Final regs. for separate-share rules issued.
Sec. 663(c) provides that, in determining distributable net income (DNI), when a single trust or estate has more than one beneficiary, substantially separate and independent shares of different beneficiaries of a trust (or estate) shall be treated as separate trusts. This rule ensures that beneficiaries whom the grantor or decedent intended to be treated equally are not taxed unequally, if income is accumulated for one beneficiary but not the others.
A trust's DNI is divided into separate shares allocable to each beneficiary. The amount of DNI carried out to any beneficiary (i.e., taxable to the beneficiary and deductible by the estate/trust) is limited to the DNI allocable to the beneficiary's separate share. If a trust distributes an amount in excess of a beneficiary's taxable portion of DNI, that beneficiary is not required to include more than his allocable portion of DNI in taxable income. The trust's distribution deduction is limited as well, so that it may be taxed on the portion of DNI allocable to the other beneficiaries that has not been distributed.
A tax adviser must first determine if separate shares exist. If an estate or trust has multiple beneficiaries, substantially separate and independent shares of different beneficiaries exist when the governing document and applicable local laws create separate economic interests in one beneficiary or class of beneficiaries, such that the economic interests of those beneficiaries are not affected by the economic interests accruing to another separate beneficiary or class of beneficiaries. The application of the separate-share rule is mandatory when separate shares exist.
The preamble to the final regulations clarifies that a separate share exists only if it includes both corpus and income attributable thereto and is independent from any other share. The Committee report for the Taxpayer Relief Act of 1997 further states "[f]or example, a separate share in an estate would exist where the decedent's will provides that all of the shares of a closely-held corporation are devised to one beneficiary and that any dividends paid to the estate by that corporation should be paid only to that beneficiary and any such dividends would not affect any other amounts which that beneficiary would receive under the will. As in the case of trusts, the application of the separate share rule is mandatory where separate shares exist." Regs. Sec. 1.663(c)-4 also states that a revocable trust for which a Sec. 645 election is made is always a separate share.
Second, a tax adviser must maintain a separate accounting for each share within a trust or estate. Regs. Sec. 1.663(c)-2 provides that a fiduciary must use a reasonable and equitable method to determine each share's value and the allocation of taxable income to each share; redeterminations in value of the separate shares must be taken into account. Thus, if an estate undergoes an audit by the Service in which the asset values are redetermined, separate shares and subsequent allocations of DNI would potentially need readjustment. This could result in amended fiduciary and individual income tax returns for all affected open years.
Third, a tax adviser needs to consider how the rules could affect current tax planning for the estate or trust under consideration. For example, a pecuniary marital bequest could be constructed to deliberately "fail" the separate-share rule, so that most or all of the income of the estate earned during the period of administration is taxable to the surviving spouse on funding of the pecuniary marital bequest. This has the effect of decreasing the surviving spouse's assets and increasing the residual portion.
Regs. Sec. 1.663(c)-4(b) provides a special exception to the separate-share rules generally applicable to pecuniary bequests. If a pecuniary bequest is not entitled to income or to share in appreciation or depreciation and the governing instrument does not provide that it is to be paid or credited in more than three installments, the pecuniary bequest is to be treated as a separate share. A tax adviser should consider having revocable trusts or wills provide that a pecuniary marital bequest is to be paid in more than three installments over a certain period of time, so that the estate's DNI will be allocable to the spouse on funding of the bequest.
FROM BARBARA COX, PASADENA, CA
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|Title Annotation:||IRS regulations|
|Publication:||The Tax Adviser|
|Date:||Apr 1, 2000|
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