Trusts’ merger does not trigger distributions or GST tax

In IRS Letter Ruling 202215015 released April 15, 2022, the IRS ruled that the merger of two trusts would not result in a loss of a grandfathered exemption from the GST tax and would not cause any distributions from the merged trust to become subject to the GST tax.

The taxpayers, a married couple, created three irrevocable trusts, Trust 1, Trust 2, and Trust 3, for the benefit of their descendants. All three trusts had an inclusion ratio of zero for GST tax purposes. The beneficiaries of all three trusts were the same. The distribution, dispositive, and trust power provisions of all three trusts were substantially identical. Trust 1 and Trust 2 had Identical termination provisions, while the provisions of Trust 3 would allow it to exist in perpetuity. The taxpayers proposed to merge Trusts 2 and 3 into Trust 1 to save administrative costs and enhance the management of the trusts’ investments.

Regs. Sec. 26.2601-1(b)(4)(i) provides rules for determining when a modification, judicial construction, settlement agreement, or trustee action with respect to a trust that is grandfathered for GST tax purposes will not cause the trust to lose its exempt status. The regulation provides that a modification of the governing instrument of an exempt trust by judicial reformation, or nonjudicial reformation that is valid under applicable state law, will not cause a grandfathered trust to be subject to GST tax if (1) the modification does not shift a beneficial interest in the trust to any beneficiary who occupies a lower generation.⁴ Than the person or persons who held the beneficial interest prior to the modification and (2) the modification does not extend the time for vesting of any beneficial interest in the trust beyond the period provided for in the original trust.

The IRS noted, as it has in other letter rulings, that there is no similarly published guidance regarding the application of GST tax to the modification of trusts that are GST tax-exempt because they have an inclusion ratio of zero (i.e., not grandfathered, but GST exemption was allocated to transfers to the trust sufficient to make the trust GST tax-exempt). Noting that there has been no guidance for GST-exemption trusts like that provided in Regs. Sec. 26. 2601-1(b)(4)(i), the IRS stated that, at a minimum, a change that would not affect the GST status of a grandfathered trust should similarly not affect the status of a trust that is GST tax.exempt.

Noting that Trust 3 with no termination date and Trust 2 with the same termination date as Trust 1 would be merged into Trust 1, the IRS ruled that merger would not (1) shift a beneficial interest in the trust to any beneficiary who occupied a lower generation than the person or persons who held the beneficial interest prior to the modification or (2) extend the time for vesting of any beneficial interest in the trust beyond the period provided for in the original trust. Therefore, the merger of the trusts would not result in a loss of GST tax-exempt status of any trust and would not cause any distributions from the merged Trust 1 to become subject to GST tax.

It is likely that the IRS would not have ruled or would have ruled negatively if Trust 1 and Trust 2 were being merged into Trust 3, which would never terminate, as it would likely violate both of the criteria cited in Regs. Sec. 26.2601-1(b)(4)(i).