New IRS Ruling: Can’t Modify A Trust To Add A Tax Reimbursement Clause

Introduction to the CCA

In a recent Chief Counsel Advice (CCA) issued November 28, 2023 the IRS took the position that modification of a grantor trust, with the beneficiaries’ consenting to that modification in order to add a discretionary income tax reimbursement provision for the grantor, resulted in a taxable gift by the beneficiaries. The rationale was that the beneficiaries were relinquishing a portion of their interest in the trust. This changes how the IRS viewed such transactions in the past, and how most tax advisers thought the IRS would respond. Since grantor trusts and tax reimbursement clauses are so common in estate planning, this is worth a deeper look. There is also a possibility that this CCA ruling might suggest that the IRS is rethinking modifications and changes to irrevocable trusts more generally, but there is no way yet to know that.

Introduction to Grantor Trusts

Grantor irrevocable trusts are the foundation of most modern estate planning. These are trusts that are disregarded or ignored for income tax purposes. That means that you the taxpayer who created the trust reports the trust income on your personal income tax return. More technically, the grantor is treated as the owner under subpart E, part I, subchapter J, chapter 1 of the Internal Revenue Code. Despite that, the assets in the trust can be outside your estate for estate tax purposes. The result of this type of planning is a shift in value outside your estate, and outside the reach of your creditors, yet ignored for income tax purposes. The latter fact permits you to sell assets to the trust without triggering gain, loan money between you and the trust with no interest income having to be reported, etc. This tool is one of the most powerful tools in today’s estate planning tool kit.

A Bit of History

The recent CCA reverses the position taken by the IRS in a Private Letter Ruling (“PLR”) 201647001 that a modification of a trust to add a tax reimbursement clause did not change the beneficial interests in the trust because the provision was administrative in nature. So the IRS now clearly views adding a tax reimbursement clause as a substantive, not an administrative change. And because of that, it may find a tax consequence to such an action. The new CCA expressly says that this old PLR no longer reflects the IRS view of the matter.

Revenue Ruling 2004-64

The IRS distinguished the recent CCA from the favorable gift tax ruling the IRS issued about two decades ago, Revenue Ruling 2004-64, because the tax reimbursement provision in the CCA was a subsequent modification of the trust, rather than a provision included in the original trust agreement (called the “governing instrument”).

To understand the recent CCA then, you need to have some background on the older Revenue Ruling 2004-64. The IRS published its position on tax reimbursement clauses in Revenue Ruling 2004-64 which held that a mandatory tax reimbursement clause would cause the full value of the trust’s assets to be includible in the grantor’s gross estate under Code Sec. 2036(a)(1). Revenue Ruling 2004-64 also held that a tax reimbursement provision that gave the trustee the discretion to reimburse the grantor for taxes paid, regardless of whether it is exercised, would not cause the trust assets to be included in the grantor’s estate. Finally, the older Ruling held that the trust agreement, or state law, would be instructive in determining whether the assets would be included in the grantor’s estate and thus accessible to creditors.


Importantly, the Ruling warns that even a discretionary reimbursement power may result in estate inclusion in certain cases. These situations may include an implied agreement between the grantor and trustee when the trust was created. This is a “wink-wink” kinda deal. While it would seem impossible to have a deal with an independent corporate trustee, one can imagine the potential for a “hush-hush” agreement with a family member or close friend. The ruling also indicated that an implied understanding may be found based on the frequent exercise of the tax reimbursement clause. That means that even if you have such a clause it should be used sparingly if at all.

Detailed Review of the New CCA

Facts: The taxpayer created and gifted assets to an irrevocable (can’t be changed) inter vivos (done during her lifetime) trust. The trust benefitted the taxpayer’s child and that child’s descendants. The trust named an independent person as the current trustee. That means the trustee was a person who was not related or subordinate to the taxpayer as defined in Code Sec. 672(c). The trust gives the trustee authority to distribute income and principal to, or for the benefit of, of the taxpayer’s child in the trustee’s absolute discretion. On the death of the child, the remaining trust assets are to be distributed to the child’s issue.

Child has no living grandchildren or more remote descendants at the time the ruling was issued. This is a critical fact and must be considered in evaluating the IRS conclusion as discussed below.


The trust is structured to be characterized for income tax purposes as a grantor trust. That means that the taxpayer retained at least one power that causes her to be the deemed owner of trust under Code Sec. 671. As explained above, the characterization of the trust as a grantor trust means that all items of income, deductions, and credits attributable to Trust are included in the taxpayer’s taxable income.

Neither State law nor the trust agreement require or provide authority to a trustee of the trust to distribute to the taxpayer who created the trust amounts to satisfy the taxpayer’s income tax liability attributable to the inclusion of trust income on the taxpayer’s personal income tax return. Simply, trust did not have a tax reimbursement clause, and state law did not create such a clause if the trust was silent.

The next year, following the creation of the trust, the trustee asks the state court to modify the terms of trust to give the trustee the power to reimburse the taxpayer for income taxes she pays on trust income included on her personal return. The state law requires that for this court action the child, and the child’s issue, must consent to the modification. Later that year, State Court grants the petition and issues an order modifying Trust.

Some observations on the above facts: What if state law did not require that the beneficiaries consent or agree to the modification? Would that change the result discussed below? The facts indicate that the trustee had unfettered authority to distribute or not trust income or principal. If no beneficiary had any expectancy to distributions from the trust how could the IRS determine the value of a gift that the beneficiaries supposedly made? The facts do not address what happens if someone was given a lifetime power of appointment (the right to direct where trust assets may be distributed) and used that power to appoint the trust to a new trust that included a tax reimbursement clause. It may be that such a scenario falls outside the CCA.

Issue: The issue that the IRS raises based on the above facts is what are the gift tax consequences to the beneficiaries when the trustee of an irrevocable grantor trust modifies the trust to add a tax reimbursement clause. And state law required the beneficiaries to consent to add a tax reimbursement clause, and they did so.

Law: The IRS in the CCA then analyzes the that pertains to the issue above. The approach the IRS uses in rulings is to sequentially analyze the law, step by step, to get to the conclusion it reaches. The analysis used by the IRS appears below, rephrased to hopefully make it easier to understand. The formality of the IRS analysis has been left to reflect the trail of the IRS’ reasoning.

If the taxpayer who created the trust, the grantor, is treated as the owner of any portion of the trust then trust income, deductions, and credits must be included in computing taxable income or credits of the grantor. Code Sec. 671.

A gift tax is imposed on a taxpayer who gave the property (called the “donor”), for each calendar year, on the gift or donative transfer of property (that is a transfer of property for less than full or fair payment called “consideration”) by any individual. Code Sec. 2501(a)(1).

The gift tax applies whether the transfer is in trust or otherwise, whether the gift is direct or indirect, and whether the property is real or personal, tangible or intangible. Basically, pretty much anything of value you transfer is subject to the gift tax. Code Sec. 2511(a).

The gift tax applies to gifts indirectly made. Further, any transaction in which an interest in property is gratuitously passed or conferred upon another, regardless of the means or device employed, constitutes a gift subject to tax. Treas. Reg. Sec. 25.2511-1(c)(1). The point of this, as with the law cited above, is to cast a broad net over gift transfers. Those are usually intra-family transfers but as this Regulation makes clear an indirect gift such as to a trust, or even an entity, which benefits a family member, is still a gift. Relevant to the particular ruling is that even if the beneficiaries of a trust indirectly benefit someone with trust property who is not a permissible beneficiary, which may be an indirect gift by the beneficiaries to that person.

If a donor transfers by gift less than their entire interest in property, the gift tax is applicable to the interest transferred. Further, if the donor’s retained interest is not susceptible of measurement on the basis of generally accepted valuation principles, the gift tax is applicable to the entire value of the property subject to the gift. Treas. Reg. Sec. 25.2511-1(e). That is a mouthful but pretty important to the IRS conclusion. So, say you are one of 10 beneficiaries of a trust and the trustee has absolute discretion of who, when and if to make any distributions. You might never get a penny even though you are a beneficiary. This Regulation says if the IRS cannot value your interest they can seemingly use the entire value of the property. That is a biggie. In this ruling the facts explicitly state: “Child has no living grandchildren or more remote descendants.” If the child had 5 kids which of the six beneficiaries would get tagged with the gift? It doesn’t seem reasonable to tax the full value of the “gift” multiplied by six. Would this conclusion of the IRS even work if there were multiple beneficiaries? Also, consider how disproportionate the Regulation might be. Tax reimbursement clauses must be in the discretion of the trustee, so that there is no assurance that the taxpayer will ever get a penny of reimbursement. And the tax cost on trust income can at most be a small percentage in any year of the trust assets. Finally, to have even the possibility of a trust tax reimbursement there must be trust income. That could be wildly different for a trust that only holds bonds, versus a trust that holds only growth stocks, versus a trust that trades stocks actively. The IRS assumptions here seem to be getting a bit thick.

You don’t have to mean to make a gift. What you think or intend is not relevant to the tax. Donative intent on the part of the transferor is not an essential element in the application of the gift tax to the transfer. The application of the tax is based on the objective facts of the transfer and the circumstances under which it is made, rather than on the subjective motives of the donor. Treas. Reg. Sec. 25.2511-1(g)(1). OK, so the beneficiaries don’t need to intend to make a gift to the taxpayer (e.g., their parent who created the trust), to be taxed.

The gift tax is not imposed upon the receipt of the property by the donee (the parent or taxpayer who created the trust in this case), nor is it necessarily determined by the measure of enrichment resulting to the donee from the transfer. Rather, it is a tax upon the donor’s act of making the transfer. The measure of the gift is the value of the interest passing from the donor with respect to which they have relinquished their rights without full and adequate consideration in money or money’s worth (i.e., who ever made the transfer, the beneficiaries, did not get fair value for what they transferred). Treas. Reg. Sec. 25.2511-2(a). This kinda begs the question as to what is the fair value of a discretionary right for an independent trustee to possibly make a payment to the taxpayer/parent who created the trust for an unknown amount of future income tax?

Any property, or interest therein, of which the donor has so parted with dominion and control as to leave in him no power to change its disposition, whether for their own benefit or for the benefit of another, the gift is complete. If a donor transfers property to another in trust to pay the income to the donor or accumulate it in the discretion of the trustee, and the donor retains a testamentary power to appoint the remainder among the donor’s descendants, no portion of the transfer is a completed gift. On the other hand, if the donor had not retained the testamentary power of appointment, but instead provided that the remainder should go to X or X’s heirs, the entire transfer would be a completed gift. Treas. Reg. Sec. 25.2511-2(b). The child as beneficiary definitely gave up the right to control whether the trustee would ever made a tax reimbursement payment to the taxpayer/parent who created the trust.

In Revenue Ruling 67-370, 1967-1 C.B. 324, the IRS concluded that a defeasible remainder interest in trust which is subject to termination at the will of another is an interest in property. The ruling notes that the fair market value of the interest would be affected by its possible divestment under general transfer tax rules for the valuation of property, but the value of that interest would not necessarily be nominal.

In Revenue Ruling 2004-64, 2004-2 C.B. 7, a grantor created an irrevocable inter vivos (lifetime) trust for the benefit of the grantor’s descendants and retained sufficient powers with respect to the trust so that the grantor is treated as the owner of the trust for income tax purposes, i.e., its grantor trust. This ruling considers two situations in which the trustee reimburses the grantor for taxes paid by the grantor that are attributable to the inclusion of all or part of the trust’s income in the grantor’s income. If a distribution reimbursing the grantor for income tax is required (“mandated”) under the terms of the trust, it is not a gift by the beneficiaries as the payment was mandatory. However, that will cause the trust assets to be included in the grantor’s estate. If instead the trust provides the trustee with the discretionary authority to reimburse the grantor for income taxes distribution it also won’t be a gift by the beneficiaries (and the trust assets will not be included in the grantor’s estate). It is not a gift by the beneficiaries because the distribution was made pursuant to the exercise of the trustee’s discretionary authority granted under the terms of the trust.

IRS’s Analysis: Under the trust the child and the child’s issue each have an interest in the trust property. As a result of the modification of trust, the taxpayer/parent/grantor acquires a beneficial interest in the trust property in that she becomes entitled to discretionary distributions of income or principal from trust in an amount sufficient to reimburse her for any income taxes she pays as a result of inclusion of trust income on her personal income tax return. In substance, the modification constitutes a transfer by child and child’s issue for the benefit of the taxpayer/parent/grantor. This is distinguishable from the situations in Rev. Rul. 2004-64 where the original governing instrument provided for a mandatory or discretionary right to reimbursement for the grantor’s payment of the income tax. Thus, as a result of the modification, the child and child’s issue each have made a gift of a portion of their respective interest in income and/or principal. The result would be the same if the modification were pursuant to a state statute that provides beneficiaries with a right to notice and a right to object to the modification and a beneficiary fails to exercise their right to object.

The gift from child and child’s issue of a portion of their interests in trust should be valued in accordance with the general rule for valuing interests in property for gift tax purposes in accordance with the regulations under Code Sec. 2512.

Planning Considerations

There are many considerations in response to the recent IRS CCA on adding tax reimbursement clauses:

1. Move the trust to a state that would permit a modification of the trust without requiring the beneficiaries to approve it. Although the IRS seems to feel that if the beneficiaries are permitted not to object to the modification that may be equivalent to their consenting.

2. The CCA applies to a situation where the trustee goes to court to have the court modify the trust. What if the trustee merely decanted or merged the trust into a new trust that included a tax reimbursement clause? Would that have the same consequence?

3. If there were multiple beneficiaries of the trust it is not clear that the IRS reasoning as pointed out above is as strong.

4. Try to put tax reimbursement provisions in the trusts from inception and the issue the IRS raises is obviated.

5. It may be possible to get money out of a trust in other ways, without adding a tax reimbursement clause. Be sure all of those are addressed before trying to add a tax reimbursement clause. These might include loans, payment of reasonable compensation from entities owned in a trust, distributions to the taxpayer’s spouse if that spouse is a beneficiary, etc.

6. Some experts might disagree with the IRS’ reasoning and interpretation that the “gift” by the beneficiaries can be valued.

7. It might be possible if the trust has lifetime powers of appointment to exercise those powers in a way that can get to a similar financial result without the risk of the IRS position in this CCA applying, or at least not applying with the same vigor.

8. If the beneficiaries presently have $13,610,000 of gift tax exemption. For most people and most trusts this just may have no impact at all. Report the gift the IRS argues exists, use some of your exemption and move on.


Tax reimbursement clauses are commonly used in modern or new grantor trusts. There use was fewer common years ago. They are not always used as the clauses themselves might create problems causing trust assets to be included in the taxpayer’s estate. Certainly in light of the recent CCA the IRS’ new position should be considered carefully before pursuing a modification of a trust to add such a clause, especially if the beneficiaries have to approve it.

A bigger question and concern for which there may be no answer is does this CCA signal a new aggressive direction that the IRS will pursue more broadly trust modifications, perhaps whether by court order, decantings, perhaps even trust protector actions, as being taxable? No one knows. Certainly being more alert to possible gift tax implications of various transactions might be advisable.


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