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Firm Seeks Clarification Under Proposed Revenue Ruling on Treatment of Private Trust Companies

NOV. 3, 2008

Firm Seeks Clarification Under Proposed Revenue Ruling on Treatment of Private Trust Companies

DATED NOV. 3, 2008
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November 3, 2008

 

 

Internal Revenue Service

 

Office of the Associate Chief Counsel

 

(Passthroughs and Special Industries), CC:PSI

 

Attn: Mary Berman, Room 5300

 

111 Constitution Avenue, N.W.

 

Washington, DC 20224

 

 

Re: Comments to Notice 2008-63 -- Proposed Guidance Regarding Private Trust Companies

Dear Ms. Berman:

These comments are in response to the request for comments regarding the proposed revenue ruling described in Notice 2008-63, which addresses the use of a private trust company ("PTC") formed by one or more members of a family to act as trustee of trusts that were formed by or for the benefit of members of the family. The proposed revenue ruling provides well-reasoned and welcome guidance on the estate, gift, generation-skipping transfer ("GST") and income tax consequences of a PTC serving as the trustee of trusts under the two fact situations described in the notice. The proposed revenue ruling is for the most part consistent with a series of private letter rulings that were issued by the Service prior to 2006 with respect to PTCs.

Although the proposed revenue ruling provides a great deal of flexibility to families who desire to form a PTC and allow family members to serve on the Discretionary Distribution Committee ("DDC") of the PTC, the proposed revenue ruling gives no comfort to the family who adopts a more conservative approach in forming a PTC by requiring that no family members or related or subordinate parties to any family members may serve on the DDC. Rather, the proposed revenue ruling suggests that there may be adverse income tax consequences if the family members have the right to participate in decisions regarding personnel of the PTC (including the hiring, discharge, promotion and compensation of employees).

The primary purpose of most PTCs is to allow family members to manage the operations of the PTC other than those regarding discretionary distributions from trusts of which the PTC is the trustee, which decisions are delegated to the DDC. Accordingly, family members are shareholders of the PTC, serve on the Board of Directors of the PTC, and act as managers or officers of the PTC. Directors of a PTC, like directors of any other company, make decisions regarding the hiring, discharge, promotion and compensation of officers, managers and other employees of the PTC. We believe that prohibiting family members and related or subordinate parties from serving on the DDC while allowing them to participate in other managerial decisions of the PTC (including personnel decisions) is a common fact pattern that the IRS ought to address in the revenue ruling.1 As discussed below, we suggest that an additional fact situation -- Situation 3 -- should be added to the proposed revenue ruling to provide guidance to those families who choose this more conservative approach in forming a PTC.

 

Situations 1 and 2

 

 

Notice 2008-63 provides a general set of facts relating to A and B, who are husband and wife, and their three children, C, D and E, each of whom is married and has children, and separate irrevocable trusts created by or for the benefit of A and B and/or their descendants (referred to in the notice as "Family").

After describing the general facts referred to in the preceding paragraph, the notice describes two fact situations -- Situation 1 and Situation 2 -- relating to the formation of a PTC. Situation 1 involves a PTC formed under the laws of a state that has enacted a private trust company statute. Situation 2 involves a PTC formed in a state without a statute governing private trust companies. Both Situation 1 and Situation 2 involve the formation of a PTC where there is no restriction on who may serve on the DDC but state law or the governing documents of the PTC provide that: (1) no member of the DDC may participate in the activities of the DDC with regard to any trust of which that DDC member or his or her spouse is a grantor or beneficiary; (2) no member of the DDC may participate in the activities of the DDC with regard to any trust of which a beneficiary is a person to whom the DDC member or his or her spouse has a legal obligation of support; and (3) only officers and managers of the PTC may participate in decisions regarding personnel of the PTC (including the hiring, discharge, promotion and compensation of employees). In both Situations 1 and 2, Family members are shareholders or directors of the PTC, members of the DDC and/or a manager and employee of the PTC.

Based on the general facts described above and the facts specific to each of Situation 1 and Situation 2, the Service proposes to issue a revenue ruling in which it would determine that the appointment and service of the PTC as trustee of any of the irrevocable trusts: (1) will not cause the value of the trust assets to be included in a grantor's gross estate under §§ 2036(a) or 2038(a) of the Internal Revenue Code; (2) will not cause the value of the trust assets to be included in a beneficiary's gross estate under § 2041; (3) will not cause the grantor's transfer of assets to the trust to be an incomplete gift; (4) will not affect the exempt status of a trust that is otherwise exempt from the GST tax under § 2601 or change the inclusion ratio of the trust; and (5) will not cause the grantor or any beneficiary of the trust to be treated as the owner of any portion of the trust under §§ 671 through 678.

 

Proposed Situation 3

 

 

Reviewing the private letter rulings that were issued prior to 2006, a number of families have formed PTCs that do not allow any family members or any related or subordinated parties to any family members to serve on the DDC. These PTCs do allow family members, as officers and/or directors of the PTC who are not members of the DDC, to participate in decisions regarding personnel of the PTC (including the hiring, discharge, promotion and compensation of employees). The Service should add a third situation -- Situation 3 -- to the proposed revenue ruling and issue the same rulings for this situation as it has for the PTCs described in Situations 1 and 2. We propose the following fact pattern for Situation 3:

 

Situation 3 -- PTC formed in a state without a statute governing private trust companies. The facts and terms of the trusts are as described above. In 2008, Family formed a corporation that is a PTC in State 2, a state that has not enacted specific legislation governing the formation or operation of a private trust company. PTC is established for the specific purpose of acting as the trustee for the various trusts established by members of Family. Family owns all of the stock in PTC, either outright or through trusts and/or other entities.

PTC's governing documents create a DDC and delegate to the DDC the exclusive authority to make all decisions regarding discretionary distributions from each trust for which it serves as trustee. Discretionary distributions are defined as permissible distributions that are not mandated in the trust instrument or by applicable law. PTC's governing documents provide that no member of the DDC shall be a member of Family or a related or a subordinate party (as defined in § 672(c) of the Internal Revenue Code) to any member of Family. PTCs governing documents do not restrict directors or executives of the PTC from participating in decisions regarding personnel of the PTC (including the hiring, discharge, promotion and compensation of employees). Thus, members of Family who are directors or officers or managers of the PTC may participate in decisions regarding personnel of the PTC.

PTC's governing documents allow a majority of the entire Board of Directors to remove and replace any member of the DDC provided that there is always at least one member of the DDC and no member of the DDC is a member of Family or a related or subordinated party (as defined in § 672(c)) to a member of Family.

The shareholders of the PTC may amend the governing documents of the PTC except for those provisions relating to the DDC. With respect to the provisions relating to the DDC, an Amendment Committee consisting of individuals who are neither Family members nor persons related or subordinate (as described in § 672(c)) to any Family members have the exclusive power to make any changes to the PTC's governing documents relating to the DDC. F and G are the initial members of the Amendment Committee. F and G are not members of Family, are not employed by PTC, and are not otherwise related or subordinate to any Family member (as defined in § 672(c)).

A, C and D are officers of PTC. A, C, D, F, and G serve on PTC's Board of Directors. F and G also serve on the DDC. A, C and D also own shares of PTC. E is a manager and an employee of PTC.

X, a financial institution organized under the banking laws of State 2, has served as trustee of each of the trusts since their inception. No grantor of any of the trusts has a relationship with X other than as a customer or client of X.

Subsequent to PTC's formation, X resigned as trustee of each of the trusts and PTC was appointed as the successor trustee of each trust. In addition, A created and transferred property to three additional irrevocable trusts (the 2008 Trusts), one for the primary benefit of each of A's children, C, D, and E, and that child's descendants. The terms of each of the 2008 Trusts are the same as those described above, except that these trusts provide that the trustee has discretionary authority to distribute income and/or principal to any one or more beneficiaries during the beneficiaries' life. Each 2008 Trust receives contributions only from A. PTC will serve as the initial trustee of each of the 2008 Trusts.

 

Based on the specific facts of proposed Situation 3 and the same analysis set forth in the Law and Analysis section of the proposed revenue ruling, the Service should issue the same rulings for proposed Situation 3 as it did for Situations 1 and 2. Accordingly, the Service should rule that the appointment and service of the PTC as trustee of any of the irrevocable trusts: (1) will not cause the value of the trust assets to be included in a grantor's gross estate under §§ 2036(a) or 2038(a) of the Internal Revenue Code; (2) will not cause the value of the trust assets to be included in a beneficiary's gross estate under § 2041; (3) will not cause the grantor's transfer of assets to the trust to be an incomplete gift; (4) will not affect the exempt status of a trust that is otherwise exempt from the GST tax under § 2601 or change the inclusion ratio of the trust; and (5) will not cause the grantor or any beneficiary of the trust to be treated as the owner of any portion of the trust under §§ 671 through 678.

Of particular concern is the implication in the proposed ruling as presently written that there may be adverse income tax consequences under §§ 671 through 678 if a director, even one who is not a member of the DDC, participates in decisions regarding personnel of the PTC (including the hiring, discharge, promotion and compensation of employees). As stated above, the primary purpose of most PTCs is to allow Family members to manage the operations of the PTC other than those regarding discretionary distributions from trusts of which the PTC is the trustee. Family members who are directors of a PTC, like directors of any other company, should be allowed to make decisions regarding the hiring, discharge, promotion and compensation of officers, managers and other employees of the PTC as long as Family members and related or subordinate parties (as defined in § 672(c)) to Family members are prohibited from being members of the DDC.

As demonstrated by the Law and Analysis section for Ruling 5 of the proposed revenue ruling, a Family member who is an officer and employee of the PTC, but not a member of the DDC, may participate in decisions regarding personnel of the PTC without being treated as the owner of any portion of the trust under §§ 671 through 678. The reasoning of that conclusion also should apply if a Family member who is a director of the PTC is not a member of the DDC and the governing documents of the PTC prohibit Family members and related or subordinate parties (as defined in § 672(c)) to Family members from being members of the DDC. Thus, even if the Service determines that it will not include proposed Situation 3 in the revenue ruling, it should modify the proposed revenue ruling to make it clear that a director who is not a member of the DDC may participate in decisions regarding personnel of the PTC (including the hiring, discharge, promotion and compensation of employees) without being treated as the owner of any portion of a trust of which the PTC is trustee under §§ 671 through 678.

We appreciate the opportunity to submit comments on the proposed revenue ruling and would welcome the opportunity to discuss this matter with you if that would be helpful.

Sincerely,

 

 

Beth Shapiro Kaufman

 

Caplin & Drysdale Attorneys

 

Washington, DC

 

FOOTNOTE

 

 

1 See PLR 200229013 and the series of related rulings in PLRs 200404005, 200404006, 200404007, 200404012, 200404014, 200404017, 200404018, 200404020, 200404021 and 200404022.

 

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