IRS ruling positions on grantor trust treatment result in uncertainty.

• Author: Coplan, Robert B.

Quite a few of the more significant estate planning trust techniques currently rely for their overall tax savings on creating a trust in a manner that will cause it to be treated as a grantor trust under Secs. 671-678. One type of benefit sought to be obtained from grantor trust treatment - exemplified by the "defective-trust" - is the payment of income tax by the donor on income that will inure to the benefit of other family members (such as children), who are remaindermen of the trust.

Other trusts need to be grantor trusts to prevent the recognition of gain or other income on dealings between the grantor and the trustee of the trust. Residence grantor retained interest trusts GRITS) and grantor retained annuity trusts (GRATs) fall into this category. In the case of residence GRITS, it is typically anticipated that the grantor will purchase the residence back from the trustee just before the trust term expires in order to (1) retain the opportunity to live in the house and (2) reestablish the potential for a step-up in basis on death. For GRATs, grantor trust status is critical to (1) prevent gain recognition if or when appreciated trust property is used to satisfy, the trustee's fixed annuity payment obligation and (2) make the trust a qualified shareholder of S stock if such stock is to be used in the GRAT. Assuming one achieves grantor trust status, the Service continues to routinely cite Rev. Rul. 85-13 for the proposition that no gain is recognized when a grantor deals with his own grantor trust; see, e.g., Letter Rulings 9535026 and 9519029.

It has become difficult, however, to be certain that grantor trust status has been achieved in a manner consistent with the trust's estate and gift tax objectives. Part of the problem has been the IRS's pattern of issuing favorable letter rulings under one approach only to subsequently change that position (or adopt a norule position) without making any public disclosure.

The first example of this change in ruling posture occurred with respect to a grantor's retained nonfiduciary power to substitute assets of equivalent value for trust assets under Sec. 675 (4). The Service issued what was probably the last "clean" favorable grantor trust ruling based on such a trust provision in Letter Ruling 9352017. In that ruling, the taxpayer and his spouse both created GRATs that were held to be grantor trusts by virtue of a Sec. 675(4) substitution power. Two other GRAT rulings issued the same week relied...