Re: Is the Credit Shelter Trust a Grantor Trust?

jba wrote:

So what you want is a trust in which the income is taxed to the trust beneficiary for income tax purposes but is not included in his estate for estate tax purposes. This kind of thing is sometimes referred to as a "defective" trust. Your only way of having someone other than the original grantor be considered the owner for income tax purposes is under section 678, which is the person has or had "a power exercisable solely by himself to vest the corpus or the income therefrom in himself...." So then you have to go over to the estate tax and see if there are any circumstances under which someone having that kind of power will not be treated as the owner for estate tax purposes. And that kind of power is known as a power of appointment. See sections 2041. A "general" power of appointment makes the property over which the power can be exercised includible in the beneficiary's estate. A power by a trustee to pay himself principal or interest is not a general power of appointment only if it comes within the definition of a limited power of appointment. That would occur when the power "is limited by an ascertainable standard relating to the health, education, support, or maintenance of the decedent shall not be deemed a general power of appointment." So it appears that a power to invade may cause the income to be taxed if it is limited to an ascertainable standard. I have not researched this to be sure it would actually work. But it appears to be this is the only way to accomplish what you want, if it can be achieved at all. Whether that is actually your goal or you are actually looking to do something different but haven't expressed yourself clearly enough, you should invest several thousand dollars in having a tax attorney figuring out exactly the best way to do what you wish. This is a very precarious assignment, and must be done very carefully and precisely. Stu

Exactly!

Some say yes, most say no--based on US v. DeBonchamps. Why do you say my only way--did you look at section 679?

Right.

Yes. There is no "standard" in the 678 statute--only the one court case as far as I know. Unfortunately, that is enough to stop most CPAs from filing as a grantor trust--and you can't really blame them-- it's basically the only data point they have on the issue.

I think you understand the goal perfectly. The only question is how to get there, and I'll be happy to pay reasonable legal fees for something of value. I'm not inclined to pay somebody to think deeply about something that they should already know. There is no such thing as precision on this kind of stuff--only reasoned judgement based on knowledge and experience. Just like most professions, most don't want to get out of their comfort zone. Thanks again for your interest.

Thanks. I wasn't aware of that case.

Basically what it says is that having a limited power of appointment is not a "to vest the corpus or the income therefrom in himself" because any power to do so is limited by a standard. I've seen it done the other way - where property is included in the taxable estate of the beneficiary for estate tax purposes, but the income is not for income tax purposes. But it may not work the way you would like it to.

Section 679 concerns foreign trusts with US beneficiaries. They don't want people to set up trusts in another country but have beneficiaries in the US, and allow them to get out of responsibility for tax on the income produced by those assets. It says the grantor is taxable, but has nothing to do with making the beneficiary taxable.

That's actually not the only case - there turn out to be several others. Apparently the provision in 678 that says the person must be able to "vest" the property "in himself" does not apply when the power is limited.

This is a very unusual request, so it's not the kind of thing most people would know off the tops of their heads. And it can't be guaranteed in advance that a way will be found. One approach would be to carefully parse the provisions of section 678 against the requirements of section 2041 and see if some sort of distinction could be found that would support your goal. But on my brief review I have not been able to find one. The only thing I could find was to give the person the unlimited right (not restricted by a standard) to withdraw all the income, but not more than 5% or $5,000, whichever is greater. That would exclude it from his estate, but include at least a portion of it in his income tax. But I don't know if that would accomplish your goal.

Explain again, if you would, why you want the beneficiary taxed on income generated by the trust? The stepped up basis is as a result of inclusion in estate tax and not related to income tax issues, so I don't really understand why you need to do that. Remember that any income actually distributed is taxed to the beneficiary. Stu

In addition to the DeBonchamps case, there are Funk v. CIR,

185 F.2d 127 (3d Cir. 1950) ("needs" deemed a sufficient limitation) and Smither v. US, 108 F. Supp. 772 (S.D. TX 1952), aff'd 205 F.2d 518 (5th Cir. 1953) ("support, maintenance, comfort, and enjoyment" is a sufficient standard) that hold that an ascertainable standard over the beneficiary-trustee's distribution powers keeps a trust from being a grantor trust. Interestingly, these standards are much broader than that permitted by section 2041.

The ascertainable standard language is written into section

2041 but not section 678. So the courts interpret the requirement in 678 that the beneficiary have the power to vest property in himself to mean an unrestricted right. Without specific language in the statute, it's not surprising that the rules round be fuzzier. Stu