Split-interest trusts as S shareholders.

• Author: Gerson, David

The IRS in Rev. Rul. 92-48 held that a charitable remainder trust could not be a qualified subchapter S trust (QSST) even though the annuitant in a charitable remainder annuity trust (CRAT) or unitrust holder in a charitable remainder unitrust trust (CRUT) was a single current income beneficiary. Subpart E treatment under the deemed grantor trust reporting rules for a QSST was incompatible with the income-sourcing and other provisions of Sec. 664.

However, the Service has concluded in two letter rulings that an irrevocable trust that is treated as a grantor trust because the donor of the trust has reserved an administrative power in a nonfiduciary capacity to substitute trust assets (as described in Sec. 674(4)(C)) was a permissible shareholder under Sec. 1361(c)(2)(A)(i).

Letter Ruling 9227013 considered irrevocable trusts in which each grantor reserved for himself a lifetime power to substitute other property of equivalent value in the trust without the approval or consent of any other person, including the trustees. The power of substitution was not assignable and would lapse at any time after the trust no longer held stock if the grantors together owned more than 20% of the corporation. The letter ruling noted that on lapse of this Sec. 675 power the grantor trust would become a QSST, since each trust provided that its single beneficiary had made the QSST election under Sec. 1361(d)(2) and that all of the income of each trust was distributed at least annually to the single beneficiary. Of particular interest, the letter ruling relied on the case of Est. of/ordahl 65 TC 92 (1975), acq. 1977-1 CB 1, to hold that the asset substitution power did not constitute a Sec. 2038 power that would require inclusion of the trust property in the donor's estate.

Letter Ruling 9227023 considered separate irrevocable GRATs for a 10-year term created by married grantors with their children named as the remainder parties of each trust. Each grantor reserved a personal right and power...