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This column continues the current series concerning Internal Revenue Service (IRS) collection against interesting assets. This column concerns IRS tax collection against trusts or beneficial interests in trusts or trust [...]

Credit shelter trusts offer an appealing means of taking full advantage of the $600,000 unified transfer tax credit, but estate planners should be sure that the powers granted to the surviving spouse as trustee do not result in estate or gift taxation at the surviving spouse's death. Powers to terminate the trust or accumulate income should be avoided. The power to divert income to the children is permissible as long as fiduciary standards are met. The IRS is likely to scrutinize these powers at the death of the second spouse.

The Tax Court ruled in Estate of Halpern that gifts from a marital trust made by the decedent after she became incompetent were included in her estate. Lillian Halpern could take distributions from the marital trust left to her, but she did not have a general power of appointment. Consents were obtained from interested parties before making the gifts. The court found the agreement to be effective for gifts made before she became incompetent from a stroke, but the court ruled that the gifts made after the year of her stroke should be included in the estate.

The spousal joint trust would appear to be a useful planning vehicle to maximize use of both spouses' $600,000 exemptions and provide basis step-up for all assets, but powers retained by the predeceased spouse may result in gift tax liabilities. The step of all assets at the death of each spouse can be particularly beneficial to residents of common law states. The spousal joint trust is typically a single trust holding all the couple's assets. The general power of appointment retained by the predeceased spouse can be characterized as dominion and control under the gift tax laws.

The Tax Court held, in Estate of Kurz, that property over which the decedent had a general power of appointment subject to contingencies was includable in the decedent's estate as long as the contingency did not have significant non-tax consequences. The decedent was allowed to control 5% of a family trust when and if her marital trust was expended. The decedent died with nearly $3.5 million in the marital trust and so did not use the contingency. Though the Tax Court's findings were accurate, the logic of non-tax consequences was based on a faulty interpretation of IRC section 2041.

Issues related to the powers and duties of trust owners and trust beneficiaries are examined, focusing on an IRS ruling of regarding a common clause that converts a beneficiary into an owner. Topics include trust provisions allowing minimum withdrawals that do not incur taxation under IRC sections 2041 and 2514.

The Tax Court agreed with the IRS' conclusions if not with its logic in Estate of Kurz when the Court held that a contingency to use 5% of a trust's principal was a general power of appointment. The IRS position stated that the trust had to be 'beyond the decedent's control' to be excluded from the estate. However, the spouse was able to control 5% of the nonmarital trust's principal annually if the marital trust was exhausted before her death. Therefore, the contingency gave her control over the 5% regardless of whether she had exercised that control at the time of her death.