Chapter 3. The Building Blocks for Payments to Beneficiaries

• Author: Jerold I. Horn
• Pages: 52-195

3

The Building Blocks for Payments to Beneficiaries

PART ONE

PRIMARY BENEFICIARIES

Subpart 1

Mandatory Payments

Examples of mandatory accumulation and distribution are included for

purposes of orientation and comparison.

I. MANDATE TO ACCUMULATE INCOME

A. Form 3.1: Trustee Directed to Accumulate Income

(A) Income. The Trustee shall accumulate the net income.

B. Taxation of Ordinary Income

If no principal is distributed, none of the ordinary income of the trust is

deductible from the gross income of the trust for income tax purposes. Code

§§ 651, 652, 661, 662.

II. MANDATE TO PAY INCOME

The trustee is directed to pay all ordinary income currently to one person or

in fixed shares to more than one person.

A. Form 3.2: Trustee Directed to Pay Income to Single Distributee

(1) Income. The Trustee shall pay the net income to my wife

quarter-annually.

B. Form 3.3: Trustee Directed to Pay Income to Plural Distributees

(1) Income. The Trustee shall pay the net income quarter-annually to

my children, in equal shares.

C. Taxation of Ordinary Income

All of the ordinary income of the trust, to the extent of distributable net

income, is includable in the gross income for income tax purposes of (i) the

distributee or (ii) the distributees proportionately. Code §§ 651, 652.

D. Taxation of Corpus Income

Generally, subject to the Treasury regulations that became effective on

January 2, 2004, with the effect of changing some principal to income (and

some income to principal) according to Code Section 643(b), none of the

corpus income of the trust is deductible from the gross income of the trust

for income tax purposes. Code §§ 641, 643(a)(3), 651, 652, 661, 662.

III. MANDATE TO PAY PRINCIPAL

A. Form 3.4: Fixed Number of Dollars

Section 2.01. Pecuniary Gift. I give to John A. Smith of Peoria,

Illinois, the sum of $5,000, if he survives me.

a [Interest on this pecuniary legacy shall be payable from my death

ai [at the rate of [#A]].]

b [This pecuniary legacy shall carry with it such net income of my estate as

would be payable if this legacy were in trust.]

For purposes of satisfying the pecuniary amount, each item of property

distributed in kind shall be valued at its fair market value as of its date

of distribution.

c [Section 4.09. Pecuniary Legacies Deemed to Carry Appropriate

Interest. The purpose of this Section is to cause each pecuniary

legacy to be deemed to carry appropriate interest according to

Treasury regulations section 26.2642-2(b)(4)(ii). This Section shall

apply separately to each pecuniary legacy that is created upon the

death of the person who is the transferor of the legacy for

generation-skipping tax purposes. Either (i) the Trustee shall pay the

entire pecuniary legacy, or irrevocably set aside property to pay the

entire pecuniary legacy, within fifteen months after the death of the

transferor, or (ii) the pecuniary legacy shall carry with it a pro rata

share of the net income, between the date of the death of the

transferor and the date on which the legacy is paid, of the fund from

which the legacy is payable. For purposes of clause (i) of the

preceding sentence, property is irrevocably set aside if it is

segregated and held in a separate account pending distribution.

Except according to this instrument (including without limitation

this Section), no pecuniary legacy shall carry with it any interest or

income

ci [; provided, any pecuniary legacy outright to my wife or in a trust of

which the name is or includes Marital Trust shall carry with it the

greater of (i) the amount (if any) payable according to the portion of

this Section that precedes this provisory clause and (ii) the amount

(if any) payable absent this Section].]

1. Income Tax Results of Form 3.4

Satisfaction of a fixed-pecuniary gift, not required to be paid in more than

three installments, does not carry distributable net income from the payer to

the payee. Code § 663(a) (1); Treas. Reg. § 1.663(a)-1.

2. Drafting of Form 3.4

Specify whether, if the named legatee fails to survive the testator, the legacy

(i) passes to the surviving descendants, per stirpes, of the named legatee, (ii)

passes elsewhere, or (iii) lapses.

Consider including such language (if any) as is necessary to cause the

legacy to bear interest or income (or not to bear it) until the legacy is

satisfied. See variables a, b, and c in Form 3.4. Consider using variable c

if (i) the governing instrument includes any pecuniary gift and (ii) the

possibilities exist that (a) any generation-skipping transfer can occur and (b)

the trust estate can exceed in value any unallocated generation-skipping tax

(GST) exemption. The purpose of variable c is to cause pecuniary legacies

to be deemed to carry appropriate interest according to Treasury regulations

section 26.2642-2(b)(4)(ii). The form provides for payment of income, not

interest. Thus, the form avoids creation of taxable income if no deduction is

available for payment of interest.