Take-Away: Retirement planning guru Natalie Choate recently wrote an article that attempted to shed some light on a favorable 2016 private letter ruling from the IRS with regard to identifying the oldest beneficiary of an accumulation see-through trust to which an IRA was made payable. The IRS’s conclusion was favorable because it seemed to ignore other contingent beneficiaries of the trust that have historically been treated as potential beneficiaries of the trust that would have jeopardized the benefits of an accumulation see-through trust for required minimum distribution purposes. In this private letter ruling an estate and an older individual beneficiary were simply ignored by the IRS in its search for the oldest individual beneficiary whose life expectancy dictates the amount of the required minimum distribution (RMD) that must be distributed to the trust.

Private Letter Ruling:  2016-33025

Background: We have covered see-through trusts on multiple occasions, so this background summary will be short and to the point, and hopefully a helpful reminder of these IRA distribution rules that tend to befuddle both trustees and estate planning attorneys.

Individual Beneficiaries: In order to take required minimum distributions(RMD) from an IRA or qualified plan account, the beneficiary must be an But there is an exception to the individual-beneficiary-only condition to the RMD rules for what are called see-through trusts, where the IRS will ignore the trustee-as-named-IRA- beneficiary and instead look to the persons who are the designed beneficiaries of the trust. The problem arises if there are non-persons as trust beneficiaries, such as a charity or an estate. As a generalization, if non-persons are named trust beneficiaries, then the see-through trust rules will not apply, and the IRA (or qualified plan account balance) must be emptied, i.e. taxable income recognized, within 5 years of the owner’s death. The obvious goal is to stretch the RMDs over as long a period as possible to avoid that sudden and immediate income recognition at marginally higher income tax brackets.

See-through Trust Exceptions: While irrevocable trusts are not individuals, they can still be used as named beneficiaries to take distributions from an IRA (or qualified plan account) following the required minimum distribution (RMD) rules. There are two types of see-through trusts, to be treated as an individual, which will enable an IRA (or other qualified plan account) that is made payable to the trustee to be depleted using the oldest identified trust beneficiary’s life expectancy to calculate the required minimum distributions (RMDs) from the IRA.

Conduit Trust: A conduit see-through trust requires the trustee to take required minimum distributions (RMD) from the IRA (or qualified plan) and fairly soon after its receipt transfer the entire RMD amount to the lifetime beneficiary, i.e. there is no discretion to accumulate the RMD taxable income inside the trust- the entire RMD must be distributed to the trust beneficiary by the trustee. Restated, with a conduit trust, the life expectancy of the recipient of the mandatory RMD distribution is used to calculate the RMD, and all other remainder beneficiaries identified in the trust instrument are ignored (ignoring possibly non-persons, or older trust beneficiaries.) The recipient is treated as the sole beneficiary of the conduit These conduit trusts are pretty simple to draft and administer. Example: The IRA owner’s beneficiary designation directs: My IRA custodian shall pay 25% of this IRA balance, calculated as of the date of my death, to Greenleaf Trust the acting trustee of the trust share that is created for my son Jeb Bush under the George H. Bush Declaration of Trust dated April 20, 1931. A quarter of the IRA is paid to the trust created for Jeb, and thus Jeb’s life expectancy can be used to determine the RMD amount, but the trust established for Jeb will also have to direct the trustee to pay the entire amount, e.g. Greenleaf Trust, acting as the trustee of this trust share that is created for the benefit of my son Jeb Bush, shall take and as soon as practicable it shall pay and distribute to my son Jeb Bush the entire (100%) required minimum amount that the trustee receives from the IRA custodian that is distributed to this trust share.

Accumulation Trust: The second type of see-through trust is often called an accumulation see-through trust, since the trustee may accumulate distributions taken from the IRA (or qualified plan) that is paid to the trustee. Key to the accumulation trust is that the identity of all trust beneficiaries must be determined by the trustee, and if a non-person is one of the beneficiaries, then the see-through trust exception will not apply. In addition, it is the oldest trust beneficiary who might possibly receive the RMD assets through the trust whose life expectancy must be used to determine the RMD amount, thus causing the IRA (or qualified plan account) to be more rapidly depleted through RMDs, in-turn, bunching more taxable income into a shorter period of time at possibly higher marginal income tax brackets. An accumulation trust is much more challenging to administer because the trustee must: (i) gather information and identify all of the countable beneficiaries, who must be individuals, and then (ii) determine who is the oldest individual beneficiary, in order to identify the correct life expectancy used to calculate the RMD. Thus, a ‘chain’ of trust beneficiaries has to be identified by the trustee, counting each successive beneficiary in the ‘chain’ until the trustee arrives at the beneficiary who would inherit the retirement benefits outright upon the death of a prior beneficiary. If one of those beneficiaries is not an individual, like an estate or charity, then the ‘game’s up’ and it is not a see-through trust. Complicating this task that the trustee faces is that if the full RMD is not taken when required, then there is a 50% penalty for that amount of RMD that should have been taken by the trustee but wasn’t, all of which thus compels the trustee to find and use the correct life expectancy upon which that RMD is calculated.

Mere Potential Successor: Yet another set of IRS rules that sets heads spinning permits some of the identified trust beneficiaries in the ‘chain’ to be disregarded since they are, called by the 2011 Regulations, only mere potential successors. A mere potential successor in the ‘chain’ can be ignored. Example #1: A trust instrument provides that upon the settlor’s death, the trustee is directed to ‘pay income to my spouse for life, remainder to my children on my spouse’s death.’ Stopping here, both the spouse and the children would be countable. What if the trust instrument then went on and said: “…and if neither my spouse nor any of my children survive me, then I leave the trust assets to the American Red Cross to be used for its general charitable purposes.” The Red Cross, despite being non-individual charity, would not be counted. That is because the children would inherit all of the retirement benefits immediately and outright at the decedent’s spouse’s death. Thus, the Red Cross would only be a mere potential successor. Example #2: Pretty much the same facts as in Example #1, with one variation. Now the trust instrument provides that “and if my spouse does not survive me, then the trust shall be divided into separate shares of equal value, one share for each of my children, which separate shares shall continue to be held in trust until the child for whom that trust share has been created shall attain age 50 at which time that child shall possess the right to withdraw all of the remaining assets in his/her trust share, and in the event my child does not survive me the remaining assets in that deceased child’s trust share shall be paid to the American Red Cross to be used for its general charitable purposes.” Under this second example, because the child does not take immediately upon the death of their parent (they have to live to age 50 to receive their inheritance outright), and they do not possess the right to take their inheritance until they reach age 50, then the IRS would include in the list of ‘countable beneficiaries’ the beneficiary (Red Cross) that would take if the child beneficiary died before reaching age 50.

Key Point: Whenever age attainments or specified events are imposed before a beneficiary can take full ownership of their share of the trust, including the right to take the balance held in the IRA that is made payable to the trust, the successor beneficiaries identified in the trust if that contingency occurs must also be considered in the ‘chain’ of identified trust beneficiaries. If those potential ‘conditional contingent’ beneficiaries are non-persons, like a charity or an estate, then the trust will not be classified as a see-through trust. Or, if those ‘conditional contingent’ beneficiaries are older than the prior beneficiary who enjoys but does not have a right to immediate possession of the IRA under the trust instrument, then the older contingent trust beneficiary’s life expectancy will be used to calculate the RMD that paid to the trustee.

PLR 2016-33025: Ms. Choate’s article found this private letter ruling to come as a surprise when compared to many earlier private letter rules issued by the IRS where the mere potential successor exception to the accumulation see-through trust rules was very narrowly interpreted.

Facts: IRA owner [‘Pete’] died at age 59. Pete left his IRA to a Trust. Pete’s Trust provided that income from the Trust was to be paid to his daughter Evelyn for her life, but it was not a right to all income, hence it was not a conduit trust. In addition, the trustee under Pete’s Trust could make discretionary distributions of principal to Evelyn and her two children, Frank and Gwen, for their health, education, or support. Pete’s Trust was to terminate when Evelyn turned 50 years of age, with her right to withdraw the balance of the Trust assets at that time. If Evelyn died before she reached age 50 years, Pete’s Trust would then be divided into shares of equal value and each share would continue to be held in trust for the benefit of Evelyn’s two children, Frank and Gwen, who were not yet age 21 years of age. Pete’s Trust provided that once Frank or Gwen reached the age of 21 years then they could withdraw their share from Pete’s Trust. In the event that either Frank or Gwen died prior to age 21, then their trust share property would be distributed to the personal representative of their [the grandchild’s] estate, unless all of Evelyn, Frank and Gwen were deceased at the time of Pete’s death, in which case all remaining assets in Pete’s Trust would be distributed to Pete’s siblings, who as siblings were no doubt older than either Evelyn (Pete’s daughter) or Frank or Gwen (Pete’s grandchildren.)

Ruling Request: The trustee of Pete’s Trust asked the IRS if Pete’s Trust: (i) qualified as a see-through trust since an estate was a named beneficiary; and (ii) who was the oldest beneficiary of that accumulation trust since Pete’s siblings were also named beneficiaries of Pete’s Trust who were much older than either Evelyn (Pete’s daughter) or her two children (Pete’s grandchildren.)

IRS’s Ruling: The Service held that Pete’s Trust qualified as a see-through trust and that the oldest beneficiary of the trust was Evelyn, Pete’s daughter. Contrary to how the Service has opined in prior PLRs going back to 2004, Frank and Gwen’s estates were ignored, as were Pete’s The IRS thus ‘stopped the chain’ of beneficiaries with the grandchildren. Why stop there? Unfortunately, the IRS gave no reasoning for its favorable decision, leaving Ms. Choate and other experts to ponder how this result came about.

The Practical Issue: When irrevocable trusts prescribe a delay in distribution to a specified age, or a specified event, before the named individual beneficiary comes into possession of their inheritance from the trust, that raises the question of when the ‘chain’ of identifiable trust beneficiaries must come to an end? Who or what we would describe as contingent trust beneficiaries identified in the trust instrument under its wipe-out (or what I used to call worst-case-scenario) distribution provisions will be treated as part of the beneficiary ‘chain?’

Speculated Reasons for the PLR: Several retirement planning experts have chimed in on the possible reasons for this change in approach taken by the IRS in its 2016 PLR, but they are only guesses as to ‘why’ the favorable outcome came about. Some of those reasons are tersely summarized below.

  1. The Preamble to the 2011 Final Regulations seem to provide a broader definition of who constitutes a mere potential successor (to the interest of another beneficiary) who are not, themselves, countable beneficiaries. [Treas. Regs. 1.401(a)(9)-4, A-5(c) and A-7(c).] From the Preamble’s admittedly confusing language this expert then concludes that “An includible contingency exists when the trust’s terms conditionally or unconditionally delay a primary remainderman’s access to the trust’s principal until the lifetime beneficiary’s death. By contrast, an excludible contingency arises if a primary remainderman’s successor has no independent beneficial interest in the trust and takes solely due to the primary remainderman’s death.”  Frankly, I’m not sure what this even means, which is why I quoted that expert. [Who reads Preambles anyway?)
  2. The PLR ignored as a countable trust beneficiaries Frank or Gwen’s estates because both Frank and Gwen were then living. Therefore, their estates did not yet exist. But, as noted, the IRS in the PLR did not tell us why it ruled the way that it did and there was no mention about ignoring the grandchildren’s estates because they did not yet ‘exist’ in the PLR.
  3. The IRS stopped its ‘chain’ of identifiable trust beneficiaries with Frank and Gwen because their interests were vested at that time, if their mother Evelyn had predeceased them under Pete’s Trust. An individual and his/her estate are often considered the same person. While that may make some legal sense, the IRS does not treat an IRA owner as being identical to his/her estate. That is why a distribution of an IRA to a deceased owner’s probate estate does not qualify for RMD treatment as a general rule.
  4. The IRS will ignore an age contingency that ends at age 21 or earlier because if Pete had left the IRA outright to Frank and Gwen, his grandchildren would have had to wait until they reached the age of majority before they could take control of their property anyway, as there were not yet emancipated. In short, the IRS will treat a trust interest that passes to a minor-age individual beneficiary the same as an outright transfer to the minor if the delay (or condition) is only until age 21 is attained.

Conclusion: The RMD rules to see-through-trusts are already complicated. Adding to the challenge in deciphering those rules is the need to figure out who (or what) is a mere potential successor. While it is nice to have this PLR to look at as some form of comfort, PLRs can only be relied upon as binding precedent for the party who asked for the PLR, so its existence will not provide much comfort when wandering the maze of the see-through-trust rules.