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IRS Debunks Heavily Advertised Trust Strategy for Income Taxes

New Chief Counsel Memorandum deems promotional materials misstate and mischaracterize the technique's efficacy in certain circumstances.

In Chief Counsel Memorandum (CCM) AM 2023-0006 (Aug. 9, 2023) the Internal Revenue Service 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 in other regard.

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 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. 

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