Individual Seeks Guidance Clarifying Trust's Qualification for Deductions

Dear Mr. Hogan and Ms. Hughes:

I am writing to request that you clarify whether a trust which mandates a payment of a unitrust amount between 3% and 5% to the beneficiary spouse from the inception of the trust, and that is governed by the law of a state that authorizes the conversion of an income trust to a such a unitrust or that defines income as such a unitrust amount, may qualify for the gift or estate tax marital deduction under sections 2056(b)(5) or (7) or 2523(e) or (f) of the Internal Revenue Code of 1986, as amended. The requested clarification is to be distinguished from a marital trust that mandates that income be paid to the beneficiary spouse at its inception, and that is subsequently converted to such a unitrust.

United States Treasury Department Regulation ("Reg.") § 1.643(b)-1 provides, in part, that a unitrust payment of between 3% and 5% is the equivalent of the payment of income if the trustee is permitted under local law to convert an income trust to a unitrust and the trustee does so. The regulation also provides that the equivalency can occur if income is defined under local law as the unitrust amount between 3% and 5%. Some states, such as New York, but not all states, define income as the unitrust amount if the governing instrument directs for the unitrust provision to apply to the trust. This seems to suggest that a trust, governed by the law of such a state, may qualify for the marital deduction where the trust directs the payment of the unitrust amount to the beneficiary spouse from the inception of the trust. (Reg. 1.643(b)-1 (sixth sentence) states, "For example, a state statute providing that income is a unitrust amount of no less than 3% and no more than 5% of the fair market value of the trust assets, whether determined annually or averaged on a multiple year basis, is a reasonable apportionment of the total return of the trust."(Emphasis added.)

However, other parts of the regulation may suggest that a trust that pays a unitrust amount will be treated as an income trust only if the trustee is permitted to and does "switch" the trust from an income trust to a unitrust. (Reg. 1.643(b)-1 (ninth sentence) provides, in part, "Allocations pursuant to methods prescribed by such state statutes for apportioning the total return of a trust between income and principal will be respected . . . regardless of which alternate permitted method is actually used, provided the trust complies with all requirements of the state statute for switching methods." (Emphasis added.)

In Florida, in contrast to New York, income is not defined as a unitrust amount. Rather, F.S. sec. 738.1041(1)(c) defines an income trust as "a trust . . . which directs or permits the trustee to distribute the net income of the trust to one or more persons. . . ." F.S. sec. 738.1041(2) provides that a "trustee may, without court approval, convert an income trust to a total return unitrust, reconvert a total return unitrust to an income trust, or change the percentage used to calculate the unitrust amount or the method used to determine the fair market value of the trust" if certain conditions are met. F.S. sec. 738.1041(11) provides, in part, "The grantor of a trust may create an express total return unitrust which will become effective as provided in the trust document without requiring a conversion under this section." However, as mentioned, Florida law, umike"New"York law, does not define income as being a unitrust amount.

In Private Letter Ruling 2011-17-005, the National Office of the Internal Revenue Service held, without discussion, that a trust, which would be created under Florida law and which directed the payment of a unitrust amount to the surviving spouse (as opposed to a trust that was converted from an income trust to a unitrust), would qualify for the estate tax marital deduction. Although under section 6110(k)(3), a private letter ruling cannot be cited or used as precedent, the ruling indicates that it is the position of the IRS that a trust that mandates the payment of a unitrust amount from the trust's inception to the surviving spouse will qualify for the estate and gift tax marital deduction pursuant to sections 2056(b)(5) and (7) and 2523(e) and (f) if state law permits a conversion of an income trust to a unitrust (of between 3% and 5%), as well as where state law defines income to be such a unitrust amount.

This is an important matter to lawyers advising estate planning clients. Many individuals wish to provide for a marital deduction trust to mandate a unitrust amount rather than income to the beneficiary spouse. I think it would be very helpful if you could issue guidance clarifying that, as long as state law either defines income as a unitrust amount (of between 3% and 5%) or permits converting an income trust to a unitrust (of between 3% and 5%), a trust that provides for a payment of unitrust (of between 3% and 5%) from its inception will be treated as directing the payment of its income for purposes of sections 2056(b)(5) and (7) and 2523(e) and (f).

As I am no longer practicing law, I have no client who would be affected by this clarification and I never have represented a client who attempted to create a marital deduction trust that mandated a unitrust payment to the beneficiary spouse from inception.

Thank you for the opportunity to express my views.