26 CFR § 1.662(c)-4 - Illustration of the provisions of sections 661 and 662.

§ 1.662(c)-4 Illustration of the provisions of sections 661 and 662.

The provisions of sections 661 and 662 may be illustrated in general by the following example:

Example.
(a) Under the terms of a testamentary trust one-half of the trust income is to be distributed currently to W, the decedent's wife, for her life. The remaining trust income may, in the trustee's discretion, either be paid to D, the grantor's daughter, paid to designated charities, or accumulated. The trust is to terminate at the death of W and the principal will then be payable to D. No provision is made in the trust instrument with respect to depreciation of rental property. Capital gains are allocable to the principal account under the applicable local law. The trust and both beneficiaries file returns on the calendar year basis. The records of the fiduciary show the following items of income and deduction for the taxable year 1955:
Rents $50,000
Dividends of domestic corporations 50,000
Tax-exempt interest 20,000
Partially tax-exempt interest 10,000
Capital gains (long term) 20,000
Depreciation of rental property 10,000
Expenses attributable to rental income 15,400
Trustee's commissions allocable to income account 2,800
Trustee's commissions allocable to principal account 1,100
(b) The income for trust accounting purposes is $111,800, and the trustee distributes one-half ($55,900) to W and in his discretion makes a contribution of one-quarter ($27,950) to charity X and distributes the remaining one-quarter ($27,950) to D. The total of the distributions to beneficiaries is $83,850, consisting of (1) income required to be distributed currently to W of $55,900 and (2) other amounts properly paid or credited to D of $27,950. The income for trust accounting purposes of $111,800 is determined as follows:
Rents $50,000
Dividends 50,000
Tax-exempt interest 20,000
Partially tax-exempt interest 10,000
Total 130,000
Less:
Rental expenses $15,400
Trustee's commissions allocable to income account 2,800
- - - - 18,200
Income as computed under section 643(b) 111,800
(c) The distributable net income of the trust as computed under section 643(a) is $82,750, determined as follows:
Rents $50,000
Dividends 50,000
Partially tax-exempt interest 10,000
Tax-exempt interest $20,000
Less:
Trustee's commissions allocable thereto (20,000/130,000 of $3,900) $600
Charitable contributions allocable thereto (20,000/130,000 of $27,950) 4,300
- - - - - 4,900
- - - - - 15,100
Total 125,100
Deductions:
Rental expenses 15,400
Trustee's commissions ($3,900 less $600 allocated to tax-exempt interest) 3,300
Charitable deduction ($27,950 less $4,300 attributable to tax-exempt interest) 23,650
- - - - - 42,350
Distributable net income 82,750
In computing the distributable net income of $82,750, the taxable income of the trust was computed with the following modifications: No deductions were allowed for distributions to beneficiaries and for personal exemption of the trust (section 643(a) (1) and (2)); capital gains were excluded and no deduction under section 1202 (relating to the 50 percent deduction for long-term capital gains) was taken into account (section 643(a)(3)); and the tax-exempt interest (as adjusted for expenses and charitable contributions) and the dividend exclusion of $50 were included (section 643(a) (5) and (7)).
(d) Inasmuch as the distributable net income of $82,750 as determined under section 643(a) is less than the sum of the amounts distributed to W and D of $83,850, the deduction allowable to the trust under section 661(a) is such distributable net income as modified under section 661(c) to exclude therefrom the items of income not included in the gross income of the trust, as follows:
Distributable net income $82,750
Less:
Tax-exempt interest (as adjusted for expenses and the charitable contributions) $15,100
Dividend exclusion allowable under section 116 50
- - - - 15,150
Deduction allowable under section 661(a) 67,600
(e) For the purpose of determining the character of the amounts deductible under section 642(c) and section 661(a), the trustee elected to offset the trustee's commissions (other than the portion required to be allocated to tax-exempt interest) against the rental income. The following table shows the determination of the character of the amounts deemed distributed to beneficiaries and contributed to charity.
Rents Taxable dividends Excluded dividends Tax exempt interest Partially tax exempt interest Total
Trust income $50,000 $49,950 $50 $20,000 $10,000 $130,000
Less:
Charitable contribution 10,750 10,750 4,300 2,150 27,950
Rental expenses 15,400 15,400
Trustee's commissions 3,300 600 3,900
Total deductions 29,450 10,750 0 4,900 2,150 47,250
Amounts distributable to beneficiaries 20,550 39,200 50 15,100 7,850 82,750
The character of the charitable contribution is determined by multiplying the total charitable contribution ($27,950) by a fraction consisting of each item of trust income, respectively, over the total trust income, except that no part of the dividends excluded from gross income are deemed included in the charitable contribution. For example, the charitable contribution is deemed to consist of rents of $10,750 (50,000/130,000 × $27,950).
(f) The taxable income of the trust is $9,900 determined as follows:
Rental income $50,000
Dividends ($50,000 less $50 exclusion) 49,950
Partially tax-exempt interest 10,000
Capital gains 20,000
Gross income 129,950
Deductions:
Rental expenses 15,400
Trustee's commissions 3,300
Charitable contributions 23,650
Capital gain deduction 10,000
Distributions to beneficiaries 67,600
Personal exemption 100
120,050
Taxable income 9,900
(g) In computing the amount includible in W's gross income under section 662(a)(1), the $55,900 distribution to her is deemed to be composed of the following proportions of the items of income deemed to have been distributed to the beneficiaries by the trust (see paragraph (e) of this example):
Rents (20,550/82,750 × $55,900) $13,882
Dividends (39,250/82,750 × $55,900) 26,515
Partially tax-exempt interest (7,850/ 82,750 × $55,900) 5,303
Tax-exempt interest (15,100/82,750 × $55,900) 10,200
Total 55,900
Accordingly, W will exclude $10,200 of tax-exempt interest from gross income and will receive the credits and exclusion for dividends received and for partially tax-exempt interest provided in sections 34, 116, and 35, respectively, with respect to the dividends and partially tax-exempt interest deemed to have been distributed to her, her share of the dividends being aggregated with other dividends received by her for purposes of the dividend credit and exclusion. In addition, she may deduct a share of the depreciation deduction proportionate to the trust income allocable to her; that is, one-half of the total depreciation deduction, or $5,000.
(h) Inasmuch as the sum of the amount of income required to be distributed currently to W ($55,900) and the other amounts properly paid, credited, or required to be distributed to D ($27,950) exceeds the distributable net income ($82,750) of the trust as determined under section 643(a), D is deemed to have received $26,850 ($82,750 less $55,900) for income tax purposes. The character of the amounts deemed distributed to her is determined as follows:
Rents (20,550/82,750 × $26,850) $6,668
Dividends (39,250/82,750 × $26,850) 12,735
Partially tax-exempt interest (7,850/ 82,750 × $26,850) 2,547
Tax-exempt interest (15,100/82,750 × $26,850) 4,900
Total 26,850
Accordingly, D will exclude $4,900 of tax-exempt interest from gross income and will receive the credits and exclusion for dividends received and for partially tax-exempt interest provided in sections 34, 116, and 35, respectively, with respect to the dividends and partially tax-exempt interest deemed to have been distributed to her, her share of the dividends being aggregated with other dividends received by her for purposes of the dividend credit and exclusion. In addition, she may deduct a share of the depreciation deduction proportionate to the trust income allocable to her; that is, one-fourth of the total depreciation deduction, or $2,500.
(i) [Reserved]

(j) The remaining $2,500 of the depreciation deduction is allocated to the amount distributed to charity X and is hence non-deductible by the trust, W, or D. (See § 1.642(e)-1.)