GST Issues

DEPARTMENT OF THE TREASURY
Internal Revenue Service 26 CFR Part 26 [REG-103841-99] RIN 1545-AX08

TITLE: GST Issues

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Notice of proposed rulemaking and notice of public hearing.

SUMMARY: This document contains proposed regulations relating to the
application of the effective date rules of the generation-skipping
transfer (GST) tax imposed under chapter 13 of the Internal Revenue
Code. The proposed regulations provide guidance with respect to the
type of trust modifications that will not affect the exempt status
of a trust. In addition, the proposed regulations clarify the
application of the effective date rules in the case of property
transferred pursuant to the exercise of a general power of
appointment. The proposed regulations are necessary to provide
guidance to taxpayers so that they may properly determine if chapter
13 of the Code is applicable to a particular trust.

DATES: Written and electronic comments must be received by February
16, 2000. Outlines of topics to be discussed at the public hearing
scheduled for March 15, 2000 at 10:00, must be received by February
23, 2000.

ADDRESSES: Send submissions to: CC:DOM:CORP:R (REG-103841-99), room
5226, Internal Revenue Service, POB 7604, Ben Franklin Station,
Washington, DC 20044. Submissions may also be hand delivered Monday
through Friday between the hours of 8 a.m. and 5 p.m. to:
CC:DOM:CORP:R (REG-103841-99), Courier's Desk, Internal Revenue
Service, 1111 Constitution Avenue, NW., Washington, DC.
Alternatively, taxpayers may submit comments electronically via the
internet by selecting the "Tax Regs" option on the IRS Home Page, or
by submitting comments directly to the IRS internet site at
http://www.irs.gov. The public hearing will be
held in room 2615, Internal Revenue Service Building, 1111
Constitution Avenue, NW., Washington, DC.

FOR FURTHER INFORMATION CONTACT: Concerning the proposed
regulations, James F. Hogan, (202) 622-3090; concerning submissions
of comments, the hearing, and/or to be placed on the building access
list to attend the hearing, Michael L. Slaughter, (202) 622-7180
(not toll-free numbers).

SUPPLEMENTARY INFORMATION:

Background

The GST tax provisions were enacted as part of the Tax Reform Act of
1986 (TRA), Pub. L. 99-514, 1986-3 (Vol. 1) C.B. 1, 634. Under
section 1433(a) of the TRA, the GST tax generally applies to all
generation-skipping transfers made after October 22, 1986, the date
the TRA was enacted.

Section 1433(b)(2) of the TRA exempts transfers from certain 
trusts from the GST tax. Hereinafter, a trust that is exempt under
section 1433(b)(2) is referred to as an A exempt trust. @ First,
under section 1433(b)(2)(A) of the TRA, the GST tax does not apply
to any transfer from a trust that was irrevocable on September 25,
1985, to the extent the transfer is not made out of additions to the
trust after September 25, 1985 (the day before the House Ways and
Means Committee began considering the bill containing the GST
provisions). Under �26.2601-1(b)(1)(ii) of the Generation-skipping
Transfer Tax Regulations, a trust created on or before September 25,
1985, is considered irrevocable on that date unless: (1) the settlor
retained a power that would cause the trust to be included in the
settlor's gross estate for federal estate tax purposes by reason of
section 2038 of the Code, if the settlor had died on September 25,
1985; or (2) the property held in the trust is a life insurance
policy transferred by the insured and the insured possessed, on
September 25, 1985, any incident of ownership that would have caused
the value of the trust to be included in the insured's gross estate
under section 2042 of the Code if the insured had died on September
25, 1985.

Second, under section 1433(b)(2)(B) of the TRA, as amended by the
Technical and Miscellaneous Revenue Act of 1988, the GST tax does
not apply to any generation-skipping transfer under a will or
revocable trust executed before October 22, 1986, if the decedent
died before January 1, 1987.

Third, under section 1433(b)(2)(C) of the TRA, the GST tax  does
not apply to any generation-skipping transfer under a trust to the
extent such trust consists of property included in the gross estate
of a decedent or reinvestments thereof, but only if the decedent
was, on October 22, 1986, under a mental disability to change the
disposition of the decedent's property and did not regain competence
to dispose of the property before death.

Numerous taxpayers have requested private letter rulings regarding
the effect that a proposed modification or construction will have on
an exempt trust for GST tax purposes. In rulings in this area, the
IRS has held that a modification will not cause the trust to lose
its exempt status if the modification does not result in any change
in the quality, value, or timing of any beneficial interest under
the trust. Although the statute does not specifically address
modifications to trusts that are exempt under section 1433(b)(2) of
the TRA, Treasury and the IRS believe that a trust that is modified
such that none of the beneficial interests change can be viewed as
the same trust that was in existence on September 25, 1985.

The majority of the ruling requests received by the Service concern
proposed modifications intended to enable the trust to adapt to
changed circumstances or to enable the trustee to administer the
trust properly. These proposed modifications often are not
inconsistent with the purpose of the TRA effective date provisions.
Accordingly, as discussed below, these proposed regulations adopt a
more liberal standard with respect to changes that may be made to
the trust without the loss of exempt status.

Treasury and the IRS intend that the regulations, when finalized,
provide sufficient guidance concerning modifications that the need
for private letter rulings will be greatly diminished. Comments are
requested regarding whether the proposed regulations will achieve
this result.

In addition, the proposed regulations clarify the application of the
effective date provisions when the exercise or lapse of a general
power of appointment over an otherwise grandfathered trust results
in property passing to a skip person.

Explanation of Provisions

1. Modifications to Trusts

The proposed regulations provide guidance regarding the types of
modifications, constructions, and settlements of controversies that
will not cause a trust to lose its exempt status. However, the rules
contained in these proposed regulations apply only for GST tax
purposes. Thus, the rules do not apply in determining, for example,
whether a modification will result in a gift for gift tax purposes,
or may cause inclusion of the trust assets in the gross estate, or
may result in the realization of gain for purposes of section 1001
of the Code.

Under the proposed regulations, a court order in a construction
proceeding that resolves an ambiguity in the terms of a trust
instrument will not cause the trust to lose its exempt status. The
judicial action, however, must involve a bona fide issue and the
court's decision must be consistent with applicable state law that
would be applied by the highest court of the state. Commissioner v.
Estate of Bosch, 387 U.S. 456 (1967).

Construction proceedings determine a settlor's intent as of the date
the instrument became effective, and thus, a court order construing
an instrument that satisfies these requirements does not alter or
modify the terms of the instrument.

Similarly, under the proposed regulations, a court-approved
settlement of a bona fide controversy relating to the administration
of a trust or the construction of terms of the governing instrument
of a trust will not cause a trust to lose its exempt status. This
will be the case, however, only if the settlement is the product of
arm's length negotiations, and the settlement is within the range of
reasonable outcomes under the governing instrument and applicable
state law addressing the issues resolved by the settlement. See
Ahmanson Foundation v. United States, 674 F.2d 761 (9 Cir. 1981);
Estate of Suzuki v. th Commissioner, T.C. Memo. 1991-624. For
example, A and B are the sole remainder beneficiaries of a trust
established by their parent. They disagree as to the portion of the
remainder each is entitled to under the terms of the trust when the
trust terminates. A settlement dividing the corpus equally among A,
B, and C, B's child and the grandchild of the parent who established
the trust, would not be considered within the range of reasonable
outcomes because C is not a potential remainderman under any
construction of the trust agreement.

The proposed regulations also address the situation in which. a
trustee distributes trust principal to a new trust for the benefit
of succeeding generations. In some cases, the governing instrument
grants the trustee broad discretionary powers to distribute
principal to or for the benefit of the trust beneficiaries, outright
or in trust. Under these circumstances, distributions by the trustee
to trusts for the benefit of trust beneficiaries will not cause the
original trust or the new trusts to lose exempt status provided the
vesting of trust principal is not postponed beyond the perpetuities
period applicable to the original trust.

Finally, under the proposed regulations, a trust may be modified and
remain exempt for GST purposes. The modification, however, must not
shift a beneficial interest in the trust to any beneficiary who
occupies a lower generation (as defined in section 2651) than the
person or persons who held the beneficial interest prior to the
modification and must not extend the time for vesting of any
beneficial interest in the trust beyond the period provided for in
the original trust.

2. Exercise of a General Power of Appointment after September 25,
1985.

In Simpson v. United States, 183 F.3d 812 (8 Cir. 1999), th the
decedent exercised a testamentary general power of appointment
granted under a marital trust that was created in 1966. Pursuant to
the decedent's exercise of the general power of appointment, the
property passed to her grandchildren who were skip persons under
section 2612. The court concluded that the  transfer to the
grandchildren was exempt from the GST tax under section 1433(b)(2)
(A) of the TRA, because the transfer was A under a trust @ that was
irrevocable on September 25, 1985.

The facts in Simpson are similar to those presented in Peterson
Marital Trust v. Commissioner, 78 F.3d 795 (2 Cir. nd 1996). In
Peterson, the decedent had a testamentary general power to appoint
property in a pre-September 25, 1985 marital trust created under her
husband's will. Rather than appointing the property outright, the
taxpayer allowed the power to lapse and the property passed to her
husband's grandchildren, who were skip persons under section 2612.
The court concluded that the transfer was subject to the GST tax.
The court noted that the effective date provisions in section
1433(b)(2) of the TRA were A designed . . . to protect those
taxpayers who, on the basis of pre-existing rules, made arrangements
from which they could not reasonably escape and which, in
retrospect, had become singularly undesirable.

Peterson Marital Trust, at 801 (footnote omitted). The court
concluded that there was no basis to apply the protection provided
in section 1433(b)(2) to the marital trust because the arrangement
could have been changed to avoid the GST tax through the exercise of
the decedent's general power of appointment.

Treasury and the IRS believe that there is no substantive difference
between the situation in Simpson where property passed pursuant to
the exercise of a general power of appointment and the situation in
Peterson Marital Trust where property passed pursuant to a lapse of
a general power of appointment. An individual who has a general
power of appointment has the equivalent of outright ownership in the
property. Estate of Kruz v. Commissioner, 101 T.C. 44, 50-51, 59-60
(1993). The value of the property subject to the general power is
includible in the powerholder's gross estate at death under section
2041(a). In either case, the powerholder can avoid the consequences
of the GST tax by appointing the property to nonskip persons.

Therefore, as the court noted in Peterson Marital Trust, there is no
basis for exempting such dispositions from the GST tax under the TRA
effective date provisions.

Accordingly, the proposed regulations clarify that the transfer of
property pursuant to the exercise, release, or lapse of a general
power of appointment created in a pre-September 25, 1985 trust is
not a transfer under the trust, but rather is a transfer by the
powerholder occurring when the exercise, release, or lapse of the
power becomes effective, for purposes of section 1433(b)(2)(A) of
the TRA.

Special Analysis

It has been determined that this notice of proposed rulemaking is
not a significant regulatory action as defined in EO 12866.
Therefore, a regulatory assessment is not required. It also has been
determined that section 553(b) of the Administrative Procedure Act
(5 U.S.C. chapter 5) does not apply to these regulations, and
because these regulations do not impose a collection of information
on small entities, the Regulatory Flexibility Act (5 U.S.C. chapter
6) does not apply. Therefore, a Regulatory Flexibility Analysis is
not required. Pursuant to section 7805(f) of the Internal Revenue
Code, the regulations will be submitted to the Small Business
Administration for comment on their impact on small business.

Comments and Public Hearing

Before these proposed regulations are adopted as final regulations,
consideration will be given to any written (a signed original and
eight (8) copies) or electronic comments that are submitted timely
(in the manner described in ADDRESSES) to the IRS. Treasury and the
IRS specifically request comments on the clarity of the proposed
regulations and how they can be made easier to understand. All
comments will be available for public inspection and copying.

A public hearing has been scheduled for March 15, 2000 at 10:00 a.m.
in room 2615, Internal Revenue Building, 1111 Constitution Avenue,
NW, Washington, DC. Due to building security procedures, visitors
must enter at the 10 Street th entrance, located between
Constitution and Pennsylvania Avenues, NW. In addition, all visitors
must present photo identification to enter the building. Because of
access restrictions, visitors will not be admitted beyond the
immediate entrance area more than 15 minutes before the hearing
starts. For information about having your name placed on the
building access list to attend the hearing, see the A FOR FURTHER
INFORMATION CONTACT @ section of this preamble.

The rules of 26 CFR 601.601(a)(3) apply to the hearing. Persons that
wish to present oral comments at the hearing must submit comments by
February 16, 2000, and submit an outline of the topics to be
discussed and the time to be devoted to each topic (signed original
and eight (8) copies) by February 23, 2000. A period of 10 minutes
will be allotted to each person for making comments. An agenda
showing the scheduling of the speakers will be prepared after the
deadline for receiving outlines has passed. Copies of the agenda
will be available free of charge at the hearing.

Drafting Information

The principal author of these proposed regulations is James F.
Hogan, Office of the Chief Counsel, IRS. Other personnel from the
IRS and Treasury Department participated in their development.

List of Subjects

26 CFR Part 26

Estate taxes, Reporting and recordkeeping requirements. Proposed
Amendments to the Regulations Accordingly, 26 CFR part 26 is
proposed to be amended as follows:

PART 26-- GENERATION-SKIPPING TRANSFER TAX REGULATIONS UNDER THE TAX
REFORM ACT OF 1986

Par. 1. The authority citation for part 26 continues to read in part
as follows:

Authority: 26 U.S.C. 7805 * * *

Par. 2. In �26.2600-1 the Table is amended under �26.2601 by
revising the entry for paragraphs (b) and (b)(4) and adding an entry
for paragraph (b)(5) to read as follows:

�26.2600-1. Table of contents.

�26.2601-1. Effective dates.

* * * * *

(b) Exceptions

* * * * *

(4) Retention of trust's exempt status in the case of modifications,
etc.

(5) Exceptions to additions rule.

* * * * *

Par. 3. Section 26.2601-1 is amended as follows:

1. Adding four sentences to the end of paragraph (b)(1)(i).

2. Redesignating paragraph (b)(4) as paragraph (b)(5).

3. Adding a new paragraph (b)(4).

4. Paragraph (c) is amended by adding a new sentence to the end of
the paragraph.

The additions read as follows:

�26.2601-1 Effective Dates.

* * * * *

(b) * * *

(1) * * *

(i) * * * Further, the rule in the first sentence of this paragraph
(b)(1)(i) does not apply to a transfer of property pursuant to the
exercise, release, or lapse of a general power of  appointment
that is treated as a taxable transfer under chapter 11 or chapter
12. The transfer is made by the person holding the power at the time
the exercise, release, or lapse of the power becomes effective, and
is not considered a transfer under a trust that was irrevocable on
September 25, 1985. See �26.2601- 1(b)(1)(v)(B) regarding the
treatment of the release, exercise, or lapse of a power of
appointment that will result in a constructive addition to a trust.
See �26.2652-1(a) for the definition of a transferor.

* * * * *

(4) Retention of trust's exempt status in the case of modifications,
etc. (i) In general. This paragraph provides rules for determining
when a modification, judicial construction, settlement agreement, or
trustee action with respect to a trust that is exempt from the
generation-skipping transfer tax under paragraphs (b)(1), (b)(2), or
(b)(3) of this section (hereinafter referred to as an exempt trust)
will not cause the trust to lose its exempt status. The rules
contained in this paragraph (b)(4) are applicable only for purposes
of determining whether an exempt trust retains its exempt status for
generation-skipping transfer tax purposes. The rules do not apply in
determining, for example, whether the transaction results in a gift
subject to gift tax, or may cause the trust to be included in the
gross estate of a beneficiary, or may result in the realization of
capital gain for purposes of section 1001 of the Code. (A) Trustee's
discretionary powers. The distribution of trust principal from an
exempt trust to a new trust will not cause the new trust to be
subject to the provisions of chapter 13, if--

(1) The terms of the governing instrument of the exempt trust
authorize the trustee to make distributions to the new trust without
the consent or approval of any beneficiary or court, and

(2) The terms of the governing instrument of the new trust do not
extend the time for vesting of any beneficial interest in the trust
in a manner that may postpone or suspend the vesting, absolute
ownership, or power of alienation of an interest in property for a
period, measured from the date of creation of the original trust,
extending beyond any life in being at the date of creation of the
original trust plus a period of 21 years, plus if necessary, a
reasonable period of gestation. For purposes of this paragraph (b)
(4)(i)(A), the exercise of a trustee's distributive power that
validly postpones or suspends the vesting, absolute ownership, or
power of alienation of an interest in property for a term of years
that will not exceed 90 years (measured from the date of creation of
the original trust) will not be considered an exercise that
postpones or suspends vesting, absolute ownership, or the power of
alienation beyond the perpetuities period. If a trustee's
distributive power is exercised by creating another power, it is
deemed to be exercised to whatever extent the second power may be
exercised.

(B) Settlement. A court-approved settlement of a bona fide 
controversy regarding the administration of the trust or the
construction of terms of the governing instrument will not cause an
exempt trust to be subject to the provisions of chapter 13, if--

(1) The settlement is the product of arm's length negotiations, and

(2) The settlement is within the range of reasonable outcomes under
the governing instrument and applicable state law addressing the
issues resolved by the settlement.

(C) Judicial construction. A judicial construction of a governing
instrument to resolve an ambiguity in the terms of the instrument or
to correct a scrivener's error will not cause an exempt trust to be
subject to the provisions of chapter 13, if--

(1) The judicial action involves a bona fide issue, and

(2) The construction is consistent with applicable state law that
would be applied by the highest court of the state.

(D) Other changes. A modification of the governing instrument of an
exempt trust (including a trustee distribution, settlement, or
construction that does not satisfy paragraphs (b)(4)(i)(A), (B), or
(C) of this subsection) by judicial reformation, or nonjudicial
reformation that is valid under applicable state law, will not cause
an exempt trust to be subject to the provisions of chapter 13, but
only if--

(1) The modification does not shift a beneficial interest in the
trust to any beneficiary who occupies a lower generation (as defined
in section 2651) than the person or persons who held the 
beneficial interest prior to the modification, and

(2) The modification does not extend the time for vesting of any
beneficial interest in the trust beyond the period provided for in
the original trust.

(E) Examples. The following examples illustrate the application of
this paragraph (b)(4). In each example, assume that the trust
established in 1980 was irrevocable for purposes of �26.2601-1(b)(1)
(ii) and that there have been no additions to any trust after
September 25, 1985.

Example 1. Trustee's power to distribute principal

authorized under trust instrument. In 1980, Grantor established an
irrevocable trust (Trust) for the benefit of Grantor's child, A, A's
spouse, and A's issue. At the time Trust was established, A had two
children, B and C. A corporate fiduciary was designated as trustee.
Under the terms of Trust, the trustee has the discretion to
distribute all or part of the trust income to one or more of the
group consisting of A, A's spouse or A's issue. The trustee is also
authorized to distribute all or part of the trust principal to one
or more trusts for the benefit of A, A's spouse, or A's issue under
terms specified by the trustee in the trustee's discretion. Any
trust established under Trust, however, must terminate 21 years
after the death of the last child of A to die who was alive at the
time Trust was executed.

Trust will terminate on the death of A, at which time the remaining
principal will be distributed to A's issue, per stirpes. In 2000,
the trustee distributed part of Trust's principal to a new trust for
the benefit of B and C and their issue. The new trust will terminate
21 years after the death of the survivor of B and C, at which time
the trust principal will be distributed to the issue of B and C, per
stirpes. The terms of the governing instrument of Trust authorize
the trustee to make the distribution to a new trust without the
consent or approval of any beneficiary or court. In addition, the
terms of the governing instrument of the new trust do not extend the
time for vesting of any beneficial interest in a manner that may
postpone or suspend the vesting, absolute ownership or power of
alienation of an interest in property for a period, measured from
the date of creation of Trust, extending beyond any life in being at
the date of creation of Trust plus a period of 21 years, plus if
necessary, a reasonable period of gestation. Accordingly, neither
Trust nor the new trust will be subject to the provisions of chapter
13 of the Code.

Example 2. Trustee's power to distribute principal pursuant to state
statute. In 1980, Grantor established an irrevocable trust (Trust)
for the benefit of Grantor's child, A, A's spouse, and A's issue. At
the time Trust was established, A had two children, B and C. A
corporate fiduciary was designated as trustee. Under the terms of
Trust, the trustee has the discretion to distribute all or part of
the trust income or principal to one or more of the group consisting
of A, A's spouse or A's issue. Trust will terminate on the death of
A, at which time the trust principal will be distributed to A's
issue, per stirpes. Under a state statute applicable to Trust, a
trustee who has the absolute discretion under the terms of a
testamentary instrument or irrevocable inter vivos trust agreement
to invade the principal of a trust for the benefit of the income
beneficiaries of the trust, may exercise the discretion by
appointing so much or all of the principal of the trust in favor of
a trustee of a trust under an instrument other than that under which
the power to invade is created, or under the same instrument. The
trustee may take the action either with consent of all the persons
interested in the trust but without prior court approval, or with
court approval, upon notice to all of the parties. The exercise of
the discretion, however, must not reduce any fixed income interest
of any income beneficiary of the trust and must be in favor of the
beneficiaries of the trust. In 2000, the trustee distributes one-
half of Trust's principal to a new trust that provides for the
payment of trust income to A for life and further provides that, at
A's death, one-half of the trust remainder will pass to B or B's
issue and one-half of the trust will pass to C or C's issue. Because
the state statue requires the consent of all of the parties, the
transaction constitutes a modification of Trust. However, because
the modification does not shift any beneficial interest in Trust to
a beneficiary or beneficiaries who occupy a lower generation than
the person or persons who held the beneficial interest prior to the
modification, neither Trust nor the new trust will be subject to the
provisions of chapter 13 of the Code.

Example 3. Construction of an ambiguous term in the instrument. In
1980, Grantor established an irrevocable trust for the benefit of
Grantor's children, A and B, and their issue. The trust is to
terminate on the death of the last to die of A and B, at which time
the principal is to be distributed to their issue. However, the
provision governing the termination of the trust is ambiguous
regarding whether the trust principal is to be distributed per
stirpes, only to the children of A and B, or per capita among the
children, grandchildren, and more remote issue of A and B. The
trustee files a construction suit with the appropriate local court
to resolve the ambiguity. The court issues an order construing the
instrument to provide for per capita distributions to the children,
grandchildren, and more remote issue of A and B living at the time
the trust terminates. The court's construction is consistent with
applicable state law as it would be interpreted by the highest court
of the state and resolves a bona fide controversy regarding the
proper interpretation of the instrument. Therefore, the trust will
not be subject to the provisions of chapter 13 of the Code. Example
4. Change in trust situs. In 1980, Grantor, who was domiciled in
State X, executed an irrevocable trust for the benefit of Grantor's
issue, naming a State X bank as trustee.

Under the terms of the trust, the trust is to terminate, in all
events, no later than 21 years after the death of the last to die of
certain designated individuals living at the time the trust was
executed. The provisions of the trust do not specify that any
particular state law is to govern the administration and
construction of the trust. In State X, the common law rule against
perpetuities applies to trusts. In 2000, a State Y bank is named as
sole trustee. The effect of changing trustees is that the situs of
the trust changes to State Y, and the laws of State Y govern the
administration and construction of the trust. State Y law contains
no rule against perpetuities. In this case, however, in view of the
terms of the trust, the trust will terminate at the same time before
and after the change in situs.

Accordingly, the change in situs does not shift any beneficial
interest in the trust to a beneficiary who occupies a lower
generation (as defined in section 2651) than the person or persons
who held the beneficial interest prior to the transfer. Furthermore,
the change in situs does not extend the time for vesting of any
beneficial interest in the trust beyond that provided for in the
original trust. Therefore, the trust will not be subject to the
provisions of chapter 13 of the Code. If, in this example, as a
result of the change in situs, State Y law governed such that the
time for vesting was extended beyond the period prescribed under the
terms of the original trust instrument, the trust would not retain
exempt status.

Example 5. Division of a trust. In 1980, Grantor established an
irrevocable trust for the benefit of his two children, A and B, and
their issue. Under the terms of the trust, the trustee has the
discretion to distribute income and principal to A, B, and their
issue in such amounts as the trustee deems appropriate. On the death
of the last to die of A and B, the trust principal is to be
distributed to the living issue of A and B, per stirpes. In 2000,
the appropriate local court approved the division of the trust into
two equal trusts, one for the benefit of A and A's issue and one for
the benefit of B and B's issue. The trust for A and A's issue
provides that the trustee has the discretion to distribute trust
income and principal to A and A's issue in such amounts as the
trustee deems appropriate. On A's death, the trust principal is to
be distributed equally to A's issue, per stirpes. The trust for B
and B's issue is identical (except for the beneficiaries), and
terminates at B's death at which time the trust principal is to be
distributed equally to B's issue, per stirpes. The division of the
trust into two trusts does not shift any beneficial interest in the
trust to a beneficiary who occupies a lower generation (as defined
in section 2651) than the person or persons who held the beneficial
interest prior to the division.

In addition, the division does not extend the time for vesting of
any beneficial interest in the trust beyond the period provided for
in the original trust. Therefore, the two partitioned trusts
resulting from the division will not be subject to the provisions of
chapter 13 of the Code.

Example 6. Merger of two trusts. In 1980, Grantor established an
irrevocable trust for Grantor's child and the child's issue. In
1983, Grantor's spouse also established a separate irrevocable trust
for the benefit of the same child and issue. The terms of the
spouse's trust and Grantor's trust are identical. In 2000, the
appropriate local court approved the merger of the two trusts into
one trust to save administrative costs and enhance the management of
the investments. The merger of the two trusts does not shift any
beneficial interest in the trust to a beneficiary who occupies a
lower generation (as defined in section 2651) than the person or
persons who held the beneficial interest prior to the merger. In
addition, the merger does not extend the time for vesting of any
beneficial interest in the trust beyond the period provided for in
the original trust. Therefore, the trust that resulted from the
merger will not be subject to the provisions of chapter 13 of the
Code.

Example 7. Modification that does not shift an interest to a lower
generation. In 1980, Grantor established an irrevocable trust for
the benefit of Grantor's grandchildren, A, B, and C. The trust
provides that income is to be paid to A, B, and C, in equal shares
for life. The trust further provides that, upon the death of the
first grandchild to die, one-third of the principal is to be
distributed to that grandchild's issue, per stirpes. Upon the death
of the second grandchild to die, one-half of the remaining trust
principal is to be distributed to that grandchild's issue, per
stirpes, and upon the death of the last grandchild to die, the
remaining principal is to be distributed to that grandchild's issue,
per stirpes. In 2000, A became disabled. Subsequently, the trustee,
with the consent of B and C, petitioned the appropriate local court
and the court approved a modification of the trust that increased
A's share of trust income. The modification does not shift a portion
of the income interest to a beneficiary who occupies a generation
lower than the generation occupied by A, B and C, and does not
extend the time for vesting of any beneficial interest in the trust
beyond the period provided for in the original trust. Accordingly,
the trust as modified will not be subject to the provisions of
chapter 13 of the Code. However, the modification increasing A's
share of trust income is a transfer by B and C to A for federal gift
tax purposes.

(ii) Effective date. The rules in this paragraph (b)(4) are
effective as of [THE DATE OF PUBLICATION IN THE FEDERAL REGISTER AS
A FINAL REGULATION].

* * * * *

(c) * * * The last four sentences in paragraph (b)(1)(i) of this
section are effective as of [THE DATE OF PUBLICATION IN THE FEDERAL
REGISTER].

Deputy Commissioner of Internal Revenue

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