Jointly held powers of appointment over trust property are rarely seen today because of the complexity associated with their tax
treatment. By way of background, there are two types of powers of appointment. The first is a general power of appointment (“GPA”) which permits the holder to appoint or direct the distribution of funds to anyone, including the holder, his or her creditors, his or her estate, or creditors of his or her estate. The second type is a special or limited power of appointment (“LPA”) which restricts the holder’s ability to appoint or transfer. An LPA is anything that does not qualify as a GPA.
The taxable estate of a holder of a GPA includes the value of assets subject to the GPA, while the taxable estate of a holder of an LPA does not. The rationale is that unrestricted use or access to property is akin to ownership and should result in estate taxation.
Joint powers of appointment (created after 10-21-42) are LPAs if the power may be exercisable only in conjunction with another person having a substantial interest in the property which is adverse to the exercise of the power by the holder. The regulations contain examples of what constitutes a general or limited power.
If, for example, Holder may only exercise the power with X’s consent, we must carefully evaluate if X is truly adverse to the Holder’s exercise of the power . Assume A creates a trust using a trust company as trustee. Income is payable to Holder; however, principal may only be distributed if X consents. At A’s death, the trust is divided equally among X, Y, and Z unless Holder, in his will, appoints in different proportions to X, Y, or Z. Will X block a distribution to Holder if X can be cut out? In this instance, X is not adverse to Holder. If we eliminate Holder’s power to appoint to X, Y, or Z, then X is clearly adverse to Holder because every principal distribution reduces X’s share of the remainder.
What if we use a Distributions Committee (“DC”) in lieu of joint powers. A DC gives the power over distributions to a committee that includes non-beneficiaries in order to avoid estate taxation of any person holding power over distributions. DCs are common in Dynasty Trusts or Delaware Incomplete Non-Grantor Trusts (“DINGS”). A private letter ruling (PLR) sets forth the tax treatment of issues arising out of a particular set of facts and is binding upon IRS and the taxpayer requesting it. In 2002 PLRs,trusts using DCs included succession provisions that permitted beneficiaries to be appointed to the DC; however, the beneficiary could not participate in distribution decisions affecting him or her. The 2002 PLRs ruled that DC membership did not
cause a member to possess a GPA.
Then, in IR-2007-127, the Service indicated it was reconsidering these 2002 PLRs because the committee members could be replaced, thus conferring a GPA upon members of a DC. Not all aspects are being reconsidered.
It appears that DCs remain an effective substitute for joint powers if beneficiaries do not replace departing members.