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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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