The income of a trust or estate may be taxable to (1) the fiduciary; (2) the beneficiary; or (3) in the case of certain trusts, to the creator of the trust. The tax liability of the fiduciary is considered in Chapter 43; the liability of the beneficiary and the creator will be considered in this chapter.

Beneficiaries

A beneficiary of a trust or an estate is, in general, taxable upon (1) income which is to be distributed currently by the fiduciary to the beneficiary; and (2) income which may, in the discretion of the fiduciary be either distributed to the beneficiary or accumulated, and which is properly paid or credited to the beneficiary during the taxable year; (3) income (in the case of an infant) which is to be held or distributed as the court may direct; and (4) income (in the case of a decedent's estate in the process of administration) which is properly paid or credited to the beneficiary. In other words, the beneficiaries of an estate or trust are taxable not only upon income

actually paid to them, but upon income which is "to be distributed currently" to them, or which is "properly credited" to them. In the case of an infant whose estate is under the jurisdiction of a court, the income is taxable to his legal representative for his personal account, even though accumulated for future distribution. The meaning of these statutory terms will be considered below.

The law provides in section 219 (b) that, except in the case of revocable trusts or of trusts the income of which may be distributed to the grantor, or used to pay premiums on his life insurance, "the tax shall be computed upon the net income of the estate or trust, and shall be paid by the fiduciary." The law then provides [section 219 (b) (2) and (3)] for special deductions, in computing the net income of the estate or trust, of

(1) "the amount of the income of the estate or trust for its taxable year which is to be distributed currently by the fiduciary to beneficiaries;"

(2) "the amount of income collected by a guardian of an infant which is to be held or distributed as the court may direct;" (3) "in the case of income received by estates of deceased persons during the period of administration or settlement of the estate. . . . the amount of the income . . . . which is properly paid or credited during such year to any legatee, heir, or beneficiary;" and

(4) "in the case of income which, in the discretion of the fidu

ciary may be either distributed to the beneficiary or accumulated, . . . . the amount of the income . . . . which is properly paid or credited during such year to any . . . . beneficiary."

It is expressly provided in the case of each of these deductions that the amounts of income so deducted shall be included in computing the net income of the legatees, heirs, or beneficiaries. In other words, the tax liability of the beneficiaries in the special cases corresponds to the scope of these deductions. Since the law is organized on the basis of determining, first, the tax liability of the fiduciary by the deduction of the specified amounts of income from the gross income of the estate or trust, and, second, the liability of the beneficiary in respect of the income so deducted, the discussion in this book has been arranged on the same basis. Accordingly, the tax liability of fiduciaries, including the scope of these deductions, is

fully discussed in Chapter 42, and will not be repeated here, except as may be necessary to clarify the discussion of the tax liability of persons other than fiduciaries in respect of the income of estates and trusts.

Beneficiary not responsible for income the tax upon which is not payable by him.-Beneficiaries should include in their returns only that income the tax upon which is payable by them. Conversely it has been held that where a part of the income of an estate is to be paid the widow "free of any and all tax or charge whatsoever"; the widow must nevertheless pay personally income taxes on her receipts. (Matter of Johnson, N. Y. Law Jour., Jan. 17, 1925.) In many cases, an estate will have income a part of which is taxable to the fiduciary and a part to the beneficiaries. It is the duty of the fiduciary to advise the beneficiaries as to what part they should return. This is particularly important in the case of income which is credited to the beneficiaries but not paid to them.

If a beneficiary receives income from two trusts, he should include in his return all of the income properly paid or credited to him by both fiduciaries. If, however, an individual is a beneficiary of two separate trusts, the income of which is to be accumulated, each trust is taxable as a separate entity. (See Chapter 43.)

Determination of taxable income.-Items of income of the trust, which are paid or credited to the beneficiary, are to be treated by the beneficiary just as if he received them directly. He is allowed the credit for the normal tax in the case of dividends and interest on obligations of the United States received through the trust.

INCOME WHICH IS TO BE DISTRIBUTED CURRENTLY. It is not necessary, under the terms of the act, that the income be actually paid or credited to the beneficiary, if it "is to be distributed currently by the fiduciary to the beneficiaries." If income is paid or credited. to the beneficiary, it is usually taxable to him, whether the trust instrument or will required the distribution or not. [See paragraphs (2) and (3) of section 219 (b) quoted in Chapter 42.] On the other hand, if it is not so paid, it is only taxable to an adult beneficiary if it is to be distributed currently. No general rule could be stated which would determine whether it is so distributable; the question can only be answered in the particular case by a careful

examination of the will or deed creating the trust, and of the local law. It is quite conceivable that, although the fiduciary decided that income which he had not distributed was taxable to him, had so returned it and had paid the tax, the Treasury might subsequently rule that the beneficiary was taxable on it under section 219 (b-2), and that the fiduciary was entitled to a credit or refund. Obviously the fiduciary and beneficiaries should, if possible, agree upon the construction of the trust instrument, and upon the method of treatment of the income. For a full discussion, see Chapter 42.

INCOME COLLECTED BY A GUARDIAN OF AN INFANT WHICH IS TO BE HELD OR DISTRIBUTED AS THE COURT MAY DIRECT. The fiduciary may make this deduction, but if he is also the guardian of the infant, he must include this income in his ward's return, whether it is distributed to his ward or not. See Chapter 43.

INCOME RECEIVED BY ESTATES OF DECEASED PERSONS DURING PERIOD OF ADMINISTRATION OR SETTLEMENT WHICH IS PROPERLY

PAID OR CREDITED TO BENEFICIARIES. -So far as the beneficiary is concerned, the principal questions to be considered are whether (1) any amount has been properly paid or credited to him; (2) whether such amount is income. The first of these questions is considered in Chapter 42.

Estate income for income tax purposes is seldom, if ever, identical with estate income for probate court purposes. Many of the deductions from gross income allowed in the income tax law are not allowed by the courts in computing net income for the purpose of distribution. Payments may be made to beneficiaries out of the net income of estates computed according to the rules of the probate court, when there is in fact no net income for tax purposes. Such payments are not taxable to the beneficiaries, unless they are the "holders of life or terminable" interests. See Chapter 42.

1

An estate's gross income was 3r dollars. The net income for probate purposes 1 and before deducting the federal estate tax was 2x dollars. The federal estate tax was 26x dollars. The fiduciary distributed the probate income of 2.r dollars. It was very properly held that the distribution was not taxable to the beneficiaries. It was not statutory net income. (C. B. II-2, 113; I. T. 1772.)

For a discussion of whether any income deducted by the fiduciary may be exempt from tax to the beneficiary, see page 699.

In most jurisdictions, estate taxes are payable out of corpus.

INCOME DISTRIBUTABLE IN THE DISCRETION OF THE FIDUCIARY WHICH IS PROPERLY PAID OR CREDITED TO BENEFICIARIES.-The important condition to the beneficiary's liability for this class of income is that the income shall have been properly paid or credited to him. In determining whether such amounts are income, the general principles applicable in other cases apply. See Chapter 13.

INCOME FROM A STOCK-BONUS OR PROFIT-SHARING PLAN.-The employee receiving amounts from the trustees of such a scheme is taxable on the excess of the distributions over the sum he paid the trustees. (C. B. IV-2, 87; I. T. 2198.) [See sec. 219 (f).]

Taxable income of life-tenants.-It is well established that profits arising out of the sale of assets in which the trust funds are invested are not ordinarily taxable to the life beneficiary, in the absence of some special provision in the trust instrument. However, a life-tenant may be entitled to such profits by virtue of such a specific provision (see Erswell's Appeal, 1 B. T. A. 1254), and if, for example, the state court so construes the instrument, the life-tenant will be subject to tax thereon.

Similarly, certain deductions may not be taken advantage of by a life-tenant. (See pages 697-701.)

DOES STOCK DIVIDEND BELONG TO LIFE-TENANT OR TO REMAINDERMAN? On the question whether a stock dividend goes to the lifetenant as income or to the remainderman as capital, there are at least three rules.2 The United States Supreme Court (Gibbons v. Mahon, 136 U. S. 549) and a minority of state courts, among them Massachusetts (Minot v. Paine, 99 Mass. 101), give it to the remainderman. England gives the stock dividend to the life-tenant if it is an ordinary dividend and to the remainderman if it is an extraordinary one.3 Pennsylvania, and several other states 5 split it. What comes from corporate profits acquired subsequent to the creation of the trust goes to the life-tenant. What comes from earlier accumulations is kept for the remainderman.

2 "The Judicial Debate on the Taxability of Stock Dividends as Income," by Thomas Reed Powell, Bulletin of the National Tax Association, Vol. V,

page 247.

See Brander v. Brander, 4 Ves. Jr. 800 (Am. Ed.); 31 Eng. Rep. 414.

Earp's Appeal, 28 Pa. St. 368.

'See cases cited in Tax Commissioner v. Putnam, 227 Mass. 522, 532; 116 N. E. 904; L. R. A. 1917 F. 806.