Tax Tips
| Publication year | 1980 |
| Pages | 504 |
1980, March, Pg. 504. Tax Tips
For a number of reasons, including the desire to maintain family control over trust affairs and the desire to avoid corporate trustee fees, clients will frequently wish to appoint a beneficiary of the trust as its trustee and to grant to the beneficiary-trustee a number of discretionary distributive and administrative powers.
For purposes of this discussion, it is assumed that the client wishes to name his spouse as trustee of a testamentary non-marital trust, of which she is to be an income beneficiary. Some income, estate and gift tax problems which are often encountered when the surviving spouse-beneficiary serves as trustee are considered.
The income of the non-marital trust (including capital gains)(fn1) will be taxed to the beneficiary-trustee, even though not actually received, if, as sole trustee, she has a power to vest income and corpus in herself.(fn2) It is arguable that if the power over income is limited in some manner, such as by an ascertainable standard, it is not exerciseable solely by her within the meaning if I.R.C. § 678(a)(1).
There is some case authority to support that position. These cases hold that an objective standard, when enforceable against the trustee, will constitute a restriction on the power sufficient to prevent taxation of the income to the beneficiary-trustee.(fn3) In Funk v. Commissioner the beneficiary had a power, as trustee, to distribute income to herself in accordance with her needs, of which she was to be the sole judge, and to accumulate the remaining income. In United States, v. Smither, the beneficiary-trustee had the power to distribute income and corpus to herself for her support, maintenance, comfort and pleasure. In each instance, the court held the trustee-beneficiary not taxable on undistributed income because her power was not unrestricted.
Section 678(a)(1) does not, however, expressly except from its operation powers limited by reasonably definite standards as do other income tax sections of the Code(fn4) and as does I.R.C. § 2041(b)(1)(A) with respect to estate tax. It is, therefore, unclear that limiting the power by a reasonably definite or ascertainable standard will prevent the application of § 678(a)(1).
An alternative to the use of an ascertainable standard is the use of a chorister. If the power is held by the beneficiary-trustee jointly with a chorister, the trust income not actually distributed to her should not be taxed to her since the power is not exercisable solely by her.(fn5) Nor is the undistributed income taxable to her if the power is reserved solely to a managing co-trustee, apparently even though the co-trustee is amenable to the interests of the beneficiary-trustee.(fn6)
Thus, one drafting approach to the income tax problem would be to make the power exercisable jointly with a chorister. Alternatively, the power might be granted solely to a disinterested corporate co-trustee.
If the spouse has a power, as trustee, to vest income in others, and not in herself, she will not be taxed on trust income under § 678, except to the extent that it is applied to the maintenance and support of a person whom she is obligated to support.(fn7) If the spouse, as trustee or chorister, exercises a power to apply corpus for the maintenance and support of a person to whom she owes an obligation of support, the corpus so applied will be treated as an amount paid or credited under I.R.C. § 661(a)(2) and taxed to her under I.R.C. § 662, to the extent of her regal obligation under local law.(fn8)
Those tax results may not be unexpected since trust income which is paid pursuant to mandatory direction of the trust instrument and which, when so paid, discharges the beneficiary-trustee of her legal obligation of support under local law, would apparently still be taxed to her under I.R.C. § 662,(fn9) even if she did not serve as trustee.
As indicated above, the income tax problems of the beneficiary-trustee having an unlimited power to distribute income and corpus to herself should be eliminated by naming a co-trustee to exercise the power jointly. However, such a power will constitute a general power...
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