Tax implications of powers of appointment (Consumer Pages)
Gift Tax on General and Special Powers
A trust could allow a power holder to distribute 5%, 10%, or some other percentage or amount of the trust’s property annually. Only the amount distributed (per year, per beneficiary) that exceeds the annual exclusion amount at the time of distribution is considered a taxable gift.
Example 1a: If a general power holder distributes 10% of a $500,000 trust to a beneficiary (a present interest gift), the taxable gift amount is $50,000 - $13,000 = $37,000. Gift taxes may also be avoided when exercising a general power by applying the marital or charitable deduction, or by applying the applicable credit amount.
The same result obtains if the holder is limited to a non-cumulative 5 & 5 distribution power.
Example 1b: A $1,000,000 trust limits the trustee to withdrawing the greater of $5,000 or 5% of the trust property. The trustee distributes $50,000 to an appointee. 5% x $1,000,000 = $50,000 (the maximum distribution allowed by the trust document). $50,000 - $13,000 (the annual exclusion) = $37,000 (taxable gift).
Gift Tax on a Lapsed General Power
The five and five exception provides that property subject to a lapsed general power will be considered a taxable gift only to the extent that the property that could have been appointed by the power holder* exceeds the greater of:
1. $5,000, or
2. 5% of the total value of the fund subject to the power as measured at the time of lapse
(*) The power, which had not been exercised in the current year, lapsed (generally as of midnight on 12/31). Note: Had the holder exercised the power in the current year, a present interest gift would be taxable to the extent it exceeded the annual exclusion amount. For example, if a general power holder distributed $13,000 from a $100,000 trust, even though $13,000 exceeds the greater of 5 & 5, it is not a taxable gift because it does not exceed the annual exclusion.
Example 1c: Assume a general power is given to the power creator’s son. The power allows the son (i.e., the power holder) to make annual exclusion distributions ($13,000 in 2009). If the son does not make a permitted distribution in 2009, the power is said to have lapsed. The power would be subject to gift, estate, and/or GST taxation but only to the extent the lapsed amount exceeds the greater of $5,000 or 5% of the trust property. If the trust was valued at $260,000 a lapse would not create a taxable gift. Why? Because the lapse is within the 5 & 5 exception limit: $13,000 ÷ $260,000 = 5%. If the trust’s value was under $260,000 a lapse would create a taxable gift. Why? Because the amount of the withdrawal right ($13,000) would then be > 5% (i.e., it would exceed the 5 & 5 exception amount).
Example 1d: A trust allows the trustee to withdraw $30,000 per year. The trust has a current value of $500,000. The trustee makes no distributions for the current year. The portion of the lapse that is a taxable gift is $5,000. Why? The greater of $5,000 or 5% of the trust property is exempt under the 5 & 5 exception. 5% x $500,000 = $25,000. $30,000 (the lapsed amount) - $25,000 (the exempt amount) = $5,000 (the amount of the taxable gift).
Summary of Gift Tax Implications of Special Powers
Special Power of Appointment: Exercised, released, or lapsed – not subject to the gift tax
Summary of Gift Tax Implications of General Powers
General Power of Appointment (with ascertainable standard, conjunction with creator of power, or adverse party exception): Exercised, released, or lapsed – not subject to the gift tax (treated as special power).
General Power of Appointment (with non-cumulative 5 & 5 withdrawal limitation): Exercised – subject to gift tax on amount in excess of annual exclusion
General Power of Appointment (with non-cumulative 5 & 5 withdrawal limitation): Released – subject to gift tax on entire amount subject to release (no annual exclusion).
General Power of Appointment (with non-cumulative 5 & 5 withdrawal limitation): Lapsed – no gift tax
General Power of Appointment (with a non-cumulative withdrawal right that exceeds the 5 & 5 limit): Exercised – No gift tax on amount up to and including the annual exclusion but subject to gift tax on the amount that exceeds the annual exclusion.
General Power of Appointment (with a non-cumulative withdrawal right that exceeds the 5 & 5 limit): Released –subject to gift tax on entire amount subject to release.
General Power of Appointment (with a non-cumulative withdrawal right that exceeds the 5 & 5 limit): Lapsed – No gift tax on amount up to and including the 5 & 5 amount but subject to gift tax on amount in excess of 5 & 5.
General Power Taxation Exceptions (Gift, Estate, GSTT)
Disclaiming a General Power
A qualified disclaimer of a general power of appointment is not considered a release of the power and would therefore not be taxable.
Conjunction with Creator of Power or Adverse Party Exception
If the transfer occurs as a result of the donee’s death it is not subject to estate and GST taxation if the general power is exercisable by the donee decedent only in conjunction with the creator of the power or a person who has a substantial interest in the property subject to the power, which is adverse to the exercise of the power in favor of the donee/decedent (adverse party exception). In other words, there are no gift, estate, or GST tax consequences of holding a general power of appointment subject to these two exceptions.
Ascertainable Standard Exception
There are no gift, estate, or GST taxes imposed by the exercise, release, or lapse of a general power of appointment limited to an ascertainable standard. See Ascertainable Standard on page 75.
Vesting in, or Distribution to, General Power Holder
If the trust’s corpus and/or income is vested in the power holder by the sole action of the power holder, there is no taxable gift but the property’s income is taxable to the holder and the property vested, unless previously disposed of, will be included in the holder’s estate.
Note: The rules discussed above also apply to the GSTT for 2009, 2011 and later years.
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