The provisions of sections 661 and 662 may be illustrated in general by the following 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 |
(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 |
(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 |
(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 |
(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.)
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