AICPA Pre-Release Comments on Private Trust Company IRS ...



The Honorable Mark W. Everson

Commissioner, Internal Revenue Service

Courier's Desk

1111 Constitution Avenue, NW

 Washington, DC20044

 

RE:   Pre-Release Comments on IRS Business Plan Project to Provide G uidance Regarding the Consequences Under Various Estate, Gift, and Generation-Skipping Transfer (GST) Tax Provisions of Using a Private Trust Company (PTC) as the Trustee of a Trust

 

Dear Commissioner Everson:

 

The American Institute of Certified Public Accountants (AICPA) is pleased to offer the attached pre-release comments on guidance needed on the estate, gift, and GST consequences of using a family-owned company as the trustee of a trust. We are providing several suggestions on specific areas involving private trust companies (PTCs) that require guidance and our suggestions on specific approaches that we hope would be considered for inclusion in future guidance in the area. Our Trust, Estate, and Gift Tax Technical Resource Panel’s Private Trust Companies Task Force developed these comments, which were approved by both the AICPA's Trust, Estate, and Gift Tax Technical Resource Panel and Tax Executive Committee.

 

The American Institute of Certified Public Accountants is the national, professional association of CPAs, with approximately 350,000 members, including CPAs in business and industry, public practice, government, and education, student affiliates, and international associates. Our members provide tax services to individuals, not-for-profit organizations, small and medium-sized businesses, as well as America's largest businesses.

 

Our attached comments focus on the valuable role that private trust companies play and address governance, discretionary trust distribution and investment powers issues involving PTCs. We welcome the opportunity to address any additional areas in which the IRS might be interested.

 

As we discuss in our attached comments, forming, staffing and running a PTC is both expensive and time consuming. IRS guidance and safe harbors are of critical importance to give families embarking on this process some degree of certainty that if properly structured, the PTC will not result in unexpected estate inclusion issues or other adverse tax consequences.

 

We welcome the opportunity to discuss our comments further with you or others at the IRS and Treasury Department. Please contact me at tpurcell@creighton.edu; Steven A. Thorne, Chair of the AICPA Trust, Estate, and Gift Tax Technical Resource Panel, at stethorne@; Lewis M. Linn, Chair of the AICPA Private Trust Companies Task Force, at llinn@; or Eileen Sherr, AICPA Technical Manager at esherr@.

 

Sincerely,

Thomas J. Purcell, III

Chair, AICPA Tax Executive Committee

AMERICAN INSTITUTE OF CERTIFIED PUBLIC ACCOUNTANTS

Pre-Release Comments on IRS Business Plan Project to Provide Guidance

Regarding the Consequences Under Various Estate, Gift, and

Generation-Skipping Transfer (GST) Tax Provisions of

Using a Private Trust Company (PTC) as the Trustee of a Trust

Approved by

Trust, Estate, and Gift Tax Technical Resource Panel (TRP)

and

Tax Executive Committee

Developed by:

Private Trust Companies Task Force

Lewis M. Linn, Chair

Geoffrey F. Grossman

Mark Levy

Lynn A. McGovern

Dulcie Truitt

Steven A. Thorne, Trust, Estate, and Gift Tax TRP Chair

Eileen R. Sherr, AICPA Technical Manager

Submitted to Treasury and IRS

March 29, 2006

AMERICAN INSTITUTE OF CERTIFIED PUBLIC ACCOUNTANTS

Pre-Release Comments on IRS Business Plan Project to Provide Guidance

Regarding the Consequences Under Various Estate, Gift, and

Generation-Skipping Transfer (GST) Tax Provisions of

Using a Private Trust Company (PTC) as the Trustee of a Trust

EXECUTIVE SUMMARY

We are pleased the IRS has undertaken this project to provide guidance on the estate tax consequences of using a family-owned private trust company (PTC) as the trustee of a family trust. Forming, staffing and running a PTC is both expensive and time consuming. IRS guidance and safe harbors are of critical importance to give families embarking on this process some degree of certainty that if properly structured, the PTC will not result in unexpected estate inclusion issues or other adverse tax consequences.

Taxpayers are interested in private trust companies primarily to avoid inter-generational conflict and trustee succession issues. PTCs fill an important role for multi-generational trusts that is different than that of either individual trustees or large corporate trustees.

In previously issued private letter rulings, the IRS has raised concerns with family control over trusts in which the PTC is trustee, either directly by participating in discretionary trust distribution decisions, or indirectly through voting control of the PTC or representation on the PTC’s board of directors. As we address in our comments below, many of these concerns are misplaced as the same issues often occur with trusts and the powers given to trustees, where there is ample precedent that can be relied upon to avoid adverse tax consequences. Our recommendations include practical safe harbors and approaches that would address these concerns.

Because PTCs are governed by state laws which vary from one jurisdiction to the next, safe harbors are also required to avoid disparate federal tax consequences to a trust resulting solely from different PTC chartering requirements of various states. For example, some states mandate family involvement in ownership and/or management in order to receive a charter.

We recommend that any future guidance contain the following important features:

1. It should state clearly that the grantor or beneficiary of any trust is not prohibited from serving on the distribution committee of the PTC as long as adequate safeguards are in place to prevent the grantor or beneficiary from participating in decisions that, acting as an individual trustee, would have caused the trust assets to be included in his or her estate.

2. It should include a safe harbor which would apply as long as the PTC’s bylaws prohibit a grantor or current beneficiary from participating in any discretionary distributions with respect to any trust of which they are a grantor or beneficiary while serving on the distribution committee. If the bylaws are later amended to eliminate this prohibition, then the safe harbor would no longer apply and the PTC owners and directors would be at risk.

3. With the exception of control over discretionary distributions as discussed above, family members should be able to participate in ownership as well as all other aspects of managing the PTC.

BACKGROUND

Many wealthy families hold their wealth in trust, frequently in trusts that are intended to last for multiple generations. When created, many of the older trusts still in existence today had a trustee who was an individual in whom the family founders had absolute confidence.

Over time, families grow and disperse geographically. Once the responsibility for choosing successor trustees passes down a generation or two, it becomes extremely difficult to find successor trustees in whom all members of the younger generations have the same degree of confidence as the founders had in the initial trustee. This creates a risk that one or more family members will seek a means, possibly through disruptive litigation, of designating the successor trustee in their family line, creating family disharmony. A private trust company (PTC) can minimize this risk when it is structured to give a representative share of family members a voice in governing the trust and, ultimately, be responsive to the goals and needs of the family’s various generations.

Individual trustees face greater risks today than ever before. Investing has become more and more complex and individual trustees must shoulder greater and greater responsibilities. These traditional trustees often feel ill-equipped to serve in this capacity or fear the trend toward increased litigation against trustees. Individual trustees often rely on family members or their staff and advisors to support them with trust administration functions such as investment advice, accounting services and tax return preparation.

Using individual trustees allows highly personalized trust administration. Shifting to a large institutional corporate trustee can be both rigid and impersonal, substantially changing the “culture” of the trustee. Employing an institutional trustee can compel the family to make significant sacrifices and lose flexibility.

Why Use a Private Trust Company?

When confronted with this choice, many families prefer a PTC, which provides the flexibility of an individual trustee while adding continuity for trust administration and trustee protection from personal liability. Other reasons why a PTC may be preferable to an individual trustee or to a large corporate trustee include:

• Quality. The PTC can work with independent service providers that provide creative, best-in-class service as opposed to being limited to in-house services.

• Privacy. PTCs provide a greater degree of confidentiality.

• Continuity/Trustee Succession. A PTC is not limited in its duration and can serve as trustee indefinitely.

• Flexibility/Culture. PTCs are flexible enough to meet the specific needs and culture of the family because the PTC is focused on a small number of individuals that it serves and is not distracted by the needs of other clients. It can be high- or low-tech. Timeliness and responsiveness are within the control of the family. Asset allocation can be influenced by the family’s desire for income or appreciation. Services can be outsourced or provided internally.

• Diversity of Services. PTCs can perform investment management, accounting, financial reporting, tax compliance, tax planning and other specialized services as the family requires. These services can either be performed internally or coordinated with outside service providers. They can be coordinated with and leverage off of services provided by the family members or their staff and advisors. In addition, when a family has its own infrastructure in place in the form of a family office, family members may not desire or need all the services which are normally bundled into the trustee services offered by large institutional trustees.

• Communication. Trust beneficiaries have greater access to management personnel in a PTC, increasing the likelihood that the client’s specific needs and concerns are addressed.

• Generational issues. PTCs facilitate succession planning and can foster better education for family members in trust administration, investment management and other matters.

• Cost control. PTCs offer only the services the family is interested in receiving, freeing the trust from paying for standardized services the family may not want or need. PTCs can take advantage of economies of scale and leverage pricing by using outside service providers, resulting in cost savings and greater efficiency for the trust.

Forming, staffing and running a PTC is both expensive and time consuming. IRS guidance and safe harbors are of critical importance to give families embarking on this process some degree of certainty that if properly structured, the PTC will not result in unexpected estate inclusion issues or other adverse tax consequences.

GOVERNANCE

If family members cannot control the operations of a PTC, they lose many of the benefits of having formed it in the first place. Furthermore, eliminating family members from participating in the governance of a PTC formed to act as a trustee is unnecessary and inconsistent with the long-accepted practice of family members acting as trustees of family trusts. If family members can serve as individual trustees, there is no reason to prevent them from serving on the board of directors of a PTC, as long as appropriate safeguards are in place that would prohibit their participation in decisions that could cause estate inclusion if made if they acted as individual trustees.

There have been possible concerns raised that control over governance of the PTC – either by sitting on the board of directors or by controlling a majority of the voting stock of the PTC – could be synonymous with control over trust distributions, which could cause estate inclusion under sections 2036, 2038 or 2041.

PTCs are organized under state law and, generally, are exempt from some requirements that apply to trust companies that serve the public. To gain this exemption, states often mandate family member involvement in the PTC.[1] State requirements of family member participation should not cause trust assets to be included in the estate of a family member who serves as a PTC director, officer or limited liability corporation member under sections 2036, 2038 or 2041 as long as that family member does not control discretionary distributions of trust income or principal for a trust in which they are either a grantor or beneficiary. Because PTCs are governed by state laws which vary from one jurisdiction to the next, safe harbors are also required to avoid disparate federal tax consequences depending on to which state laws a PTC may need to adhere.

Rather, a governing family member empowered to appoint members of the discretionary distributions committee (DDC) should be treated in the same manner as any individual with the right to appoint successor trustees with authority over discretionary distributions, which does not trigger inclusion of trust assets in the appointer’s estate. Because there may be situations where, absent appropriate safeguards, family involvement in governing a PTC could cause estate inclusion, creating a practical safe harbor is critically important to allow taxpayers to avoid potential inclusion without resorting to the expense of using independent outsiders to control the PTC’s board.

IRS guidance should include a safe harbor requiring PTC bylaws to place a prohibition on the ability of the grantor or current beneficiary to participate in any discretionary distributions with respect to any trust of which they are a grantor or beneficiary while serving on the distribution committee. If the bylaws are later amended to eliminate this prohibition, then the safe harbor would no longer apply and the PTC owners and directors could be at risk for estate inclusion, depending on their specific facts and circumstances.

DISCRETIONARY TRUST DISTRIBUTIONS

The governing documents of most PTCs create a discretionary distributions committee (DDC) to make all decisions regarding discretionary trust distributions (that is, distributions that are neither mandatory nor limited by an ascertainable standard within the meaning of section 2041). Typically, DDC members are elected or appointed for a specified term by the directors or officers of the PTC or their equivalent.

Recent private letter rulings conclude that appointing a PTC as a trustee will not result in the inclusion of any portion of the trust in the estate of the grantor of the trust under sections 2036 or 2038, or in the estate of a discretionary beneficiary of the trust under section 2041, if the grantor or beneficiary is prohibited from participating in discretionary distribution decisions of any related trust. This restriction “prevents” “the possibility of outside reciprocal agreements that may indirectly give members…of the family effective control over the discretionary distributions from the trusts….” (See, for example, PLR 200548035.)

Although we agree with the PLRs’ conclusions, we do not agree with the reasoning. If the reference to “the possibility of outside reciprocal agreements” means that future favorable guidance will be conditioned upon an absolute prohibition of participation by any grantor or discretionary beneficiary in any decision of the DDC regarding distributions to family members, the effect will be to bar any family member from serving on the DDC in many cases. We believe that such a bar is excessive and unnecessary.

Our task force members represent a large number of PTCs, and they are not aware of any PTC established to achieve an estate tax savings. We agree that members of a family should not be able to alter the estate tax consequences that currently exist merely by operating under the umbrella of a PTC. However, families should not be penalized for choosing to shift trusteeship to a PTC. Having a PTC as the trustee should not require a family member to relinquish an existing power that the individual has or would have if that individual became a trustee, at the risk of incurring estate tax consequences that the individual would not have incurred otherwise. The estate tax consequences of exercising a power under the umbrella of a PTC should not differ from the result if the same family member exercises the same power as an individual trustee.

Treating each member of the DDC as a trustee for purposes of applying section 2041 is appropriate. If a family member can serve as a trustee without causing the trust assets to be included in that trustee’s estate under section 2041, the result should be the same if that family member serves as a member of a PTC’s DDC with respect to that trust.

For example, if a parent could serve as a trustee of a discretionary trust established by a grandparent for that parent’s adult children without the trust being included in the parent’s estate under section 2041, we see no reason why the parent should not be able to serve on the DDC of a PTC trustee of the same trust without adverse estate tax consequences. The only change in the parent’s position is from being a trustee to being a member of the DDC – a change without a meaningful distinction.

Similarly, for purposes of sections 2036 and 2038, a grantor of any trust who retains the right to designate successor trustees without triggering estate inclusion of trust assets should, within the context of a PTC, be allowed to participate in the selection of DDC members of the PTC and achieve the same result. Restricting grantors from appointing themselves to the DDC is the only necessary limitation. If each member of the DDC serves for a specified period of not less than two years and may not be removed from the DDC except for cause, we do not believe that Rev. Rul. 95-58 should be construed as preventing the grantor from appointing a family member to serve on the DDC.[2]

For example, a grandfather can establish a discretionary trust for his adult grandchildren, appoint their parent as the trustee and retain the power to appoint (but not to remove) successor trustees (other than himself), without including the trust assets in the grandparent’s estate under sections 2036 or 2038. Therefore, if a PTC becomes the trustee in place of the parent, the grandfather should be able to appoint the parent or anyone other than himself to serve on the DDC without adverse estate tax consequences. Again, the change from appointing successor trustees to appointing members of the DDC is a change without a meaningful distinction.

If the Service remains concerned about the possibility of reciprocity among family members using different trusts, we suggest requiring, under the PTC’s governing documents, that only persons on the DDC who are not related or subordinate (as defined in section 672(c)) to any family member on the DDC may participate in any decision to make a distribution (or in discharge of any legal obligation) to or on behalf of that particular family member.

For example, if family members A and B are serving on the DDC, either may participate in any decision to make a discretionary distribution to any family member not on the DDC, but A may not take part in any decision to make a distribution to (or in discharge of any legal obligation of) B, and B may not take part in any decision to make a distribution to (or in discharge of any legal obligation of) A. This way, only the non-family members of the DDC may participate in any decision to make a distribution to (or in discharge of any legal obligation of) A or B.

IRS guidance should state clearly that the grantor or beneficiary of any trust is not prohibited from serving on the DDC as long as adequate safeguards are in place to prevent the grantor or beneficiary from participating in decisions that, if acting as an individual trustee, would have caused the trust assets to be included in his or her estate.

INVESTMENT POWERS

One significant purpose for a establishing a PTC is to allow a family a greater level of control over the investment of trust assets. Families with assets in trusts sufficient to warrant the formation of a PTC face limited options for the day-to-day investment management. Although large corporate trustees are well-equipped to serve as investment advisors, their investment services can be expensive and biased with respect to their own proprietary products. A wealthy family that develops their own investment expertise often does not need – or wish to pay for – the full services of a public corporate trustee. Individual trustees frequently lack sufficient investment expertise and can be fearful of making investment decisions that violate their fiduciary duty to both current and future trust beneficiaries. Creating a PTC as trustee allows families to use their own investment expertise to develop personalized investment policies and asset allocations tailored to the family’s needs.

Retention of the power to make investment decisions over trust assets by a grantor does not trigger estate inclusion. This well-established principle was articulated by the Supreme Court in United States v. Byrum, 408 U.S. 125 (1972). Thousands of inter vivos trusts have relied on this principle for many years. This principle centers on a trustee’s fiduciary duty to the trust beneficiaries (and the adverse consequences of breaching it) that prohibits a trustee from managing trust assets in a way that could be interpreted as retaining control over the right to designate who shall posses or enjoy trust property or the income there from within the meaning of section 2036(a) (2). The principles established in Byrum have also been upheld in numerous other decisions, including Estate of King v. Commissioner, 37 T.C. 973 (1962), where a grantor reserved the power to direct a trustee in the management and investment of trust assets without causing the trust to be included in the grantor’s estate.

A PTC routinely forms an investment committee that includes one or more investment professionals, as well as trust company owners, directors or officers who could themselves be grantors or trust beneficiaries. Any IRS guidance that restricts the ability of grantors to reserve the power to direct trustees in managing trust investments would have a serious adverse impact on numerous trust grantors and their estates. We encourage the Service to stipulate that mere retention of investment control by PTC owners, directors or officers will not cause estate inclusion.

Further, serving on the PTC trustee’s investment committee should not, by itself, trigger estate inclusion for trust beneficiaries. Instead, any powers retained by the beneficiary must constitute a general power of appointment under section 2041 before any trust assets could be included in that beneficiary’s estate, following reg. section 20.2041-1(b), which states that the mere power of management, investment or custody of assets exercisable in a fiduciary capacity is not a power of appointment.

It is our belief that any IRS guidance or regulations on PTCs should explicitly state that retaining a right to actively manage the investment of trust assets – including the right to sell or exchange trust property – would not cause inclusion in the grantor’s estate under section 2036(a) (2) or in a trust beneficiary’s estate under section 2041.

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[1] For example, under the Texas Trust Company Act (Tex. Fin. Code Ann. section 182.011), a trust company can be granted an exemption if the PTC “does not transact business with the public,” meaning under Texas law that the PTC does not “provide trust or other business service(s) … with any individual who is not related within the fourth degree of affinity or consanguinity to an individual who controls the state trust company.” Therefore, the PTC must be controlled by family members to gain the exemption. This creates the potential for a classic whipsaw – the state law requirements to be treated as a PTC could potentially result in including the trust in the estate unless IRS clarifies that family members can be involved.

[2] Rev. Rul. 95-58 held that where a grantor has the right to remove and replace the trustee, the grantor is not considered to possess the discretionary rights of the trustee if any trustee so appointed must be someone who is not related or subordinate (as defined in section 672(c)) to the grantor. Merely because members of the DDC serve for a specified term rather than an indefinite term as trustees generally do, should not give the grantor a removal right. If members of the DDC served from day-to-day at the pleasure of the grantor or a group that included the grantor, it might be argued that the grantor possesses a power equivalent to the power to remove a trustee for purposes of Rev. Rul. 95-58.

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