• Internal Revenue Service debunks advertised trust strategy for income taxes—In Chief Counsel Memorandum (CCM) AM 2023-0006 (Aug. 9, 2023) the IRS evaluated a trust strategy being marketed in promotional materials by attorneys, accountants, enrolled agents and tax advisors. The memorandum is limited to rebutting how those materials present the trusts under Internal Revenue Code Section 643. The CCM didn’t address other open issues regarding the trust structure.
The proposed trust is described as non-grantor, irrevocable, discretionary, complex and spendthrift. The general structure is as follows:
- third party establishes trust;
- taxpayer is the “Compliance Overseer” with the power to add and remove trustee and change beneficiaries;
- beneficiaries may include taxpayer’s spouse and children, but not taxpayer;
- distributions to beneficiaries are discretionary;
- spendthrift provisions are included;
- there’s no power to revoke or terminate the trust in favor of the taxpayer; and
- taxpayer sells assets to the trust in exchange for a promissory note.
The materials promoting the trust claim that none of the trust income (capital gains, extraordinary dividends and taxable stock dividends) will be taxable if the trustee allocates it to corpus and doesn’t make any distributions to the beneficiaries.
The CCM determines that the promotional materials misstate and mischaracterize how IRC Section 643 would apply. IRC Section 641 defines “taxable income.” Section 643, with reference to Section 641’s definition of “gross income,” then determines what’s “distributable net income” (DNI). DNI is calculated by making certain adjustments to a trust’s taxable income. DNI is the portion of the income that’s then taxable to the beneficiaries.
The CCM goes on to explain that if the trustee allocates all income to principal (without making distributions to beneficiaries), then that income will shift out of DNI under Section 643, back to the gross income reportable by the trust under Section 641 as a non-grantor trust.
• IRS approves IRC Section 642(c) deduction—In Private Letter Ruling 202332011 (Aug. 11, 2023), the taxpayer sought confirmation that distributions to a donor-advised fund (DAF) would be deductible for income tax purposes. The taxpayer established a trust and named the trust as the sole beneficiary of his individual retirement account. The trust required that residue of the trust be distributed to a DAF (a public charity).
After the taxpayer’s death, the IRA made distributions to the trust, which the trust paid out in the same taxable year to the charity. The IRA distributions qualified as income in respect of a decedent (IRD) under IRC Section 691(a). Section 642(c) provides that gross income paid to charity pursuant to the terms of the governing instrument is deductible for income tax purposes. The IRS determined that the trust distributions of residue qualified under Section 642(c), and the deductions were allowable.