The Impact of the CCAM on Trust Decanting in New York

On Dec. 29, 2023, the Office of the Chief Counsel (the Chief Counsel) of the Internal Revenue Service (IRS) released Chief Counsel Advice Memorandum 202352018 (the CCAM).

Although some have commented on the CCAM’s impact on trust modifications, a further question is what impact, if any, will the CCAM have on trust decantings in New York?

Summary of the CCAM

The CCAM concerned trustees of an irrevocable grantor trust who petitioned a state court to modify the trust’s terms. The trustee asked the court to add to the trust a discretionary power to distribute trust assets to the grantor in order to reimburse the grantor for any income tax liability attributable to the trust’s income (an income tax reimbursement clause). Local law required the trust’s beneficiaries to consent to the modification, which they did. The court allowed the modification.

Upon review, the Chief Counsel opined that the modification caused a taxable gift by the beneficiaries because the addition of an income tax reimbursement clause constitutes a relinquishment of the beneficiaries’ interest in the trust. Of note, the Chief Counsel advised that “[t]he result would be the same if the modification was pursuant to a state statute that provides beneficiaries with a right to notice and a right to object to the modification and a beneficiary fails to exercise their right to object.”

The CCAM also explicitly stated that the Chief Counsel no longer follows its previous position that the addition of an income tax reimbursement clause via trust modification is a mere administration change, but instead views it as a substantive change. See the CCAM (citing PLR 201647001). This policy shift made headlines among estate practitioners.

What Weight Does Chief Counsel Advice Have?

Internal Revenue Code (IRC) §6110(i)(1)(A) defines Chief Counsel Advice as “written advice or instruction, under whatever name or designation, prepared by any national office component of the [Chief Counsel] which (i) is issued to field or service center employees of the Service or regional or district employees of the [Chief Counsel] and (ii) conveys (I) any legal interpretation of a revenue provision; (II) any [IRS] or [Chief Counsel] position or policy concerning a revenue provision; or (III) any legal interpretation of State law, foreign law, or other Federal law relating to the assessment or collection of any liability under a revenue provision.”

IRC §6110(k)(3) provides that unless the Secretary of the Treasury otherwise establishes by regulation, Chief Counsel Advice may not be used or cited as precedent.

Although Chief Counsel Advice is not binding on the public, it reflects how the IRS interprets and enforces federal tax lax. Therefore, practitioners should be mindful of the CCAM.

Grantor Trusts and Income Tax Reimbursement Clauses

Put simply, a “grantor trust” is a trust of which the grantor is deemed the owner for income tax purposes. The practical consequence is that the grantor is personally liable for the income tax on income generated by the trust, even if he or she does not receive that income. See IRC §671. While the grantor trust rules were enacted long ago as a punitive measure, they have since become widely viewed as an important estate planning tool.

Newer grantor trusts often include an “income tax reimbursement clause” that gives an independent trustee the power to use trust assets to reimburse the grantor for his or her tax liability attributable to the trust’s income. Until the CCAM, if a grantor trust lacked an income tax reimbursement clause, some trustees would decant the trust to another trust that contains one. Such trustees took comfort in Revenue Ruling 2004-64, which issue two important rulings. One was that that a grantor’s payment of income tax is not a taxable gift by the grantor to the trust’s beneficiaries because that tax payment is made in discharge of the grantor’s own liability. The other was that that the reimbursement of a grantor for the grantor’s payment of his or her income tax liability on trust income pursuant to a discretionary reimbursement power held by an independent trustee is not a gift by the trust beneficiaries.

The CCAM’s Effect on Trust Decanting in New York

Although the CCAM opines on the gift tax consequence of a trust “modification,” some may argue that a trust decanting is tantamount to a trust modification. See, e.g., 26 C.F.R. §26.2601-1(b)(4); I.R.S. Notice 2011-101, 2011-2 C.B. 932; T.D. 9846; T.D. 9889; P.L.R. 201820007 (Feb. 5, 2018); P.L.R. 200736002 (May 22, 2007); 12 Warren’s Heaton on Surrogate’s Court Practice §200.04 [e] (“[t]rustees have also relied on [Estates, Powers, and Trusts Law (EPTL) § 10-6.6] to modify trusts…”); Kruse & Nason, “Guiding the Dead Hand: Decanting Under EPTL 10-6.6”, N.Y.L.J., Jan. 16, 2018, p. 9, col. 1; Zeydel, “Changing the Unchangeable: Modifying Irrevocable Trusts By Reformation, Construction Decanting and Early Termination” (2015).

Whether a decanting technically constitutes a modification is debatable. A trust decanting is rooted in a trustee’s ability to invade the principal of an irrevocable trust and pay over such assets to another trust with different terms. See EPTL §10-6.6. If a trust does not explicitly permit the trustee to distribute trust assets to another trust (a “non-statutory decanting”) but gives the trustee authority to distribute the trust’s principal to a beneficiary, then the trustee may decant the trust pursuant to the provisions of EPTL §10-6.6 (a “statutory decanting”).

In New York, a statutory decanting is effective thirty days after the date of service of notice upon the trust beneficiaries, unless the beneficiaries consent in writing to a sooner effective date. See EPTL §10-6.6(j). A beneficiary may object to the trustee’s exercise. Importantly, EPTL §10-6.6(j)(4) provides “[t]he failure [of a beneficiary] to object shall not constitute a consent.”

Thus, the CCAM and New York state law appear to conflict to the extent (i) a New York statutory decanting is deemed a modification and (ii) the beneficiary is provided notice but does not object. The CCAM suggests that the failure to object is tantamount to consent and, thus, constitutes a gift, even though New York law is clear that such failure does not constitute consent. Could there be a gift absent consent? What if some beneficiaries consent to a decanting that adds a reimbursement clause, others object, and the court allows the decanting? Did those beneficiaries who consented make a gift, but those who objected not do so?

Things could be even murkier for non-statutory decantings, which often allow a trustee to decant without first notifying the beneficiaries. Can a beneficiary of an appointed trust that, unlike the invaded trust, contains an income tax reimbursement clause be deemed to have made a gift even if he or she was unaware of the decanting? Is the CCAM going to dissuade trustees from notifying beneficiaries of a non-statutory decanting in order to prevent a gift argument?

The CCAM raises other practical questions. Will it spur litigation by encouraging beneficiaries to object to a decanting that adds an income tax reimbursement clause (whether statutory or non-statutory) to avoid gift tax? What about incapacitated beneficiaries or those without access to attorneys and tax advisors—should they be treated as having made a gift?

The crux of the problem in all of these scenarios is that the CCAM fails to recognize that trust beneficiaries sometimes have little to no control, or even knowledge, over decisions made with respect to trusts. On the flip side, some trustees refuse to decant absent explicit beneficiary consent. In light of the possible gift tax issue raised by a beneficiary consent, will the CCAM have a chilling effect on decantings generally because some trustees might not decant without consent?

Practice Tips in Light of the CCAM

How should the practitioner proceed in light of the CCAM? At the drafting stage of grantor trusts, consider the prudence of including (1) an income tax reimbursement clause, which would allow you to avoid the gift tax issue raised by the CCAM and (2) a non-statutory decanting provision that does not require advance notice of the decanting to the beneficiaries.

At the trust decanting stage, in order to add a reimbursement clause, consider the prudence of: (1) not having the beneficiary consent to the decanting, regardless of whether the decanting is statutory or non-statutory (although the CCAM advises that a beneficiary’s failure to object is tantamount to consent, an argument might be made that such position is inequitable and could have negative consequences for public policy (see reasons stated in the previous section of this article)) and (2) timely filing a gift tax return (on Form 709) that reports the decanting as a non-gift transaction, which would start the running of the statute of limitations with respect to the decanting.

Conclusion

New York trusts and estates practitioners should consider the possible implications of the CCAM, as it could impact the tax consequences of trust decantings.

Reprinted with permission from the New York Law Journal^©, ALM Media Properties, LLC. Further duplication without permission is prohibited. All rights reserved.