Distribution of Annuity Contracts from Trust to Beneficiaries Ruled Not a Gratuitous Transfer
IRS privately ruled that flexible premium deferred annuity contracts purchased by a trust, of which each of the trust beneficiaries is the named annuitant of the contract in proportion to his residuary share of the trust, will be considered owned by natural persons, so that the distribution of the contracts to the beneficiaries will not be treated as a gratuitous transfer.
Facts. Husband established a grantor trust (Trust) and named as beneficiaries his Wife and their six descendants. Husband and Wife served as co-trustees during Husband’s life. Upon the death of Husband, Wife became the sole trustee and divided the Trust into subtrusts A, B, and C.
Subtrust A was allocated an amount based on the allowed estate tax exemption and marital deduction. Subtrust C was allocated an amount based on the estate tax exemption, provided the amount was not used for the payment of taxes, debts, or administration expenses of Husband’s estate. Once all taxes, debts, and expenses have been paid, the assets of Subtrust C were to be distributed to Subtrust B, for administration.
During her life, and in her capacity as trustee, Wife was authorized to pay or use the property of Subtrust B for the benefit of herself and others who were partly or wholly dependent upon her. Upon her death, the property of Subtrust B was directed to be divided and distributed among the descendant-beneficiaries in the proportions stated in the Subtrust B.
In seeking the private letter ruling, Wife proffered to the IRS that:
as trustee, she intended to purchase flexible premium deferred annuity contracts and name each of the descendant-beneficiaries as the annuitant on one annuity contract, in proportion to each beneficiary’s residuary share of Trust;
the material provisions of each contract were substantially the same, except for the dates of annuitization;
the Trust will be the owner and beneficiary of the contracts during Wife’s life;
the Trust is anticipated to have sufficient assets to fund its expenses and make nominal distributions to Wife, so there should not be any need for the Trust to take a distribution from the annuity contracts; and
Upon the final distribution of the Trust, each beneficiary will be distributed the contract for which that beneficiary is the annuitant. This distribution is anticipated to occur before the contract’s annuity starting date.
IRS’ Decision. Under Internal Revenue Code Section 72(u), an annuity contract will not be treated as an annuity contract if it is held by a person who isn’t a “natural person.” Instead, the income on the contract for any tax year of the policyholder will be treated as ordinary income received or accrued by the owner during that tax year (i.e., there is no deferral of income). In issuing this ruling, the IRS determined that the annuity contracts owned by Wife’s Trust are considered owned by natural persons for Code Sec. 72(u) purposes.