January–February 2011
Estate & Succession
Planning Corner
by Lawrence I. Richman
The Power to be Flexible: How Powers of Appointment Afford
the Ability to Respond to Changes in Circumstance
A
Lawrence I. Richman is a Partner with
Neal Gerber & Eisenberg in Chicago.
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power of appointment is a power to effect
the distribution of property. Significantly, for
property law purposes a power of appointment does not constitute an ownership interest in
property.1 This provides the basis for the tax law’s
treatment of powers of appointment as not being
taxable incidents of ownership except to the extent
provided under Code Sec. 2041 or 2514.2
There are three requisites for no adverse tax consequences to the existence or exercise of a power of
appointment. First, the power of appointment cannot
be created by the powerholder; in other words, the
donor and the donee of the power of appointment
must be different persons. Second, the donee of the
power may neither have the ability to, nor in fact
may, exercise the power so as to benefit himself or
herself.3 Third, the power may not be exercised in
a manner that would allow the property (and any
reinvestment thereof) to remain held in trust for a
period longer than the original perpetuities period of
the trust pursuant to which the power was originally
granted. The infamous so called Delaware tax trap led
to the creation of this rule when Delaware allowed
as a matter of state law the creation and exercise of
a series of successive limited powers of appointment
by which the vesting of property could be indefinitely postponed. The abolition of the rule against
perpetuities in almost half the states has lessened the
significance of the principle for currently established
irrevocable trusts in those states.
It is the nontax aspects of powers of appointment
that are the basis for their usefulness and importance
in estate planning. While it is the donor of the power
who determines (a) the scope of the power by detail-
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Estate & Succession Planning Corner
were incorporated by reference in the exercise of
ing the conditions of its exercise (such as whether
daughter’s power under her Will. In all events, daughduring lifetime or death and at what age the power
ter achieved a measure of consistency in her estate
may be exercised) and (b) the objects in whose faplan; all property passing for her children’s benefit
vor it may be exercised (whether those objects be
would be held under the same dispositive provisions
descendants, spouses, charities or anyone as long as
regardless if the property passed from her estate or
the donee, donee’s estate or the creditors of either
the trust estate of her father.
are not benefitted), the mere existence of the power
The dispositive provisions daughter applied to
provides the donee with the flexibility to revise the
the trust property were significantly more restrictive
donor’s estate plan.
than the outright distribution to his grandchildren
A recent private letter ruling highlights the flexibility
provided by daughter’s father. In fact, the daughter’s
and opportunities provided in power of appointment
children could only receive income and principal
planning and details how to accomplish those estate
from the trust under a strict standard, meaning that
planning goals in a tax-efficient and effective manincome and principal could be paid or distributed
ner. In LTR 201029011,4 daughter sought to exercise
to them only as the trustee found reasonably neca power of appointment granted her pursuant to the
essary for their health, maintenance, support and
provisions of a trust created for her benefit under her
education. The only right the child beneficiary had
father’s Will. Father had died before the effective date
to obtain the principal of
of the generation-skipping
the trust was through the
transfer tax so daughter’s
LTR 201029011 illustrates how
exercise of a noncumulatax planning involved extive power to withdraw
tending the period the
powers of appointment can add
up to five percent of the
property would remain in
signifi
cant
fl
exibility
to
an
estate
trust principal each year.
trust beyond her lifetime.
plan and how that flexibility can be Significantly, daughter
Under the terms of father’s
trust, the trust for the benprovided in a manner that does not provided each of her children with a testamentary
efit of daughter was to
cause adverse tax consequences.
power of appointment
terminate upon her death
which was exercisable in
with the outright distribufavor of the descendants of the marriage of daughter
tion of the trust estate to her children (technically per
and her husband and which also was exercisable in
stirpes to her issue).5
favor of husband. Both the noncumulative power of
The power granted daughter was a testamentary
withdrawal and the power of appointment daughter
power exercisable by her Will and the objects of
granted her children were structured so as not to
her power were her then living issue. Even though
cause the inclusion of the trust property in the estates
the same class of people who would take in default
of daughter’s children beyond any portion of the five
of the exercise of a power of appointment were the
percent not withdrawn prior to the death of a child
objects of the power, the existence of the power alof daughter’s. Like her father, daughter provided that
lowed daughter the flexibility to accomplish several
in default of her child’s exercise of his or her power
tax and personal estate planning objectives. First,
of appointment the property remaining in such trust
daughter’s Will directed that the appointed property
would be distributed outright to such child’s children.
(the trust estate of the trust her father had created for
The perpetuities period of the children’s trusts created
her benefit) would be administered under the terms
by daughter’s exercise of her power of appointment
of her Family Trust, which was a revocable trust
under her father’s trust was measured by the perpeestablished by daughter and her husband. The rultuities period in effect under daughter’s father’s trust
ing does not state whether the Family Trust became
instrument: namely 21 years after the death of the
irrevocable upon daughter’s death or if daughter’s
last to die of father’s descendants who were living
surviving husband could modify the provisions of
at father’s death.
the trust by the exercise of any power he retained
In LTR 201029011, two rulings were requested.
over the Family Trust. Furthermore, the ruling does
The first ruling asked whether daughter’s grant of a
not indicate whether the appointed property poured
second power of appointment exercisable by her
over to and became part of daughter’s Family Trust
children at their deaths caused her father’s trust to be
or whether the provisions of daughter’s Family Trust
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January–February 2011
includible in her estate under Code Sec. 2041(a)(3).
The second ruling asked whether that second power
daughter granted her children caused the property
of the trust estate appointed by daughter to lose its
grandfathered generation-skipping transfer tax (GST)
exempt status.
In ruling that daughter had not exercised the power
of appointment granted by her father in a manner
that caused daughter’s power to be classified as a
taxable general power of appointment under Code
Sec. 2041, the IRS cited the rule under Code Sec.
2041(a)(3) that the value of the gross estate includes
the value of all property to the extent a decedent exercises a post 1942 power by creating another power
of appointment which could be validly exercised
in a manner that would postpone the vesting of the
property for a period ascertainable without regard
to the date of creation of the first power. The facts of
the instant LTR prohibited daughter’s children from
exercising the testamentary power she granted them
in a manner that would postpone the vesting of any
property originally appointed by her for a period not
limited by the date of creation of daughter’s power of
appointment under the trust established by her father.
As long as no power of appointment could extend
the original perpetuities period of the trust created by
daughter’s father, no exercise of such power would
result in estate inclusion of the trust property under
Code Sec. 2041(a)(3).
In ruling that daughter’s exercise of her power of
appointment so as to create a further power in her
children did not cause the appointed property to lose
its grandfathered GST exempt status, the IRS based its
conclusion on two critical aspects of the law relating
to GST grandfathered trusts. The first was that no additions of property either actual or constructive had
been made to father’s trust after September 25, 1985.
The second was the language of Reg. §26.2601-1(b)
(1)(v)(B), which provides that the exercise of a power
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of appointment (that is not otherwise a taxable general power) under a GST grandfathered trust does
not constitute an addition to the trust for transfer tax
purposes, if such exercise cannot be accomplished
in a manner that may postpone the vesting of the
trust property for a period measured from the date
of the trust’s creation extending beyond any life in
being at the date of creation of the trust plus a period
of 21 years (the common law maximum perpetuities
period). Since daughter’s exercise of her power of
appointment and her further grant of a power of appointment to her children would not cause the trust
property to be retained in trust for a period longer
than the maximum common law perpetuities period
that applied to her father’s trust, the IRS ruled that
the appointed property did not lose its grandfathered
GST exemption.
LTR 201029011 illustrates how powers of appointment can add significant flexibility to an estate plan
and how that flexibility can be provided in a manner
that does not cause adverse tax consequences. By
being able to respond to both changes in the tax law
and the desire for dispositive consistency in her estate
plan daughter, in LTR 201029011 demonstrates how
powers of appointment afford the ability to respond
to changes in circumstance.
ENDNOTES
1
2
3
4
5
RESTATEMENT (SECOND) OF PROPERTY §13.6.
Reflecting the fact that powers of appointment do not constitute ownership interests in property, neither a general nor a special limited power
of appointment was taxable for transfer tax purposes prior to 1951.
This is sometimes described as the donee’s inability to exercise in
favor of the donee, the donee’s estate, the creditors of the donee or
the creditors of the donee’s estate.
LTR 201029011 (Apr. 12, 2010)
There was an intervening trust for the benefit of Father’s spouse, but
since his spouse neither possessed any powers with respect to the
trust nor made any additions to it, the spousal trust was of no tax or
dispositive significance.
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