5,00 or5 per cent poer is not includible ingrantor-husband's estate at his death.2c

On the other had, under Section 2036,

it might be includible in grantor-hus-band's estate if it discharged his legalobligation of support.21

In Wishad 21 decedent while alivebought an annuity which he trans-ferred to his wife and sister. Thiswas payable to them during theirlives. The Commissioner questionedwhether this annuity discharged thedecedent's legal obligation to his de-

pendent wife and sister. The Courtof Appeals held:

"The annuitants had unfettered rightto use the payments in any mannerher death. Reg. Sec. 20.2041 -3 ( d). Vol. 1,Casner, Estate Plannillg, p. 717 (1962 ed.).21 Reg. Sec. 20.203ó-l(b)(2) states:

"The 'use, possession, right to the in-come or other enjoyment of the transferredproperty' is considered as having been 1"e-

tained by or reserved to the decerlent tothe extent that the use, possession, right

to the income, or other enjoyment is to beapp/it'd toward the discharge of the leirlobligation of the deced~nt, or otherwiseior his pecuniary benefit. The term 'legalobligation' includes a legal obligation tosupport a dependent during the decedent'slifetime."22 Wisliard v. Unit~d States .LZ USTC

11 10,135, 143 F. 2d 704, 709 (CA-7). Alsosee Mertens, Law of Ft'dcral Gift and EstateTaxation, Cum. Supp. 1972, p. 225.

479

they saw fit. No obliirtion was placed

upon them to use the money to sup-port themselves, nor was there anyshowing that this was the purposeof the annuity. An independent in-Lome is different from an income tobe used for support."

The value of the annuity thereforewas not includible in decedent's estate.

The Court of Appeals for the TenthCircuit in Richards 23 stated:

.,.\ husband may make a gift to hiswife without affecting his duty orsupport, and there is no presumptionthat such a gift is in discharge of thedonor's marital duty."

In Bel ~l the decedent while alivemade a gift of mineral interests andstocks to his minor daughter. TheCommissioner argued that the valueof that property should be included

in the decedent's gross estate under

Section 2036( a) (i).The District Court, disagreeing with

the Commissioner, held;"Here ~'!. Bel made outright gifts

of the mineral interests and stock toJeanne (his daughterJ. He did notstipulate the purpose for which thestock or mineral interests were tobe used. The gifts were donationsinter vivos with no strings attached

and the decedent had no right to usethe mineral interests and stocks ortheir revenues to discharg-e any legal

obligation which he might have owedto his daughter. He attached nostring-s to the gifts. The gifts .were

irrevocable and unconditionaL. The,¡nly authority Mr. Bel had with re-,;pect to these interests under the lawof Louisiana resulted from his being

administrator of his children's estateduring the marriage. This authoritydid not give Mr. Bel the right to use

the money for Jeanne's support andeducation. Considering his financialcondition, if :\Ir. Bel had applied tothe court for authority to sell hisdaughter's property to pay for hersupport, the court would have dis-missed his application out of hand."

Gift SpliHin9

Upon occasion the insurance trans-ferred in trust is fully paid up, orhas suffcient cash surrender value topay all remaining premiums. The

$3,00 annual exclusion would notthen be so important to the grantor.This is because after transferring thepolicies he need make no further gifts(for premium payments) to this trust.

On the other hand, reducing theamount of the initial gift of the in-surance policies is very important.'The reason for this is gift tax appliesto the value uf the policy transferred,~s

which could be very substantial. Toreduce this value, compliance withthe gift splitting provisions of the

Code is necessary. Specifically, Sec-tion 2513 permits gifts by one spouseto a third party to be treated as thoughthe donor and his spouse each madea gift of one-half the total value:

"The gift splitting privilege . . .makes it possible for one spouse tomake a gift and have it treated forgift tax purposes as though it hadbeen made one-half by each spouse.This permits the application of two$30.00 tax exemptions and increasesthe effective annual exclusion to $6.00on account of each person (other than

"Richards. 67-1 USTC 11 12,-l3, 375 F.2(t 997 (CA-lO); also Colonial-AmericaniVational Bank, etc., 57-1 l'STC 11 11,689, 2'l3

F. 2d 312 (CA--l):l B cl v. United States 70-1 USTC 11 12,6ìO,

310 F. Supp. 1189 (DC La.), aff'd, rev'd~md rem'd on another issue 72-1 USTC ~ 12,818,

452 F. 2d 683, cert. denied 406 U. S. 919.

480

,. Generally the value is its interpolatedterminal reserve value. Reg. Sec. 25.2512-6

(a). That is the amount the insurancecompany holds in reserve to cover itsliability on the policy. Simmons, "FederalTaxation of Liic Insurance," ALI-ABAT'I.'atiùn/Practi", HmidllOok, p. .l (1966 ed.).

August, 1973 . T A XES - The Tax Magazine

a spouse) to whom a gift is made." ilSParentheses added.

It is conceivable, therefore, for

grantor to transfer property valueda.t $6,00 to an irrevocable trust inone year completely free of gift taxIn order to do this, his spouse mustconsent to such gift splitting, and theamount directed to the third-partydonee must be ascertainable. Reg.Sec. 25.2513-1(h)(4) on point states:

"1£ one spouse transferred property

in part to his spouse and in part tothird parties, the consent is effectivewith respect to the interest trans-ferred to third parties only insofar assuch interest is ascertainable at thetime of the gift and hence severable

from the interest transferred to hisspouse."

Practical Considerations

Practical considerations most cer-tainly should govern the instrument.As later discussed, a provision shouldappear allowing the trustee to dis-trihute principal to the beneficiary

wife at any time for her support,maintenance, health, medical atten:-tion and other external standards,first taking her other assets and sourcesof income into account. Any remain-der will then go to children or other

"third parties."

This occasions the diffculty of de-termining the value of the remainderto these third parties. If unascer-

tainable, no gift splitting is allowed.

There have been several cases on thissubiect. .\ brief analysis of twomight be usefuL.

In Robertson 2j Mr. Robertson trans-ferred $59,388 of stock to his newly

created irrevocable trust. The trust

provided for Mr. Robertson's wife, asfollows:

:e 2 CCH FEDERAL ESTATE AND GrIT TAX

REPRTS 1f 7056.2f Robertson, crn Dec. 21,726, 26 TC 246

(1956).

The Not-So Irrevocable Trust

"The Trustees shall pay over thenet income, and so much of the prin-cipal as the corporate trustee in itssole discretion but with due regardto her other sources of funds, shalldeem necessary for her maintenanceand support. . . so long as she maylive."

The trust nrn"idprlt"..-......- that after he!'

death, the remainder was to go tothird parties.

The Commissioner urged that thereshould be no gift splitting. This wasbecause the value of her interestcould not be determined, since thetrustee could distribute all principalto her and thereby "destroy the i~come interest of the wife." If herlife interest could not be determined,it follows that the remainder (to thirdparties) was not "ascertinable at thetime of the gift and hence severablefrom the interest transferred to hisspouse." 28

The Tax Court stated:"\Ve concluded (in earlier cases)

on principle and authority that thesolution of this problem depended onwhether the power to invade princi-pal was absolute or was limited by

certain standards by which the possi-bility of invasion could be gauged,and on whether, if there were stand-ards of limitation, there was a likeîi-hood of the ex:ercise of such power asdisclosed by the facts. . . ."In the instant case, unlike the

cases cited and relied on by respond-ent. an invasion of the trust corpus

for the benefit of the life beneficiary

could be made only if the corporatetrustee should deem it 'necessary forher maintenance and support' 'with dueregard to her other sources of funds,'. . . and there is also in the record

'"1939 Code Reg. 108, Sec. 86.3(a)(4);1954 Code Reg. Sec. 25.2513-1 (b)(4). Alsosee Stark v. United States 73-1 USTC 1T 12,921

(CA-8).

481

here evidence as to what were thestandards of living of petitioner'swife. In the instant case we are of

the opinion that the power to invadeprincipal is limited by standards bywhich the possibility of such invasioncan be gauged. Cf. j\1 erchants Bankv. Commissioner, supra, where 'intro-ducing the element of the widow'shappiness and instructing the trutee

to exercise its discretion with liberali-ty' to her and to 'consider her welfare,comfort and happiness prior to theclaims of residuary beneficiaries . . :'brought into the calculation elementsof speculation too large to be over-

come notwithstanding the widow'sprevious mode of life wa modest andher own resources substantiaL.' "(Parentheses added.)

The Court then considered thelikelihood of the exercise of the trus-

tee's power to invade. Based uponthe ages of Mr. Robertson (61) andspouse (60) at the date of gift intrust, the family wealth and theirrelatively modest life style, the courtthere was concluded little likelihoo ofexercise of the power to invade.

Mr. Robertson, therefore, was al-lowed a $3,00 exclusion for the life-time gift of income to his wife. Hewas also allowed to split the remin-der value of the gift (to third parties)in half with his wife.In the 1972 Wang 29 case, on the

other hand, the Tax: Court deter-mined gift splitting unavailable.

~:Ir. Wang transferred insurncepolicies plus real estate to an irrev-ocable trust. The beneficiaries ofthis trust were his wife for life and

remainder to descendants. The trus-tees had the power to invade for thewife "for her proper support, care andhealth, or for any emergency affect-ing' the donor's said wife or her family,

"' C;tanley L. Wang v. Commissioner. CCHDec. 31,44(M), 31 TCM 719 (1972).

482

first having regard to her othersources of income. . . ."

The Tax Court in disallowing thegift splitting claim of Mr. \Vangstated:"It has been held that an ascer-

tainable standard exists when the lan-guge of the will or trust allowsinvasion of the principal ony to theextent necessary to maintain the lifetenant's present standard of living.Thus, words such as 'comfort andsupport,' 'maintenance and support:'comfort and welfare,' 'proper care,support and maintenance,' and 'sup-port maintennce, welfare and cofort'have been held to constitute an ascer-tainable standard based upon the lifetenant's present standar of livi~g."

"We think that this language (inthe instant case) does not constitute

an ascertainable stanard. The 'emer-~ency' is not limited whatsoever. Itis broad enough to cover any type ofemergency which might afect her orher family. It would seem that bythis langue the petitioner had some-

thing more in mind than merely en-suring the preservation of his wife'scustomary standard of living. Itshould be observed that it is well-settled that proof of extrinsic circum-stances cannot supply the necessaryelement of ascertinability if thewording of the instrument åoes notfurnish the basis for an objectivestandard:' (Parentheses added.)

In the event that gift splitting weredesired, language grating the spouse

a power to invade to the extent of$5 000 or 5 per cent might make there~ainder unascertainable, since thisis not limited by an ascertainablestandard.

Gifts in Contemplation of DeathSection 2035 (b) raises the pre-

sumption that a gift of property (in-

August, 1973 · T A XES - The Tax Magazine

surance or otherwise) within threeyears of date of death is "deemed toha.ve heen made in contemplation ofdeath." Section 2035(a) includes the

\':ilue of the gift so made in the de-(cJents g-ross estate.30 If the insur-:ince policies were transferrerl morethan three years hefore death, only

the premiums will be so includible.3tThe dang-er is that if the proceeds

are includible in the deceased grator'sestate, they will not aualify for themarital deduction. The reason forthis is, a.lthough the decedent's wilprovides for the max:imum maritaldeduction, that only applies to prop-

erty passing to his wife. The insur-

ance proceeds deemed includible indecedent's estate pass not to his wife,but in fact to a trust. This trust most

. probably would not qualify for themarital deduction under Section 2056,

unless specific aualifying language

were employed. To remedy this, lan-guag-e could provide that if insuranceproceeds are includible in decedent's

estate for any reason, the wife willhave such powers, interests and rig-hts("pecified in the instrument) to qualifyfor the maximum marital deduction.32

Grantor TrustsA grantor-insured may transfer an

insurance policy with cash surrender

value to an irrevocable trust. Hemay then wish the trustee to paypremiums by using (borrowing) thatcash surrender value. This is impor-

tant if the trust were otherwise un-

funded. The trustee must pay interest14 Bel v. United States, cited at footnote 24.

.. Rev. Rut. 71-l97, 1971-2 cn 329; Cole-man, CCH Dec. 29,734, 52 TC 921 (96).

,. See Woolfolk, "How to Control Spouse-owned Life Insurance, etc.," Jo-lirnaJ of Ta.-cition. July 1971, p. 24.

:i Reg. Sec. 1.671-2(a).H Reg. Sec. 1.671-2(b); also se~ the fore-

runner of Code Subpart E, Clifford i'. H di'-t'nng, 40-1 USTC 11 9265, 309 U. S. 331; and

Volume 6 :\fertcns Law of Federal IncomeT iJxatio,i, 11 37.05.

The Not.So Irrevocabie Trust

on that borrowed money. The in-terest deduction is useless to an un-funded trust since it offsets no income.That deduction, however, is usefulto a high-bracket grntor. If thetrust were considered a "grantortrust," the grantor must include incomputing his tax.bl~ income "thoseitems of income, deduction :ind creòitagainst tax" of the trust (italicsadded).3!

A "grntor trust" results when agrantor retains such dominion andcontrol over the trust that he is con-

sidered the owner thereof.' He is theowner, however, solely for incometax purposes.35 Reg. Sec. 1.671-2 (a)states the general rule:

"Under section 671 a grantor oranother person includes in comput-ing his taxable income and creditsthose items of income, deduction, and

credit against tax which are attribut-able to or included in any portionof a trust of which he is treated asthe owner."

Thus, if that Section applies, "the

income ",rill be included in the incomeof the grantor and he will be allowedthose deductions for such expenseswhich he would have been entitledto if the trust had not he en created." 36

As the Regulations state:"An item of income, deduction or

credit included in computing the tax-able income and credits of a grantor. . . under Section 671 is treated as

if it had been received or paid di-

rectly by the grantor. . . ." 31i5 Senate Committee Reports on Sec. 671;

also see Lowndes and Kramer, FederalE.rtate and Gift Taxes. Incomplete Trans-fers, Sec. 28.2 (2nd ed., 1962); and BNATax Monagniwnt Seri(',r 50-2. A-i6.

,. Senate Committee Reports on Sec. 671;also see United States '¡'. Grt'n. 59-2 USTC

11 9595, 170 F. Supp. 359 (DC N. Y.), involv-ing the predecessor of Section 671.

:I Reg. Sec. 1.671-2(c).

483

The interest deduction item, there-fore, is treated as if it had been paiddirectly by grntor. Of course, with

or without this trust, grntor mustsatisfy the Section 264 specific provi-sion on rlerluctibility of interest oninsurance loans.

Reclaiming Proceeds

or Trustee's Power

of Invasion for Emergencies

The practical problem with an ir-revocable trust is its irrevocability:assets once committed are irrevoca-bly committed. It behooves a grntor,therefore, to establish an irrevocable

trust providing for every possible dis-

tribution contingency, while retaining

the indepedent tax status of the trust.

A prudent grntor could vest trustee~Ü trust inception with power to dis-tribute income or principal to a bene-ficiary for: comfortable support,maintenance in accustomed standardof living', education, health needs,

medical care, extraordinary circum-stances, such as for weddings, giadu-ations, births, purchase of a residence

or purchase of a business, in the eventof accident or disability and otherobjective, external standards. Thispower should be exercised, however,only when the property and all sourcesof income of or available to the bene-ficiary are inadequate for such pur-pose, in the sole judgment of thetrustee.

Thus, upon a later change of cir-cumstance, the trustee could distributepart or all corpus of the trust to the

grantor's spouse, children or otherbeneficiaries. It is conceiváble then

for the trustee to effectively ter-minate the trust if an unforeseen

practical (nontax) circumstance did

arise in the distant future.

To achieve greater flexibility, thewantor may wish to directly granta benefciary (for example, his spouse)

a power to invade for that benefici-ary's sole benefit. This power mustbe limited by an ascertainable stand-

ard relating to health, education, sup-port or maintenance. If so limited,the value of this power will not be

includible in beneficiary's estate uponhis or her demise.3s The beneficiary,therefore, will be empowered to rle-mand payments during his or herlifetime for the above purposes. Thismay be a wise move diplomatically,besides providing asurance of that

beneficiary's control of his or herbasic needs.

Mandatory Support TrustsIf the trustee were mandated to

distribute trust income and principal

for the maintenance and support ofdependent beneficiaries, it is clearthat the proceeds of the trust wouldbe includible in the grntor's estate

at his demise. This is because thetrust discharged a legal obligation of

the decedent.3D

In Richards.o grantor established

a trust which said:

"My trustees shall pay unto mywife . . . for her maintenance andsupport the net income from my trustestate at such times as they in theirsole discretion shall detennine. . . .

"This is a trust for maintenance,

and I direct the payments to my saidwife and children hereinbefore speci-fied be made by my trustees. . . "

The Court of Appeals stated:

"Sec. 20..U(b)(l)(A). Also see Ales-sandruni, "Tax and Other I mplications ofPowers Measured by a Definite or Ascer-tainable Standard," Uni'versity of MimiiiFourth Institute on Estate Planning, ~ 70.900.

!t Reg. Sec. 20.2036-1 (b)(2), see footnote

21 above. Also, see Section 2038 on Revo-cable Transfers.

.. Richards, cited at footnote 23.

484 August, 1973 · T.A. XES - The Tax Mggozine

". . . that the gift to the wife mustnot be restricted and that if the donor

reserves unto himself the right tohave the in\:ome applied to his wife'ssupport, it is linked. to relief for him-self from his financial responsibilities

as a husband. . . .

"These (above) provisions clearlyinrlicate a restricted trust whose pur-pose was maintenance and support.The only discretion granted the trusteeswas the determination of the timewhen payment should be made.

"We are of the opinion that thevalue of trust corpus is includible indecedent's estate."

A mandatory support trust, there-fore, wil be regarded as a reservedlife estate, includible under Section2036, if the grantor dies during the

period of dependency.41

Discretionary Support Trusts

A trustee may possess a discre-tionary power to invade for dependent

beneficiaries (for example, wife andminor children). If circumscribed by

an ex:ternal standard, Section 2036

wil not apply.

In JenniPlgs.2 the Court of Appealsstated:

l1 The converse is that if the beneficiarybecomes independent (child reaching ma-jority) before grantor's ùeath, there was nooblig-ation to support at death. Therefore,the applicable proceeds are not includiblein grantor's estate. Lowndes and Kramer,Federal Estate mw Gift Taxes, p. 146 (2nded.. 1962).

-, B. B. Jennings, et al., Errs. v. Smit/i, 47-1USTC 1f 12,751, 161 F. 2d 74, (CA-2). The

trustees had the power to invade capitalif the beneficiary or his i5sue "should 5uffer

prolonged ilness or be overtaken by finan-cial misfortune which the trutees deem t'tra-orinary." This was considere an appropriate

external standard. Also see Ddancev i'.United States, 67-1 USTC 11 12,459, 264 F.

Supp. 904, where the grantor retained thepower to pay corpus when "necessary oradvisable to provide for the comfortablecare, maintenance and support of the in-come beneficiary." This was held an appro-

The Not-So Irrevocable Tnist

"Since: the trustees were not fret:to exercise untrammeled discretionbut were to be governed by deter-minable standards, their power toinvade capital, conditioned on con-tingencies which had not hap'pened,

\did not in our opinion bring the trustproperty within the reach of Section

811 (d)(2)."In essence, the theory is that if

the exercise of the power is subjectto an external standard, the powerin the trustee is properly circum-scribed..¡ That is, the trustee has nomore power that that of a court ofequity, since that court could ad-

minister the standard. As one com-mentator pertinently stated, the trusteeunder this reasoning has no powerat all, but is a mere ministerial func-tionary of the equity court...

In these discretionary support cases,

the courts emphasize the importanceof an "independent trustee.".5 (Al-though the grantor in Jennings wasone of three trustees.) In Abner W.i\1itcliell48 the grantor's son was thetrustee for the grantor's wife. Thegrantor's son was also a remainder-man. The trust instrument provided:

"The trust shall pay over to mywife . . . during the term of her

priate stanrlard, not includible in grantor'sestate under Sections 203ó and 2038.

.- vl.onneii, "Tax Consequences to theGrantor," 13 Ari=ona Law Rt'iew, 284 (1971).

~ Pedrick, "Desultory Comment5 on I r-revocable Trusts and Federal Estate Taxa-tion," Uni'lJersity of ,¡\1ianil 2nd Institute miEstat~ Planning, 11 68.1904. See Merteiis,Law of Federil Gift and Estate Taratil1t/,Cum. Supp., 1f 24.10 et seq. on determinationof an external standard.

Ü Rev. Rut. 73-143, L R. R. 1973-12, 27.

Where grantor-tistee holds a power ofinvasion limited only by "special needs" ofbeneficiary, the trust value is includible in

his gross estate under Section 2038 (Re-vocable Transfers); ~fertens, Law of Fed-rral Gift and Estate Taxation, Cum. Supp.,

1T 24.13.

.. Ahner W. Mitcliell, CCH Dec. 30,478,55 TC 576 (1970), aCQ. 1971-18, S.

AO C"OJ""

natural life, such amounts of the netincome, and principal of saiù trustfund if required as said trustee shallin his unrestricted discretion deter-

mine to be necessary for the com-fortable support and maintenance ofmy wife. . . taking into considerationher other sources of income. . . ."

The .i.antor was 70 years of agewhen he established that trust. Thecourt determined that the grantorand wife at all times lived conserva-

tively and that while he was alive, hewas able to support his wife. Thetrustee at no time made any paymentsto or for her benefit.

The Tax Court in holding the trustproperty not includible in decedent's

estate said:

"It is to be noted that the provi-

sion of the estate tax regulationsstates that the use, possession, right

to the income, or other enjoyment ofthe transferred property is considered

as having been retained by or re-served to the decedent to the extentthat the use, possession, right to the

income, or other enjoyment is to beapplied toward discharge of a legalobligation of decedent. And it is wellestablished that where the rig-ht toincome from, or other enjoyment of,the trust property is to be applied for

the support and maintenance of the

decedent's wife, the decedent is con-

sidered to have retained the posses-

sion of enjoyment of or the right tothe income from the transferred prop-erty within the meaniiig of section

2036(a)(i). Here, however, there was

no direction in the trust instrument

that either the principal or the in-come of the trust was to be so applied.It ha been held that the language of the

regulations 'is to be applied' is not to beread to mean 'may be applied: thesituation 'u.lhicJi exists where the discre-tion with respect to distributions isvested Í1i an independent trustee.

486

"It is true that in the Douglass and

Chrysler cases the trustee was not amember of the decedent's family,whereas here the trustee was. the de-cedent's son. However, in a similarsituation where the trustees were thewife and son of the settlor, it washeld that the same reasoning- is ap-plicable (citations omitted). The courtthere stated that to 'assume that the

donor could control the trustees be-cause they were his wife and anotherson is but to speculate.''' (Italics andparentheses added.)

Does the line of cases culminatingin the acquiesced Mitchell case mean:

(1) \Vhere an independent trusteehas a discretionar power todistribute, the Regulation im-mediately discussed above isinapplicable?

(2) \Vhere an independent trusteehas a discretionary power todistribute and does not, theRegulation is inapplicable?

(3) \Vhere an inciependent trusteehas a discretionary power todistribute based on externalstandards, the Regulation doesnot apply?

(4) \Vhere an independent trusteehas a discretionary power todistribute based on externalstandards and does not distrib-ute, the Regulation does notapply?

It seems prudent, therefore, whenthere is one or more dependent bene-ficiaries, to consider:

(1) A truly "independent" trustee;

(2) Discretionary language;

(3) Naming a number of externaldistribution events;

(4) Limiting distribution to theex:tent the beneficiary's sources

of income and property, includ-ing anyone supporting him, areinadequate for the purpose in-tended;

August, 1973 · T A XES - The T ux Mugoiine

(5) Limiting- distribution discre-

tion to the sole judgment of

the trustce.If the heneficiaries wcre financially

independent of g-rantor (or upon theiroecoming- indepcndent) a. disinterestedtrustee could invade for their benefitfor any purpose.41 No part of thcundistributed principal will be in-cludible in any Iieneficiary's estate."s

Limited Power of AppointmentTo assurc furthcr llcxibility, a lim-

ited power of appointment vested inone or more 1iencficiaries should beconsidered. Thio. enables the holder

of the power to distribute all or anypart of the trust property subject to

thc power to other beneficiaries-theobjects of the power. Trust propertysubJcct to a limited power of appoint-ment is not includible in the estateof the holdcr of the power.t9 A lim-itcd powt.r of appointment is a powerby which thc hoIrler can appoint thed.:sig-natcd property to anyone otherthan (I) himself, (2) his creditors.

(3) his estate and (4) creditors of hisestate.~o This, coupled with the powerof invasion by the trustee, provides

additional tlexihility with respect tofuture distributions based on unfore-seen circumstances.

51

ConclusionAn ¡'nter vivos, irrevocable trust

permits a transfer to g-antor's bene-

ficiaries in a most effcicnt manner.Specifically, it avoids death taxes oninsurance proceeds and other trustprOpl'fty passing at grantor's dcath.

It may be structured to avoid death

taxes on this property upon the de-

mise of his spouse ami dcscendants.

The insurance proceeds and otherproperty could be used (by loans orpurchase of estate assets) to pay death

taxes on estate property. These bene-fits obtain, yet at all times from in-ception the trust property is available

for immediate distribution to familymembers (bcnctìciarics) for unfore-seen financial needs. (The End)

IT Littenlicrg'. "How to Use Tmsts andPowers of Appointment to Skip SuccessiveE,;tate Taxes," P-H. ."ùicccssfui Estate Plmi-"ill.'7 J deas and Jft'liods fi fJ08 and 608A.

.. Littenberg, ihid; '-fertens, Law of Fed-aal Gilt and Estate Taxation, Cum. Supp.,

p. 247 5 tates:"\\There, however, the trustee is inde-

peniient and has sole discretion as to thedistributions anii/or use of the trust prop-

erty including distributions which might or

The Not-So Irrevocable Trüsl

might not serve to discharge a legal obli.gation of the transferor, such property isnot normally includible in the transferor'sgross estate:"

l'Sec. 2041 (a).

"Sec. 2()l(b)(l) and Reg. Sec. 20.2041-1

(c)(l).31 \'liley, "Achieving Flexibilty," Power,"of .4 !,!,ointllCJit Rcsoiirce il aterials for Es-tate !Jlaiininq iii Depth, ALI-ABA 1972, p.327.

487