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Course: Trust Tax 2003
School: Wayne State University
Year: 2003
Professor: unknown
Course Outline provided by Legalnut.com

  1. Current Distributions: CHP 5

    1. Simple Trusts;

      1. TTee can defer making the mandatory distribution until after the close of the trust’s taxable yr. Ttee can deduct the distribution in the yr that the income is earned and required to be distributed, even if the amount was not determined by the close of the yr. §652

      2. Reg §1.651(a)-2(b) states that the deduction is allowed as long as the ttee distributes to some group of persons. §652 doesn’t deal with taxation of the bene.

      3. Special Allocation:

        1. TEI is deemed distributed to bene’s in the same ratio that they share FAI, unless the governing instrument states otherwise. §652(b).

        2. An allocation will be respected only if it has “an economic effect independent of the income tax consequences of the allocation”. §1.652(b)-2.

        3. Can’t say in gov instru that “income is first to be paid from one particular source-this is insufficient economic effect.” §1.652(b)-2.

      4. A provision that all TEI be distributed to one bene and all TI be distributed to another bene should be recognized as an effective special allocation for purposes of §652 & §662. Such a provision may not be effective if the fiduciary seeks to realize an equal amt of both classes of income. There is no clear law on point. IRS looks to see if the entire instrument & special allocation has economic effect.

    2. Estates & Complex trusts.

      1. Bene’s of an estate and complex trust, like those of a simple trust, include in GI under §662 the amount for which the entity has rec’d a distribution deduction under §661. The DD for a complex trust is limited to DNI rather than FAI.

      2. Distr from an estate or trust are considered to carry out a pro rate part of DNI.

      3. Tier system;

        1. The amt of income required to be distributed are 1st tier distributions. Other deductible distributions are called 2nd tier distributions.

        2. Under 1st tier, DNI is first allocated to bene’s in proportion to their interests in the FAI required to be distributed. §662(a)(1). Any remaining DNI is allocated to the 2nd tier bene.

          1. 1st tier includes only mandatory distributions of income. A bene can be 1st tier even if bene has no fixed rt to income (discretionary bene).

          2. A person can be both 1st tier and 2nd tier.

          3. Available DNI is allocated 1st to DNI and any remaining DNi is allocated to 2nd tier.

      4. Treatment of Annuity pmt; (P.5-7)

        1. An annuity if 1st composed of FAI and 2nd of corpus or accumulated income.

        2. AN annuity pmts can be paid out of corpus, hence 2nd tier distributions.

        3. FINSIH (problems p 5-8)

      5. When income exceeds NI;

        1. FAI may exceed DNI when exps or other items are deducted for income tax purposes but are charged to corpus for FAI. In such situations, the fiduciary’s deduction and the amount of current income on which the bene’s are taxed is still limited to DNI.

        2. If DNI exceeds 1st tier distributions, 1st tier bene’s are required to include the full amount of their distr in GI. The remaining DNI after the 1st tier allocation is taxable to 2nd tier bene.

          1. Ex. FAI is 40 and DNI is 36. A, B, C, D are bene’s. A gets 20 (1/2 of FAI), and B gets 30 and C gets 10. All of A’s $ is taxable b/c it came from DNI. The remaining 10 is divided btwn B & C. 30/40 = 75% allocated to B and 10/40 = 25% is allocate to C for the remaining 10k of DNI.

      6. Charitable contributions on bene;

        1. First Tier bene: §662(a)(1) DNI for a complex trust is computed without the deduction allowed by §642(c) (w/o considering charitable deductions), relating to the deduction for charitable purposes. §662(a)(1). This prevents first tier bene’s from benefiting from the charitable deduction; in substance the charitable deduction is treated as a “super second tier” distribution.

          1. Ex. If A is income bene of a complex trust and the trust has accumulated income of 50k and trust makes a distribution of 40k, to charity; even though the general rule is that the charitable contribution reduces DNI so that DNI is only 10 (50-40) the full amount is taxable to A.

        2. 2nd Tier bene; the charitable deduction is not available to 1st tier bene’s but maybe available to reduce or eliminate the amount taxable to 2nd tier bene’s. (p.5-10)

          1. Ex. If A has a mandatory distribution of 20 and ttee makes 25k of additional distributions out of current income to other persons. Under these circumstances, the 1st tier distribution, but none of the 2nd tier distribution is taxable. The DNI available for 2nd tier is 50 – (20+50), a negative # treated as 0. DNI available for the 2nd tier is not computed by subtracting A’s 02k from 50 of total income and then allocating the 30k balance btwn the gifts to charities and to other bene’s. The charitable contribution comes off the top, so the 2nd tier bene’s portion comes off the bottom.

    3. Identifying the bene; (P5-11)

      1. §1.662(a)-3 states that a distribution to or for the benefit of a child is deemed to have been made to a child’s parents, if the distribution is used in full or partial discharge or satisfaction of a legal obligation.

      2. Pmts made to discharge creditors or defray personal living or family exp of the bene are deemed to be made to the bene as 1st or 2nd tier distr.

      3. Issue is whether certain luxury items constitute support: ex. Summer camp, private school or college tuition. The modern view is to consider the parent’s financial and social status in deciding whether these items are part often-legal support obligation.

      4. Braun v Comm: Grantor was taxed on all of the trust income used to pay for education of minor children and emancipated children.

      5. Stone v Comm; A created a trust for children and funded it w/50k then he borrowed against it and gave the trust a promissory note. Trust required the ttee to distribute all trust income to the bene for education. TC stated that any pmt of trust income in a manner that discharges the grantor’s legal obligation to support their minor children must be taxable to the grantor’s under §677(a).

      6. Sharon v Comm; (p.5-14)

    4. Character & Items in DNI;

      1. 3 general types of income: OI, CG, TEI.

      2. Deductions may be attributable to a particular item of GI or to FAI as a whole.

      3. Allocation among bene’s;

        1. §662(b) amts distributed to bene’s shall be treated as consisting of the same portion of each class of items entering into the computation of DNI unless the gov instru allocates differently. §652(b) applies to ST and states that each distribution of DNI carries out a pro rata share of each type of item included in DNI, unless the gov instru expressly provides otherwise.

        2. If DNI is not distributed in a particular yr then the NI retained at the trust level is generally deemed to also consist of a pro rata part of each character of income and deduction.

        3. Income that is distributed to bene retains the same character in the hands of the bene as in the hands of the trust (e. foreign source income retains foreign source status; and capital G/L’s).

    5. Allocations btwn bene’s in different tiers;

      1. §662(b) doesn’t distinguish btwn 1st tier and 2nd tier bene’s. It concentrates on how much DNi is available to carry out each tier. §662(b) defers to the governing instrument that allocate DNI in other than prorate manner.

    6. Impact of charitable distributions: (P5-20)

      1. A

    7. Fiduciary and Bene w/ different tax yrs

      1. Death of a bene;

      2. Termination of other bene’s;

      3. Expatriation or loss of alien’s residence status

      4. 2% floor on MISC itemized deductions;

      5. AMT

    8. Non-taxable settlements;

 

 

  1. Taxation of Grantor and Controlled Trusts CHP 7

    1. Development of statutory provisions;

      1. Helvering v Clifford; involved an irrevocable trust making himself the sole ttee and for benefit of wife for 5 yrs. Ct said husband was still the owner of the property b/c had control over property. Ct said there was no significant change in control of trust assets. Clifford Regulations: grantor is treated as the owner if the reversionary interest would (1) vest w/in 10 yrs, 15 yrs in certain situations; (2) grantor had pwr to control the beneficial enjoyment of the trust principle regardless of whether it was exercisable alone or by another person; (3) or a broad administrative pwr.

      2. In 1954 Congress enacted §671 thru §678 as the grantor trust rules which taxes a bene as the owner of trust assets over which he or she holds substantially unfettered control.

    2. Grantor trust status;

      1. Grantor trust rules are based on the idea that a trust s/not be recognized as a separate entity if someone has such dominion or control over it as to create an identity of interest btwn that person and the trust.

      2. RR 87-61 a US citizen transferred appreciated property to a foreign situs grantor trust. B/c the grantor continued to own the assets, §671, no transfer had occurred for tax purposes. If the grantor had released the pwrs that had caused the trust to be deemed owned by the grantor then the grantor trust status would end.

      3. IDIT; §671 does not state that a grantor trust should be deemed not to exist for all purposes, but only that all items of a trust income, deduction, and credit be included in the grantor’s personal income tax computation. RR 87-61 stands for the rule that a grantor trust would not exist for estate or gift tax purposes, b/c those taxes are also excise taxes on lifetime and testamentary transfers of property. Grantor rules are not on the same subject with estate and gift tax rules.

    3. Gift tax treatment of grantor’s income payments; IDIT

      1. If grantor pays the gift tax then that pmt is a gift unless the trust terms vary from statute. Both the Uniform Principle and Income Act and the Revised UPIA allow trust terms to vary the statutory rules. Letter ruling 9543049 amends LTR 9444033 and permits the pmt of IDIT taxes by the grantor and is not treated as a gift for gift tax purposes.

      2. Use of a discretionary reimbursement clause is the best clause to allow the grantor to pay the taxes without making a gift.

    4. Anticipatory Assignment of income doctrine;

      1. McGinnis v Comm; grantor gave irrev trust a 15% int in rental income. This was assignment of fruit & not transfer of the tree.

 

    1. Comparison w/ Estate tax rules;

      1. §2036 transfers w/ retained interest

      2. §2037 transfers at death or w/ retained reversions

      3. §2038 transfers over which the donor retained a rt to alter, amend, revoke, or terminate

      4. Distinction: estate tax rules deal with powers actually retained by the grantor while grantor trust rules often affect powers held by either the grantor or a non-adverse party.

    2. Grantor trust as partners;

      1. A grantor trust may not be a separate entity for income tax purposes, but is a separate entity for state law purposes. Therefore, a trust can be a ptnr in s PS.

      2. Two grantors trusts owned by the same person can form a partnership. P7-18. But it can’t be treated as a PS for tax purposes. RR77-402

    3. Concepts and terminology;

      1. Grantor;

        1. §1.671-2(e)(1); is the individual, corporation creator, settlor and the same individual that transferred property to the trust.

        2. Grantor is not necessarily the person who creates the trust and signs the instrument; these functions can be delegated to an agent. Cts look to maintenance of control and the making of gifts.

        3. If A creates a trust and at his death, that trusts is directed to create trust 2 then A is the grantor of trust 2. Trust 1 is the owner of trust 2.

        4. Nominal grantor is not the real grantor. Must contribute more than a nominal amount of property to the trust.

          1. Ex. If A creates a trust and then B makes a gratuitous transfer to the trust then A & B are both grantors

          2. If A creates a trust for B and B has an unrestricted pwr to w/drawl from the trust then B is the grantor. §678 says that the person with the w/drawl pwr (control) is the grantor. §1.671-2(e)(6)

          3. A PS or corp can be treated as a grantor. If it’s for the benefit of a ptnr then it’s considered a distribution to a P.

            1. If PS makes a gratuitous transfer for benefit of a P’s debt then the PS is the grantor.

            2. If corp creates a trust for the benefit of a shsrs son then there is a constructive distribution to shareholder and shr is treated as the grantor with respect to the contribution. §1.671-2(e)(4).

      2. Gratuitous transfer (ic)

        1. Deals w/ $ or assets but not services. Services don’t make you a grantor.

        2. Is a transfer that is not made for fmv & at arms length interest. If arms length then not gratuitous.

          1. The value of any interest in a trust rec’d in exchange for a contribution of property is ignored in determining whether the transferor rec’d fmv. §1.671-2(e)

      3. Multiple grantors;

        1. If one person creates a trust and another person make a significant contribution to the trust.

      4. Corporate grantors;

        1. Can be the grantor §1.671-2(e). Payments by the trust to the bene may be taxable to the bene and deductible by the corp §402 §404.

          1. Ex corp creates a trust for charity.

      5. Intermediaries creating a foreign trusts;P7-29

        1. If A a US citizen gifts 1m to B (non-US citizen) and B then creates a foreign situs trust, A is considered the grantor of the foreign trust §679.

        2. A a non-US citizen transfers property to a foreign corp and the foreign corp creates a trust for the benefit of A. The trust is revocable by the corp. A is the owner of the trust §679(a)(4).

        3. Gifts that are excludable from federal gift tax purposes under §2503(b) are ignored for purposes of determining the grantor. §672(f)(5).

      6. Involuntary grantors;

        1. RR 83-25 the person for who the trust was created may be treated as the grantor. If created by a minor or person with disability then cant be the grantor.

          1. Ex. Ct creates a trust for benefit of a minor. If the minor died b4 age 21 then the trust property would pass to the minor’s estate.

      7. Reciprocal grantor trust;

        1. When a husband and wife create substantially identical trusts of which each is named the other spouse’s bene and ttee, the form of the transaction would not be respected. Rather, each spouse would be deemed to create the trust nominally created by the other. H owns the trust that he is the ttee of the S is the owner in which she is the ttee for. Also applies to non-spouses (ex. Brothers create trusts for benefit of each other).

          1. Differences in size of the trusts will not preclude the IRS from treating the trusts as reciprocal.

          2. Estate of Levy v Comm; the TC refused to treat 2 trusts as reciprocal when one grantor held a broad pwr of apptment (to terminate the trust early) that was not available to the other.

        2. Trusts are reciprocal only to the extent that they leave their deemed grantor’s in the same economic condition as if they had each created the trusts deemed reciprocal rather than their own trusts.

      8. Adverse party; (ic)

        1. Is any person (1) who has a beneficial interest in the trust; (2) whose beneficial interest is substantial and (3) whose interest would be adversely affected by the exercise or non-exercise of the power or interest held by the other person in question. §672(a) §1.672(a)-1.

      9. Non-adverse party;

      10. Beneficial interest;

        1. An adverse party must have a beneficial interest in the trust. Any mandatory or discretionary bene of a trust or principle has a beneficial interest in a trust.

        2. An individual is considered as having beneficial interest in a trust if he has a power of appointment with respect to income or principle. §1.672(a)-1(a).

        3. Individual need not have a present interest in a trust to have a beneficial interest. Thus a holder of a remainder interest in a trust has a beneficial interest, even though there may be no present enjoyment interest until after the death of one or more of the bene’s. §1.672(a)-1(d).

        4. A ttee doesn’t have beneficial interest merely b/c he has the rt to ttee fees. §1.672(a)-1(a).

        5. Must be Substantial: Substantiality of an interest:

          1. A contingent bene who shares with 1000 people may have insubstantial interests. Whereas, being 1 of 4 bene’s maybe substantial.

          2. Looks at facts and circumstances; for ex look at the age when the interest will vest. If minor bene has to wait 20 yrs then his beneficial interest will be small.

          3. The value of the total trust to the value of the beneficial interest determines substantiality.

        6. Interest must be adverse;

          1. A bene is not an adverse party unless his or her substantial beneficial interest is adversely affected by the exercise or non-exercise of the power held by the grantor or non-adverse party. §1.672(a)-1.

          2. If a bene shares in both income and principle at all times, his interest is clearly adverse to whatever power the grantor or non-adverse party may possess.

            1. Family members with adverse interests;

              1. It is the interest in the trust rather than its holder, that must be adverse to the grantor’s or non-adverse party’s power. The identity of the holder of an adverse interest should be irrelevant under grantor trust rules. It is likely that close family members will be given substantial adverse interest, b/c they are not natural objects of a donor’s bounty.

              2. Spouses and former spouses as well as close friends can be adverse parties under grantor trust rules.

            2. Interest adverse to the non-exercise of the grantor’s power.

              1. Interest is adverse to the non-exercise of a grantor’s or non-adverse party’s power if its holder were a taker in default of the exercise of such a power.

          3. Interest in a fraction of the trust;

            1. P.7-39

          4. Income interest;

            1. Bene’s interest in the income of a trust is adverse to the exercise of pwr over that trust income.

          5. Remainder and other principle interests;

            1. Bene’s interest can be adverse as to income but not adverse as to principle.

          6. False or sham interests;

        7. Related, Subordinate, and Subservient parties; (ic) p7-41

          1. In certain situations a pwr that w/ create a G trust if held by the G or a NA party will not do so if it is held by someone who though NA is not a “related or subordinate” party subservient to the G’s wishes. This limited exception from the G trust rules requires examination of 2 components;

            1. Related or subordinate party AND

              1. This is a non-adverse party who is also a member of the grantor’s family or related to the grantor through certain types of business contracts. Only the following members of the grantor’s family are considered related parties:

                1. Grantor’s spouse (unless they are not living together)

                2. Grantor’s direct descendents, parents, siblings, and children. Grandparents, aunts, uncle, and in-laws are too remote.

              2. Or subordinate party;

                1. SP if he or she is an ee of the G

                2. Or a corp in which the G is an executive and in which the indiv is a subordinate ee

                3. Or a corp in which the stkhdgs of the G and the trust are subject to several ambiguities that make their application difficult.

            2. Subservient to the wishes of the grantor.

              1. An indiv who is related or subordinate is presumed to be subservient to the G’s wishes for G trust purposes. But this evidence may be rebutted by a preponderance of evidence. §1.672©-1.

    4. Ownership of a portion of the trust (income or corpus);

      1. A grantor or 3rd person may own a portion of the trust and is therefore taxed only on those items of trust income, deductions, and credits allocable to the portion of the trust he is deemed to own.

      2. Fractional or pecuniary share ownership; (ic)

        1. Fractional shares: If own a specific dollar amt then = fractional share. Ex. pwr to appoint 1/10th of trust assets. P7-46.

        2. Pecuniary share: ownership is based on size of trust so if trust assets fluctuate then ownership % may change.

      3. Specific trust assets; (ic)

        1. Own amt directly related to that item. Ex cash and shr of stk. Bene must reflect income from stk and CG.

        2. Trouble is allocating trust exp.

      4. Principle or income alone;

        1. Remainder-man get principle and income bene gets current income.

        2. Exps may be allocated to income or principle depending on the gov document.

        3. FAI rules normally require that CG/L be allocated to principle rather than income.

        4. Reserve/accumulations may be incorp in trust.

      5. Income interest alone;

        1. Exp’s are 1st allocate to OI then to CG.

        2. (ic) Can’t be negative DNI, so any exp exceeding combined income and gains are not currently allowable as deductions to the bene or grantor. A grantor that owns only the income interest of a trust that generates a net loss b/c of non-business admin exp’s will lose the bene of the deductions.

 

          1. Edgar v Comm; distinguished the disallowance of excess deductions for business operating losses from the deduction for depreciation and depletion, b/c the latter group of deductions can be allocated to either income or principle. Depr deductions can be allocated even if they exceed trust OI.

          2. Ex: G creates a trust and reserves a rt to w/d the 1st 20k of income annually. B is the sole income bene. Trust has 100k of OI; 20k of CG and 6k of admin exp, which are allocated proportionately btwn income and principle. G declines to w/d any income and ttee pays all of OI to B. G has TI of 19k computed as follows:

            1. 6k of admin fees are allocated 5/6 to income (100/120) and 1/6 to principle. Income int has 100k of income and 5k of exp; G owns 20% of the total income interest (20/100). 20% X 100k = 20k of income and 20% of 5k = 1k of exp. 20-1 = 19.

    1. Exceptions for foreign trusts;

      1. §672(f) renders the grantor trust rules inapplicable to a foreign trust if the person who would be deemed to own the trust is not a citizen or a resident of the US or a domestic corporation. §672(f)(1).

      2. If a foreign grantor is not treated as owning a foreign trust under this rule, any US bene of the trust will be treated as the grantor to the extent such bene has made (directly or indirectly) transfers of property to the foreign grantor. §672(f)(2)

      3. §672(f)(4) allows the secretary to re-characterize any transfer from a PS or foreign corp in which the transferee treats the transfer as a gift or bequest to prevent tax avoidance.

      4. §672(b)(5) states that the bene rather than the nominal grantor of a trust shall be treated as the grantor of any portion of a trust to the extent such ben has made (directly or indirectly) transfers of property, except for sales for full consideration, and gifts excludable under §2053 (annual exclusion 11k).

      5. The limitations on grantor trust status for foreign trusts established by non-US persons do not apply to:

        1. Trusts over which the grantor has an absolute power to revoke the trust and reacquire the trust assets, exercisable soley by the grantor without the approval or consent of any other person, other than a related or subordinated party who is subservient to the grantor §672(f)(2)(A)(i)

        2. Any portion of a foreign trust if distributions of any amounts from such portion (principle or income) can be made, during the grantor’s lifetime, only to the grantor or the grantor’s spouse.

        3. Any portion of a trust, distribution from which are taxable as compensation for personal services. §672(f)(2)(B).

      6. If the ttee has the power under local law to add the grantor’s spouse as a bene to the trust, then the trust would be taxable as a grantor trust under §677.

      7. FINISH p7-55 example

    2. Powers subject to a condition precedent;

      1. A grantor or third person is taxed as the owner of a trust or portion of a trust b/c of a grantor trust power, even though the exercise of that pwr is subject to a condition precedent of the giving of notice by the person who would exercise that power. §672(d). Ex. a power to revoke that can only be exercised upon giving written notice to ttee creates a grantor trust even though the grantor does not actually give noticed during the yr.

      2. Ex A creates trust 1 with pwr to revoke it after yr 2 and creates trust 2 with pwr to change income bene after 45 yrs (I checked). A is the owner of trust 1 from the day it is created regardless of the fact that she cannot revoke the trust. A is not the owner of trust 2 b/c under §673, this period would not have created a grantor trust had her power been a reversionary interest. §1.672(d)-1.

    3. Spousal attribution of powers and interests;

      1. §672(e) states that if the spouse and the grantor are eligible to file a joint tax return for the relevant period then spousal attribution rules apply.

      2. US citizen or resident alien is not eligible to file a joint tax return with a non-resident alien spouse unless the spouse elects under §6013(g) to be treated as a US person for all income tax purposes. §6013(a)(1). A nonresident alien spouse who has previously elected under §6013(g) but who has rescinded or revoked the election cannot again make the election.

      3. Spouses can’t file jointly if they have different tax yrs. §613(g)(6).

      4. Change in marital status;

        1. Un-important

    4. Synopsis of G trust rules;

      1. §673 states the G is the owner of any portion of a trust in which he holds a reversionary int that on the date of the transfer of the trust has a value in excess of 5% of the trust fund. Called the Clifford rule-made the reversionary int impt.

      2. §676 states the G is the owner of any portion of a trust over which he holds power to revoke the trust. This is the oldest of the G trust rules.

      3. §674 states that the G is the owner of a trust if he hold the pwr to control beneficial enjoyment even if that pwr can’t be exercised for the G’s personal benefit; subject to exceptions.

      4. §675 states that the G is the owner of any portion of a trust if he holds certain admin pwrs.

      5. §677 states that the G is the owner of any portion of a trust; the income of which is or may be used to pay premiums on life insurance policies of the G or G’s spouse.

      6. §679 taxes a US G as the owner of a foreign trust that the G had someone create or has a US bene.

      7. §678 taxes all person other than the G as the owner of any portion of a trust which such 3rd person (usually as bene) holds a substantially unrestricted pwr to invade trust assets.

 

  1. Effect of Reversionary Interest in Income and Corpus (CHP 8)

    1. Reversionary interest or a spousal remainder §673:

      1. Under §673 a grantor of a trust is treated as its owner if the grantor retains significant reversionary interest or the grantor’s spouse has a significant remainder interest in the trust’s income or principle.

      2. A reversionary interest is significant if it’s value on the date created exceeds 5% (See tables in Reb 2031-7(d) (also the same % as in other s of the code §2041) of the trust fund’s total value (corpus and interest) §673(a).

      3. Even if no significant in value; §673 doesn’t insulate the grantor from the operation of the other grantor trust rules.

    2. Violating §673:

      1. It grantor owns a significant interest then he owns ALL of the trust

      2. If the reversionary interest or remainder interest relates to only a portion then the owner may be taxed on the portion of the trust.

        1. Ex. G creates a trust and gives ttee discretion to pay income for B (not his wife) for 40 yrs, but not currently used for B during the 1st 10 yrs. During 1st 10 yr the $ must be held in a separate account and be distributed to G at the end of the trust term. At the end of the 40 yr term, G gets the principle. G is deemed the owner of the trust income interest during the 1st 10 yrs b/c he has a reversion interest that becomes possessory after ten yrs, and a reversion that becomes possessory after ten yrs has an actuarial value (based on tables) in excess of 5% of the trust property to which it relates. G doesn’t own the rest of the trust b/c his reversionary interest in the other assets vests in possession only after 40 yrs, and a reversionary interest after 40 yrs has a value of less than 5% of the trust fund (based on actuarial tables)

      3. A reversionary trust still is considered a grantor trust under §679 if it has foreign situs, a US settlor, and US bene, or under §674 thru 677 if the grantor or other person possesses any of the powers and interest in the trust described in those rules.

    3. Reversionary interest that cause grantor status;

      1. Valuing reversionary interest;

        1. Under §2037, a decedents gross estate includes the value of certain lifetime transfers as to which the decedent retained a reversionary interest that, on the date of death was worth more than 5% of the total value of the transferred assets.

        2. Standard actuarial principles in the Reg’s under §2031 and §7520 are used to value a reversionary interest under §67.3. Each month the IRS publishes a revenue ruling that sets the discount/interest rate to be used under §7520 in valuing life estates, annuities, and remainders that need to be valued in that month (P.8-4)

        3. The value of the reversionary interest or remainder interests following a term of yrs or a life estate vary inversely with the assumed discount rate: It increases as the discount rate decreases and decreases as the discount rate increases. Thus monthly variations in the interest rate assumptions affect the length of the term that must lapse before a reversionary interest becomes possessory, if the drafter’s goal is to avoid creating a grantor trust.

      2. Actuarial v Actual life expectancies: (ic)

        1. Health conditions are only taken into account only if decedent was known to have an incurable illness or other physical condition, b/c of which there is at least a 50% probability (ic) that he will die within 1 yr. Need clear and convincing evidence. §1.752-3(b)(3).

        2. An individual who actually lives for 18months or longer after the trust is funded shall be presumed to have not been terminally ill at the time of the transaction unless contrary evidence is established by CCE.

          1. Thus, if the individual lives for more than 18 months, the reversionary interest’s value is ordinarily determined by use of the IRS-prescribed life expectancies, rather than any other personal health circumstances. P8-6.

      3. Conditional reversionary interest:

        1. Its difficult to value a reversionary interest that vests upon an uncertain event. §673 doesn’t explain how to determine whether a conditional interest is worth less than 5%.

        2. §673 appears to be patterned after §2037, which deals with estate tax treatment of certain reversionary interests.

        3. §2037 states that a reversionary interest has some value unless it is apparent from the facts that property would have reverted to the decedent only upon conditions or contingencies that are remote (ic)If remote then cant be valued actuarily.

          1. Marriage and remarriage contingencies are actuarially valued.

            1. Whether an individual aged under age 40 will have or adopt kids is not actuarially determinable.

 

            1. An interest that becomes possessory solely in the discretion of another person cannot be valued actuarially.

        1. A tp has the burden of proving that the value of the reversionary interest is not more than 5% of the total trust value. A finding that the reversionary interest has some interest has some value is sufficient to impose a significant probative burden on tp. §20.2037-1(c)(3).

        2. (ic) An interest that becomes possessory solely in the discretion of another person cannot be valued actuarially. §673(3) states that the value of the grantor’s reversionary interest shall be determined by assuming the maximum exercise of discretion in favor of the grantor (ic).

      1. Reversionary interest that does not count toward the 5%: (p. 8-8);

        1. The value of a reversionary interest that becomes possessory only if a bene dies intestate is ignored for purposes of §673.

        2. Thus the mere fact that the grantor might be one of the bene’s heir does not give him a reversionary interest.

          1. If the instrument confers a pwr of appointment on a bene (p.8-8)

          2. A grantor’s reversionary interest would probably be taken into acct under §673 if the instrument confers a power of appointment on a bene and the grantor is a take in default of appointment.

        3. If pwr or interest becomes possessory only following the death of one of the lineal descendants of the grantor before the decedent reaches 21 and the descendant is also the only current bene of the portion of the trust in which the reversion exists. §673. (FINISH sentence)

          1. §2503© a traditional children’s trust should not be a grantor trust under §673 merely b/c the grantor or the grantor’s spouse will rec the trust funds if the income bene dies b4 reaching 21. §673(b).

        4. Hidden reversionary interest: (P8-9)

          1. McGinnis v Comm (1993) demand note case – he could affect beneficial interest. (ic)

    1. Remainder interest held by grantor’s spouse;

      1. §672(e) eliminated the spousal remainder trust as a means of shifting income from the grantor to a bene. This § imputes to the grantor any pwr or interest held by the grantor’s spouse if the spouse is living with the grantor at the time of the creation of the power or interest. Thus, a spousal remainder interest is treated the same as a grantor’s reversionary interest.

    2. Ownership elements of a reversionary trust; (p. 8-11)

      1. Capital gains;

        1. Grantor of a reversionary trust is taxed on capital gains recognized by the ttee since such items are normally allocated to principle of the trust.

        2. A provision in the trust that specifically allocates all capital gains to the income bene should be respected for income tax purposes so that gains are taxed and distributed currently to the income bene. §1.643(b)-1.

          1. Problems with this: (1st) allocating gains to income makes the reversionary interest unascertainable. Therefore the gift on creation of the trust would be the full value of the property transferred to the trust rather than the income interest alone. Rev Rul 77-99 1977-1BC 295.

          2. (2nd) The 10k annual exclusion should not be available for gifts made to a reversionary trust containing such a provision, since the amount of income interest is not longer clearly ascertainable. Rev Rul. §77-358 1977-2 CB 342.

        3. If the grantor or a non-adverse party is the ttee of a reversionary trust and has the authority to sell appreciated assets, the grantor s/be deemed to own the principle portion of the trust form its inception, b/c the grantor or a non-adverse party has the authority to recognize the inherent gains and then revoke that portion of the trust.

      2. Installment obligations: (P 8-14)

        1. §453 permits cash basis tp to report gains recognized on a sale or exchange of property on the installment method.

        2. The disposition of an installment obligation by gift or transfer causes the seller to recognize most or all of the gain previously unreported immediately, even if the grantor doesn’t rec and consideration for the disposition of the installment obligation. §453B(a) Rev Rul 76-630 1976-2 CB 132.

        3. A gift of an installment obligation to a reversionary interest trust is not a disposition b/c the grantor remains the owner of the principle of the trust under §677(a) and thus doesn’t surrender the principle portion of the obligation. Rev Rul 67-70 1967-1 CB 106.

          1. IRS applies the anticipatory assignment of income doctrine and ruled that the tp remained taxable on the interest income.

    3. Gift & Estate Tax Considerations: (p 8-16)

      1. Completed taxable gifts;

        1. A gift to a reversionary trust is normally a completed gift of a term for yrs to the income bene. Reg §25.2511-1(d). The retention of a reversionary interest does not itself render a gift to a trust incomplete, b/c the grantor still parts with dominion and control over thee beneficiary’s term-for-yrs interest. Therefore a gift to a reversionary trust is normally a completed transfer for gift tax purposes. §25.2511-2(d

          1. Ex. its not a gift if the grantor is the ttee and can w/h interest pmts and keep it for corpus which reverts back to grantor after the term for yrs. ).

      2. Value of bene’s interest.

        1. Value of bene’s interest in a reversionary trust is based on actuarial tables contained in §25.2512-5(f) and adjusted by the interest rate(which changes monthly) §7520.

          1. §2702 doesn’t consider the vale of the retained interest if the transfor is for the benefit of a member of the transferor’s family and the retained interest is not a qualified interest. A reversionary interest following an income interest is not a qualified interest, although a reversionary interest following certain annuity or uni-trust interest is. §2702(a)(1).

          2. For purposes of §2702, a member of transferor’s family includes the transferor’s spouse, any ancestor or lineal descendant of the transferor’s spouse, the brother or sister of the transferor (but not of the transferor’s spouse), and the spouse of any ancestor, descendant, brother or sister.

      3. Eligibility for annual exclusion; (P8-18)

        1. A gift to a reversionary trust qualifies for the gift tax annual exclusion if the trust’s terms give the beneficiary a present interest. A bene’s rt to current distribution of all of the trust’s income is a present interest qualifying for the annual exclusion, even though the bene will not rec’ most of the income until it is earned at some future date.

          1. Ex. Give 100k to trust 1 to invest & give income to bene; then give 100k of land to trust 2 and restrict trust from selling land. Trust 1 qualifies for the annual exclusion and trust 2 doesn’t because trust 2 has no immediate benefit b/c its an income interest in non-productive property; and doesn’t qualify for 11k annual exclusion.. But both trusts are grantor trusts.

          2. Ex. If ttee has discretion to invest in productive or non-productive assets then this deprives the bene of a present interest and thus deprives the grantor of an annual exclusion. (P. 8-21)

          3. If some or all accumulated trust income must be distributed to a bene that reached age 21, the portion that is distributed qualifies for the annual exclusion even if the ttee is not required to distribute income currently. The income that must be paid out when the bene reaches 21 meets the requirement of a donor’s trust under §2503©, even though the principle portion of the trust does not so qualify. Rev Rul 68-670, 1968-2 CB 413.

            1. Ex. Trust accumulates income for a 10 yr old girl. The income is subject to IRS discount rates, and the grantor gift is X but the discount rate.

      4. Crummey powers: (p. 8-20) qualify for the annual exclusion if bene rec’s the crummy pwr – a pwr to require the ttee to pay out currently any gifts made to the trust for a short time after any transfer occurs. Bene must be given adequate notice of the transfer and the demand pwr, and adequate time within which to exercise demand pwr.

    4. Estate tax considerations: (p. 8-21)

      1. The value of the grantor’s reversionary interest is includable in his gross estate under §2033, as an interest in property held on the grantor’s death.

      2. Deathbed gifts of a reversionary interest are still included in the estate. The value of a trust is included in the grantor’s estate if w/in 3 yrs b4 his death, he gives away a reversionary interest the retention of which would have triggered application of §2037.

      3. §2036, retained life estate and §2038 retained rt to amend, revoke, or terminate may also apply to a reversionary interest, but §2033 and §2037 usually reduce the importance of §2036 & §2038.

 

  1. Power to revoke or control trust; Chp 9

    1. Power to revoke the trust;

      1. General; GT

        1. PTR represents absolute and complete control over the trust property.

        2. §676(a) taxes the grantor of a trust as the owner of the trust if the grantor or a non-adverse party has power to “revest in grantor title to” the trust assets without consent of the adverse party.

        3. Revest; revoke; terminate; alter; amend; or appoint are all the same. . §1.676(a)-1.

        4. Rt to revoke a pre-need funeral trust was taxable under §676 even if the funds would not be paid to the grantor but rather used to benefit the grantor’s estate. Therefore include in the estate the $$ deposited in the funeral trust.

      2. Family estate trusts & other shams; GT

        1. Grantor creates an irrev trust and assigns all of his or her personal and business assets and the rt to all of the grantor’s future services. The grantor then becomes an ee of the trust and trys to avoid future income, gift and estate tax liab. Cases hold that grantor retained control whether expressed or implied by the actual operations of the trust.

      3. Pwr to revoke held by non-adverse party;

        1. The grantor of a trust will be taxed as its owner if a non-adverse party holds a pwr to revest the trust funds in the grantor even though the grantor cant personally exercise or join in the exercise of the pwr.

      4. Establishing a pwr to revoke;

        1. Indicating revocability in the trust doc;

        2. Creating a revocable trust by reformation;

          1. Done too reflect the grantor’s intent

          2. Show that the trust was created by fraud, duress, undue influence or mistake; error or misunderstanding of the import of the terms maybe accepted.

 

        1. Power to modify v the pwr to revoke; GT

          1. Power to modify empowers the grantor to revoke the trust.

          2. Totten trusts;

            1. When a bank acct trust is created by grantor with the grantor as the ttee it is revocable under §676.

        2. Post-posed powers to revoke; GT

          1. A pwr to revoke will not create a grantor trust if it cannot be exercised by the grantor, a non-adverse party, or both within a period such that if the pwr had been a reversionary interest, the interest would have had a value of more than 5% of the trust fund. §1.676(b)-1.

            1. Ex; G creates a trust to pay income to B for B’s life with remainder to B’s heirs. The trust instrument states that after 15yrs, G’s brother (non-adverse party) will be able to revoke the trust and revest the assets in G. The trust is a grantor trust from its inception, b/c if the pwr to revoke had been a reversionary interest, it w/h have a value of more than 5%.

        3. Required consent of an adverse party to revoke;

          1. Such a pwr doesn’t create a grantor trust. §1.676(a)-1.

        4. Effect of actual distributions to bene;

          1. Grantor is still the owner regardless of actual distributions are if there is a charitable bene.

    1. The funded revocable trust after the grantor’s death;

      1. Income tax comparison of estates and revocable trusts;

        1. Estate may use a fiscal yr; but a revocable trust must use a calendar yr §642(b).

        2. Estate has a personal exemption of $600 and a trust has either a $100 or $300

        3. Estate is exempt of the requirement of qtrly-estimated taxes during the 1st 2 yrs after the decedents death.

        4. Estate rec’s an income tax deduction for amts paid or set aside for charities. A trust rec’s a deduction for amts properly paid to charities but it rec’s no deduction for amounts set aside for charitable purposes. §642©. Trust must actually pay out the $

        5. An estate can make “trapping” distributions (distribution of corpus to a simple trust) to a trust, but a funded revocable trust cant make trapping distributions to another trust or subsidiary trust.

        6. An estate’s PR may elect to file a joint income tax return with the surviving spouse. §6013(a)(3). A revocable trust has no PR.

        7. An estate can hold S-corp stk indefinitely, but a funded revocable trust is an eligible stkhr for only 2 yrs after the decedents death.

        8. An estates PR and a revocable trusts ttee are liable for estate taxes on property under their respective control. §6324(a)(2), but only the PR/executor can legally request for discharge of personal liability for any deficiency. §2204. The ttee of a revocable trust cant take advantage of the discharge procedure. RR 57-424

      2. The undivided administrative trust; (P. 9-13)

        1. A revocable trust becomes irrevocable at the grantors death and becomes a separate taxpayer. RR 57-51.

    2. Pwr to control trust; GT

      1. Can have an open class of children but cant have new bene’s – if pwr to add bene then it’s a grantor trust.(ic)

        1. §674(b)(4) can state educational purpose – Ct said even though its discretionary its ok(ic)

        2. Bene cant have rt to distribute $ to another – not a grantor trust b/c child is an adverse party(ic)

        3. §674 states that a grantor owns any portion of a trust over which the grantor or non-adverse party holds any pwr to control beneficial enjoyment of the trust, exercisable w/o an adverse party’s consent, but then lists exceptions.

        4. Definition of “Pwr to control beneficial enjoyment”.

          1. §1.674(a)-1(a) states that any power that can affect the beneficial enjoyment of a trust or portion of a trust is a power to dispose of the beneficial enjoyment even if it is held in a fiduciary capacity. Ex. Pwr to allocate income or principle among multiple trust bene’s is clearly a pwr to affect beneficial enjoyment. Also, a pwr to add or delete bene affects beneficial enjoyment. Also, the rt to use trust funds w/o adequate compensation (rent free; to recall a demand note) affects beneficial enjoyment.

        5. Pwr affecting beneficial enjoyment postponed;

          1. A pwr to control beneficial enjoyment does not create a grantor trust if it cant be exercised by the grantor or non-adverse party or both w/in a period that had the pwr been a reversionary interest, w/have given it a value of more than 5% of the trust fund. §674(b)(2).

            1. If G creates a trust giving him pwr to be ttee in 40 yrs then not a grantor trust until G actually becomes ttee b/c 40 yr reversionary interest does not create a grantor trust under §673. A 20 yr postponed reversionary interest creates a grantor trust under §673. P9-18.

          2. Grantor can have the pwr to be co-trustee for a period of yrs and then exercise his rts to be sole ttee. If grantor relinquishes his rt to be sole ttee then at that point it is no longer a grantor trust.

        6. Pwr affecting beneficial enjoyment exercisable only by will;

          1. The grantor owns no portion of a trust b/c of any pwr exercisable only by will, except a power that (1) enables the grantor to appoint the accumulated income by will and (2) is accompanied by a mandatory or discretionary accumulation of trust income by the grantor or a nonadverse party or both.

            1. G creates a trust giving an independent ttee the pwr to accumulate income or pay it currently to the bene. G retains an unlimited general pwr to appoint the accumulated income. The ttee is a non-adverse party so G is taxed as the owner of trust income.

            2. If same facts but ttee has pwr to accumulate 5k of trust income annually then G is not a grantor with regard o the 5k b/c he has no pwr over that portion.

            3. G creates a trust to pay ½ of its income to Betty for life and the other ½ may be accumulated and disposed of by Bob. G is not deemed to own any portion of the trust b/c of B’s testamentary pwr to appoint half of the trust income.

            4. G also owns items allocated to principle if G holds a testamentary pwr to appoint the remainder interest in trust. Thus the G who owns the trust remainder owns any capital gains and losses allocated to trust principle. §1.674(a)-1(b)(3).

      2. Pwr G or anyone else may hold.

        1. Pwr to apply income to support a dependant.

          1. A G does not own any portion of a trust merely b/c the grantor or a non-adverse party holds a pwr to apply trust income to support of an indiv the grantor is legally obligated to support. §677(b) states that the grantor does own any trust income that is actually used to discharge the G’s legal support obligation.

        2. Pwr to allocate income and principle among charitable bene’s.

          1. a

        3. Pwr to distribute principle charged against bene; NGT

          1. A G owns no part of a trust merely b/c the G or a non-adverse party or both retains a pwr to distribute trust principle for a bene or a class of bene’s if the pwr is limited by a reasonable definite std in the trust. §674(b)(5)A).

            1. Ex if G retains rt to distribute corpus to benes (income bene’s) for medical-G is not the grantor.

            2. ***However, if G has pwr to distribute principle to persons that are not the income or remainder bene’s then G is not protected by §674(b)(5).

            3. So if G has pwr to add bene’s then G is grantor regardless if bene is income or principle bene. This doesn’t apply to generic descriptions in the trust “all my children”. P9-27;28.

        4. Pwr to w/hold income temporarily; NGT

          1. §674(b)(6) states that a G is not taxed as the owner of any portion of a trust merely b/c the G may temporarily w/hold income from a bene if the accumulated income is ultimately payable in any 3 ways:

            1. to bene, bene’s estate or bene’s appointee’s

            2. to bene on occurrence of an event that could have reasonably been expected to occur. §674(b)(6).

            3. to current income been in fixed shrs

          2. Ex. P9-31; if G creates a trust naming himself as ttee and trust specifies that G may pay income to B or accumulate it. The trust will terminate upon the first occurrence of G or B’s death. If B survives G then B gets all the accumulated income. If G survives B the $ goes to N. Despite the fact that G can shift income from B to N by accumulating income, this is unlikely to occur b/c G is substantially older than B and as a result the trust is not a grantor trust.

            1. Actuarial tables s/be used to determine whether the event’s probability is reasonably likely to occur within the bene’s lifetime. §7520 tables. G has burden to prove that the date on which the event will occur is reasonably determinable. If not actuarially determinable then it’s a G trust.

        5. Pwr to w/h income during minority or disability; NGT

          1. §674(b)(7). States that a G doesn’t own any portion of a trust merely b/c the G holds a pwr to distribute income or to accumulate income and add it to principle during the legal disability or the period of time before bene reaches age 21.

        6. Pwr to allocate btwn corpus and income;

          1. §674(b)(8); (P9-34)

      3. Pwrs non-adverse ttee may hold;

        1. NA ttee may also hold some very significant pwrs to affect beneficial enjoyment without triggering the G trust rules.

          1. A sole ttee is independent if he is neither related nor subordinate to G. Multiple ttee’s are viewed as a unitary body. If G creates a trust and bank and brother are co-ttee’s then trust is not a grantor trust. If bank resigns then it’s a grantor trust. Until another independent ttee is named.

      4. Pwr to replace ttee; GT

        1. If G has pwr to remove, substitute or add ttee then G has pwr over beneficial enjoyment and thus the trust is a grantor trust.

          1. If G retains the rt to change ttee of an irrev trust but the allows the ttee to apportion trust principle for the bene maintenance and support then not a grantor trust b/c the rt to apportion trust principle under a reasonably definite std is not a grantor trust powr when held by the grantor.

          2. Also, G’s pwr to remove tte or add ttee will not create a grantor trust f the conditioned event or fact did not occur during the taxable yr.

    3. Gift and Estate Tax consideration;

      1. Donor’s retained unrestricted pwr to revoke a transfer to a trust make the transfer incomplete for gift tax purposes. And the pwr to revoke makes those trust funds includable in G’s estate for estate tax purposes.

      2. Pwrs exercisable by G with consent of NA party;

        1. This is treated as if it were held by the G alone for income/gift/estate tax purposes.

 

      1. Postponed pwr to revoke;

        1. a pwr to revoke that is not exercisable until the expiration of a specified period or the occurrence of a specified event makes a transfer incomplete for estate tax purposes and either partially incomplete for gift tax purposes.

      2. Pwr to control beneficial enjoyment;

        1. A gift is incomplete for gift tax purposes unless the donor has completely parted with dominion and control over the property leaving him no pwr to change its disposition and control over the property.

        2. Estate tax consequences; §2036 includes in a decedent’s gross estate the value of the property over which the decedent held a pwr exercisable to designate the persons who would enjoy or possess property for the decedent’s life.

        3. §2038 causes the decedent’s gross estate to include the value of property transferred during decedent’s life time in which the decedent retained the power to alter amend revoke or terminate the transfer.

 

 

  1. Retained Interest in Trust Income; Chp 10

    1. Portion issues under §677;

      1. Ownership of principle interest;

        1. §677 makes the G the owner of the principle of the trust if the G or the G’s spouse has a remainder or reversionary interest.

        2. CG/CL will be allocated to the grantor.

        3. If trust directs that accumulated income be allocated to principle then the G owns that also.

    2. Current distributions to G or G’s spouse; GT

      1. G control not required;

        1. A G that can demand that pmts be made to himself for his spouse will be taxed as the owner of the trust income.

      2. Discretionary pmts;

        1. If amts “may be” paid to G then G is the owner of that amt. §677(a)

      3. Conditional rt to income;

        1. G is taxed as the owner.

      4. Discharge of G’s nonsupport obligations;

        1. The use of trust income to discharge the legal obligation of the G or G’s spouse or both w/o the consent of the adverse party is equivalent to the pmt of that income to the G.

        2. Rabbi trusts; P10-12 §677(a)

          1. Rabbi trust is a form of nonqualified deferred compensation arrangement using an irrev trust to provide the ee’s a measure of protection from the er’s change in attitude toward the benefits program. The trust hold funds for future payment to the participating ee’s on such terms as the grantor/corp may have established. If the G becomes insolvent, the assets of the trust are subject to the claims of the G’s creditors.

        3. Secular trust; §677(a)

          1. The participants rather than the er created an irrev trust by which the deferred compensation benefit would be funded. Not subject to claims of er’s creditors.

        4. Gifts of enumerated property;

          1. If ttee is obligated to pay debts of G then G trust. P10-15.

          2. Net gift: If the trust is obligated to pay the gift tax; this is an obligation of the G then the gift tax portion is income to G.

        5. Defective private annuity sales;

          1. P10-17 FINISH

    3. Accumulation for future distribution to G or G’s spouse;

      1. Under §677(a) the G owns any trust income that is or may be accumulated for future distribution to the G, or G’s spouse or both, w/o an adverse party’s consent even though neither the G nor the G’s spouse rec any current benefits from and has no access to the accumulated income. The G is taxed on the income in the yr in which it is accumulated, even though it is not distributable until a later yr.

        1. The G is not taxed as the trust owner if the pwr to accumulate income is held by a ttee who is an adverse party.

          1. G creates a trust and names bank as ttee. Ttee holds pwr to accumulate al of trust income for up to 15 yrs and then pay the accumulated income to G. If ttee is required to obtain the consent of an adverse party to accumulate income for future distribution to G; G would not be taxed on the accumulated income.

      2. Postponed powers to accumulate income;

        1. A G is not taxed as the owner of any trust income that can be accumulated under a pwr that may be exercised only after expiration of a period long enough that were the pwr a reversionary interest it would not have created a grantor trust under §673.

      3. Capital gains and other principle items;

        1. CG /CL; depreciation and depletion deductions are often allocated to trust principle rather than to current income bene’s. G of a reversionary (or spousal remainder) trust owns the principle; CG/CL. If G’s reversionary interest is less than 5% then G does not own the entire trust under §673

    4. Pmt of life insurance premiums;

      1. Under §677(a)(3) the G is deemed to own any trust income that is or may be used to pay premiums on insurance policies on the life of the grantor or G’s spouse or both w/o the consent of an adverse party.

      2. Definition of life insurance; P10-25; §7702 sets out 3 tests that must be met in order for a K to be treated for federal tax purposes as a life insurance K:

        1. The cash value accumulation test

        2. The guideline premium requirement

        3. And the cash value corridor test

      3. These tests were designed to prevent certain contracts with large mkt-rate investment features from qualifying for the tax benefits accorded to life insurance policies under the code. The test require actuarial calculations;

      4. Unauthorized payments;

      5. Special portion problems; difficult to determine which portion of the trust is owned by the G.

    5. Trusts benefiting G’s spouse;

      1. G owns any trust income that is or may be paid for his spouse regardless if they live together.

      2. Estate of Petschek; was a simple trust & G expatriated so he was still the owner

      3. Furstenberg case; was a complex trust: and expatriated & b/c no obligation to distribute trust income currently the bene was taxable on trust income actually distributed before renunciation of citizenship. P10-30

    6. Trusts for support; GT

      1. G creates an irrev trust for benefit of minor children and names bank as ttee. If trust pays for room and board for children at camp (or educational exp), which is G’s responsibility; G is taxed on that amt spent for children, which relinquished his pmt obligation. P10-31. Considered a constructive distribution. Even if the pmt is for a nonsupport obligation.

      2. Use of principle or accumulated income to discharge the support obligation;

        1. §677(b) makes the G the owner of pmts discharging the support obligation of the G but only if made from current trust income.

      3. Determination of legal obligation of support;

        1. Family members must be supported till the age of majority. P10-34

        2. Types of pmts that constitute support;

          1. Food; shelter; clothing; medical; dental; education; and the like. §1.151-1(a)(2)

          2. Issue is whether luxury items are support. Cts consider the parents financial and social status in deciding whether items are part of support.

    7. Estate; Gift and GST treatment of reserved income interest;

      1. Estate tax; P10-38.

        1. §2036(a) a deceased G’s gross estate includes the value of property given away at any time during the G’s life if the G retains an income interest pr pwr to affect the trusts beneficial enjoyment for life or for a period that does not end b4 the G’s death.(even one month prior to death §20.2036-1(b)(1)(i))

        2. Discharge of G’s legal obligations;

          1. §2035(d)(2).

          2. G’s estate doesn’t include the value of such property if the ttee is merely authorized but not required to expend trust funds in a manner that discharges the G’s personal nonsupport obligation. §20.2036-1(b)(2),

        3. Discretionary pmts of income to G;

          1. A pwr in the ttee to make discretionary distributions of trust income to the G w/o the consent of an adverse party makes the trust a grantor trust. §677(a)(1)

          2. The ttee’s ability to make pmts to the G is not a retained life estate or power to affect beneficial enjoyment of the trust funds b/c it is not held by the G or exercisable at the G’s discretion.

    8. Gift tax treatment;

      1. A transfer of property to a trust is a taxable gift even if the G retains a rt to mandatory or discretionary pmts of trust income; or use of income for the benefit of the G’s spouse.

      2. A transfer is not a gift if the donor retains any interest or pwr permitting the donor to change the disposition of the gift whether for the benefit of the donor or someone else. §25.2511-2

      3. Value of the taxable gift;

        1. The subtraction method

        2. §2702 Under this § the retained interest is ignored in valuing a taxable gift. If §2702 applies the entire value of the gift will be retained by G w/o any reduction for the value of the retained interest.

          1. §2702 applies only if there is a transfer in trust to or for the benefit of a member of the transferor’s family. 2125.2702-2(a)(2).

      4. Gift tax annual exclusion;

        1. The annual gift tax exclusion is not available for gifts of future interest. Ex if A is to rec’ a remainder interest in a trust the remainder interest is a future int and no gift tax annual exclusion is permitted.

    9. GST;

      1. Annual exclusion; 1,030,000. A G’s 1m GST exemption cant be applied to a trust in which the G retained an income interest and that were the G to die at some later date, w/ cause the trust to be included in the G’s gross estate for federal estate tax purposes.

 

 

  1. Effect of Administrative powers; Chp 11

    1. Effect of §675;

      1. Generally;

        1. §675 states that if G or G’spouse holds certain admin pwrs described in §675 and these pwrs are exercisable w/o the consent of an adverse party then G is taxed as the owner of any portion of a trust if:

          1. G can deal with the trust for less than adequate and full consideration

          2. G can borrow from the trust w/o adequate interest or security

          3. G actually borrows funds from the trust OR

          4. G hold pwr to vote or control the trusts investment in certain closely held stk.

      2. Sources of admin pwr;

    2. Pwr to deal w/ the trust for inadequate consideration;

      1. This pwr minimizes or eliminates the rts of the benes and benefits the G’s interest.

      2. This pwr is not implied from the mere fact that the trust instrument grants ttee broad authority to buy sell and deal with trust assets. If the ttee actually exercises its authority to allow the G to deal with the trust funds on favorable terms to the G and are inconsistent with the rts of the bene’s then it’s a grantor trust.

        1. Ex;

          1. Give assets to a trust then lease them back at a bargain rate.

          2. Buy stk from the trust at a bargain rate.

 

    1. Rt to borrow from the trust;

      1. §675(2) says that the G owns any portion of the trust that the G can borrow w/o both adequate interest and adequate security.

      2. A trust is not deemed to be a grantor trust merely b/c a ttee can lend trust funds to any person w/o adequate interest and security; thus broad pwrs would not create a grantor trust under this §. §1.675-1(b)(2). Ttee’s actual lending of trust funds create a grantor trust.

      3. Requirement of both adequate interest and security; P11-7

        1. “Or” relationship not “and”.

        2. Indirect borrowing;

          1. G’s power to borrow funds directly or indirectly creates a grantor trust.

          2. If the trust purchases a portion or G’s mortgage this constitutes an indirect loan.

          3. Ttee nor the G need to have knowledge that the loan is being made to G.

          4. Can happen by trust borrowing $ to a PS in which G is a ptr.

        3. Trust loans to S-corp;

          1. A trusts loan to an S-corp that had other business activities and assets s/not create a grantor trust under §675(2) or §675(3).

      4. Portion that can be owned; P11-11.

        1. G owns any portion of a trust that can be lent to the G under any one or more of these pwrs.

    2. Actual borrowing from the trust;

      1. G is taxed on the portion of the trust that G actually borrowed whether directly or indirectly unless the loan was either:

        1. Made by an independent ttee and bears adequate interest and adequate security OR

        2. Repaid b4 the beginning of the taxable yr.

      2. Mkt loans made by an independent ttee;

        1. Repayment be the beginning of the taxable yr

          1. §675(3)

        2. Portion of a trust deemed owned;

          1. G owns any portion of a trust that he has actually borrowed w/ adequate security and interest from an independent ttee.

          2. The word “portion” causes problems;

            1. “In respect of which” the entire trust.

    3. General pwr of administration held in a non-fiduciary capacity;

      1. General pwrs of admin include;

        1. Vote or direct voting of stk when the ownership of the trust and the G in such corp is significant with respect to control

        2. Control the trust investments or reinvestments in such closely held shs OR

        3. Reacquire the trust corpus by substituting other property of equal value.

      2. Holding Pwrs in a fiduciary capacity; p11-15

        1. §675(4) only applies if a general pwr of admin is held in a non-fiduciary capacity.

        2. Fiduciary capacity is defined by state law-look at gov instru and gov state.

        3. The identity of the person holding the general pwr of admin in a non-fiduciary capacity is irrelevant for §675(4) purposes. P11-16.

      3. Powers over closely held shrs:

        1. Holding must represent significant control; p11-18.

          1. Code and reg’s provide no guidance as to when the holdings of a grantor and a trust are significant with respect to control. To decide control look at things in the aggregate.

          2. If A,B,C are the only shareholder of ABC corp & all of them sign a shr agreement where A can vote all the shr & A gives his shrs of ABC to trust for his children then A’s non-fiduciary rt to vote the shr makes the trust a grantor trust to the extent of its ABC stk holdings.

        2. Pwr to control investments;

          1. An individual rt to veto the purchase of add’l shrs may make the trust a grantor trust.

    4. Estate & Gift and GST considerations;

      1. If retains to pwr to affect the trusts beneficial enjoyment then a trust fund may be included in G’s estate under §2036. Ex. Purchase, exchange or deal with property.

      2. G owns any part of a trust where he can both borrow without adequate interest and security. §675(2).

 

 

  1. Beneficiary controlled trusts Chp 12

    1. §678 If not the grantor then you are deemed to own all or a part of the trust if you hold one or more of the following specified pwrs §678 pwrs;

      1. Rt to w/d trust corpus or income

      2. A grantor type pwr §671-§677

      3. Actual use of trust income to discharge the holder’s legal support obligation.

    2. Unlike the grantor trust trust §678 can apply to both intervivos and testamentary trust;

    3. Trusts that are treated as owned by someone other than the G are known as bene-controlled trusts.

    4. Pwr to w/d principle or income;

      1. Bene is deemed to own any portion of a trust over which he has pwr to vets the corpus or income to himself-even if not exercised. §678pwr. W/d pwr.

      2. If pwr is subject to a condition precedent then the ben is not deemed the owner until the condition is satisfied.

      3. Bene must “solely” hold and exercise the pwr. §678(a)(1).

      4. Crummey pwr;

        1. temp w/d pwrs. Present int §2503.

 

 

  1. Procedure, Admin and Compliance Chp 16

    1. Notice of fiduciary relationship Form 46; for guardianship conservators, committees and persons holding broad pwr of attny.

    2. Est tax requirements:

      1. 3 alternative ways to compute

        1. 22.5% of the liab for the yr .

      2. Estates are not subject to the est tax req until 2 yrs aftr the date of decedents death.

      3. No est tax pmt if tax liab is less than $500.

 

 

  1. Special Trusts Chp 17

  1. Alimony trusts;

    1. §682 taxes the bene of an alimony trust on the trust income properly payable to her enough though the pmts discharge the grantor’s legal obligation.

    2. §682 applies to any former spouse whose marriage was terminated by a divorce decree and any spouse legally separated under separate maintenance.

    3. To invoke §682 the trust need not be mentioned in the divorce settlement.

    4. §2523(f) grants QTIP trusts gift tax marital deductions. §672(e) imputes to the G any pwr or int held by the G’s spouse. Such deemed G possession is fixed irrevocably when the pwr is created.

  2. Trusts for the support of children;

    1. §677(a) says the G owns any income that is paid to G’s minor children.

  3. Trusts eligible to own S-corp stk;

    1. QSST trusts may be shs.

    2. G and bene controlled S-corp trusts; p17-7

      1. §1361©(2)(A)(i) states that S corp stk can be owned by an indiv who is a citizen of US.

      2. Any trust owned entirely by the G is eligible to own S corp stk. Reg refer to this as “qualified Subpart E trusts” b/c subpart E refers to the G trust rules under §671-§679.

      3. Can own S-corp stk as long as that person owns all of the trust while the trust holds s-corp stk..

        1. So if G is G with regard to 25% of trust and G’s daughter owns the other 75% then the trust cant own s-corp stk.

    3. Bene controlled trust;

      1. §678(a) states that a bene owns a trust if he has the pwr to w/d income and principle.

      2. So if a bene can terminate a trust by exhausting trusts assets then the trust can own s-corp stk. §1361(a)(1)

      3. During the life of the G the G pays taxes on s-corp income; at death the trust and trust bene’s pay taxes on s-corp income. p17-12.

    4. Accumulated s-corp income;

      1. If the s-corp doesn’t distribute income then the trust may not have DNI to distribute. Then the trust would be taxed on the income.

    5. Testamentary trusts; p17-15

      1. A G trust which owns s-corp stk which turns into an irrev trust at death is eligible to own s-corp stk for 2 yrs aftr the decedent’s death.

    6. Voting trusts; p17-15.

      1. §1.362-1(h)(1)(v) states that an s-corp voting trust must meet 6 requirements;

        1. Be created pursuant to a written trust agreement entered into by the shrs

        2. Delegate to one or more ttees the rt to vote.

        3. Require all distributions with respect to the stk of the corp held by the trust be paid to the beneficial owners of the trust.

        4. Require title and possession of that stk to be delivered to those beneficial owners upon termination of the trust

        5. Terminate under its terms of gov instr or state law.

        6. Contain terms such that the beneficial owners of the shrs are treated as G and owners of their respective portions of the trust.

    7. Qualified Subchapter trust; p17-16

      1. This is a trust that is allowed to own s-corp stk provided that the benefits of its s-corp stk are almost entirely dedicated to one indiv bene and that this bene agrees to be treated as the deemed owner of the trust.

      2. A charitable remainder trust cannot be an eligible s-corp shs. §1361(e)(1)(b)(3).

      3. Must meet 5 requirements;

        1. The trust distributes or is required to distribute all of its income to one US citizen or resident. Cannot have multiple bene’s.

          1. Bene cant divert income to another person (prohibited).

        2. The trust distributes no principle other than to the income bene

        3. The interest of the trust’s income bene terminates at his death or when the instrument terminates; which ever comes first.

        4. The trust assets must be distributed to the income bene if the trust terminates when the income bene is alive.

        5. The trusts income bene elects to be treated as the owner of that portion of the trust consisting of s-corp stk as if the bene had a §678 pwr.

      4. Electing small business trust;

        1. ESBT is any trust other than QSST in which all of its benes are US indiv or estates eligible to be s-corp shr. Charitable org can hold a contingent remainder interest but a tax exempt trust cant be an ESBT. §1361(e)(1)(A).

        2. Ttee must make an ESBT election under §1361(e). there is no specific filing date. Can only be revoked with consent of the Sec of Treasury.

        3. It’s a separate trust for income tax purposes.

        4. Converting an QSST into an ESBT and vice versa;

          1. Rev Proc 98-23 id’s the procedure. Avail every 3 yrs.

  4. Nonexempt ee benefit trusts – Rabbi & Secular trusts; p14-42

    1. To enhance the security foe ee non-qualified deferred compensation.

    2. Rabbi trust;

      1. Irrev trust o/s the reach of er but w/in reach of er’s creditors.

      2. B/c the trusts income and principle can be used to satisfy the corp’s debts the corp is taxed as its owner. §677(a).

      3. Participating bene’s are not taxed as on trust income prior to distributions.

      4. Ee can lose his entire compensation if the business becomes insolvent.

    3. Secular trusts;

      1. 2 categories;

        1. ee-Grantor;

          1. Letter Ruling 87841021 & 8843023 authorized them.

          2. EE’s rather than the er create the trust.

          3. Neither the er nor its creditors could touch trust assets.

          4. ER makes contributions to the trust.

        2. ER created trust;

          1. §402(b)(1)

          2. Participants of eh trust are taxed on the contributions when they become vested.

  5. Grantor retained annuity and unitrusts; p17-49. GRATS; GRUTS;

    1. General;

      1. To create both the donor transfers assets to an irrev trust and retains an annuity int for a specified # of yrs.

      2. The retained interest is described either as a dollar (GRAT) amt or a % (GRUT) of the initial value of the trust assets.

 

      1. The amount of the annuity is set according to IRS actuarial tables issued by §7520.

      2. When the retained annuity term ends, the trust either terminates and pays all of the assets outright to the bene or holds the assets in continued trust for the bene on terms set out in the instrument.

      3. The advantage of a gift to either is that the transfer of assets to a grat or grut is a taxable gift of only the value of the remainder interest and the remainder interest may have relatively little gift tax value.

      4. Structure;

        1. Gift tax and estate tax advantages of a grat or grut are lost unless the retained int is a “qualified interest”. §2702(b). A qualified int is one that is in the form of a fixed annuity payable at least annually, a fixed % of the value of the trust assets payable at least annually (unitrust) or a non-contingent remainder following an annuity or unitrust int.

      5. Requirements common to grats and gruts; p17-51.

        1. Trust must operate either as a grat or grut exclusively from the first day of existence except for a trust, which provides for the greater of a prescribed annuity or a prescribed unitrust amt.

        2. Until its expiration, the trust must absolutely prohibit distributions from the trust fund to any person other than the annuitant. Therefore the trust cant permit distributions of income or principle to persons other than the annuitant, regardless of need or hardship.

        3. The gov instru must fix the retained annuity or unitrust interest. Int may be for the life of the annuitant or for a specified term of yrs.

        4. The trust instru must absolutely prohibit any communication of the interest of the annuitant. §25.2702-3(d)(1).

      6. Additional requirements for grats;

        1. The qualified annuity interest in a grat must be an irrev rt to rec a fixed amt payable annually or more often. The amt may be expressed as either a fixed dollar amt or a fixed % of the trust initial value.

        2. If the grat instu describes the annuity amt as a % of the initial value of the trust assets it must require that if the ttee incorrectly values the trust assets a compensating pmt will be made either to or by the annuitant on acct of the mis-valuation.

        3. The grat must include a provision requiring that the annuity amt be adj for short taxable yrs and for the trusts last taxable yr.

        4. A qualified grat must absolutely prohibit the ttee from accepting any additional contributions to the trust.

      7. Additional requirements for grust; p17-53

        1. The qualified unitrust interest in a grut must be an irrev rt to rec a fixed % of the annually determined value of the trust fund payable annually or more often.

        2. If the ttee incorrectly values the trust assets a compensating pmt will be made either to or by the annuitant on acct of the mis-valuation.

        3. The grat must include a provision requiring that the annuity amt be adj for short taxable yrs and for the trusts last taxable yr.

    1. GRAT Ex B gets 10k yr of r15yrs then remainder to H. B rec’s only the stated 10k yr even if the trust generates 11k yr of income. But B is taxed on the entire 10k as OI and the 1k as CG.

  1. Personal residence trust;

    1. §2702 state that the value of the G’s retained int in a trust is zero for gift tax purposes unless the retained int is a qualified int as in a GRAT or GRUT. §2702 does not apply to a transfer of an interest in trust all the property in which consists of a residence to be used as a personal residence by persons holding term interests in such trust.

      1. P17-56. Ex. A transfer home worth 500. A retains the rt to use the residence exclusively for 12 yrs after which it passes to her children. If A dies during the trust term the residence passes to her estate. The residence trust is assumed created when the assumed return on trust investments under §7520 is 7.6%.

    2. Structure;

      1. Personal residence trust;

        1. PRT

        2. Gov instru must expressly prohibit any assets other than one residence to be used as a personal residence.

        3. The trust must specifically prohibit the sale or transfer of the residence. Can’t sell the home.

        4. PRT can’t hold cash or other assets (furnishings) apart from the personal residence.

        5. Exp’s can be paid directly by the term holder.

        6. There is no way to prohibit the destruction of the residence by fire or casualty or condemnation.

          1. Therefore in addition to an interest in a G’s personal residence, a PRT can also hold qualified proceeds from the disposition of such a residence. §25.2702-5(b).

      2. Qualified residence trust;

        1. The reg permit the use of a QPRT, which unlike a PRT may hold certain incidental amts of personal property in addition to the real estate. QPRT can do several things that a PRT cant do but a QPRT requires several mandatory provisions:

          1. A QPRT may hold only one principle residence like a PRT but a QPRT may also permit household improvements made to the residence as long as the improved property continues to meet the definition of a personal residence.

          2. A QPRT’s gov instru must expressly include the following:

            1. Mandatory distribution of income

            2. A prohibition against distributions of income or principle to anyone other than the term holder except principle distributions on termination

            3. A prohibition against the trust holding cash in excess of certain limitations and that certain excess cash be distributed.

            4. A prohibition on commutation of the trust

            5. A prohibition against the trust sale or transfer of the residence directly or indirectly by the G, or G’s spouse.

            6. The required termination or conversion of the trust into a GRAT on the cessation of the trust property use as a personal residence.

      3. Grantor trust status; p17-59

        1. Both PRT and QPRT should be G trusts but unlike a GRAT or GRUT, a PRT and QPRT own only the income interest and not the principle portion of the trust.

        2. In a grat or grut if the G dies b4 the term of the trust then the trust assets will be included in the G’s estate under §2036(a). These are not probate assets and they are not available to pay additional estate taxes.

 

 

 

  1. Income Tax Problems of Estate Administration; CHP 18

    1. Notice of fiduciary relationship; P18-5

      1. §6903 states that fiduciaries s/notify the IRS of the commencement of their fiduciary position. IRS Form 56 (Notice Concerning Fiduciary Relationship).

    2. PR has a filing obligation for estate’s whose annual income is > = $600.

    3. §643(e)(3) permits the PR to elect annually to recognize the gain (not loss) on distribution of appreciate property.

    4. §267(b)(13) an estate may recognize LOSSES on distribution of depreciated property in satisfaction of a pecuniary legacy.

    5. IRD;

      1. A distribution of the rt to rec’ IRD is not deductible by an estate; whether the distribution is made as part of a specific bequest, a residuary bequest or in full or partial satisfaction of a pecuniary bequest.

    6. Termination of estates;

      1. An estate terminates when the PR makes a complete distribution of its assets and rec’ a receipt from the bene’s whether or not a formal court accounting has been filed.

      2. An estate can also be terminated by the IRS if it has been established that it has been “unduly prolonged-if it is continued after the expiration of a reasonable period for the performance by the PR of all the duties of administration.

    7. Income taxation of foreign estates;

      1. Income if outside the US; and not connected w/ a trade or business inside the US.

 

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