Powers of Appointment — Estate, Gift, and Income Tax Considerations (Portfolio 825)

Detailed Analysis

I. Introduction

A. General Definitions

B. Tax Consequences - In General

C. History of Estate and Gift Taxation

II. How and When a Power of Appointment Is Created

A. How a Power Is Created

B. When a Power Is Created

C. Which Terms Govern a Power of Appointment?

III. General Power of Appointment Defined

A. Power of Appointment Defined

B. General Power of Appointment - General Definition

C. Ascertainable Standard Exclusion

1. Regulatory Definition

2. Interpreting the Regulations

a. Interpreting the Word "Comfort"

b. Cases and Rulings Finding an Ascertainable Standard

c. Cases and Rulings Finding No Ascertainable Standard

3. Other Factors Influencing the Ascertainable Standard

D. Joint Power Exclusion

1. Pre-October 22, 1942 Joint Power

2. Post-October 21, 1942 Joint Power

a. Exercisable with the Donor

b. Exercisable with an Adverse Person

c. Exercisable with a Nonadverse Person

d. Fractional Interest

E. Converting a Limited Power to a General Power - The "Delaware Tax Trap"

F. Law Governing Existence and Scope of Power

1. State Law - In General

2. Statutory Conversion of a General Power to a Limited Power

G. Effect of Particular Situations on Powers of Appointment

1. Power Created Under Will of Decedent Dying Between January 1 and April 2, 1948

2. "Reverse Powers"

3. Judicial Remedy as a Power

4. Power to Replace Power Holder

5. Administrative Power

6. Wrongful Death Action

7. Right of Election

8. Contingency or Agreement Affecting Existence of Power

9. Section 2032A Special Use Valuation

10. Extrinsic Evidence Affecting Power

11. Income Accumulation as a General Power

H. Retained Power Distinguished

I. Power to Dispose of Property Distinguished

IV. Estate and Gift Taxation of General Powers of Appointment

Introductory Material

A. Estate Tax Consequences

1. Definition of "Exercise"

2. Pre-October 22, 1942 Power

a. Complete or Partial Release

b. Disclaimer or Renunciation of Power

c. Lapse

3. Post-October 21, 1942 Power

a. Defining "Possession" of Power of Appointment

(1) Significance of Physical or Mental Capability to Exercise

(2) Significance of Lack of Knowledge

b. Creating Another Power

c. Release

d. Disclaimer or Renunciation of Power

e. Lapse

(1) General Rule

(2) "Five and Five" Power

B. Gift Tax

1. Definition of "Exercise"

2. Pre-October 22, 1942 Power

3. Post-October 21, 1942 Power

a. Exercise or Release Deemed a Taxable Transfer

(1) Partial Exercise

(2) Creating Another Power

b. Release

c. Exercise of Limited Power Constituting Release

d. Power Disclaimed or Renounced

e. Lapse

(1) General Rule

(2) Exception for Incompetent Holder

(3) "Five and Five" Power

C. Estate and Gift Tax Consequences of Limited Powers of Appointment

1. Reciprocal Trusts

2. Lifetime Exercise of Limited Powers

D. Amount of Inclusion

1. Property to Be Included

2. Valuation

a. "Five and Five" Power

b. Successive Power

E. Creating an Incomplete Gift with a Testamentary Power of Appointment

F. Interaction of § § 2041 and 2056

V. Income Tax Consequences

Introductory Material

A. Grantor Trust Rules

1. Powers That Result in Grantor Being Taxed

2. Powers That Result in Person Other Than Grantor Being Taxed

3. Income Tax Consequences Where Holder of Power Treated as Owner of Income or Corpus

a. Holder Reports Allocable Portion of Income

b. Trust Fiscal Year Irrelevant to Holder

4. Meaning of "Income'' Under Subpart E

5. Meaning of "Portion'' Under Subpart E

a. Holder as Owner of Entire Trust

b. Holder as Owner of Specific Trust Property

c. Holder as Owner of Fractional or Pecuniary Amount of Principal

d. Holder as Owner of Income Only

e. Holder as Owner of Portion of Principal

f. Holder as Owner of Dollar Amount of Ordinary Income

B. Special Considerations of the "Five and Five'' or "Crummey" Withdrawal Power

C. Basis of Property

1. Where Power Is Exercised

2. Where Power Is Not Exercised

3. One-Year Exception

VI. Generation-Skipping Transfer Tax Consequences

Introductory Material

A. GST Tax Generally

B. Treatment of "Grandfathered" Trusts

C. GST Tax Consequences of Crummey Powers

VII. Planning Ideas

A. Drafting Powers of Appointment - The Basics

1. Carefully Draft if Entities Are to Be Permissible Appointees of a Limited Power

2. When Naming a Class of Appointees, Exclude the Power Holder from the Class

3. Do Not Give a Power Holder the Right to Relieve Support Obligations

4. When Drafting an Ascertainable Standard, Stick to the Exact Words in the Regulations

5. When Drafting a Power of Appointment, Allow the Donee the Greatest Flexibility

B. Using Powers of Appointment to Create Flexibility

1. Power of Appointment Allows for Discretionary Distributions

2. Use Limited Powers to Accomplish Family Goals

3. Use Special Trustees to Determine Distribution Levels

C. GST Tax Drafting Tips

1. Using Powers of Appointment to Determine the Transferor

a. Avoid General Powers of Appointment in GST Tax Exempt Trusts

b. Consider General Powers of Appointment in Non-Exempt Trusts

2. GST Tax Consequences to Crummey Trusts

D. Using a Power of Appointment to Allow for Maximum Exclusion Amount Planning