Trustee Removal Powers: Warnings from the Plrs

• Publication year: 1991
• Pages: 901
• Citation: Vol. 20 No. 5 Pg. 901

20 Colo.Law. 901 Colorado Lawyer 1991.

1991, May, Pg. 901. Trustee Removal Powers: Warnings from the PLRs

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Vol. 20, No. 5, Pg. 901

Trustee Removal Powers: Warnings from the PLRs

by Clifton B. Kruse, Jr

Recent Private Letter Ruling ("PLR") 8916032(fn1) concludes that a beneficiary of a discretionary trust who has the power to remove and replace the trustee of the trust holds a general power of appointment. Therefore, the value of the trust corpus is taxable in the estate of the trust beneficiary.(fn2)

This applies even if the beneficiary is unable to appoint himself or herself as trustee(fn3) and even if the power is not exercised.(fn4) It applies notwithstanding that the beneficiary is not the trust settlor. Revenue Ruling ("Rev. Rul.") 79-353, which holds that the value of a trust created by a settlor is taxable in the settlor's estate where the settlor has retained the power to remove and replace the trustee, has been extended in its effect by the recent PLR 8916032.(fn5)

It appears that a trust settlor is now forbidden from making grants of authority to a beneficiary and from removing and replacing a trustee unless such powers are limited by ascertainable standards.(fn6) The Internal Revenue Service ("IRS") cites Rev. Rul. 79-353 as the authority for this position. The IRS cites PLR 8916032 as the justification for the right to include the value of the trust corpus in the estate of a trust beneficiary in cases where (1) the beneficiary, at the time of his or her death, is a discretionary beneficiary of the trust, (2) dis- tributions are not limited by ascertainable standards and (3) the beneficiary has the power to remove and replace the trustee.

Both Rev. Rul. 79-353 and its progeny, PLR 8916032, which extends the revenue ruling, have been widely criticized.(fn7) The primary purpose of this article is to alert the bar to the position the IRS has taken. Whether or not this position is legally defensible, knowledge of the posture the IRS may take (as evidenced by these rulings) may affect the powers granted to trust beneficiaries by lawyers in planning documents.(fn8) Rev. Rul. 79-353 affects only inter-vivos trusts. However, the recent rulings, taxing the granted power to remove and replace the trustee of a testamentary discretionary trust, affect will drafting as well.

PLR 8916032

PLR 8916032 concerned a surviving spouse who was the beneficiary (along with her minor children) of a family trust and who had the power to remove the trustee and substitute a corporate successor. The IRS held that the surviving spouse will be taxed on the value of the trust to which the granted power relates. Because the beneficiary can discharge and substitute the trustee of the family trust, the trust corpus will be included in the beneficiary's gross estate Rationalized by the IRS as equalling a general power of appointment,(fn9) the right to remove and replace a corporate trustee at will is determined in this ruling to be the equivalent of control over the disposition of the trust assets by the beneficiary. The ruling states that

the spouse's removal power would be regarded as a general power of appointment over the portion of the corpus of the Family Trust that was contributed by the predeceased spouse, by reason of the removal power and the corporate trustee's [authority] to make discretionary distributions to the power holder's minor children.(fn10)

Discretion of the trustee to disburse trust funds to the minor children of an adult beneficiary who can replace the trustee is imputed in this ruling to that beneficiary. That result is not prevented by limiting principal distributions to recognized, ascertainable standards, such as health, education, support and maintenance:(fn11)

[T]he trustee's power to make distributions to the minor children constitutes an indirect benefit to the surviving spouse because it permits a discharge of the surviving spouse's legal obligation to support those children.(fn12)

With the power granted in the trust to change the corporate person who has authority to make discretionary distri-

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butions, the power holder ("spouse-beneficiary") is treated as holding a general power of appointment over the trust estate that could be exercised in the spouse-beneficiary's favor. Therefore, the value of the trust corpus is taxable in the spouse-beneficiary's estate. Even though the children's interest is legally adverse to the spouse-beneficiary's interest, the parent's right to vote for the removal of the trustee on behalf of the minor children gives the spouse-beneficiary a majority of the votes sufficient to discharge and replace the trustee.

Finding a fiduciary to the spouse-beneficiary's liking, who presumably would do the spouse-beneficiary's bidding, gives the spouse-beneficiary power over the trustee. PLR 8916032 held that having this authority and, in this way, controlling distributions that can satisfy the surviving parent's support obligations to minor children causes the parent legally to possess a taxable power.(fn13)

Further, even though the trustee is limited in making distributions, "a power is not limited by an ascertainable standard if distribution discharges a legal obligation."(fn14) When the spouse-beneficiary loses voting control to substitute the trustee---an event occasioned by the children attaining adulthood---the spouse-beneficiary's power lapses. However, the release of the general power of appointment, coupled with a retention during the spouse-beneficiary's lifetime of an income interest which the trust provided, continues to cause the trust value to be included in the beneficiary's estate under the Internal Revenue Code of 1986, as amended ("Code").(fn15)

The FNB Decision

Two years after Rev. Rul. 79-353 was published and...