[Federal Register Volume 64, Number 248 (Tuesday, December 28, 1999)]
[Rules and Regulations]
[Pages 72540-72545]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 99-32694]
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DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Part 1
[TD 8849]
RIN 1545-AW57
Section 663(c); Separate Share Rules Applicable to Estates
AGENCY: Internal Revenue Service (IRS), Treasury.
ACTION: Final regulations.
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SUMMARY: This document contains final regulations concerning separate
share rules applicable to estates under section 663(c) of the Internal
Revenue Code. These regulations provide that substantively separate and
independent shares of different beneficiaries are to be treated as
separate estates for purposes of computing distributable net income and
applying the distribution provisions of sections 661 and 662. These
regulations also provide that a surviving spouse's statutory elective
share of a decedent's estate and a pecuniary formula bequest are
separate shares. Further, a revocable trust that elects to be treated
as part of a decedent's estate is a separate share.
DATES: Effective Date: December 28, 1999.
[[Page 72541]]
Applicability Dates: For dates of applicability of these
regulations, see Sec. 1.663(c)-6.
FOR FURTHER INFORMATION CONTACT: Laura Howell, (202) 622-3060 (not a
toll-free number).
SUPPLEMENTARY INFORMATION:
Background
On January 6, 1999, a notice of proposed rulemaking was published
in the Federal Register (64 FR 790) relating to the application of the
separate share rules to estates under section 663(c). Written comments
were received on the proposed regulations, and a public hearing was
held on April 22, 1999. After consideration of all the comments, the
proposed regulations under section 663(c) are adopted as revised by
this Treasury decision.
Explanation of Provisions
General Separate Share Rules
The proposed regulations define a separate share as a separate
economic interest in one beneficiary or class of beneficiaries of the
decedent's estate such that the economic interests of the beneficiary
or class of beneficiaries (for example, rights to income or gains from
specified items of property) are not affected by economic interests
accruing to another beneficiary or class of beneficiaries. The proposed
regulations conclude that there are separate shares in an estate when a
beneficiary or class of beneficiaries has an interest in a decedent's
estate (whether corpus or income, or both) that no other beneficiary or
class of beneficiaries has.
Two commentators suggested a narrower definition of a separate
share. One commentator suggested that separate shares exist only when
the estate is administered as two or more well-defined shares that
could be separate estates. Another commentator suggested that separate
share treatment should apply only where the existence of separate
shares is clear and the funding thereof does not require burdensome
adjustments due to disproportionate distributions.
Generally, the final regulations clarify the definition and narrow
the application of the separate share rules that are in the proposed
regulations. The final regulations generally define a separate share as
a separate economic interest in one beneficiary or class of
beneficiaries of the decedent's estate such that the economic interests
of the beneficiary or class of beneficiaries neither affect nor are
affected by economic interests accruing to another beneficiary or class
of beneficiaries. The final regulations add ``nor are affected by'' to
clarify the definition of a separate share. Under this revised
definition, a separate share generally exists only if it includes both
corpus and the income attributable thereto and is independent from any
other share. Thus, income earned on assets in one share (first share)
and appreciation and depreciation in the value of those assets have no
effect on any other share. Similarly, the income and changes in value
of any other share have no effect on the first share.
Effect on Section 663(a)(1)
The proposed regulations provide that the separate share rules do
not change the rules involving bequests of specific sums of money or
specific property described in section 663(a)(1).
Commentators asked for clarification concerning whether the
separate share rules apply to bequests described in section 663(a)(1).
One commentator recommended that separate share treatment should apply
to these bequests. Another commentator suggested that while revising
Sec. 1.663(c) to apply to estates, the IRS and the Treasury Department
should reconsider and amend Sec. 1.663(a)-1(b)(1) to permit principal
distributions that are made to fund both pecuniary formula bequests and
surviving spouses' elective shares to be recognized as coming within
the definition of excluded gifts or bequests described in section
663(a)(1).
The final regulations provide that bequests described in section
663(a)(1) are not separate shares. The separate share rules are
applicable only to determine the distributable net income of each share
when applying the distribution provisions of sections 661 and 662 to
the trust or estate and its beneficiaries. Bequests described in
section 663(a)(1) are not subject to the distribution provisions and
therefore are not separate shares.
Surviving Spouse's Elective Share
The proposed regulations provide that a surviving spouse's
statutory elective share constitutes a separate share of an estate. As
a result, the surviving spouse may be taxed on the estate's gross
income only to the extent of the surviving spouse's share of that
income under state law.
One commentator recommended that separate share treatment for a
surviving spouse's elective share should be reconsidered. Elective
shares should be a matter of further study because they are forced by
state law, differ from state to state, and usually are part of an
acrimonious conflict. Another commentator requested clarification of
whether a surviving spouse's statutory elective share is included in
the subchapter J estate. Further, this commentator recommended that an
elective share that is not entitled to income or appreciation should be
excluded from the subchapter J estate, but an elective share that is
entitled to income and appreciation should be included in the
subchapter J estate.
Conversely, other commentators agreed that separate share treatment
should apply to a surviving spouse's statutory elective share
regardless of whether the surviving spouse is entitled to income and
shares in appreciation or depreciation. One commentator suggested that
the separate share examples in the proposed regulations be revised to
track more closely the Uniform Probate Code model because it will
likely be adopted by most states.
These final regulations do not change the result of the proposed
regulations. However, under these final regulations, a surviving
spouse's elective share that under local law is entitled to income and
to share in appreciation or depreciation constitutes a separate share
under the general definition. Further, under a special rule in the
final regulations, a surviving spouse's elective share that is not
entitled to income or does not share in appreciation or depreciation is
also a separate share.
Revocable Trust as a Part of Estate
The proposed regulations provide that a qualified revocable trust
that elects under section 645 to be treated as part of the decedent's
estate for income tax purposes constitutes a separate share. In
response to comments, these final regulations include a reference that
the electing revocable trust itself may have two or more separate
shares. These final regulations further provide that qualified
revocable trusts within the definition of section 645(b)(1) are subject
to the separate share rules applicable to estates rather than trusts
whether or not an election is made to be part of the estate.
Pecuniary Formula Bequests
The preamble to the proposed regulations requests comments
concerning the treatment of pecuniary formula bequests as separate
shares. Several commentators, noting that pecuniary formula bequests
are similar to a surviving spouse's statutory elective share, suggested
that such bequests be treated as separate shares. Commentators
disagreed, however, on whether pecuniary formula bequests not entitled
to income should be separate shares.
[[Page 72542]]
Under these final regulations, any pecuniary formula bequest that
is entitled to income and to share in appreciation or depreciation
under the governing instrument or local law constitutes a separate
share under the general definition. Further, under a special rule, a
pecuniary formula bequest that is not entitled to income or to share in
appreciation or depreciation is also a separate share if the governing
instrument does not provide that it is to be paid or credited in more
than three installments. This provision regarding three or fewer
installments parallels the specific bequest requirements in section
663(a)(1).
Administrative Rules
Commentators requested guidance concerning several administrative
matters. Commentators asked for guidance concerning when separate
shares come into existence. The final regulations provide that separate
shares come into existence at the earliest moment that a fiduciary may
reasonably determine, based upon the known facts, that a separate share
exists.
Two commentators expressed concern about the need to readjust the
separate shares as a result of an IRS examination. One commentator
suggested that separate share treatment should apply to pecuniary
formula bequests only if no amended returns and no adjustments to any
tax periods would be required when the tax returns were filed in good
faith. Another commentator recommended that separate share treatment
should not apply to residuary bequests unless or until the regulations
provide simple and practical methods of compliance for possible
adjustments made during IRS examinations.
These final regulations do not adopt either suggestion. The
regulations provide that the fiduciary must use a reasonable and
equitable method to determine the value of each separate share and the
allocation of taxable income to each share. This approach gives the
fiduciary flexibility, within limits, in applying the separate share
rules. However, redeterminations in value of those separate shares must
be taken into account.
Commentators asked for a clarification of whether gross income of
an estate must be allocated to a separate share based upon the amount
of income each share is entitled to under the terms of the governing
instrument or applicable local law. These final regulations clarify
that, in computing the distributable net income for each separate
share, the portion of gross income that is income within the meaning of
section 643(b) must be allocated to each share based upon the amount of
income each share is entitled to under the terms of the governing
instrument or applicable local law. A similar allocation rule is
provided for the amount of gross income that is not attributable to
cash received by a trust or estate, such as a distributive share of a
partnership's tax items, or the pro rata share of an S corporation's
tax items.
Commentators asked whether the general rule for allocating gross
income is applicable for income in respect of a decedent under section
691(a). These final regulations clarify that such gross income is
allocated among the separate shares that could potentially be funded
with these amounts irrespective of whether a share is entitled to
receive any income under the terms of the governing instrument or
applicable local law. The amount allocated to each share is based upon
the relative value of each of those shares that could potentially be
funded with such amounts.
One commentator requested clarification concerning the allocation
of expenses to a separate share. These final regulations do not change
the long standing rule under Sec. 1.663(c)-2 of the Income Tax
Regulations that any expense which is applicable solely to one separate
share of a trust is not available as a deduction to any other share of
the same trust. The IRS and the Treasury Department are not aware of
any issues that have arisen in applying this rule.
Interest on Pecuniary Bequests or Delayed Estate Distributions
Commentators questioned why the proposed regulations take the
position that interest, imposed by state law, on a pecuniary bequest or
a delayed estate distribution is a payment of interest by the estate
and not a distribution for purposes of sections 661 and 662. These same
commentators indicated that alternatively such interest payments should
be deductible administrative expenses if the interest was required to
be paid by state law as part of the distribution and settlement of the
estate. The final regulations retain the position taken in the proposed
regulations because the IRS and the Treasury Department view this
result as compelled by section 163(h) which disallows a deduction for
personal interest as described in section 163(h)(2).
Requests Concerning Applicable Dates
One commentator suggested that either the applicable date of these
final regulations should be retroactive to the date that section 1307
of the Tax Reform Act of 1997 became applicable, or the regulations
should provide that during the interim period before final regulations
are published, the IRS will accept any reasonable interpretation of the
separate share rules, including those rules provided in the proposed
regulations.
Another commentator requested that the final regulations, to the
extent applicable to trusts, apply prospectively and apply either only
to trusts that become irrevocable after the date the regulations are
finalized or only to taxable years of trusts beginning after the date
the regulations are finalized.
The final regulations have taken these comments into account as
noted below.
Effective Dates
These final regulations are applicable for estates and qualified
revocable trusts within the meaning of section 645(b)(1) with respect
to decedents who die after December 28, 1999. However, for estates and
qualified revocable trusts with respect to decedents who died after the
date that section 1307 of the Tax Reform Act of 1997 became effective
but before December 28, 1999, the IRS will accept any reasonable
interpretation of the separate share provisions, including those
provisions provided in 1999-11 I.R.B. 41 (see
Sec. 601.601(d)(2)(ii)(b)). For trusts other than qualified revocable
trusts, Sec. 1.663(c)-2 is applicable for taxable years of such trusts
beginning after December 28, 1999.
Effect on Other Documents
The following publications are obsolete as of December 28, 1999:
Rev. Rul. 64-101 (1964-1 C.B. 77).
Rev. Rul. 71-167 (1971-1 C.B. 163).
Special Analyses
It has been determined that these final regulations are not a
significant regulatory action as defined in Executive Order 12866.
Therefore, a regulatory assessment is not required. It also has been
determined that section 553(b) of the Administrative Procedure Act (5
U.S.C. chapter 5) does not apply to these regulations and, because
these final regulations do not impose a collection of information
requirement on small entities, the Regulatory Flexibility Act (5 U.S.C.
chapter 6) does not apply. Pursuant to section 7805(f) of the Internal
Revenue Code, the notice of proposed rulemaking preceding these
regulations was submitted to the Chief Counsel for Advocacy of the
Small Business Administration for comment on its impact on small
business.
Drafting Information. The principal author of these regulations is
Laura Howell of the Office of Assistant Chief Counsel (Passthroughs and
Special
[[Page 72543]]
Industries). However, other personnel from the IRS and Treasury
Department participated in their development.
List of Subjects in 26 CFR Part 1
Income taxes, Reporting and Recordkeeping requirements.
Adoption of Amendments to the Regulations
Accordingly, 26 CFR part 1 is amended as follows:
PART 1--INCOME TAXES
Paragraph 1. The authority citation for part 1 is amended by adding
an entry in numerical order to read in part as follows:
Authority: 26 U.S.C. 7805 * * *
Sections 1.663(c)-1, 1.663(c)-2, 1.663(c)-3, 1.663(c)-4,
1.663(c)-5, and 1.663(c)-6 also issued under 26 U.S.C. 663(c). * * *
Par. 2. In Sec. 1.663(a)-1, paragraph (b)(3) is amended by revising
Example 1, Example 2, and Example 3 to read as follows:
Sec. 1.663(a)-1 Special rules applicable to sections 661 and 662;
exclusion; gifts, bequests, etc.
* * * * *
(b) * * *
(3) * * *
Example 1. Under the terms of a will, a legacy of $5,000 was
left to A, 1,000 shares of X company stock was left to W, and the
balance of the estate was to be divided equally between W and B. No
provision was made in the will for the disposition of income of the
estate during the period of administration. The estate had income of
$25,000 during the taxable year 1954, which was accumulated and
added to corpus for estate accounting purposes. During the taxable
year, the executor paid the legacy of $5,000 in a lump sum to A,
transferred the X company stock to W, and made no other
distributions to beneficiaries. The distributions to A and W qualify
for the exclusion under section 663(a)(1).
Example 2. Under the terms of a will, the testator's estate was
to be distributed to A. No provision was made in the will for the
distribution of the estate's income during the period of
administration. The estate had income of $50,000 for the taxable
year. The estate distributed to A stock with a basis of $40,000 and
with a fair market value of $40,000 on the date of distribution. No
other distributions were made during the year. The distribution does
not qualify for the exclusion under section 663(a)(1), because it is
not a specific gift to A required by the terms of the will.
Accordingly, the fair market value of the property ($40,000)
represents a distribution within the meaning of sections 661(a) and
662(a) (see Sec. 1.661(a)-2(c)).
Example 3. Under the terms of a trust instrument, trust income
is to be accumulated for a period of 10 years. During the eleventh
year, the trustee is to distribute $10,000 to B, payable from income
or corpus, and $10,000 to C, payable out of accumulated income. The
trustee is to distribute the balance of the accumulated income to A.
Thereafter, A is to receive all the current income until the trust
terminates. Only the distribution to B would qualify for the
exclusion under section 663(a)(1).
* * * * *
Par. 3. Section 1.663(c)-1 is amended as follows:
1. The section heading is revised.
2. Paragraph (a) is amended by revising the words ``trust'' and
``trusts'' to read ``trust (or estate)'' and ``trusts (or estates)'',
respectively, in the first through fourth sentences.
3. Paragraph (b)(2) is removed and paragraphs (b)(3) and (b)(4) are
redesignated as paragraphs (b)(2) and (b)(3), respectively.
4. Paragraphs (b) through (d) are amended by revising the words
``trust'' and ``trusts'' to read ``trust (or estate)'' and ``trusts (or
estates)'', respectively.
The revision reads as follows:
Sec. 1.663(c)-1 Separate shares treated as separate trusts or as
separate estates; in general.
* * * * *
Par. 4. Section 1.663(c)-2, is revised to read as follows:
Sec. 1.663(c)-2 Rules of administration.
(a) When separate shares come into existence. A separate share
comes into existence upon the earliest moment that a fiduciary may
reasonably determine, based upon the known facts, that a separate
economic interest exists.
(b) Computation of distributable net income for each separate
share--(1) General rule. The amount of distributable net income for any
share under section 663(c) is computed as if each share constituted a
separate trust or estate. Accordingly, each separate share shall
calculate its distributable net income based upon its portion of gross
income that is includible in distributable net income and its portion
of any applicable deductions or losses.
(2) Section 643(b) income. This paragraph (b)(2) governs the
allocation of the portion of gross income includible in distributable
net income that is income within the meaning of section 643(b). Such
gross income is allocated among the separate shares in accordance with
the amount of income that each share is entitled to under the terms of
the governing instrument or applicable local law.
(3) Income in respect of a decedent. This paragraph (b)(3) governs
the allocation of the portion of gross income includible in
distributable net income that is income in respect of a decedent within
the meaning of section 691(a) and is not income within the meaning of
section 643(b). Such gross income is allocated among the separate
shares that could potentially be funded with these amounts irrespective
of whether the share is entitled to receive any income under the terms
of the governing instrument or applicable local law. The amount of such
gross income allocated to each share is based on the relative value of
each share that could potentially be funded with such amounts.
(4) Gross income not attributable to cash. This paragraph (b)(4)
governs the allocation of the portion of gross income includible in
distributable net income that is not attributable to cash received by
the estate or trust (for example, original issue discount, a
distributive share of partnership tax items, and the pro rata share of
an S corporation's tax items). Such gross income is allocated among the
separate shares in the same proportion as section 643(b) income from
the same source would be allocated under the terms of the governing
instrument or applicable local law.
(5) Deductions and losses. Any deduction or any loss which is
applicable solely to one separate share of the trust or estate is not
available to any other share of the same trust or estate.
(c) Computations and valuations. For purposes of calculating
distributable net income for each separate share, the fiduciary must
use a reasonable and equitable method to make the allocations,
calculations, and valuations required by paragraph (b) of this section.
Par. 5. Section 1.663(c)-3 is amended by revising the section
heading and the first sentence of paragraph (a), and removing paragraph
(f) to read as follows:
Sec. 1.663(c)-3 Applicability of separate share rule to certain
trusts.
(a) The applicability of the separate share rule provided by
section 663(c) to trusts other than qualified revocable trusts within
the meaning of section 645(b)(1) will generally depend upon whether
distributions of the trust are to be made in substantially the same
manner as if separate trusts had been created.
* * * * *
Sec. 1.663(c)-4 [Redesignated as Sec. 1.663(c)-5]
Par. 6. Section 1.663(c)-4 is redesignated as Sec. 1.663(c)-5.
Par. 7. A new Sec. 1.663(c)-4 is added to read as follows:
[[Page 72544]]
Sec. 1.663(c)-4 Applicability of separate share rule to estates and
qualified revocable trusts.
(a) General rule. The applicability of the separate share rule
provided by section 663(c) to estates and qualified revocable trusts
within the meaning of section 645(b)(1) will generally depend upon
whether the governing instrument and applicable local law create
separate economic interests in one beneficiary or class of
beneficiaries of such estate or trust. Ordinarily, a separate share
exists if the economic interests of the beneficiary or class of
beneficiaries neither affect nor are affected by the economic interests
accruing to another beneficiary or class of beneficiaries. Separate
shares include, for example, the income on bequeathed property if the
recipient of the specific bequest is entitled to such income and a
surviving spouse's elective share that under local law is entitled to
income and appreciation or depreciation. Furthermore, a qualified
revocable trust for which an election is made under section 645 is
always a separate share of the estate and may itself contain two or
more separate shares. Conversely, a gift or bequest of a specific sum
of money or of property as defined in section 663(a)(1) is not a
separate share.
(b) Special rule for certain types of beneficial interests.
Notwithstanding the provisions of paragraph (a) of this section, a
surviving spouse's elective share that under local law is determined as
of the date of the decedent's death and is not entitled to income or
any appreciation or depreciation is a separate share. Similarly,
notwithstanding the provisions of paragraph (a) of this section, a
pecuniary formula bequest that, under the terms of the governing
instrument or applicable local law, is not entitled to income or to
share in appreciation or depreciation constitutes a separate share if
the governing instrument does not provide that it is to be paid or
credited in more than three installments.
(c) Shares with multiple beneficiaries and beneficiaries of
multiple shares. A share may be considered as separate even though more
than one beneficiary has an interest in it. For example, two
beneficiaries may have equal, disproportionate, or indeterminate
interests in one share which is economically separate and independent
from another share in which one or more beneficiaries have an interest.
Moreover, the same person may be a beneficiary of more than one
separate share.
Par. 8. Newly designated Sec. 1.663(c)-5 is amended by:
1. Revising the section heading and introductory text.
2. Redesignating the Example as Example 1 and, in newly designated
Example 1, redesignating paragraphs (a) through (e) as paragraphs (i)
through (v), respectively.
3. Adding Example 2, Example 3, Example 4, Example 5, Example 6,
Example 7, Example 8, Example 9, Example 10, and Example 11.
The revisions and additions read as follows:
Sec. 1.663(c)-5 Examples.
Section 663(c) may be illustrated by the following examples:
Example 1. * * *
Example 2 (i) Facts. Testator, who dies in 2000, is survived by
a spouse and two children. Testator's will contains a fractional
formula bequest dividing the residuary estate between the surviving
spouse and a trust for the benefit of the children. Under the
fractional formula, the marital bequest constitutes 60% of the
estate and the children's trust constitutes 40% of the estate.
During the year, the executor makes a partial proportionate
distribution of $1,000,0000, ($600,000 to the surviving spouse and
$400,000 to the children's trust) and makes no other distributions.
The estate receives dividend income of $20,000, and pays expenses of
$8,000 that are deductible on the estate's federal income tax
return.
(ii) Conclusion. The fractional formula bequests to the
surviving spouse and to the children's trust are separate shares.
Because Testator's will provides for fractional formula residuary
bequests, the income and any appreciation in the value of the estate
assets are proportionately allocated between the marital share and
the trust's share. Therefore, in determining the distributable net
income of each share, the income and expenses must be allocated 60%
to the marital share and 40% to the trust's share. The distributable
net income is $7,200 (60% of income less 60% of expenses) for the
marital share and $4,800 (40% of income less 40% of expenses) for
the trust's share. Because the amount distributed in partial
satisfaction of each bequest exceeds the distributable net income of
each share, the estate's distribution deduction under section 661 is
limited to the sum of the distributable net income for both shares.
The estate is allowed a distribution deduction of $12,000 ($7,200
for the marital share and $4,800 for the trust's share). As a
result, the estate has zero taxable income ($20,000 income less
$8,000 expenses and $12,000 distribution deduction). Under section
662, the surviving spouse and the trust must include in gross income
$7,200 and $4,800, respectively.
Example 3. The facts are the same as in Example 2, except that
in 2000 the executor makes the payment to partially fund the
children's trust but makes no payment to the surviving spouse. The
fiduciary must use a reasonable and equitable method to allocate
income and expenses to the trust's share. Therefore, depending on
when the distribution is made to the trust, it may no longer be
reasonable or equitable to determine the distributable net income
for the trust's share by allocating to it 40% of the estate's income
and expenses for the year. The computation of the distributable net
income for the trust's share should take into consideration that
after the partial distribution the relative size of the trust's
separate share is reduced and the relative size of the spouse's
separate share is increased.
Example 4 (i) Facts. Testator, who dies in 2000, is survived by
a spouse and one child. Testator's will provides for a pecuniary
formula bequest to be paid in not more than three installments to a
trust for the benefit of the child in the amount needed to reduce
the estate taxes to zero and a bequest of the residuary to the
surviving spouse. The will provides that the bequest to the child's
trust is not entitled to any of the estate's income and does not
participate in appreciation or depreciation in estate assets. During
the 2000 taxable year, the estate receives dividend income of
$200,000 and pays expenses of $15,000 that are deductible on the
estate's federal income tax return. The executor partially funds the
child's trust by distributing to it securities that have an adjusted
basis to the estate of $350,000 and a fair market value of $380,000
on the date of distribution. As a result of this distribution, the
estate realizes long-term capital gain of $30,000.
(ii) Conclusion. The estate has two separate shares consisting
of a formula pecuniary bequest to the child's trust and a residuary
bequest to the surviving spouse. Because, under the terms of the
will, no estate income is allocated to the bequest to the child's
trust, the distributable net income for that trust's share is zero.
Therefore, with respect to the $380,000 distribution to the child's
trust, the estate is allowed no deduction under section 661, and no
amount is included in the trust's gross income under section 662.
Because no distributions were made to the spouse, there is no need
to compute the distributable net income allocable to the marital
share. The taxable income of the estate for the 2000 taxable year is
$214,400 ($200,000 (dividend income) plus $30,000 (capital gain)
minus $15,000 (expenses) and minus $600 (personal exemption)).
Example 5. The facts are the same as in Example 4, except that
during 2000 the estate reports on its federal income tax return a
pro rata share of an S corporation's tax items and a distributive
share of a partnership's tax items allocated on Form K-1s to the
estate by the S corporation and by the partnership, respectively.
Because, under the terms of the will, no estate income from the S
corporation or the partnership would be allocated to the pecuniary
bequest to child's trust, none of the tax items attributable to the
S corporation stock or the partnership interest is allocated to the
trust's separate share. Therefore, with respect to the $380,000
distribution to the trust, the estate is allowed no deduction under
section 661, and no amount is included in the trust's gross income
under section 662.
Example 6. The facts are the same as in Example 4, except that
during 2000 the estate receives a distribution of $900,000 from the
[[Page 72545]]
decedent's individual retirement account that is included in the
estate's gross income as income in respect of a decedent under
section 691(a). The entire $900,000 is allocated to corpus under
applicable local law. Both the separate share for the child's trust
and the separate share for the surviving spouse may potentially be
funded with the proceeds from the individual retirement account.
Therefore, a portion of the $900,000 gross income must be allocated
to the trust's separate share. The amount allocated to the trust's
share must be based upon the relative values of the two separate
shares using a reasonable and equitable method. The estate is
entitled to a deduction under section 661 for the portion of the
$900,000 properly allocated to the trust's separate share, and the
trust must include this amount in income under section 662.
Example 7 (i) Facts. Testator, who dies in 2000, is survived by
a spouse and three adult children. Testator's will divides the
residue of the estate equally among the three children. The
surviving spouse files an election under the applicable state's
elective share statute. Under this statute, a surviving spouse is
entitled to one-third of the decedent's estate after the payment of
debts and expenses. The statute also provides that the surviving
spouse is not entitled to any of the estate's income and does not
participate in appreciation or depreciation of the estate's assets.
However, under the statute, the surviving spouse is entitled to
interest on the elective share from the date of the court order
directing the payment until the executor actually makes payment.
During the estate's 2001 taxable year, the estate distributes to the
surviving spouse $5,000,000 in partial satisfaction of the elective
share and pays $200,000 of interest on the delayed payment of the
elective share. During that year, the estate receives dividend
income of $3,000,000 and pays expenses of $60,000 that are
deductible on the estate's federal income tax return.
(ii) Conclusion. The estate has four separate shares consisting
of the surviving spouse's elective share and each of the three
children's residuary bequests. Because the surviving spouse is not
entitled to any estate income under state law, none of the estate's
gross income is allocated to the spouse's separate share for
purposes of determining that share's distributable net income.
Therefore, with respect to the $5,000,000 distribution, the estate
is allowed no deduction under section 661, and no amount is included
in the spouse's gross income under section 662. The $200,000 of
interest paid to the spouse must be included in the spouse's gross
income under section 61. Because no distributions were made to any
other beneficiaries during the year, there is no need to compute the
distributable net income of the other three separate shares. Thus,
the taxable income of the estate for the 2000 taxable year is
$2,939,400 ($3,000,000 (dividend income) minus $60,000 (expenses)
and $600 (personal exemption)). The estate's $200,000 interest
payment is a nondeductible personal interest expense described in
section 163(h).
Example 8. The will of Testator, who dies in 2000, directs the
executor to distribute the X stock and all dividends therefrom to
child A and the residue of the estate to child B. The estate has two
separate shares consisting of the income on the X stock bequeathed
to A and the residue of the estate bequeathed to B. The bequest of
the X stock meets the definition of section 663(a)(1) and therefore
is not a separate share. If any distributions, other than shares of
the X stock, are made during the year to either A or B, then for
purposes of determining the distributable net income for the
separate shares, gross income attributable to dividends on the X
stock must be allocated to A's separate share and any other income
must be allocated to B's separate share.
Example 9. The will of Testator, who dies in 2000, directs the
executor to divide the residue of the estate equally between
Testator's two children, A and B. The will directs the executor to
fund A's share first with the proceeds of Testator's individual
retirement account. The date of death value of the estate after the
payment of debts, expenses, and estate taxes is $9,000,000. During
2000, the $900,000 balance in Testator's individual retirement
account is distributed to the estate. The entire $900,000 is
allocated to corpus under applicable local law. This amount is
income in respect of a decedent within the meaning of section
691(a). The estate has two separate shares, one for the benefit of A
and one for the benefit of B. If any distributions are made to
either A or B during the year, then, for purposes of determining the
distributable net income for each separate share, the $900,000 of
income in respect of a decedent must be allocated to A's share.
Example 10. The facts are the same as in Example 9, except that
the will directs the executor to fund A's share first with X stock
valued at $3,000,000, rather than with the proceeds of the
individual retirement account. The estate has two separate shares,
one for the benefit of A and one for the benefit of B. If any
distributions are made to either A or B during the year, then, for
purposes of determining the distributable net income for each
separate share, the $900,000 of gross income attributable to the
proceeds from the individual retirement account must be allocated
between the two shares to the extent that they could potentially be
funded with those proceeds. The maximum amount of A's share that
could potentially be funded with the income in respect of decedent
is $1,500,000 ($4,500,000 value of share less $3,000,000 to be
funded with stock) and the maximum amount of B's share that could
potentially be funded with income in respect of decedent is
$4,500,000. Based upon the relative values of these amounts, the
gross income attributable to the proceeds of the individual
retirement account is allocated $225,000 (or one-fourth) to A's
share and $675,000 (or three-fourths) to B's share.
Example 11. The will of Testator, who dies in 2000, provides
that after the payment of specific bequests of money, the residue of
the estate is to be divided equally among the Testator's three
children, A, B, and C. The will also provides that during the period
of administration one-half of the income from the residue is to be
paid to a designated charitable organization. After the specific
bequests of money are paid, the estate initially has three equal
separate shares. One share is for the benefit of the charitable
organization and A, another share is for the benefit of the
charitable organization and B, and the last share is for the benefit
of the charitable organization and C. During the period of
administration, payments of income to the charitable organization
are deductible by the estate to the extent provided in section
642(c) and are not subject to the distribution provisions of
sections 661 and 662.
Par. 9. Section 1.663(c)-6 is added to read as follows:
Sec. 1.663(c)-6 Effective dates.
Sections 1.663(c)-1 through 1.663(c)-5 are applicable for estates
and qualified revocable trusts within the meaning of section 645(b)(1)
with respect to decedents who die after December 28, 1999. However, for
estates and qualified revocable trusts with respect to decedents who
died after the date that section 1307 of the Tax Reform Act of 1997
became effective but before December 28, 1999, the IRS will accept any
reasonable interpretation of the separate share provisions, including
those provisions provided in 1999-11 I.R.B. 41 (see
Sec. 601.601(d)(2)(ii)(b) of this chapter). For trusts other than
qualified revocable trusts, Sec. 1.663(c)-2 is applicable for taxable
years of such trusts beginning after December 28, 1999.
Robert E. Wenzel,
Deputy Commissioner of Internal Revenue.
Approved: December 13, 1999.
Jonathan Talisman,
Acting Assistant Secretary for the Treasury.
[FR Doc. 99-32694 Filed 12-27-99; 8:45 am]
BILLING CODE 4830-01-U