Client established a trust for the benefit of her son and his descendants. Client also named son as trustee. Under the terms of the trust, the trustee can make distributions to son for “health, support, and maintenance” and to son’s descendants for “health, support, education, and happiness.” Son, as trustee, exercises his power under the trust to distribute assets to his daughter for her happiness. What is the result?
The gift tax regulations state the following:
If a trustee has a beneficial interest in trust property, a transfer of the property by the trustee is not a taxable transfer if it is made pursuant to a fiduciary power the exercise or nonexercise of which is limited by a reasonably fixed or ascertainable standard which is set forth in the trust instrument.
In other words, a trustee who is also a beneficiary will not be treated as making a taxable gift if he makes a distribution to another beneficiary pursuant to an “ascertainable standard.” By implication, if the distribution is not made pursuant to an ascertainable standard, it is a gift.
So what is an ascertainable standard? It is a “clearly measurable standard under which the holder of a power is legally accountable.” The regulations provide the following examples:
- a power to distribute corpus for the education, support, maintenance, or health of the beneficiary;
- for her reasonable support and comfort;
- to enable her to maintain her accustomed standard of living; or
- to meet an emergency.
However, a power to distribute corpus for the pleasure, desire, or happiness of a beneficiary is not such a standard. Moreover, even if the distribution standards are restricted to those listed above, the power will not be limited by a reasonably definite standard if the trustee’s distribution discretion is not subject to review (e.g., when the trustee has “sole and absolute discretion”).
In this case, son made a distribution to daughter for her “happiness.” Happiness is not an ascertainable standard. Therefore, according to the federal gift tax regulations, son has made a taxable gift to his daughter.
Source: Treas. Reg. § 25.2511-1(g)(2)
Posted by Joel D. Roettger, JD, LLM, EPLS