Valid Trust As Bene- Life Expectacny To Be Used?

[Guest Taxwoman]

If an individuals designates, as the beneficiary of the IRA, a valid trust as defined under Prop. Treas. Reg. 1.401(a)(9), can the individual beneficiaries ( there are multiple) under the trust use their own life expectancies if the assets are separated into individual inherited accounts by 12/31 of the next year?

Under the old rules, it was mandatory that the life expectancy of the oldest beneficiary be used- has this changes with the new rules?

[BPickerCPA]

Taxwoman,

This is a tough question. My understanding is that if the trust document itself mandates the split into separate trusts, one for each bene, then each trust uses that bene's life expectancy. Otherwise, it's considered one trust and you go with the oldest bene's LE.

[Guest Taxwoman]

Thanks Barry-

[Guest reg_h2b]

I'm extremely interested in this since I have a PLR outstanding on this issue.

Questions:

1. Barry, was your response applicable only to situations covered by the new reg.'s; or both new reg's and old reg's?

2. If only "new reg's", do you agree that under old reg's that it is ALWAYS eldest bene's LE?

3.Your answer's logic seems to depend SOLELY on the way the trust is written i.e. that the trust itself mandates the split into separate subtrusts. In other words, the trustee has NO discretion. Is this true?

4. What is your source for this "understanding": PLR or informal talk with IRS? Would appreciate any specifics to document your understanding (PLR # etc.)

Thanks in advance.

[BPickerCPA]

1. The question of splitting of the trusts would theoretically be applicable under both old and new regs, but under the old regs it would only be applicable if death was before the RBD. Under the new regs, it would also be applicable if death was after the RBD.

2. Technically, it's not the eldest bene's LE, it's the bene with the shortest LE. That's why if the trust could benefit the estate (pay estate taxes or expenses or administration costs), the trust fails.

3. I've never seen a situation where the trustee had discretion. I think it would have to be mandated in the trust document. The rule is clearly that you use the bene with the shortest LE when you have multiple bene's of a trust. The only way the split works is if you can show that it's multiple trusts, not multiple bene's of one trust.

4. There are enough PLRs to lead to the understanding that if it's one trust with multiple bene's, you use the bene with the shortest LE. I have to admit that I don't recall where my understanding came from. I don't recall a PLR, so it could be from discussions with the IRS, or discussions with other IRA pros. Sorry.

Good luck with your PLR.

[Guest reg_h2b]

I appreciate the reply and the sentiment. Still confused a bit by your position. I'll cut to the chase by giving our PLR's fact pattern as an example:

IRA owner dies pre-RBD in 1999. "Look through" trust ("T") primary bene on IRA bene form. At death, under the terms of trust, T splits into subtrusts A and B. Spouse sole bene of subtrust A. Children sole bene's of subtrust B. Assume IRA is sole asset that funds trust T. Trust T says fund B up to unified credit. The rest goes to A.

My interpretation of your position is that since the split of the IRA into subtrusts A/B is under the terms of the T we can use spouse LE for subtrust A and shortest childs LE under subtrust B.

Is this your position? If it is, why isn't shortest LE of trust T used (under general rule E-5) If not, what am I missing?

As a footnote, we know from past PLR's that:

If Trust A and B were actually ON the IRA bene form as two separate primary bene's and separate accounting is used, then you CAN use the shortest LE under Trust A and the shortest LE under Trust B for each MRD (under H-2).

Also, in a previous PLR, the IRS ruled that if trust T is sole primary of the bene form, you CAN'T use "separate accounting" under H-2 if the IRA is split under the "terms of the trust" as opposed to the "terms of the plan".

[Bruce Steiner]

You can easily have a discretionary trust. For example, most credit shelter (bypass) trusts give the trustees discretion to distribute income and principal to the spouse or the issue. In that case, assuming the spouse is older than the issue, the spouse will have the shortest life expectancy, and his/her life expectancy will be used. Perhaps under the new proposed regulations, the trustees will be able to divide the trust (for example, to set aside a portion for the issue, of which the spouse will not be a beneficiary) by December 31 of the year following the IRA owner's death. But the trustees might not want to do so absent the spouse's disclaimer or consent (after all, the purposes of the credit shelter trust are to keep the money available for the spouse's benefit, and ofte to permit the spouse to control the ultimate disposition of the trust assets to or in further trust for the issue upon his/her death.

The real issue comes up where you have two or more children, and you leave each child's share to him/her in trust rather than outright.

Let's assume that the trustees have discretion to distribute the income and principal of each child's trust to that child or the child's issue. Ignoring the possibility that the siblings could be treated as beneficiaries (if a child dies without issue), each child is the oldest beneficiary of his/her trust.

If the division into shares takes place in the beneficiary designation, then each child's trust uses the life expectancy of the child who is the beneficiary of the trust (again assuming that the child is the oldest beneficiary of the trust, and that there is no other reason that you couldn't look through to the beneficiaries of the trust).

To do this, you would need a beneficiary designation along the lines of "my issue, per stirpes, except that each person's share shall not be payable to him or her, but instead shall be payable to the trust for his or her benefit under my Will."

Since some IRA trustees/custodians may not like this, because it won't fit in the small space provided on the beneficiary designation form, some people instead have a beneficiary designation that says something like "the family trust under my Will," and then provide in the Will that if the spouse does not survive, the family trust is divided per stirpes and held in separate trusts for their benefit.

There is no economic difference whether the division takes place in the beneficiary designation form or in the Will (or other trust instrument). And even under the old proposed regulations, assuming each child was at least 10 years younger than the IRA owner, there wouldn't have been an opportunity to manipulate the system even if IRA owners had to take distributions from separate IRAs or separate shares pro rata (which wasn't even the case). But there were some PLRs before the new proposed regulations that drew this distinction, at least where the IRA owner died after the required beginning date. Since reg_h2b is the lawyer seeking the PLR, I'll let him/her do the research to find them. In most cases, if the children were close in age, it may not have been worth the effort to create a more complicated beneficiary designation form and look for a financial institution that would accept it.

Presumably the new proposed regulations will give the fiduciaries until December 31 of the year following death to set up the appropriate beneficiary accounts.

Reg_h2b: Please keep us posted on your PLR.

[Mary Kay Foss]

I'd be concerned in your ruling fact pattern that the Trust B designation would be a pecuniary bequest. If that were the case, all IRD would be taxable upon funding and the life expectancies would be unimportant. I suppose you could have gotten around this by designating a fraction equal to the exemption amount.

I'm also very interested in how the ruling comes out. If you decide to withdraw it, please let us know that as well.

[Bruce Steiner]

Whether using the IRA to fund Trust B accelerates the IRD has been the subject of some discussion and differences of opinion. Some people have argued that the income should not be accelerated because Sections 72 and 408 override the general principles of acceleration when using IRD to fund a pecuniary bequest. It is also possible that the IRS may not spot the issue.

Obviously this issue could have been avoided in several ways. While fractional share estates are difficult to administer, the trust could have used a fractional share formula. Or there could have been a fractional share formula in the beneficiary designation, which would have applied only to the IRA. Or, what is probably the simplest approach (though a disclaimer trust is less flexible than a mandatory credit shelter trust), the IRA owner could have named the spouse as primary beneficiary, and the credit shelter trust as contingent beneficiary, and the spouse could have decided whether to disclaim.

In addition to the issue of whether the IRD is accelerated, there is also an issue as to whether the portion going to Trust A will qualify for a spousal rollover. There have been numerous PLRs on this, some favorable and some unfavorable, which I discuss in my article in the October 1997 issue of Estate Planning.

[Guest reg_h2b]

Appreciate the thoughts and analysis. I'll post the outcome of the PLR as soon as we get it.

Your Concerns:

Mary Kay, the trust actually has a pecuniary formula on the maritial trust (A) and not the family trust (B). The share in the maritial trust will be distributed to the spouse and rolled over. So the IRD issue should not be a problem.

Bruce, the only assets used to fund Trust T are the IRA assets so the Trustee does not have ability to deny IRA assets to Trust A . Maritial Trust (A) gives the spouse unlimited power to withdraw all assets in Trust A. Spousal rollover should be a slam dunk.

In addition, Bruce, the SOLE bene's of the family trust are the children. (Spouse qual. disclaimed the entire family trust).

My Remaining Problem(s):

Given the previous posted fact pattern, what LE do we use on the IRA amount in the famliy trust (B)?

If it's the shortest LE of Trust T then it's the spouse (LE 16 years).

If it's the shortest LE of trust B then it's the eldest child (LE 44 years).

So the stakes are significant. (Yes, I know there were better ways to accomplish this goal).

Where We Are Now/Outstanding Questions:

1.Unhappily the new reg's don't seem to change the BENE LE tables at all. It only changes the LE table for the IRA OWNER! Agree?

2. PLR 199903050 is close to our fact pattern. IRS ruled that separate accounting could not be used if a Trust is on the bene form. Again, the reason was that the separation of accounts occured under the terms of the Trust and not the Plan. Thus the IRS ruled that the shortest LE should be used looking at ALL the design. bene's of the Trust on the bene form.

Many other PLR's just ask for shortest LE approval and don't challenge the conventional wisdom.

3. I was interested in Barry's analysis since it seemed to go against my understanding. Can the shortest LE of EACH subtrust be used and why?? Barry?

4. Let me add to the fact pattern by mentioning that there were actually 3 IRA's that had Trust T as primary bene. (Only one IRA is the subject of the PLR; that one funds both subtrusts A and b). Here's the interesting fact: one of the IRA's, "X", only goes into the Family Trust (B). Does the IRS intend to say that even though the spouse does NOT benefit from IRA X that her LE should still be used for the MRD for IRA X? That's my read of the IRS's strict interpretation of D-5(B) and E-5 general rule! Do you agree?

Final Thought:

I believe, in situations like ours, where the trustee does not have discretion in the allocation of IRA assets that the trust, on the bene form, merely acts as an "administrative conduit". As Bruce said there is "no economic difference whether the division takes place in the beneficiary designation form or in the Will (or other trust instrument)". Exactly.

Indeed, the analogy between a spousal rollover and our situation may be appropiate. In our situation, it's clear a spousal rollover would be allowed even though the trust is on the bene form. The IRS would rule that even though the IRA came through the trust they would deem it as coming from the IRA owner/plan and NOT from the trust because the trustee had no discretion and withdraw is not subject to a standard. In other words, the Maritial Trust is acting like an administrative conduit. OK, fine.

But the facts are the same for the Family Trust also: the separation of IRA assets was not subject to the trustees discretion and the ability to withdraw from the Family Trust is not subject to a standard. In this case, why shouldn't the separation of assets be deemed to have occured under the plan and thus separate accounting allowed? The IRS would merely be saying that in both situations the Trust on the bene form is acting as an administrative conduit.

Interested in any feedback. Thanks again.

[Bruce Steiner]

I agree that if you have a pecuniary marital/credit shelter (the form I generally prefer for the reasons set forth in my article in the October 1986 issue of the Journal of Taxation), the IRA benefits passing to the credit shelter won't accelerate the IRD because it's the residuary share.

It sounds like you shouldn't have any trouble getting a favorable ruling on the spousal rollover if the spouse has the power to withdraw all of the assets of the marital trust.

While the issue is not entirely free from doubt, the spousal rollover ought to reduce the risk that the use of IRA benefits to fund the pecuniary marital might accelerate the IRD.

If the spouse disclaimed his/her interest in the credit shelter, then presumably it passes to or in further trust for the children, in separate shares. So (ignoring the possibility that the children take in trust and don't have any issue so that each child is the presumptive remainder beneficiary of the other child's trust and thus may be treated as a measuring life), you may be able to use each child's life expectancy for that child's share. In this regard, new Prop. Treas. Reg. § 1.401(a)(9)-8 Q&A 2(B), which allows separate shares to be established by the end of the year following death, may be helpful.

Again, keep us posted on how your ruling goes.

[Guest reg_h2b]

Bruce/Mary Kay/Barry et al-

Could someone define "accelerate the IRD" in the context of this post (when funding first the marital trust and funding the family trust with the residual)?

Here are the relevant facts to consider:

1. The funding language in the trust is thus "The Trustee shall allocate to the Marital Trust the least amount which, if allowed as a marital deduction for Federal estate tax purposes, would result in the least amount of Federal Estate tax payable as a result of the Grantor's death."

2. DOD was 9/99, Funding 12/2000, Sps Rollover of IRA from Marital Trust to occur in 12/2001.

Does the fact that sps delayed rollover change effect the "accelerate the IRD" issue? Again I think I need an explanation of what is meant by "accelerate the IRD" with regard to funding the trust. Would this effect the ability to do the sps rollover?

Reg