IRS Reverses Position on Modifying Irrevocable Grantor Trusts

The Internal Revenue Service (“IRS”) issued Private Letter Ruling (“PLR”) 201647001 in November of 2016, in which it took the position that a modification to an irrevocable grantor trust to add a discretionary income tax reimbursement clause did not change the beneficial interests in the trust, and therefore did not result in a gift, because the provision was administrative in nature. The IRS recently issued Chief Counsel Advice 202352018 (the “CCA”), in which it has explicitly stated that the conclusion reached in PLR 201647001 no longer reflects the position of the IRS.[1] Instead, the CCA indicates that such a modification results in a taxable gift by the beneficiaries of the trust.

Irrevocable Grantor Trusts and Income Tax Reimbursement Clauses

A grantor trust is one which is considered disregarded for federal income tax purposes, meaning that it is one and the same as the grantor (solely for federal income tax purposes). The grantor of a grantor trust is treated as owning all (or in some instances, a specific portion) of the trust assets and must report all of the trust’s income, deductions, and credits on his or her individual tax return. For a more in-depth discussion of what a grantor trust is and powers that might cause a trust to be a grantor trust, please see the Charles Allen’s prior article. [2]

When a trust is irrevocable, yet the grantor retains certain rights or powers sufficient to trigger grantor trust status, we refer to such a trust as an irrevocable grantor trust.[3] Often, irrevocable grantor trusts are structured such that transfers to the trust by the grantor are completed gifts for federal gift and estate tax purposes (and thus not included in the grantor’s taxable estate) while not triggering any federal income tax consequences.[4] This structure opens up a plethora of advanced estate planning for clients however, for this structure to work, the grantor should generally not be a beneficiary of the trust. The result is that once the grantor has transferred assets to the trust, they no longer have access to such assets, but are still taxed on the income the assets generate.

There are multiple benefits associated with the grantor continuing to be taxed on the income generated by the trust assets. First, since trusts have extremely condensed income brackets, having the grantor taxed personally on the income generated by the trust assets typically results in an overall lower effective income rate. Second, allowing the grantor to expend funds outside of the trust (and presumably includable in his taxable estate) to pay the income tax on the trust assets, means that the grantor can further reduce property which will be subject to the gift and estate tax, while preserving assets that are exempt from the gift and estate tax (the assets transferred to the trust via a completed gift). The downside is that a cash flow problem can be created if the grantor does not have sufficient liquid assets (outside of the trust) to cover the resulting income tax liability.

To mitigate this concern, practitioners often add income tax reimbursement clauses in irrevocable grantor trusts. Income tax reimbursement clauses generally either require the trustee to make distributions from the trust to the grantor sufficient to cover any income tax liability associated with the trust assets or grant the trustee the discretion to make such distributions. The IRS stated its position regarding income tax reimbursement clauses in Revenue Ruling 2004-64, in which it stated that mandatory tax reimbursement clause would cause the full value of the trust’s assets to be includible in the grantor’s gross estate under Section 2036(a)(1). The ruling also held that a discretionary income tax reimbursement clause, whether or not exercised, would not cause the trust assets to be included in the grantor’s gross estate. However, the ruling stated that if there is an implied agreement between the grantor and trustee that the trustee would exercise its discretion to make the distributions to the grantor, then the optional tax reimbursement clause would be treated the same as the mandatory clause (i.e. included in the grantor’s gross estate). Thus, even where a discretionary income tax reimbursement clause is included in an irrevocable grantor trust that is not intended to be included in the grantor’s taxable estate, trustees are advised to exercise their discretion rarely if at all.

What is a grantor to do if they have already transferred assets to an irrevocable grantor trust that does not contain an income tax reimbursement clause, and they later start having difficulty paying the income tax liability associated with the income generated by the trust assets? Depending on the situs of the trust, one potential option is to amend the trust agreement pursuant to relevant state law.[5] This was the rough fact pattern set out in PLR 201647001, with the IRS ruling that adding an income tax reimbursement clause to an irrevocable grantor trust after its initial formation pursuant to relevant state law did not result in a transfer tax issue. Now, it would seem that the IRS has changed its mind.

CCA Facts

The IRS lays out the following facts in the CCA. In Year 1, a grantor establishes and funds an irrevocable trust, for the benefit of his or her sole child and that child’s further descendants. The current trustee of the trust satisfies the requirement of the trust agreement that a trustee must be a person not related or subordinate to the grantor within the meaning of Section 672(c). Under the trust agreement, a trustee may, in the trustee’s absolute discretion, distribute income and principal to or for the benefit of the grantor’s child. Upon the child’s death, the remainder of the trust is to be distributed to the child’s issue, per stirpes.

Under the trust agreement, the grantor retains a power that causes the trust to be a grantor trust. The trust agreement does not include an income tax reimbursement clause and state law does not provide a similar power for the trustee to reimburse the grantor for the income tax liability related to the trust’s assets. In Year 2, when the grantor’s child has no living grandchildren or more remote descendants, the trustee petitions a state court to modify the terms of the trust. Pursuant to a relevant state statute, the grantor’s child and his or her issue consent to the modification. Later that year, the court grants the petition and issues an order modifying the trust to include a discretionary income tax reimbursement clause.


The IRS begins its analysis by stating that the grantor’s child and that child’s issue each have an interest in the trust property under the trust agreement. The IRS then states that as a result of the Year 2 modification, the grantor acquires a beneficial interest in the trust property in an amount sufficient to reimburse him or her for the income tax liability associated with the trust assets. The IRS then concludes that this is in essence, a transfer by the grantor’s child and that child’s issue for the benefit of the grantor and thus each has made a gift of a portion of their respective interest income and/or principal. The CCA then states that the result would be the same if the modification was 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.

According to the CCA, this position is distinguishable from Rev. Rule 2004-64 because the facts in the revenue ruling contemplated trust agreements that originally included mandatory or discretionary income tax reimbursement clauses. Additionally, the CCA includes a footnote specifically referencing the conclusions in PLR 201647001 that the modification of a trust to add a discretionary income tax reimbursement clause is administrative in nature, and therefore does not result in a change of the beneficial interests in the trust, and the footnote states that such conclusions no longer reflect the position of the IRS. A second footnote includes an acknowledgement by the IRS that valuing such gifts will be complex, but that such complexity does not change the treatment.


The CCA has caused quite a stir in the tax world as it raises all types of concerns. In this case, the trustee is the one who took the action to amend the trust, and the beneficiaries simply consented to the modification. Yet the beneficiaries are the ones who are deemed to have made a gift. This makes since, given that the trustee had no beneficial interest in the trust, but still is a “feels bad” situation due to fact that the beneficiaries are not the ones taking action. The CCA indicates that if state law provided that the beneficiaries did not have to actively consent, but rather merely be noticed with a right to object, and fail to do so, they could similarly be treated as making a gift. Does this mean that the IRS expects beneficiaries to contest any similar trust modifications to avoid having made a taxable gift? If so, do the beneficiaries have to engage counsel to actively contest the proposed modification, appeal to the highest available court, etc.? If objection is necessary, we simply do not know how actively pursued the objection must be.

Speaking of similar modifications, if the IRS’s position is that a modification to add a discretionary income tax reimbursement provision (which may never even be exercised by the trustee) results in a gift from the beneficiaries of the trust, then many other modifications could potentially result in adverse gift tax consequences, such as a modification to grant a beneficiary a limited testamentary power of appointment over property which would otherwise pass under the terms of the trust agree to such beneficiary’s issue. If the trustee attempted to modify the trust such that instead of passing at the child’s death to his or her issue, the grantor’s child now has the power to appoint property at his or her death among the grantor’s siblings and their descendants, would that result in the child’s issue making a gift of some portion of his or her entire interest in the trust, even though such testamentary power of appointment may never be exercised by the grantor’s child?

What about other methods whereby the trustee may modify the trust agreement, such as decanting powers? We don’t know at this point exactly how far the IRS might push this argument. One thing is clear though, practitioners should make double sure that discretionary income tax reimbursement clauses are included in their trust agreements when they may be needed in the future. If a taxpayer finds themself in a situation where the tax burden of an irrevocable grantor trust is getting unmanageable and there is no income tax reimbursement clause, there may be other options to alleviate these concerns other than modifying the trust agreement. One such option is lending funds from the trust to the grantor, but taxpayers must be sure any such loan is bona fide debt by, among other thing, charging sufficient interest on the loan. Another option to contemplate would be to have the grantor relinquish the power(s) causing the trust to be a grantor trust. In light of the CCA, taxpayers and practitioners would be wise to consider the consequences of all alternative options, such as the aforementioned examples, before modifying the trust agreement to add an income tax reimbursement clause.

Finally, there are a litany of valuation concerns associated with the holding of the CCA. The IRS graciously acknowledged that valuing the interests gifted by the beneficiaries is going to be difficult, but likely underestimates the real burden placed on taxpayers to determine an accurate value of the modification (if it is even possible to do so). How are practitioners expected to determine when and to what extent, if at all, the trustee will exercise the discretion granted to it under the income tax reimbursement clause? Perhaps we are supposed to assume that the trustee will always exercise this discretionary power and discount the value of such to a present value. But is that really reflective of reality? While I am no valuation expert, I would argue that such an assumption is likely going too far (barring other evidence that an implied understanding exists between the trustee and grantor indicating such). Maybe the IRS will provide additional guidance on the valuation issue and/or the others discussed here. Until it does, all we can do is guess and wait.

[1] Chief Counsel Advice 202352018 issued November 28, 2023.

[2] Charles Allen, “My Favorite Presentation from Heckerling” (January 29, 2020),

[3] Such rights or powers triggering grantor trust status are enumerated in Internal Revenue Code Sections 671-678.

[4] Irrevocable trusts can also be structured to be incomplete gifts non-grantor trusts, in which case they are often referred to as ING trusts. For more details on INGs and their uses, see the following article by Parker Durham: Parker Durham, “Incomplete Non-Grantor Trusts: A Tax Planning Tool” (September 12, 2022).

[5] See, e.g., Uniform Trust Code § 411. The Uniform Trust Code has been adopted in the majority of the states although not always with this uniform provision.


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