How the sec. 1411 tax applies to CRTs and beneficiaries.

• Author: Nuckolls, John
• Position: Charitable remainder trusts

This item discusses how the net investment income tax under + applies to charitable remainder trusts (CRTs) and their beneficiaries. The IRS published final regulations under Sec. 1411 in November 2013, which had been originally proposed in 2012. Simultaneously with the issuance of the final regulations (T.D. 9644), the IRS issued additional proposed regulations (REG-130843-13) that are also relevant to CRTs.

Effective Date

The net investment income tax applies to trusts and estates for tax years beginning after Dec. 31,2012. Since CRTs are required to have a calendar year, to the extent applicable, individual beneficiaries of CRTs became subject to the new tax commencing Jan. 1, 2013.

CRTs Are Exempt

The Sec. 1411 tax applies to decedents' estates and trusts that are subject to the provisions of part 1 of subchapter J of chapter 1 of subtitle A of the Code. Because Sec. 1411 is in subtitle A of the Code, any trust, fund, or other special account that is exempt from taxes imposed under subtitle A is exempt from the tax imposed under Sec. 1411. This exclusion applies even if such a trust may be subject to a tax on unrelated business taxable income (UBTI) and even if that UBTI contains net investment income. This category of trusts includes trusts that are exempt from tax under Sec. 501(a), such as charitable organizations formed as trusts (Sec. 501(c)) and qualified plan trusts (Sec. 401(a)). CRTs also fall within this category. Although a CRT in and of itself is exempt from the application of Sec. 1411, distributions from the CRT to individuals are subject to Sec. 1411 to the extent such distributions consist of net investment income.

Taxation of Beneficiaries of CRTs--Initial Proposed Regulations

Solely for purposes of the Sec. 1411 tax, the proposed regulations issued in late 2012 (REG-130507-11) provided special computation rules for the classification of the income of, and the distributions from, CRTs. In effect, the special rule would have required a new and separate category of the CRT's current and accumulated net investment income. The proposed rules provided that distributions from a CRT to a beneficiary for a tax year would consist of net investment income equal to the lesser of the total amount of the distributions for that year or the current and accumulated net investment income of the CRT. "Accumulated net investment income" (ANII) means the total amount of net investment income received by a CRT for all tax years beginning after Dec. 31,2012, less the total amount of net investment income distributed for all prior tax years beginning after Dec. 31, 2012.

Although Treasury and the IRS acknowledged that the new category for Sec. 1411 purposes deviated from the existing Sec. 664 category and class system, the government felt that the simplified method spelled out in the proposed regulations was justified to reduce the recordkeeping and compliance burdens on trustees. Comments received by the government, however, expressed a preference that the final regulations follow the existing rules under Sec. 664 that create subclasses in each category of income as the tax rates on certain types of income are changed from time to time. The comments indicated that...