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Company Seeks Exemption for Trust Under Provision on Gift Tax Treatment of Transfers in Trust

MAR. 2, 2010

Company Seeks Exemption for Trust Under Provision on Gift Tax Treatment of Transfers in Trust

DATED MAR. 2, 2010
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March 2, 2010

 

 

Laura Urich Daly, Esquire

 

Office of Associate Chief Counsel

 

(Passthroughs and Special Industries)

 

CC: PSI:4

 

Room 4107

 

1111 Constitution Avenue, NW

 

Washington, DC 20224

 

 

Catherine V. Hughes, Esquire

 

Department of the Treasury

 

1500 Pennsylvania Avenue, NW

 

Room 4212B

 

Washington, DC 20220

 

 

Re: Request to Exempt the DING Trust from the Scope of I.R.C. § 2511(c)

Dear Ms. Daly and Ms. Hughes:

Pursuant to my recent telephone conversation with Ms. Hughes and for the reasons set forth below, I am writing to ask the Treasury Department or the Internal Revenue Service ("Service") to issue a notice or regulation in the near future exempting the Delaware Incomplete Nongrantor ("DING") Trust from the application of Internal Revenue Code ("I.R.C.") § 2511(c).

What is the DING Trust?

A DING Trust is an irrevocable self-settled spendthrift trust created under the law of one of the several states that currently allow a trustor-beneficiary to obtain protection from claims by his or her creditors, a type of trust often referred to as a domestic asset-protection trust ("APT"). The DING Trust is called the DING Trust because most attention has focused on trusts established under Delaware's Qualified Dispositions in Trust Act.1 But, similar trusts may be created under the laws of several other states, including Alaska, Nevada, New Hampshire, Rhode Island, South Dakota, Tennessee, Utah, and Wyoming.2

As the name suggests, the DING Trust is a domestic APT that is designed to be an incomplete gift for federal gift-tax purposes and to be a nongrantor trust for federal income-tax purposes. The first goal is achieved by giving the trustor a limited power of appointment, exercisable by Will, to dispose of the principal remaining in the trust at his or her death. The second goal is achieved, inter alia, by giving adverse parties control over distributions to the trustor-beneficiary in order to prevent the trust from being classified as a grantor trust under I.R.C. § 677(a).

A typical DING Trust was considered in PLR 200731019.3 There, the trustor created an irrevocable trust that authorized the two-member distribution committee by unanimous agreement (or the trustor and a member of the distribution committee by unanimous agreement) to distribute income and principal during the trustor's lifetime to the trustor, the trustor's current spouse and descendants, and the members of the distribution committee (as permissible beneficiaries, the distribution committee members were adverse parties). On the trustor's death, the remaining trust fund was to be distributed as the trustor appointed by exercising a nongeneral testamentary power of appointment. Provision was made for the disposition of the trust fund in default of appointment.

From 2001 to 2007, the Service issued nine private letter rulings in which it concluded that a DING Trust or comparable trust was a nongrantor trust and an incomplete gift.4 Although the Service announced in the summer of 2007 that it was studying one aspect of the structure approved by these rulings (i.e., whether the members of the distribution committee used in the trusts described in the rulings possessed general powers of appointment),5 that issue is not relevant here.

Objectives

The DING Trust is not intended to reduce federal income or transfer taxes. Besides allowing the trustor-beneficiary to protect assets from claims by his or her creditors, the DING Trust permits the trustor to reduce state -- not federal -- income taxes. For example, a nongrantor trust currently does not have to pay New York State or City income tax on its accumulated income and capital gains if the trust has no New York fiduciary, assets, or source income.6 As illustrated in a 2006 article, the state income-tax savings achievable by a DING Trust taking advantage of this rule are striking:7

 

Let's say a couple residing in New York City has a sizeable portfolio of marketable securities and other intangible assets. These two are concerned about liability to potential future creditors. They are in the highest federal income tax bracket and pay combined state and city income tax at an 11 percent rate. They don't want to make a completed gift because they don't want to pay gift tax or use any of their gift tax exclusion amount. Within their portfolio of securities, they have $2 million of assets that they essentially hold for the benefit of their children because they don't foresee any circumstance (other than a catastrophic lawsuit or similar financial setback) in which they would expend that money during their lifetimes given the magnitude of their other assets.

A Delaware nongrantor/incomplete gift trust could be a powerful planning tool for this couple. As settlors of such a trust, they could retain the right to receive discretionary distributions of income and principal from the trust (subject to the consent or direction of a distribution committee comprised of their children who are also potential discretionary beneficiaries). This would provide the couple with a safety net against the possibility of a major financial setback. The trust also will provide creditor protection for the trust assets. At the same time, the trust's income will not be subject to New York state or city income taxation. The federal income tax imposed on the trust's assets would be about the same in the trust as it would be if the couple owned the assets outright.

Had the couple retained this $2 million in their own names and achieved an enviable 10 percent annual rate of return before taxes, the $2 million would grow to about $8.6 million in 20 years, assuming the earnings are comprised entirely of qualified dividends and realized capital gains. The effective rate of tax on these investment assets would be 24.35 percent (15 percent federal rate on capital gains and dividends; 11 percent New York state and city tax on all income; New York taxes deducted in computing federal taxes). By contrast, contributing the $2 million to a Delaware non-grantor/incomplete gift trust means the effective rate of tax is reduced to 15 percent, and the trust grows to about $10.225 million in the same time with the same rate of return. Thus, merely by creating the trust, the couple would obtain asset protection for the trust property during the entire 20-year trust period and, at the end, the value of the property would be $1.6 million greater.

 

I.R.C. § 2511(c) Should Not Apply

I.R.C. § 2511(c), as in effect this year, provides:

 

Notwithstanding any other provision of this section and except as provided in regulations, a transfer in trust shall be treated as a transfer of property by gift, unless the trust is treated as wholly owned by the donor or the donor's spouse under subpart E of part I of subchapter J of chapter 1 [IRC Sections 671 et seq.].

 

Given that the DING Trust is not "wholly owned by the donor or the donor's spouse" for federal income-tax purposes, the creation of such a trust will be "a transfer of property by gift" for federal gift-tax purposes, unless regulations provide that I.R.C. § 2511(c) does not apply.

A commentator describes the purpose of I.R.C. § 2511(c) as follows:8

 

The scope of this provision is quite unclear. This provision may reflect a concern that repeal of the estate tax after 2009, coupled with the retention of the gift tax, would encourage grantors to make gifts to trusts that would be incomplete (absent § 2511(c)) to shift income to lower-income-tax-bracket trust beneficiaries. Section 2511(c) may reflect a policy choice that the gift tax should not apply if the transfer in trust does not accomplish an income shift, and no income shift occurs if the trust is a grantor trust.

 

I respectfully suggest that the DING Trust does not offer the income-shifting at which I.R.C. § 2511(c) is directed. In the typical DING Trust, the ordinary income and capital gains are accumulated in the trust as a safeguard against the trustor-beneficiary's future financial reversals. As a nongrantor trust, the DING Trust might actually pay more federal income tax than it would as a grantor trust. In 2010, a trust will reach the top 35% federal income-tax bracket at only $11,200 of income whereas a single taxpayer and joint filers will not do so until $373,650 of income.9 If a distribution is made back to the trustor, there should be no federal tax consequences; if a distribution is made to a trust beneficiary other than the trustor (such as a beneficiary in a lower income-tax bracket), the distribution will be subject to gift tax.

Conclusion

For the above reasons, I respectfully ask that guidance be issued as soon as possible to exempt the DING Trust from the scope of I.R.C. § 2511(c).

Sincerely,

 

 

Richard W. Nenno

 

Managing Director and

 

Trust Counsel

 

Wealth Advisory Services

 

302-651-8113

 

rnenno@wilmingtontrust.com

 

Wilmington Trust Company

 

Wilmington, DE

 

FOOTNOTES

 

 

1See 12 Del. C. §§ 3570-3576. See Pulsifer & Flubacher, Eliminate a Trust's State Income Tax, 145 Tr. & Est. 30 (May 2006); Steiner, The Accidentally Perfect Non-Grantor Trust, 144 Tr. & Est. 28 (Sept. 2005).

2See Alaska Stat. § 34.40.110, Nev. Rev. Stat. §§ 166.010-166.170, N.H. Rev. Stat. Ann. §§ 564-D:1-564-D:18, R.I. Gen. Laws §§ 18-9.2-1-18-9.2-7, S.D. Codified Laws §§ 55-16-1-55-16-17, Tenn. Code Ann. §§ 35-16-101-35-16-112, Utah Code Ann. § 25-6-14, Wyo. Stat. Ann. §§ 4-10-510-4-10-523.

3 PLR 200731019 (May 1, 2007).

4 PLRs 200148028 (Aug. 27, 2001), 200247013 (Aug. 14, 2002), 200502014 (Sept. 17, 2004), 200612002 (Nov. 23, 2005), 200637025 (June 5, 2006), 200647001 (Aug. 7, 2006), 200715005 (Jan. 3, 2007), 200729025 (Apr. 10, 2007), 200731019 (May 1, 2007).

5 I.R. 2007-127, 2007 I.R.B. Lexis 589 (July 9, 2007).

6See N.Y. Tax Law § 605(b)(3)(D)(i).

7 Pulsifer & Flubacher, Eliminate a Trust's State Income Tax, 145 Tr. & Est. 30 (May 2006).

8 Lischer, 845-2nd T.M., Gifts at A-24.

9 Rev. Proc. 2009-50 § 3.01, 2009-45 I.R.B. 617, 619-21 (Oct. 15, 2009).

 

END OF FOOTNOTES
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