With the significant increase in non-probate assets such as 401k’s and IRA’s owned by individuals the importance of proper planning for these assets become more and more important. Indeed Natalie Choate has published books, articles and presented lectures and seminars and is considered by many as America's leading authority on these topics.
An example of how difficult such planning is and the consequences of not planning properly is demonstrated In PLR 201438014. In this private letter ruling the decedent created a testamentary trust. At the time of his death he owned an individual retirement account (IRA) and designated the trust under his will as a beneficiary. The trust provided for distribution of the decedents estate including the payment of the pecuniary bequests of two different amounts to two different charities. At the time of the decedents death the estate assets consisted of funds in his IRA. The charitable bequest to the two charities however exceeded the amount of the trust non-IRA assets.
The estate moved before the local court for a reformation of the trust. The purpose of the reformation was to ensure that the trust distribution of IRA assets to the two charities would be treated as a direct bequest to the charities rather than as income in respect of a decedent (IRD) under IRC section 691. Alternatively the trustee attempted to qualify the trust for a charitable deduction. The IRS held that the distribution of the IRA by the estate and satisfaction of the charitable pecuniary bequest accelerated the IRD as income in respect of a decedent.
The IRS pointed to Keanan v. Commissioner, 114 F.2d 217 (2nd Cir. 1940) which held that if a trust or estate satisfies its pecuniary legacy with property, the payment is treated as a sale or exchange of the property. The service also pointed out that in the Supreme Court case of the Estate of Bosh, 387 U.S. 456 (1967) the court concluded that a decision of a state trial court should not control the application of a federal statute.
In Revenue Ruling 59–15 1959-1 C.B. 164, citing Emanuelson v. United States,
159 F. Supp 34 (Conn. 1958), it was held
that a settlement agreement from a will contest qualifies as a governing
instrument for purposes of section 642 (C) assuming the court decision was in
settlement of a conflict. The IRS determined however that neither of these
authorities held that a modification to a governing instruments will be
construed to be the governing instrument in situations where the modification
did not stem from a conflict. Hence because the trust used IRA assets to
satisfy its pecuniary legacies the distributions must be treated these payments
as sales or exchanges. These payments are transfers of the right to receive the
income in respect of a decedent and the trust must include the in its gross
income the value of the portion of the IRA which is IRD to the extent the IRA
was used to satisfy the pecuniary legacy.