6.3 Effective Uses of Powers

• Library: A Lawyer's Guide to Estate Planning: Fundamentals for the Legal Practitioner (ABA) (2018 Ed.)

6.3 Effective Uses of Powers

6.31 Limited Power of Appointment

For federal estate tax purposes, a general power of appointment is a power that can be exercised in favor of the holder, his or her estate, his or her creditors, or the creditors of his or her estate. A power will not result in an estate tax, no matter how broad the group for whom it can be exercised, if it cannot be exercised in favor of the holder, his or her estate, his or her creditors, or the creditors of his or her estate.⁴ A power so limited is termed a nongeneral or limited power of appointment, which is not taxable to the holder. This presents a good planning opportunity.

Property can be transferred by the settlor into a trust for the lifetime benefit of the beneficiary. The beneficiary can be given a limited power of appointment exercisable during lifetime or at death, and this power will not result in an estate or gift tax to the beneficiary, whether or not the power is exercised. Typically, this power will be limited to being exercised in favor of the power holder's spouse, children and children's spouses, more remote descendants and their spouses, and tax-exempt charities.

Caution: While the holding of a limited power of appointment does not result in the property subject to the power being included in the gross estate for federal estate tax purposes, it may make the holder subject to the gift tax.⁵ If the holder of the power also has an interest in the property, a taxable gift will result from the inter vivos exercise of the limited power. For example, a widow who receives income for life from a trust makes a taxable gift when she exercises a limited power of appointment during her lifetime in favor of her children. She has passed part of the principal of the trust to them, which has the effect of...