Section 61 Income Tax: Distributable Net Income; Sale or Exchange; and Grantor Trust Implications

• Library: Trust and Estate Legislation 2012

Any trustee should be aware of the concept of DNI (distributable net income) and its function in fiduciary accounting. The application of the DNI rules is beyond the scope of this chapter, but every distribution from a trust requires an analysis of the income tax consequences and particularly of whether the distribution carries out DNI (and how much). But, generally, it seems likely that certain exercises of decanting could carry out DNI and others might not.

A second issue for a trustee to consider is whether the act of decanting would constitute a realization event under I.R.C. § 1001(a), which imposes capital gains liability on “the gain [or loss] from the sale or other disposition of property.” Assuming that a decanting is not a “sale” of the property, might it be held to be a “disposition” instead?

Typically, distributions of appreciated property are not realization events unless made in satisfaction of a pecuniary bequest. Instead, the beneficiary takes a transferred basis and is thus liable for the gain at the beneficiary’s later sale of the property. But it is less established whether this rule applies to a decanting as well. Narrowly construed, a decanting is merely a distribution to another trust and so would presumably enjoy the same treatment as any other distribution. But the IRS might take the position that a decanting is not merely a distribution but rather a...