The Internal Revenue Service (IRS) recently issued Private Letter Ruling (PLR) 202504006, addressing several important estate and gift tax questions related to the division of a marital trust and the subsequent disclaimer of a surviving spouse’s interest in a portion of the trust. This ruling provides valuable insights into the tax treatment of trust divisions, qualified terminable interest property (QTIP) trusts, and disclaimers, which are common tools in estate planning. Below, we break down the ruling into three parts: (1) the structure and questions presented, (2) the applicable law and IRS analysis, and (3) the broader implications for taxpayers and their advisors.

Questions Presented

    The ruling involves a revocable trust established by a decedent, which became irrevocable upon the decedent’s death. The trust was divided into two separate trusts: a marital trust (Marital Trust) and a decedent’s trust. The surviving spouse (Spouse) had a qualifying income interest in the Marital Trust, entitling them to all income from the trust during their lifetime, with no power to appoint the trust’s assets. Upon Spouse’s death, the Marital Trust was to be distributed to specific beneficiaries, including grandchildren and charities, with the remainder going to the decedent’s children.

    The trustees proposed dividing the Marital Trust into two new trusts, Trust 1 and Trust 2, on a non-pro rata basis. Trust 1 would hold assets up to the amount of Spouse’s unused federal gift tax exclusion, and Trust 2 would hold the remaining assets. Spouse, through a durable power of attorney, would then disclaim their interest in Trust 1, causing the assets in Trust 1 to be distributed to the remainder beneficiaries. The trustees sought rulings on several tax issues, including whether the division of the trust would trigger income or capital gains taxes, whether the new trusts would retain their QTIP status, and the gift and estate tax consequences of Spouse’s disclaimer.

    Applicable Law and IRS Analysis

    The IRS applied several key provisions of the Internal Revenue Code (IRC) and related regulations to address the taxpayer’s questions:

    • Income and Capital Gains Tax (Ruling 1): The IRS ruled that the division of the Marital Trust into Trust 1 and Trust 2 would not trigger income or capital gains taxes under IRC §§ 61 and 1001. The non-pro rata division was authorized under the trust instrument and state law, and the new trusts retained the same terms as the original trust. The IRS cited Treasury Regulation § 1.1001-1(h)(1), which allows for non-pro rata divisions without triggering gain recognition if authorized by the trust or state law.
    • QTIP Trust Status (Ruling 2): The IRS confirmed that Trust 1 and Trust 2 would continue to qualify as QTIP trusts under IRC § 2056(b)(7) after the division. Spouse retained a qualifying income interest in both trusts, and no other person had the power to appoint the trust assets to anyone other than Spouse.
    • Gift Tax Consequences (Rulings 3 and 4): The IRS ruled that Spouse’s disclaimer of their interest in Trust 1 would be treated as a disposition of their qualifying income interest, resulting in a gift under IRC § 2511. Additionally, Spouse would be treated as making a gift of the remainder interests in Trust 1 under IRC § 2519. However, the disclaimer would not cause any property in Trust 2 to be treated as a gift under § 2519.
    • Estate Tax Consequences (Ruling 5): The IRS concluded that the assets in Trust 1, which were treated as transferred under § 2519, would not be included in Spouse’s gross estate under IRC § 2044(a) due to the application of § 2044(b)(2). This provision excludes property from the gross estate if § 2519 applies to a disposition of the property prior to the surviving spouse’s death.
    • Valuation of Retained Interests (Ruling 6): The IRS ruled that Spouse’s disclaimer of their interest in Trust 1 would not cause their interest in Trust 2 to be valued at zero under IRC § 2702, which governs the valuation of retained interests in trusts.

    Implications for Taxpayers and Advisors

    This PLR has several important implications for estate and gift tax planning:

    • Trust Severance: The IRS confirmed that dividing a trust under certain conditions does not trigger income tax consequences.
    • QTIP Trust Maintenance: Dividing a QTIP trust does not automatically disqualify the resulting trusts from QTIP treatment, provided the spouse retains the requisite income interest.
    • Gift Tax Implications of Disclaimers: Disclaiming an interest in a QTIP trust can have significant gift tax implications, especially if the disclaimer is not “qualified” under Section 2518. In this case, the disclaimer was deemed a gift of the income interest.
    • Estate Tax Exclusion: Disclaiming an interest and thus triggering gift tax under § 2519 can prevent the assets from being included in the disclaimant’s estate under § 2044.
    • Valuation of Retained Interests: The IRS clarified that disclaiming interest in one trust will not cause retained interests in another trust to be valued at zero under § 2702.