Tax Concerns When Modifying Trusts
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In May 2013, the Internal Revenue Service issued a Private Letter Ruling addressing tax concerns resulting from a trust modification agreement. PLRs are issued when a taxpayer directly requests guidance from the IRS on a specific matter. A PLR may be relied upon by the taxpayer who requested it; however, PLRs offer an excellent opportunity for individuals to help determine how the IRS might treat a similar situation.
The recent PLR addressed a trust modification agreement that changed trustees’ requirements concerning annual distributions of net income. Trusts can be modified for a number of other reasons, and some changes may create tax implications for beneficiaries.
Each trust modification situation is unique, but when considering the implications of modifying a trust, ask your attorney about the following:
- Income tax. A trust modification that increases beneficiaries’ rights to income from properties will typically require them to pay more income tax on their distributions.
- Gift tax. In some cases the modification effectively causes a transfer of interest among beneficiaries, which may cause the IRS to recognize this as a gift and impose a gift tax.
- Generation-skipping transfer tax. The GST tax is not only imposed on gifts, but also on certain trust transfers and distributions. The GST tax may be imposed even when a trust transfer is subject to gift tax. It applies only to trust transfers to or for the benefit of persons who are 37 ½ years younger than and unrelated to the grantor, or to related individuals more than one generation younger than the grantor. This is a greater concern in states that allow Dynasty Trusts (including North Carolina). Learn about proposed limitations on Dynasty Trusts.
While irrevocable trusts can provide asset protection and tax savings, over the years the trust may no longer adequately address the needs of beneficiaries. With the adoption of the Uniform Trust Code, North Carolina trusts are now easier to modify; in some cases a court order is not required.
