§ 1.663(c)-5 Examples.
Section 663(c) may be illustrated by the following examples:
Example 1.
(i) A single
trust was created in 1940 for
the benefit of A, B, and C, who were aged 6, 4, and 2, respectively. Under
the terms of
the instrument,
the trust income is required to be divided into three equal shares. Each beneficiary's share of
the income is to be accumulated until he becomes 21
years of age. When a beneficiary reaches
the age of 21, his share of
the income may thereafter be either accumulated or distributed to him in
the discretion of
the trustee.
The trustee also has discretion to invade corpus for
the benefit of any beneficiary to
the extent of his share of
the trust estate, and
the trust instrument requires that
the beneficiary's right to future income and corpus will be proportionately reduced. When each beneficiary reaches 35
years of age, his share of
the trust estate shall be
paid over to him.
The interest in
the trust estate of any beneficiary dying without
issue and before he has attained
the age of 35 is to be equally divided between
the other beneficiaries of
the trust. All expenses of
the trust are allocable to income under
the terms of
the trust instrument.
(ii) No distributions of income or corpus were made by the trustee prior to 1955, although A became 21 years of age on June 30, 1954. During the taxable year of 1955, the trust has income from royalties of $20,000 and expenses of $5,000. The trustee in his discretion distributes $12,000 to A. Both A and the trust report on the calendar year basis.
(iii) The trust qualifies for the separate share treatment under section 663(c) and the distributable net income must be divided into three parts for the purpose of determining the amount deductible by the trust under section 661 and the amount includible in A's gross income under section 662.
(iv) The distributable net income of each share of the trust is $5,000 ($6,667 less $1,667). Since the amount ($12,000) distributed to A during 1955 exceeds the distributable net income of $5,000 allocated to his share, the trust is deemed to have distributed to him $5,000 of 1955 income and $7,000 of amounts other than 1955 income. Accordingly, the trust is allowed a deduction of $5,000 under section 661. The taxable income of the trust for 1955 is $9,900, computed as follows:
| Royalties |
$20,000
|
|
| Deductions:
|
|
|
| Expenses |
$5,000
|
|
| Distribution to A |
5,000
|
|
| Personal exemption |
100
|
|
|
|
10,100
|
| Taxable income |
9,900 |
(v) In accordance with section 662, A must include in his
gross income for 1955 an
amount equal to
the portion ($5,000) of
the distributable
net income of
the trust allocated to his share. Also,
the excess
distribution of $7,000 made by
the trust is subject to
the throwback provisions of subpart D (section 665 and
following), part I, subchapter J, chapter 1 of
the Code, and
the regulations thereunder.
Example 2.
(i) Facts. Testator, who dies in 2000, is survived by a spouse and
two children. Testator's will contains a fractional formula bequest dividing
the residuary
estate between
the surviving spouse and a
trust for
the benefit of
the children. Under
the fractional formula,
the marital bequest constitutes 60% of
the estate and
the children's
trust constitutes 40% of
the estate. During
the year,
the executor makes a partial proportionate
distribution of $1,000,0000, ($600,000 to
the surviving spouse and $400,000 to
the children's
trust) and makes no
other distributions.
The estate receives
dividend income of $20,000, and pays expenses of $8,000 that are deductible on
the estate's federal
income tax return.
(ii) Conclusion. The fractional formula bequests to the surviving spouse and to the children's trust are separate shares. Because Testator's will provides for fractional formula residuary bequests, the income and any appreciation in the value of the estate assets are proportionately allocated between the marital share and the trust's share. Therefore, in determining the distributable net income of each share, the income and expenses must be allocated 60% to the marital share and 40% to the trust's share. The distributable net income is $7,200 (60% of income less 60% of expenses) for the marital share and $4,800 (40% of income less 40% of expenses) for the trust's share. Because the amount distributed in partial satisfaction of each bequest exceeds the distributable net income of each share, the estate's distribution deduction under section 661 is limited to the sum of the distributable net income for both shares. The estate is allowed a distribution deduction of $12,000 ($7,200 for the marital share and $4,800 for the trust's share). As a result, the estate has zero taxable income ($20,000 income less $8,000 expenses and $12,000 distribution deduction). Under section 662, the surviving spouse and the trust must include in gross income $7,200 and $4,800, respectively.
Example 3.
The facts are
the same as in
Example 2, except that in 2000
the executor makes
the payment to partially fund
the children's
trust but makes no payment to
the surviving spouse.
The fiduciary must use a reasonable and equitable method to allocate income and expenses to
the trust's share. Therefore, depending on when
the distribution is made to
the trust, it may no longer be reasonable or equitable to determine
the distributable
net income for
the trust's share by allocating to it 40% of
the estate's income and expenses for
the year.
The computation of
the distributable
net income for
the trust's share should take into consideration that after
the partial
distribution the relative size of
the trust's separate share is reduced and
the relative size of
the spouse's separate share is increased.
Example 4.
(i) Facts. Testator, who dies in 2000, is survived by a spouse and one
child. Testator's will provides for a pecuniary formula bequest to be
paid in not more than three installments to a
trust for
the benefit of
the child of
the largest
amount that can pass free of Federal
estate tax and a bequest of
the residuary to
the surviving spouse.
The will provides that
the bequest to
the child's
trust is not entitled to any of
the estate's income and does not participate in appreciation or
depreciation in
estate assets. During
the 2000
taxable year,
the estate receives
dividend income of $200,000 and pays expenses of $15,000 that are deductible on
the estate's federal
income tax return.
The executor partially funds
the child's
trust by distributing to it
securities that have an
adjusted basis to
the estate of $350,000 and a
fair market value of $380,000 on
the date of
distribution. As a
result of this
distribution,
the estate realizes long-term
capital gain of $30,000.
(ii) Conclusion. The estate has two separate shares consisting of a formula pecuniary bequest to the child's trust and a residuary bequest to the surviving spouse. Because, under the terms of the will, no estate income is allocated to the bequest to the child's trust, the distributable net income for that trust's share is zero. Therefore, with respect to the $380,000 distribution to the child's trust, the estate is allowed no deduction under section 661, and no amount is included in the trust's gross income under section 662. Because no distributions were made to the spouse, there is no need to compute the distributable net income allocable to the marital share. The taxable income of the estate for the 2000 taxable year is $214,400 ($200,000 (dividend income) plus $30,000 (capital gain) minus $15,000 (expenses) and minus $600 (personal exemption)).
Example 5.
The facts are
the same as in
Example 4, except that during 2000
the estate reports on its federal
income tax return a
pro rata share of an
S corporation's
tax items and a distributive share of a
partnership's
tax items allocated on Form K-1s to
the estate by
the S corporation and by
the partnership, respectively. Because, under
the terms of
the will, no
estate income from
the S corporation or
the partnership would be allocated to
the pecuniary bequest to
child's
trust, none of
the tax items attributable to
the S corporation stock or
the partnership interest is allocated to
the trust's separate share. Therefore, with respect to
the $380,000 distribution to
the trust,
the estate is
allowed no
deduction under section 661, and no
amount is included in
the trust's
gross income under section 662.
Example 6.
The facts are
the same as in
Example 4, except that during 2000
the estate receives a
distribution of $900,000 from
the decedent's individual retirement account that is included in
the estate's
gross income as income in respect of a decedent under section 691(a).
The entire $900,000 is allocated to corpus under applicable local law. Both
the separate share for
the child's
trust and
the separate share for
the surviving spouse may potentially be funded with
the proceeds from
the individual retirement account. Therefore, a portion of
the $900,000
gross income must be allocated to
the trust's separate share.
The amount allocated to
the trust's share must be based upon
the relative
values of
the two separate shares using a reasonable and equitable method.
The estate is entitled to a
deduction under section 661 for
the portion of
the $900,000 properly allocated to
the trust's separate share, and
the trust must include this
amount in income under section 662.
Example 7.
(i) Facts. Testator, who dies in 2000, is survived by a spouse and three adult
children. Testator's will divides
the residue of
the estate equally among
the three
children.
The surviving spouse files an
election under
the applicable
state's elective share statute. Under this statute, a
surviving spouse is entitled to one-third of
the decedent's
estate after
the payment of debts and expenses.
The statute also provides that
the surviving spouse is not entitled to any of
the estate's income and does not participate in appreciation or
depreciation of
the estate's assets. However, under
the statute,
the surviving spouse is entitled to
interest on
the elective share from
the date of
the court order directing
the payment until
the executor actually makes
payment. During
the estate's 2001
taxable year,
the estate distributes to
the surviving spouse $5,000,000 in partial satisfaction of
the elective share and pays $200,000 of
interest on
the delayed
payment of
the elective share. During that
year,
the estate receives
dividend income of $3,000,000 and pays expenses of $60,000 that are deductible on
the estate's federal
income tax return.
(ii) Conclusion. The estate has four separate shares consisting of the surviving spouse's elective share and each of the three children's residuary bequests. Because the surviving spouse is not entitled to any estate income under state law, none of the estate's gross income is allocated to the spouse's separate share for purposes of determining that share's distributable net income. Therefore, with respect to the $5,000,000 distribution, the estate is allowed no deduction under section 661, and no amount is included in the spouse's gross income under section 662. The $200,000 of interest paid to the spouse must be included in the spouse's gross income under section 61. Because no distributions were made to any other beneficiaries during the year, there is no need to compute the distributable net income of the other three separate shares. Thus, the taxable income of the estate for the 2000 taxable year is $2,939,400 ($3,000,000 (dividend income) minus $60,000 (expenses) and $600 (personal exemption)). The estate's $200,000 interest payment is a nondeductible personal interest expense described in section 163(h).
Example 8.
The will of Testator, who dies in 2000, directs
the executor to distribute
the X
stock and all
dividends therefrom to
child A and
the residue of
the estate to
child B.
The estate has
two separate shares consisting of
the income on
the X
stock bequeathed to A and
the residue of
the estate bequeathed to B.
The bequest of
the X
stock meets
the definition of section 663(a)(1) and therefore is not a separate share.
If any distributions,
other than shares of
the X
stock, are made during
the year to either A or B, then for purposes of determining
the distributable
net income for
the separate shares,
gross income attributable to
dividends on
the X
stock must be allocated to A's separate share and any
other income must be allocated to B's separate share.
Example 9.
The will of Testator, who dies in 2000, directs the executor to divide the residue of the estate equally between Testator's two children, A and B. The will directs the executor to fund A's share first with the proceeds of Testator's individual retirement account. The date of death value of the estate after the payment of debts, expenses, and estate taxes is $9,000,000. During 2000, the $900,000 balance in Testator's individual retirement account is distributed to the estate. The entire $900,000 is allocated to corpus under applicable local law. This amount is income in respect of a decedent within the meaning of section 691(a). The estate has two separate shares, one for the benefit of A and one for the benefit of B. If any distributions are made to either A or B during the year, then, for purposes of determining the distributable net income for each separate share, the $900,000 of income in respect of a decedent must be allocated to A's share.
Example 10.
The facts are the same as in Example 9, except that the will directs the executor to fund A's share first with X stock valued at $3,000,000, rather than with the proceeds of the individual retirement account. The estate has two separate shares, one for the benefit of A and one for the benefit of B. If any distributions are made to either A or B during the year, then, for purposes of determining the distributable net income for each separate share, the $900,000 of gross income attributable to the proceeds from the individual retirement account must be allocated between the two shares to the extent that they could potentially be funded with those proceeds. The maximum amount of A's share that could potentially be funded with the income in respect of decedent is $1,500,000 ($4,500,000 value of share less $3,000,000 to be funded with stock) and the maximum amount of B's share that could potentially be funded with income in respect of decedent is $4,500,000. Based upon the relative values of these amounts, the gross income attributable to the proceeds of the individual retirement account is allocated $225,000 (or one-fourth) to A's share and $675,000 (or three-fourths) to B's share.
Example 11.
The will of Testator, who dies in 2000, provides that after
the payment of specific bequests of money,
the residue of
the estate is to be divided equally among
the Testator's three
children, A, B, and C.
The will also provides that during
the period of administration one-half of
the income from
the residue is to be paid to a designated charitable
organization. After
the specific bequests of money are
paid,
the estate initially has three equal separate shares. One share is for
the benefit of
the charitable
organization and A, another share is for
the benefit of
the charitable
organization and B, and
the last share is for
the benefit of
the charitable
organization and C. During
the period of administration,
payments of income to
the charitable
organization are deductible by
the estate to
the extent provided in section 642(c) and are not subject to
the distribution provisions of sections 661 and 662.
[T.D. 6500,
25 FR 11814, Nov. 26, 1960;
25 FR 14021, Dec. 31, 1960. Redesignated and amended by T.D. 8849,
64 FR 72543, 72544, Dec. 28, 1999;
65 FR 16317, Mar. 28, 2000]
