The IRS has determined in a private letter ruling (PLR 2012-16-034) that a beneficiary should be treated as the owner of a trust under Section 678.
The trust agreement stated that the beneficiary had the right to withdraw the entire amount of any contribution made to the trust. Each year, the beneficiary's power of withdrawal lapses regarding the greater of $5,000 or 5 percent of the value of the trust corpus (this provision prevents a gift by the beneficiary to the trust that may occur upon the lapse of general power of appointment under Section 2514(e)). The beneficiary was also the trustee of the trust. The trust agreement provided that the trustee may pay income and principal to the beneficiary subject to an ascertainable standard. The beneficiary had the power, in a nonfiduciary capacity, to acquire the trust corpus by substituting other property of an equivalent value as determined by an independent appraiser.
Section 678(a)(1) provides that an individual other than the grantor is treated as the owner of any portion of a trust if the individual has the power, exercisable solely by the individual, to vest the corpus or the income from it for himself or herself. Similarly, if that individual releases such a power and thereafter retains an interest in the trust that would treat the individual as the owner if the individual were the grantor, that individual is treated as the owner of all or a portion of trust under Section 678(a)(2). Section 678(b), however, provides that Section 678(a) does not apply with respect to a power over income if the grantor is otherwise treated as the owner under the grantor trust provisions other than Section 678. Section 675(4)(C) provides that a grantor will be treated as the owner of a trust for federal income tax purposes if any person in a nonfiduciary capacity (and without the approval or consent of any person in a fiduciary capacity) has the power to reacquire the trust corpus by substituting assets of an equivalent value.
The letter ruling concluded that the beneficiary is treated as the owner of the portion of the trust over which his withdrawal right has not lapsed under Section 678(a)(1). In addition, to the extent the withdrawal right lapses each year, the beneficiary is treated as having released the power, while retaining a power of administration, exercisable in a nonfiduciary capacity to acquire trust corpus by substituting other property of an equivalent value. Such a provision could make the beneficiary the owner of the rest of the trust under Section 678(a)(2). The IRS typically will not rule on whether a substitution power can be exercised in a nonfiduciary capacity because it believes this is a question of fact that must be deferred until it examines the federal income tax returns of the parties involved. Nevertheless, the ruling states that if the circumstances indicate that the power of administration can be exercised in a nonfiduciary capacity, the primary beneficiary will be treated as the owner of the entire trust under Section 678.
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