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Subchapter J — Throwback Rules (Portfolio 856)

Tax Management Portfolio, Subchapter J — Throwback Rules, No. 856-2nd 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.

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DESCRIPTION

Tax Management Portfolio, Subchapter J — Throwback Rules, No. 856-2nd 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, 856-2nd T.M., Subchapter J — Throwback Rules.


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AUTHORS

DANIEL C. KNICKERBOCKER, JR., ESQ. (1919-2010)
Daniel C. Knickerbocker, Jr. (deceased), A.B., Syracuse University (1940); J.D., Cornell University (1950); Advanced Management Program, Harvard University Graduate School of Business Administration (1969). Member of the New York and Massachusetts Bars. Member, American Bar Association; Association of the Bar of the City of New York; American Law Institute; Association of Life Insurance Counsel; Society of American Law Teachers.

TABLE OF CONTENTS

Detailed Analysis

I. Introduction

A. Background: The Trust's Potential for Tax Avoidance

B. Legislative Solutions

1. Before 1954

2. Internal Revenue Code of 1954

3. Tax Reform Act of 1969

4. Tax Reform Act of 1976

5. Tax Reform Act of 1986

6. Small Business Job Protection Act of 1996

7. Taxpayer Relief Act of 1997

II. The Throwback Structure

A. General Principles of Trust and Beneficiary Taxation

B. When Throwback Occurs

1. Scope

2. Prerequisites

a. Accumulation Distribution

b. Undistributed Net Income

(1) Preceding Taxable Year

(2) Taxes Imposed on the Trust

C. Allocation

D. Taxes Deemed Distributed

1. In General

2. Credits Against Tax

a. Domestic Trusts

b. Foreign Trusts

E. Tax on the Beneficiary

III. Special Rules and Problems

A. Calculating the Accumulation Distribution

1. Distribution of Accounting Income in Excess of Distributable Net Income

2. Distributions in Excess of Accounting Income

3. Exercise of Power

4. Gifts, Bequests, and Charitable Distributions

5. Minority Accumulations

6. Distribution from One Trust to Another

7. Separate Share Rule

8. 65-Day Rule

9. Distributions in Kind

10. Estates

11. Exclusions from DNI

a. Section 644 Gains

b. Electing Small Business Trusts

12. Overpayments of Estimated Taxes

B. Allocation of Accumulation Distributions

1. In General

2. Undistributed Net Income

a. Items of Ordinary Income Allocated to Corpus

(1) Non-Capital Gains

(2) Imputed Income

b. Nondeductible Charges Against Income

(1) Miscellaneous Itemized Deductions

(2) Excess Investment and Personal Interest

(3) Suspended Deductions

3. Years That Are Not Preceding Taxable Years

a. 1969 Transition

b. Simple Trusts

(1) “Outside Income”

(2) Trustee's Failure to Distribute All Income Required To Be Distributed Currently

4. Allocation When Records Are Inadequate

5. Where Accumulation Distribution Includes Amounts Distributed by Another Trust

6. Apportionment of Deemed Distributions Among Several Beneficiaries

a. In General

b. Where Separate Share Rule Applies

C. The Beneficiary's Tax Calculation

1. Reductions in Allocated Amounts

a. Minority Accumulations

b. Tax-Exempt Interest

2. Addition of Allocated Amounts to Taxable Income

a. What Is the Taxable Income to Which Throwbacks Are Added?

(1) Audit Adjustments

(2) Items Dependent Upon the Amount of Gross, Adjusted Gross, or Taxable Income

(3) Effect of Other Accumulation Distributions

(4) Income Averaging

(5) Taxpayer Not in Existence in Preceding Taxable Year

b. Elimination of Character Rules

c. Taxes Deemed Distributed

(1) In General

(2) Exclusion of Alternative Minimum Tax

(3) Multiple Trust Rule

(4) Exception to the Minority Exception

(5) Determining Which Are “Third” Trusts

3. Certain Years Not Taken into Account

4. Special Cases

a. Beneficiary's Taxable Income the Same in Two or More Base Years

b. Alternative Minimum Tax

c. Adjustments for Estate and Generation-Skipping Transfer Taxes

d. “Kiddie Tax”

e. Electing Small Business Trusts

5. Interest

IV. The Former § 644 Tax

V. Foreign Trusts

A. Governing Principles

1. Definition and Basic Tax Rules

2. Foreign Trust Throwbacks

a. In General

b. Default Calculation

c. Calculation of Interest Charge

B. Forestalling Tax Avoidance

1. Distributions Through Nominees

2. Loans

VI. Comment, Caveat, Critique

A. Planning and Execution

B. Interpretation

C. Appraisal


WORKING PAPERS

Working Papers

Table of Worksheets

Worksheet 1 Form 1041, Schedule J, Accumulation Distribution for a Complex Trust

Worksheet 2 Form 4970, Tax on Accumulation Distribution of Trusts

Worksheet 3 Assumptions and Filled-In Form 4970 for Examples in Detailed Analysis

Worksheet 4 House Ways and Means Committee Report on the Accumulation Trust Provisions of the Tax Reform Act of 1976 (H.R. 10612) [H.R. Rep. No. 658, 94th Cong., 1st Sess. 183–87 (1975)]

Worksheet 5 Senate Finance Committee Report on the Accumulation Trust Provisions of the Tax Reform Act of 1976 (H.R. 10612) [Sen. Rep. No. 938, 94th Cong., 2d Sess. 169–175 (1976)]

Worksheet 6 Conference Committee Report on the Accumulation Trust Provisions of the Tax Reform Act of 1976 (H.R. 10612) [H.R. Rep. No. 1515, 94th Cong., 2d Sess. 441–42 (1976)]

Worksheet 7 Staff of Joint Committee on Taxation, General Explanation of the Tax Reform Act of 1976 [Explanation of Accumulation Trust Provisions, 159–64 (1976)]

Worksheet 8 House Ways and Means Committee Report on the Trust Provisions of the Tax Reform Act of 1984 (H.R. 4170) [H.R. Rep. No. 432 (Part 2), 98th Cong., 2d Sess. 1237-40 (1984)]

Worksheet 9 Senate Finance Committee Report on the Trust Provisions of the Tax Reform Act of 1984 (H.R. 4170) [S. Prt. No. 169 (Vol. I), 98th Cong., 2d Sess. 245-48 (1984)]

Worksheet 10 Staff of Joint Committee on Taxation General Explanation of the Revenue Provisions of the Tax Reform Act of 1984 [Explanation of Trust Provisions 253–57 (1984)]

Worksheet 11 Conference Committee Report on the Small Business Job Protection Act of 1996 (H.R. 3448) [H.R. Rep. No. 737, 104th Cong., 2d Sess. 218-220 & 330-338 (1996)]

Worksheet 12 Conference Committee Report on the Taxpayer Relief Act of 1997 (H.R. 2014) [H.R. Rep. No. 220, 105th Cong., 1st Sess. 408-410 (1997)]

Bibliography

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Treasury Regulations:

Legislative History:

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Cases:

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