Estates, Gifts, And Trusts (EGT)

Subchapter J — Throwback Rules (Portfolio 856)

  • This Portfolio describes and analyzes the provisions of §§665-668 of the Internal Revenue Code, dealing with the income tax treatment of “accumulation distributions”.

Description

Tax Management Portfolio, Subchapter J — Throwback Rules, No. 856 T.M., describes and analyzes the provisions of §§665-668 of the Internal Revenue Code, dealing with the income tax treatment of “accumulation distributions” (i.e., distributions that exceed current income) from certain trusts to their beneficiaries. These provisions are known as the “throwback rules.” Under the throwback rules, a beneficiary receiving an accumulation distribution is taxed as if the trust had made the distribution in the year it accumulated the income.

First added to the tax law in 1954, the throwback rules were designed to discourage the accumulation of income in trusts where it might be taxed at a lower rate than if it were distributed to beneficiaries. The compression of the trust tax rate brackets, begun in the Tax Reform Act of 1986 and continued in succeeding acts, eliminated nearly all of the tax-saving potential of accumulation. As a result, in the Taxpayer Relief Act of 1997, Congress eliminated the throwback rules for most domestic trusts with respect to distributions made in taxable years beginning after August 5, 1997. The only trusts remaining subject to throwback are foreign trusts and domestic trusts that either (a) were at any time foreign trusts, or (b) were created before March 1, 1984, and would have been subject to the aggregation requirement of § 643(f) if that provision had then applied. Almost concurrently with the enactment of this relief for domestic trusts, Congress adopted broader and harsher deterrents to the accumulation of income for foreign trusts.

If a distribution is an accumulation distribution, then its amount is allocated among the earlier years (commencing with the earliest) in which less than total current income was distributed, until either the total of those years’ undistributed incomes, or the amount of the current year’s excess, has been consumed. The total of these allocated amounts, together with an amount equal to the taxes that the trust paid thereon, is included in the beneficiary’s income for the year of the distribution. The beneficiary is then taxed on these amounts as if they had been distributed currently, but reduces his or her tax by the amount of taxes paid by the trust. Nevertheless, a beneficiary will not be taxed on any income accumulated in a domestic trust before his or her birth or attainment of age 21. (This “minority exception” is not available to the beneficiaries of foreign trusts.)

There can be no accumulation distribution in any year in which total distributions do not exceed trust accounting income. Further, a “simple” trust (one operating under an instrument requiring the current distribution of all income and allocating no income to charity, and that in the particular taxable year made no distributions of principal) will almost never make any such distribution.

Special rules govern the tax treatment of accumulation distributions to a beneficiary of multiple trusts whenever such distributions from three or more of those trusts are allocated to any of the same prior taxable years of that beneficiary.

There are special rules as well to determine both the amounts of accumulation distributions from foreign trusts and the resulting burdens on their recipients.

The text sets forth numerous examples of the calculations required by throwback. These are based on assumptions set forth in the Worksheets.

This portfolio may be cited as Knickerbocker, 856 T.M., Subchapter J — Throwback Rules.

Table of Contents

I. Introduction
II. The Throwback Structure
III. Special Rules and Problems
IV. The Former § 644 Tax
V. Foreign Trusts
VI. Comment, Caveat, Critique

Daniel Knickerbocker, Jr.
Daniel Knickerbocker, Jr.
New York
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