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Saturday, January 06, 2007


Under Internal Revenue Code Section 678, a person is treated as the owner of any portion of a trust with respect to which that person has the power, solely exercisable by himself or herself, to vest the corpus or the income in himself or herself. When a person is treated as the owner of a portion of a trust under section 678, special rules apply to not tax the trust directly. Instead, the person treated as the owner takes into account the trust's items of income, deduction, and credit attributable to that portion of the trust.

As Thomas B. Goldsby, Jr. learned, the "portion" of the trust that the deemed owner is taxable on can be limited at times to the income of the trust, and not the corpus.

Mr. Goldsby was an income beneficiary and trustee of a trust. Instead of receiving the income of the trust, he allowed it to remain in the trust - although it was treated on the books and records as segregated and due to Mr. Goldsby. The trust contributed a conservation easement in real property it owned to charity which qualified for the charitable income tax deduction. Mr. Goldsby reported himself as owning the portion of the trust making the contribution, and sought to take the income tax deduction individually. The IRS challenged his use of the deduction, asserting that Mr. Goldsby was taxable only on the "income" portion of the trust and that the contribution was made from principal or corpus, so that deduction was not allocable to him under the grantor trust rules.

Mr. Goldsby did make some interesting arguments, but they were all rejected by the Tax Court. First, he asserted that since he left undistributed net income in the trust, this was effectively mingled with and converted to corpus, and thus he still should have been entitled to the deduction. This was rejected because under the trust agreement Mr. Goldsby had no interest in corpus and because the net income was separately accounted for on the trust books and records as undistributed income and not principal.

Second, Mr. Goldsby argued that the conservation easements came from the undistributed net income, regardless of whether that income was converted to principal. However, Mr. Goldsby provided no evidence how the contribution was made from such net income instead of the principal assets of the trust,and thus this argument was also rejected.

Thus, in situations where an income tax item relates to corpus/principal and not income, and the grantor trust rules are involved, care must be taken to determine whether the grantor trust rules apply to income only, or also to principal in determining which taxpayer bears the benefits or burdens of the tax item.

Thomas B. Goldsby, Jr., TC Memo 2006-274

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