Tax Notes has published an article titled "IRS Rules on Income, Estate, Gift Tax Consequences of Judicial Trust Modification." The article discusses LTR 201132017, a private letter ruling where-in the IRS discussed the tax implications of a judicial modification of Trust. In this case an equitable reformation of Trust under common law and state statute was provided by the court to correct a scrivener's error in a trust document. The questions before the IRS are whether: 1) the assets removed from Trust by judicial modification were still included in surviving spouse's estate for estate tax purposes, or 2) whether the removal of assets from the surviving spouse's estate by way of judicial modification of trust would be considered a gift of those assets by the surviving spouse for gift tax purposes.
In considering the impact of the State Court's modification of Trust on the application of the federal code, the IRS considered Commissioner v. Estate of Bosch where the Supreme Court held that the decision of a state trial court as to an underlying issue of state law should not be controlling when applied to a federal statute. Instead, the highest court of that state is the best authority. Where no decision of the state's highest court is on point, the federal authority must consider the impact of the state trial court's ruling as well as other relevant ruling's of courts in that state.
The IRS concludes in this PLR that the judicial modification of Trust is consistent with applicable state law as it would be applied by the highest court of the state. As such, the modification of Trust to correct for a scrivener's error has the effect of successfully moving assets out of the taxable estate of a surviving spouse. The Trust modification is effective to determine the application of the estate tax as well as the ownership of the assets.
Furthermore, the IRS concludes that the judicial modification of the trust is not an exercise of a general power of appointment under section 2514(b), nor a deemed transfer of an interest in Trust under section 2501. As a result, the judicial modification of the trust does not trigger the application of the gift tax.
See "IRS Rules on Income, Estate, Gift Tax Consequences of Judicial Trust Modification," 2011 TNT 157-40 (Aug. 15, 2011).
Posted by Jason Tyler Young, Associate Editor, Wealth Strategies Journal.
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