Rev. Rul. 86-39

1986-1 C.B. 301, 1986-11 I.R.B. 23.

RECAPITALIZATION; SHIFT IN VALUE OF TRUST ASSETS; RELEASE OF GENERAL

POWER OF APPOINTMENT

Published: March 17, 1986

Section 2511.-Transfers in General 26 CFR 25.2511-1: Transfers in general.  

(Also Section 2036, 2041, 2514: 20.2036-1, 20.2041-3, 25 .2514-1.)

  Recapitalization; shift in value of trust assets; release of general power of appointment. Acquiescence in a recapitalization of closely held stock in a trust is a transfer by the trust beneficiary subject to the gift tax, where the recapitalization results in a shift in the beneficiary's interest by decreasing the value of the remainder interest over which the beneficiary has a general power of appointment.

ISSUE

  If the beneficiary of a trust possesses a general testamentary power of appointment over the trust corpus, if the trust holds stock of a closely held corporation, and if a recapitalization results in a shift in value from that trust to a second trust over which that beneficiary has no power of appointment, then for purposes of estate and gift taxation, is acquiescence in the recapitalization a release of the power of appointment?

FACTS

  D owned 100 percent of the voting shares of X corporation. D died in 1980 and D's will provided for the creation of two testamentary trusts. Trust A provided D's spouse, S, with a lifetime income interest and a general testamentary power of appointment over the corpus. Trust A was funded with shares of X corporation common stock worth 120x dollars. Trust B provided S with a life income interest C, D's child, with the remainder interest. Trust B was funded with shares of X corporation common stock worth 80x dollars. The trustees of Trust A and Trust B were unrelated to the decedent or the trust beneficiaries.

  In 1982, the stock of X corporation was recapitalized, resulting in two new classes of stock, voting common and nonvoting preferred. Preferred stock worth

50x dollars was allocated to Trust A and common stock work 150x dollars was allocated to Trust B. The trustees of Trust A acquiesced in the recapitalization, and S executed a release, valid under local law, in which S agreed not to challenge the trustee's action with respect to the recapitalization. S died in 1985, when the fair market value of the preferred stock held by Trust A was 55x dollars and the fair market value of the common stock held by Trust B was 225x dollars.

LAW AND ANALYSIS

  Section 2501 of the Internal Revenue Code imposes a tax on the transfer of property by gift.

  Section 2511 of the Code appliesthe gift tax to transfers in trust or otherwise, whether the gift is direct or indirect, and whether the property is real or personal, tangible or intangible.

  Section 2512(b) of the Code provides that where property is transferred for less than adequate and full consideration, the amount by which the value of the property transferred exceeds the value of the consideration received is a gift.

  Section 2514(b) of the Code treats an exercise or release of a general power of appointment created after October 21, 1942, as a transfer of property by the individual possessing such power.

  Section 25.2511-1 of the Gift Tax Regulations provides that all transactions whereby property or property rights or interest are gratuitously passed to, or conferred upon, another regardless of the means or device employed, constitute gifts subject to gift tax. However, the gift tax is not applicable to transfers for full and adequate consideration in money or money's worth, or to transactions at arm's length in the ordinary course of business.

  Section 25.2511-2(b) of the regulations provides that a gift is complete if the donor parts with dominion and control so as to retain no power to change the disposition of property or any interest therein, whether for the donor's benefit or for the benefit of another.

  Under section 2036(a) of the Code, for purposes of the estate tax, the value of the gross estate includes the value of any interest in property transferred, by trust or otherwise, by a decedent if the decedent had retained for life either the possession or enjoyment of, or the right to income from, the property, or the right to designate the persons who shall possess or enjoy the property or the income therefrom.

  Section 2041(a)(2) of the Code provides, in part, that the gross estate shall include the value of property to the extent that the decedent had exercised or released a general power of appointment by a disposition which if it were a transfer of property owned by the decedent, would have been includible in the decedent's gross estate under section 2036 of the Code.

  Section 20.2041-3 (d)(1) of the Estate Tax Regulations provides that a release of a power of appointment need not be formal or express in character. See section 25.2514-3(c)(4) for an identical rule under the Gift Tax Regulations.

  Rev. Rul. 83-120, 1983-2 C.B. 170, sets forth factors to be considered in valuing the stock of a closely held corporation for gift tax purposes where a recapitalization of the corporation results in a stockholder receiving preferred and common stock in exchange for that individual's former common stock interest.

  Rev. Rul. 84-105, 1984-2 C.B. 197, holds that if a surviving spouse acquiesces in an underfunding of a testamentary trust established for the spouse's benefit (by not appealing a local probate court's order), the acquiescence is treated as a gift by the spouse to the person or persons who receive the property that would otherwise have comprised the trust.

  The recapitalization of the stock in X corporation resulted in a shift in the value of the interests between Trust A and Trust B.

  Prior to the recapitalization, S, as beneficiary of Trust A, had an income interest in, and a general testamentary power of appointment over, the stock of X corporation worth 120x dollars and an income interest, as beneficiary of Trust B, in the remaining stock worth 80x dollars. As a result of the recapitalization, S, as beneficiary of Trust A, received an income interest in, and a general testamentary power of appointment over, a difference class of stock worth 50x dollars and, as beneficiary of Trust B, received an income interest for life in stock worth 150x dollars. Although the total value of S's income interest in the two trusts was unchanged as a result of the recapitalization, the value of the corpus of Trust A over which S retained a general testamentary power of appointment decreased by 70x dollars, the excess of 120x dollars over 50x dollars.

  By consenting to the reallocation of stock, the trustee of Trust A, accepted stock with a lesser value than the value held prior to the recapitalization. S, as the beneficiary of Trust A, could have asserted the right of a trust beneficiary under local law to prevent the trustee from permitting a loss in value of the trust assets. The execution of the release in which S agreed not to raise an objection to the trustee's conduct with respect to the recapitalization constitutes a release of a general testamentary power of appointment by S over stock worth 70x dollars.

  For purposes of the gift tax, the release by S is treated as a transfer of property to C, the owner of the remainder interest in Trust B, for which S did not receive adequate and full consideration . See Rev. Rul. 84-105. The value of the gift from S to C as a result of the recapitalization of X corporation is equal to the present value of the remainder interest in 70x dollars worth of stock that was shifted from Trust A to Trust B.

  For purposes of the estate tax, the release of the general testamentary power of appointment over the remainder interest in the 70x dollars worth of stock is treated as a transfer under which S, as the income beneficiary of Trust B, retained an income interest for life in the transferred stock. An actual transfer of such an interest would have resulted, upon S's death in 1985, in the portion of the Trust B corpus attributable to the value of the interest so transferred being includible in S's gross estate under section 2036. Thus, in this case, S's release of the power results in the inclusion of a portion of the corpus of Trust B in the gross estate under section 2041 of the Code to the same extent that the property would have been includible under section 2036 if there had been an actual transfer.

HOLDING

  In the circumstances described above, if a recapitalization of a closely held corporation causes a shift in the value of the interest of the beneficiaries of trusts that own stock in the corporation, the shift is treated as a transfer for estate and gift tax purposes.

  When the holder of a general testamentary power of appointment releases the power over property while retaining an income interest for life in that same property, the property is includible in the transferor's gross estate under section 2041 of the Code.

Rev. Rul. 86-39, 1986-1 C.B. 301, 1986-11 I.R.B. 23.