Red Headed Stepchild
(The Barrett family memoir of Navy Life)
by Sophie Ruth Meranski with photos

 

1383.
90-1383 Sophie in Panama 1934 or 1935 possibly with Mary Boyd or member of McKim family where Sophie resided part of time.

 

 


 

1384.
90-1384 Sophie Panama

 

 


 

1385.
Phil and Pggy Dahlquist on Alaska cruise 1973 inside passage 90=1385

 

 


 


Union Blockade, Gen.Benjamin Butler,Rowena Reed

 

Union Blockade Dear Professor [David G.] Surdam [Economics, Loyola university of Chicago]I have several times re-read with great interest your Autumn 1998 Naval War College Review article "The Union Navy's Blockade Reconsidered." It gives a balanced presentation, citing a variety of studies,and I think concluding that despite weaknesses,the blockade did contribute to ultimate victory.If you are still working in this area,and considering more definitive treatment of a large topic, I wonder whether you have run across Rowena Reed's 1978 book "Combined Operations in the Civil War"? At least two issues concerning the blockade are raised, both by Reed's analysis and by her referencs to the campaigns, writings, and opinions of General Benjamin Butler 1818-1893 of Masachusetts.One issue is whether the Union Navy could have been used more effectively in other ways - for example if it had developed greater efficiency in attacking Southern coastal and river fortified positions- capturing Southern ports rather than blockading them.In 1861 Butler achieved some success in capturing Confederate ports in the Hatteras area of North Carolina,but [Reed, page sixteen] "If Union success at Hatteras was followed up, even to the extent of holding it as a base,a Naval squadron would be required to command the Sound, leaving fewer ships for blockade duty." [Navy Secretary Gideon] Welles ... had urged Lincoln abandon the blockade policy ... and declare Confederate ports 'closed' by Act of Congress." In the index of Reed's book you will find extensive references under "blockade" and "Butler", and her opening chapter "The Anaconda" has a great deal of material relevant to economic issues. Ben Butler's 1892 autobiography and voluminous other writings contain a great deal of material - especially his argument that the BLOCKADE on COTTON EXPORTS hurt the NORTH as much or MORE than the SOUTH. Butler in late 1850s was part owner with Navy Assistant Secretary Fox of a cotton mill inLowell,Massachusetts.He argued the EXPORT blockade forced the Europeans to pay high prices for Southern COTTON so that the effect on income of Southern cotton growers were relatively mild, while New England mills felt the full brunt and were closed down. From a legal and diplomatic standpoint I do not know whether there would have been any way to BLOCK IMPORTS while exempting COTTON EXPORTS at least to domestic United States mills.. Butler had one of the most remarkable intellects in nineteenth century America, and he was consistently a champion of the poor, the workers,the common people,-beginning 1850s when he supported better wages, hours and workingconditions for the immigrant workers of Lawrence and Lowell against the Boston Whig aristocrat mill owner families.Curiously, like Pierce and Hawthorne and other New England Democrats in the 1850s he sought accord with Southerners,and at one time he was friendly with Buchanan's Secretary of War, Jefferson Davis. Some achievements of Butler:[l.]In February 1861 as War-Democrat-turned-Lincoln-supporter he was remarkably effective in recruiting Massachusetts volunteers,and his prompt arrival in Baltimore-Washington D.C. area played a vital role stabilizing the Washington capital area, permitting Lincoln's inaugural and reducing chance of Maryland secession.He incurred jealousy of West Pointers but [2.] although never gifted as a field commander captured North Carolina fort near Hatteras [3.] organized huge ammunition and supplies for 1862 New Orleans expeditin with Admiral David Farragut [4]. became strong advocate of Negro rights and of effective use of black troops, with justice for them -- a family friend Gershom Bradford 1879-1978 did research on his family connection Brigadier General Edward Wild who commanded black troops under Butler 1863-64 [5.]Butler broke Southern resistance in occupied New Orleans until European consuls engineered his removal- he was a master of psychological warfare.[6.] In his last command at Fort Fisher, North Carolina, late in 1864 his officers supported his decision to withdraw rather than take heavy casualties in storming the fort with inadequate materiel - West Pointers Halleck and Grant sabotaged Butler in supply. Later they saw the importance of the Wilmington North Carolina port to southern General Johnston - his last port -and also to the vulnerable overextended Northern Army of Sherman, so for the Second attack on Fort Fisher they gave Admiral David Dixon Porter more adequate support February 1865.[6.] Research Butler's economic views as Congressman 1860s Massachusetts governor 1883 and Populist party Presidential candidate 1884.


 


1953 tax thesis Commander Barrett p 91-1389

 

Cdr. J.B. Barrett Northeastern University School of Law Graduate Division Thesis A DRAFT STATUTE TO REPLACE THE SIXTY-FIVE DAY RULES, FEDERAL INCOME TAXATION OF ESTATES AND ORDINARY TRUSTS, ELIMINATING INEQUITIES AND AMBIGUITIES. The Sixty-Five Day Rules (Internal Revenue Code,Chapter 1, Income Tax, Supplement E - Estates and Trusts, Sec. 162 (d).) were enacted in the Revenue Act of 1942, of which, shortly afterwards, Dean Erwin N. Griswold said (56 Harvard Law Review 331), "The Revenue Act of 1942 is on the books. To the public eye it properly appears as the biggest tax bill that has ever been enacted. It will produce approximately twenty-five billion dollars in a full year of operation, which is very nearly five times as much as the amount of internal revenue raised in any year of the First World War." The Act lowered personal exemptions, increased normal and surtax rates for individuals and corporations, added a Victory tax, and increased excess profits and excise taxes. It was signed by the President on October 21,1942. Struggles for Guadalcanal and Stalingrad were then in progress, and the North African campaign was about to begin, so it is not surprising that some defects in the Act then passed unnoticed. it is remarkable, however,the the Sixty-Five Day Rules have survived so long since then.Experts have called them "extraordinarily complicated," "highly technical", and "perplexing", and difficulty in their interpreation and administration has plagued taxpayers, Treasury officials, and students alike. Utilization of the trust device for devious purposes is not new, because its flexibility is adaptable for trickery.[2] In the "Handbook of the Law of Trusts", G.G. Bogert, 1942, p. 7, we find,"It was said by an English lawyer many years ago that 'the parents of the trust were Fraud and Fear, and the Court of Conscience was its nurse' (Attorney General v. Sands, Hard. 488, 491." Like the Statute of Uses (1536) the Sixty-Five Day Rules were intended to prevent use of a device separating legal title from beneficial ownership to avoid or reduce the benefcial owner's liability to contribute to the governmental revenue. The immediate purpose was served, but just as a few more words and the new term "trust" provided a detour around the Statute,it seems that, by virtue of subsection 162 (d) (4) (added in 1943) the Sixty-Five Day Rules can be circumvented by payment of the income of year X on the sixty-fifth day of the following year Y and then paying the income of the year Y on the 65 day of the next year Z. Before and since the 1942 Act solutions have been proposed for the problem of finding a sound and fair method of taxing trust income. Amendments to Sections 162 (b), (c), and (d) in which the Sixty-five Day Rules were dropped were included in a bill introduced May 26 and passed June 19, 1948 in the House of Representatives. It went to the Senate, was referred to the Committee on Finance, but was not acted upon in the Senate. Further reference will be made to some of these proposed solutions. [3] Attempted modification of specific portions of the Internal Revenue Code like alteration of the foundation of a building, is likely to lead into unintended ramifications because of interrelation of the parts of the Code. This aspect is indicated in a much quoted article, "Thomas Walter Swan," by Learned Hand, 57 Yale Law Journal 167, 169, - after reference to Judge Swan's rare facility in "thickets of verbiage in statutes or regulations", thus: "In my own case the words of such an act as the Income Tax, for example, merely dance before my eyes in a meaningless succession; cross-reference to cross-reference, exception upon exception - couched in abstract terms that offer no handle to seize hold of - leave in my mind only a confused sense of some vitally important but successfully concealed purport, which it is my duty to extract, but which is in my power, if at all, only after the most inordinate expenditure of time. I know that these monsters are the result of fabulous industry and ingenuity, plugging up this hole and casting out that net, against all possible evasion; yet at times I cannot help recalling a saying of William James about certain pasages of Hegel: that they were no doubt written with a passion of rationality; but that one cannot help wondering whether to the reader they have any significance, save that the words are strung together with syntactical correctness. Much of the law is now as difficult to fathom, and more and more of it is likely tobe so...." [4] Obviously then, inherent difficulties are to be expected in drafting substitute provisions for any part of the Code, and there is need to tread warily lest "cross-reference to cross-reference" lead far afield on tangential excursions far outside the intended scope of discussion.On the other hand,re-examination of essentials as to trusts and taxation may prove desirable to establish a firm basis for change. CONTENT AND PURPOSE OF THE SIXTY-FIVE DAY RULES.- For present purposes, an adequate statement of the content and purpose of the Sixty-Five Day Rules is set out in "The Law of Federal Income Taxation" (1949) Jacob Mertens, Jr., (1948 Revision by James M. Henderson), Volume 6, p. 223 et seq., as follows: "Section 36.03a 1942 and Subsequent Amendments of Code. The 1942 Act made certain amendments in and additions to Section 162 of the Internal Revenue Code.--- It changed Sction 162 (b) to read as follows (changed portions being indicated ---- and a deletion by *****.) (b) There shall be allowed as an additional deduction in computing the net income of the estate or trust the amount of the income of the estate or trust for the taxable year which is to be distributed currently by the fiduciary to the LEGATEES,HEIRS,or BENEFICIARIES, ** but the amount so allowed as a deduction shall be included in computing the net income of the legatees, heirs or beneficiaries, whether distributed to them or not. As used in this subsection, "income which is to be distributed currently" includes income for the taxable year of the estate or trust, which, within the taxable year, becomes payable to the legatee, heir or beneficiary. Any [5]amount allowed as a deduction under this paragraph shall not be allowed as a deduction under subsection (c) of this section in the same or any succeeding taxable year; It then added the following new subsection - (d) Rules for Application of Subsections (b) and (c)- For the purposes of Subsections (b) and (c)- (1) Amounts distributable out of income or corpus.- In cases where the amount paid, credited, or to be distributed can be paid, credited or distributed out of other than income, the amount paid, credited, or to be distributed (except under a gift, bequest, devise or inheritance not to be paid, credited or distributed at intervals) during the taxable year of the estate or trust shall be considered as income of the estate or trust which is paid, credited, or to be distributed if the aggregate of such amounts so paid,credited, or to be distributed does not exceed the distributable income of the estate or trust for its taxable year. If the aggregate of such amounts so paid, credited, or to be distributed during the taxable year of the estate or trust in such cases exceeds the distributable income of the estate or trust for its taxable year, the amount so paid, credited or to be distributed to any legatee, heir or beneficiary shall be considered income of the estate or trust for its taxable year which is paid, credited, or to be distributed in an amount which bears the same ratio to the amount of such distributable income as the amount so paid, credited, or to be distributed to the legatee, heir or beneficiary [6]bears to the aggregate of such amounts so paid, credited,or to be distributed to legatees, heirs, and beneficiaries for the taxable year of the estate or trust.For the purposes of this paragraph "distributable income" means either (A) the net income of the estate or trust computed with the deductions allowed under subsections (b) and (c) in cases to which this paragraph does not apply, or (B) the income of the estate or trust minus the deductions provided in subsections (b) and (c) in cases to which this paragraph does not apply, whichever is the greater.In computing such distributable income the deductions under subsections (b) and (c) shall be determined without the application of paragraph (2). (2) Amounts distributable out of income of prior period.- In cases, other than cases described in paragraph (1), if on a date more than sixty-five days after the beginning of the taxable year of the estate or trust, income of the estate or trust becomes payable, the amount of such income shall be considered income of the estate or trust for its taxable year which is paid, credited, or to be distributed to the extent of the income of the estate or trust for such period, or if such period is a period of more than twelve months, the last twelve months thereof. (3) DISTRIBUTIONS IN FIRST SIXTY-FIVE DAYS OF TAXABLE YEAR.- (A) General Rule.- If within the first sixty-five days of any taxable year of the estate or trust, income of the estate or trust, for a period beginning before the beginning of the taxable year, becomes payable, such income, to the extent of the income of the estate or trust for the part of such period (7)not falling within the taxable year or, if such part is longer than twelve months, the last twelve months thereof,shall be considered, paid, credited, or to be distributed on the last day of the preceding taxable year.This subparagraph shall not apply with respect to any amount with respect to whiich subparagraph (B) applies. (B) PAYABLE OUT OF INCOME OR CORPUS.- If within the first sixty-five days of any taxable year of the estate or trust, an amount which can be paid at intervals out of other than income becomes payable, there shall be considered as paid, credited, or to be distributed on the last day of the preceding taxable year the part of such amount which bears the same ratio to such amount as the part of the interval not falling within the taxable year bears to the period of the interval.If the part of the interval not falling within the taxable year is a period of more than twelve months, the interval shall be considered to begin on the date twelve months before the end of the taxable year. The purposes of the above changes were: (1) to cover situations where there is trust or estate income, but various expenditures or distributions could be made out of or charged against either principal or income; (2) To define the meaning of "DISTRIBUTABLE INCOME"; and (3) to tax to beneficiaries amounts distributed or distributable within sixty-five days after close of a taxable year of the estate or trust but proportionately attributable to income of that year. In the latter respect, [8]what were known as "Dean" trusts had acquired a measure of popularity.These provided for distribution to the beneficiaries "then living" (or by similar phrasing kept uncertain as to identification) on a date shortly after the first of the taxable year of the trust thus keeping the income taxable to the trust for the preceding taxable year. By that means, a large part of each year's taxable income could be kept taxable to the trust, making use of its separate tax entity, in effect, to split income and keep a major part of that coming from trust assets out of the high-tax brackets of a beneficiary having considerable independent income. The "sixty-five days" , it will be noted,brings the determinative distribution date up to early in March where the taxable year of the trust is a calendar year, or similarly close to the time for making return if it is a fiscal year. Postponing the distribution date to sixty-five days after close of the trust's taxable year had the effect (apparently unforeseen) of causing double taxation in certain instances. This evoked complaints which induced Congress, in the 1943 Act, to add still another paragraph to Internal Revenue Code Section 162 (d),the language of which is rather difficult to comprehend except in the light of its known object and its explanation by regulation. [9] (4) Excess Deductions.- If for any taxable year of an estate or trust the deductions allowed under subsection (b) or (c) solely by reason of paragraph (2) or (3)(A) in respect of any income which becomes payable to a legatee, heir, or beneficiary exceed the net income of the estate or trust for such year,computed without deductions,the amount of such excess shall not be included in computing the net income of such legatee,heir,or beneficiary under subsection (b) or (c). In cases where the income deductible solely by reason of paragraph (2) or (3)(A) becomes payable to two or more legatees, heirs, or beneficiaries,, the benefit of such exclusion shall be divided among such legatees, heirs, and beneficiaries in the proportions in which they share in such income.In any case where the estate or trust is entitled to a deduction by reason of paragraph (1),in the determination of the net income of the estate or trust for purposes of this paragraph the amount of such deduction shall be determined with the application of paragraph (3)(A)." For ease of comprehension of the entire subject, it may well be borne in mind that all of Section 162 (d) of the Code is directed to relatively unusual situations, and that neither it, nor the unavoidably complex regulations construing it, come into play except where the problems to which they are directed are involved.No widespread upheaval has been wrought, but rather an amplified coverage of certain [10]phases which we would like to refer to as a matter of "clarification" did we not feel that the mantle of charity would be too strained by the use of that term." In another section of the same book (Mertens, "The Law of Federal Income Taxation" (1949), Volume 6) the taxation of annuity payments is discussed as follows: "36.80. TRUSTS FOR THE PAYMENT OF ANNUITIES. Up to 1942 amendments of the Code, "annuity trusts" for many years, following decisions of the Supreme Court in Burnet v. Whitehouse (283 U.S. 148, 75 L.Ed.916, 51 S.Ct. 374, 1931) and Helvering v. Pardee (290 U.S. 365,78 L. Ed. 365, 54 S.Ct.221, 1933)were in a somewhat different category as to the taxability of the income as between the trustee and the beneficiary.It was generally held that an "annuity" being a sum payable at intervals or periodically in any event whether or not there was adequate income for the purpose could not be taxed to the beneficiary even though the income for the taxable year was adequate to make the payment - neither could amounts so paid be deducted from the gross income of the trust, because they could not be attributed to any right to "income" as contrasted with "corpus". As a result, there was a loophole for tax avoidance by providing for annuity payments by a trust, keeping income from trust assets taxable to the separate trust entity.Sometimes, moreover, taxing of income actually going to pay annuities caused total trust income [11] or assets to be depleted by the amount of the tax, to the detriment of beneficiaries other than the annuitants. The 1942 Act changed the above by provisions the purpose of which is not at first glance obvious, but which become clear in view of the background and the announced intention of Congress in the committee reports concerning the measure.The gist of them is to attribute or "allocate" to annuity beneficiaries such portion of the distributable income for the taxable year as could be used for paying annuities,- such portion to be deducted by the trust and taxed to the beneficiaries as in the case of other income "currently distributable"---- Even before the 1942 amendments, "annuity" payments were treated as other current distributions where directed to be made outof income and so made.Now it is PRESUMED that they are made out of income. Though a trust instrument can validly direct the trustee to pay income tax with respect to income used to pay an annuity,apt language is required to this end (Toretta v. Wilmington Trust Company, 71 F.Supp. 281, 1947) and the Regulations declare that the amount paid out of income by way of tax "is, in turn, income of the beneficiary." Another author, Montgomery, "Federal Taxes- Estates,Trusts, and Gifts, 1950-51", The Ronald Press, New York, p, 190 et seq., "Amounts Which Can Be Paid, Credited, or Distributed [12] Out of Other Than Income," although contesting the view in Regulations 111 Section 29.162-2(a)of the meaning of "can be paid, credited, or distributed out of other than income", agrees that the intent of Congress was clear, saying, "That Congress, in enacting Sections 162 (d)(1) and 162(d)(3)(B) intended to repudiate the rule of Helvering v. Pardee cannot be seriously questioned.Whether Congress succeeded in enacting its intention is another matter." (He makes the point that, "When a fiduciary is REQUIRED to make a payment out of income and to invade corpus only if the income is insufficient (the situation in the Pardee case) the payment CANNOT be made out of other than income if the income is sufficient", and asserts that "There is nothing ambiguous in the use of the word 'can' in the statute." In "Notes.-Some Aspects of the Revenue Act of 1942" (56 Harvard Law Review 428 Nov. 1942)in discussion of incentives for the Act, it was said,---"revealed numerous defects in the old revenue laws, defects which have allowed flagrant tax avoidance in some instances while causing hardship in others. Furthermore,the sharply increased rates make fairness in the imposition of the tax more imperative...." altogether there seems to be no doubt that the purpose of Section 162 (d) was to make annuitants or other beneficiaries subject to tax on so much trust income as could be used to pay them despite the fact that they could be paid otherwise [13] [13]i.e. "out of other than income", Section 162 (d)(1) and to prevent "Dean trust" splitting of tax between fiduciary and beneficiary. The arbitrary setting of a sixty-five day deadline, close to the due date for returns (Internal Revenue Code Section 53 now allows fiduciary until fifteenth day of fourth month for filing) could be expected to trap existing "Dean" type trusts neatly, throwing payments back to end of preceding year (To "extent of income" for that year, if they were payments of income only; and in proportion to time interval, up to twelve months, of that year since previous payment, if payment could be made out of other than income.) The post-Sixty-Five day rule, 162 (d)(2), obviously was aimed at another tax-splitting maneuver whereby payment in the middle of the year was used to make beneficiary taxable only for so much as came from current year's income, with the fiduciary taxable for so much as was derived from the preceding year as if it were corpus. AMBIGUITIES AND INEQUITIES OF THE SIXTY-FIVE DAY RULES.- Probably the sixty-five day rules pleased some people by producing additional revenue from existing trusts of the type at which they were aimed, but dissatisfaction with the rules was expressed almost immediately and has steadily increased ever since. It would be futile to catalogue all criticisms and proposals for change, but consideration of some of them together with analysis of fundamental defects should be effective in the search for something better. [14] Section 162 (d)(1), like a stingaree, has its barb at the tail end. Under the heading "Amounts distributable out of income or corpus", it requires that the "amount" paid or payable, if it "can be paid---out of other than income"--- "shall be considered as income --- if the aggregate --- so paid --- does not exceed the distributable income --- for its taxable year" or that a proportionate part be considered as income if the aggregate paid exceed the distributable income. It then defines "distributable income" as the greater of either (A) the "net income" less deductions allowed for straight income payments (Section 162 (b) and (c)) or (B) "INCOME" less such deductions for straight income payments, the deductions (Section 162 (b) and (c)) to be determined iin either case, (A) or (B), without application of Section 162 (d)(2), the post-Sixty-Five Day Rule. As in the song, Shakespeare's "The Two Gentlemen of Verona", "Who is Sylvia? What is she?---", so here there is a question - or questions -,"What is income? Where is it income? When is it income?" Montgomery, "Federal Taxes - Estates, Trusts, and Gifts, 1950-51", p. 196, discussing regulations interpretative of Section 162 (d)(1), says, "Congress was guilty of inexcusable carelessness in using the word "income" without definition in a Code which repeatedly uses and defines "gross income" and "net income" for various purposes. However, from the fact that the definition of gross income contained in Section 22 excludes certain items from the ordinary concept of income [15] the deliberate use of the unmodified word "income" indicates a Congressional intention not to exclude such items.


 


pp 15-28 trust tax thesis 1953 Cdr. Barrett p 91-1390

 

[15] Furthermore, some idea of what was going through the mind of Congress may be gleaned from the Senate Finance Committee report on the 1942 Act:--- "income" means, in general, the amount which under the applicable law of estates and trusts is considered income available for distribution to the life tenant, legatee, or beneficiary, as the case may be." No attorney familiar with the "applicable law of estates and trusts" in any of the states would contend that "under the applicable law of estates and trusts" "income available for distribution the life tenant, legatee, or beneficiary as the case may be" may not include "items of income which are not includible in income of an individual for Federal income tax purposes." ---For example, a trust deriving income from interest on tax-exempt bonds does not include that interest in income for federal income tax purposes; but that interest may certainly under the applicable law of estates and trusts be income available for distribution to the life tenant, legatee, or beneficiary, as the case may be. "Income" means what the Senate Finance Committee said it means, in the quotation set out above. Nontaxable income should not be excluded therefrom.--- When a legislature uses the same word twice in one paragraph, it is fair to assume that it meant the same [16] thing both times. In Section 162 (d)(1) Congress used the unmodified word "income" twice - "out of other than income" and "the income of the estate or trust." In view of the fact that the Senate Finance Committee, as heretofore noted, stated that income meant "the amount which under the applicable law of estates and trusts is considered income available for distribution" we may further assume that Congress meant that type of income." In "Federal Income Taxation of Trusts and Estates",Lloyd W. Kennedy, 1948 (1953 Supplement) p. 161, discussing Section 162(d)(1), the author says, "It must be noted at the outset that under (A) the phrase is NET INCOME, whereas under (B) the word is INCOME. Resort to the Committee Reports and the Regulations discloses that NET INCOME means the income entered on Line 15 of the 1946 Fiduciary Income Tax Form 1041; i.e., the taxable gross income of the trust, minus the deductions which the trust may deduct from gross income under all Code provisions, except the special deduction under Section 162 (b) or (c). In applying this NET INCOME under (A) , the deductions of Section 162 (b) and (c) are applied to diminish the net income to what would be Line 17 on the 1946 Form 1041. The word INCOME as used in (B) means the amount which the will, trust instrument , or State law considers to be income (as distinguished from corpus) which can be paid to a beneficiary who is to receive the estate's or trusts's income, minus any amounts in this income whch is not [17] taxable income (such as tax-exempt interest on State obligations). The failure to eliminate from INCOME items which are deductible from gross income for Federal tax purposes because, under the terms of the will or trust insrument as interpreted by State law, such items are not to be applied to reduce the amount available for distributrion as INCOME, means that INCOME under (B) may often exceed net income under (A)." He examines the Treasury example, Regulation 111, Section 29.162-2(a), wherein the variation between State law and Federal tax law as to treatment of tax exempt income and capital gains results in "income" of $3300 taxable to the beneficiary and deductible by the trustee, although the trust reports Federal tax net income of only $3000 against which the $3300 deduction may be applied. By a slight modification of the facts, he further illustrates the penalty imposed upon the use of a trust by the definition of "distributble income" in the law "without regard to what would be taxable net income if the RES were directly owned by the individual beneficiary" and states, "The effect of Section 162(d)(1) in such as case is to create taxable income out of receipts received by the trust whic were not income to it at all." He is in agreement with Montgomery's view, referred to above, that the statement, (Regulation 111, Section 29.162-2(a) , third paragraph), "Second, there must be [18] eliminated from the income of the estate or trust, determined in accordance with the terms of the trust instrument and State law, items of income which are not includible in income of an individual for Federal income tax purposes.".is not set out in the law. He says,"The second principle in the quoted Regulation has no basis within Section 162(d)(1). It may be that the Commissioner considered that without this second principle the entire section might be vulnerable to attack on constitutional grounds as indirectly taxing receipts which are not income. However, the adoption by the Commissioner of this principle is favorable to taxpayers and is consonant with the treatment which he has consistently accorded to tax-exempt income received by a trust and distributed to a beneficiary." By footnote, he indicates that the problem is "real and not a mere academic speculation", referring to a decision (McCullough v. Commissioner, 153 F2d 345, CCA 2d,1946) that, "The fact that the stock dividend shares were not taxable income to the executors under the rule of Eisner v. Macomber, 252 U.S. 189---- does not preclude them from being taxable income to Mrs. McCullough when delivered to her in satisfaction of her right to receive income." He adds, "It is possible, however, that the Bureau may not apply the McCullough case." In another part of his book, 2.19, p. 273, he states that this decision "cannot be reconciled with the theory of trust-beneficiary taxation expressed by the Supreme Court in the Freuler decision" and in the 1953 Cumulative Supplement to his book, p. 29, footnote 24 [19] it is stated, "In a Special Ruling dated March 12, 1952 (reproduced in 525 CCH Par. 6157), it is indicated that the Bureau will not apply the McCullough theory." Further questions as to "What is income? Where? When?" occur in reference to depreciation of trust property, foreclosure by trust as mortgagee, transmutation of corpus by equitable decrees of State courts adjusting conflicting claims of life beneficiaries and remaindermen as to non-productive trust property, and capital gains or losses of such amount as to make Federal tax "net income" greatly above or below "income" by state law. Obviously, uniform interpretation and application of Federal tax law is certain to be impaired by gearing it to a definition of "income" subject to state law. Even the meaning of "can" has been subjected to comment by Montgomery and Kennedy. The former, p. 190 et seq., says, "When a fiduciary is REQUIRED to make a payment out of income and to invade corpus only if the income is insufficient (the situation in the Pardee case),the payment CANNOT be made out of other than income if the income is sufficient. There is nothing ambiguous in the use of the word 'can' in the statute. We are, therefore, justified in reading the law without going to the Committee reports for interpretation." (The allusion being to the language of the Senate Finance Committee Report adopted in Regulations 111, section 29-162-2(a).) Kennedy, 2.12B, p. 169, says, "This statutory language[20]raises the question of what the word "can" is supposed to mean." Another effect of Section 162(d)(1) that seems unfair is its requirement that deductions for income distributions be made "in cases to which this paragraph does not apply" before the determination of "distributable income" for cases where it does apply. The result is that the income beneficiary does not share the benefit of the pro rata apportionment of Section 162(d)(1) when total distributions to all beneficiaries exceed income. This may be defensible, however, on the theory that the apportionment is itself merely compensatory for arbitrary classification as income for payments that can be made "out of other than income." The post-Sixty-Five Day Rule, Section 162(d)(2) AMOUNTS DISTRIBUTABLE OUT OF INCOME OF PRIOR PERIOD.- applies to income which "becomes payable" more than sixty-five days after the beginning of the taxable year. Its reaching back to make income which "becomes payable" be treated as income for the taxable year "to the extent of income" for the source period or its last twelve months caused some double taxation by taxing the beneficiary in the currrent year for income already taxed to the trust in the preceding year.This was corrected by the enactment of Section 162(d)(4) in 1943. The discrepancy between "prior period" in the heading and "any period" in the text apparently has not given any difficulty, any posssible doubt apparently resolved in favor of the latter more-inclusive term. [21] The intent of the rule seems clear although there can be practical difficulties in interpreting "income" when the period involved does not coincide with the fiduciary's taxable year, particularly if income receipts of the estate or trust are not received at a uniformly regular rate. The next rule, Section 162 (d)(3)(A), for income distributions in the first sixty-five days of the taxable year, also involved double taxation until relief was provided in 1943 by Section 162 (d)(4). As in the case of (d)(2), "income" determination for fractional parts of a year and identification of source period may prove troublesome.A dubious presumption asserted in the Regulations (Regulation 111, Section 29.162(b),paragraph 2 and (c) paragraph (3)) that payable income be considered to be from "the most recently accumulated income" of the period adds complexity. The sixty-five day rule of Section 162(d)(3)(B), applicable to distributons in the first sixty-five days of the taxable year of amounts "which can be paid out of other than income", seems clear enough by itself, except for the apparently accidental omission of the word "preceding" before the final two words "taxable year" of the last sentence. (Context and subsequent regulations indicate that "preceding tax year" was intended. The difficulties under this rule arise from the necessary use of Section 162 (d)(1) in its application. Section 162 (d)(4), Excess deductions-, added in 1943, provides relief where deductions allowed the fiduciary "solely by reason of paragraph (2) or (3)(A)" exceed the "net income"[22] for the year by eliminating "such excess" from the taxable net income of the beneficiaries computed under Section 162 (b) or (c). a special exception to the usual requirement that any deduction allowed to the fiduciary for distributions shall be taxed to beneficiary recipients,- this rule does not present much difficulty by itself but may accentuate problems of "income" and "net income" determinations under Section 162 (d)(2) and(3)(A).The final sentence requires that, if both income beneficiaries and others who receive payments "out of other than income" are involved, deductions to which Section 162 (d)(3)(A) applies shall be treated as if they were actually made in the preceding year, before computation of "distributable income" under Section 162 (d)(1).Since no relief is given by Section 162(d)(4) to beneficiaries payable "out of other than income", trusts which have both kinds of beneficiaries may have computations to make under all paragraphs of Section 162 (d) and under certain situations the total amount taxable to beneficiaries may exceed the taxable net income of the fiduciary. It is evident, then, that the rules of Section 162 (d) are very intricate, with some vague definitions as to "What is income?" and some complex fictions as to "When" and "Where" it is to be considered income. The use of a definition that involves two very different concepts of income (Federal tax law and State distribution law) is further confused by the illogical amelioration in the Regulations. The rules [23] seem more favorable to annuitants than to income recipients in Section 162 (d)(1) and less so in Section 162 (d)(4). They may permit total tax to beneficaries in excess of the fiduciary's net income. Finally, although effective against those trusts already existing in 1942 which were paying a year's income in the early days of a new tax year, they seem useless as to a trust operated to throw the income of the preceding year into the current year by Section 162 (d)(2) and therafter to throw another year's income into the current year by Section 162 (d)(3)(A), by making first payment slightly after and the second slightly before the Sixty-Five Day demarkation point. THEORETICAL ASPECTS.- As stated earlier, alteration of any part of the Internal Reveue Code may lead into undesired ramifications. The problems that the Sixty-Five Day Rules were intended to meet and the confusion resulting from enactment of those rules may be merely symptoms of an internal disorder in the scheme of taxation for estates and trusts. Possibly the trusts should be treated as something less than a taxable entity or as something more, i.e., part of a dual or multiple entity for tax purposes. Early treatment of trusts as merely reporting or accounting entities permitted income for unascertained beneficiaries to escape taxation for lack of a person or entity to be taxed. On the other hand, in an article, "Trust and Beneficiary under the Income Tax", by Jacob Rabkin and Mark H. Johnson, 1 Tax Law Review 117 Volume 1, 1945-46, it is said, "The emphasis upon the trust as a separate entity has been [24] responsible for the difficulties which the 1942 Act attempted to solve." Other excerpts from the article follow: "The ENTITY - A RULE OF EXPEDIENCY. While overemphasis of Trust Entity has caused needless difficulty,it is undeniable that the entity must be recognitzed under certain circumstances. Occasionally the trust must be the taxpayer for the simple reason that no beneficiary is entitled to any amount with which to pay the tax.--" "THE ENTITY LOOPHOLE AND THE 1942 ACT. Any loophole which existed in the pre-1942 Statute did not arise from an outright exemption of income realized by the trust. All that income had to be reported on the returns of either the trust or the beneficiary. The only problem was determining which of the two taxpayers was to bear the tax burden. This allocation problem, however, became increasingly important as surtax rates began to press heavily on higher income brackets.--- Tax justice dictates that a beneficiary pay the tax upon income which is economically his. Nevertheless, in the course of judicial interpretation of pre-1942 law, there developed three types of situation in which this principle was overriden. These may be roughly characterized as (1) annuity trusts, (2) corpus distribution trusts, (3) delayed distribution trusts. In each of these situations, the language of the tax statute became entangled with artificial concepts of trust law, and the basic philosophy of trust [25] taxation was perverted. The result normally was unjustifiable tax avoidance." ENTITY INCOME IN VACUO. If it is a cardinal principle of trust taxation that all trust income should be somehow taxed to the trust or to the beneficiary, the converse proposition should be equally valid: the aggregate taxable income of trust and beneficiary should be limited to the net income realized by the trust. This latter rule, however, has not been uniformly accepted." (Baltzell v. Mitchell, 3 F2d 428, 431; Anderson v. Wilson, 289 U.S. 20). The article proposed an amended Section 162 to correct "two structural weaknesses in the pre-1942 law" --- "within the basic framework --- with but a small fraction of the rigmarole introduced by the 1942 and 1943 Acts." This may be referred to again, but at this point other views on the underlying theory seem desirable. In "Federal Income Taxation of Inter Vivos Trusts", by Abraham S. Guterman, (Institute of Federal Taxation, New York University, Ninth Annual - 1951), p.184, under "Basic Pattern of Trust Taxation" "Sections 161 and 162", we read, "The basic sections of the Internal Revenue Code dealing with the manner in which trusts generally are taxed are Sections 161 and 162. In substance, these sections provide that the trustee reports income and deductions, with certain exceptions, in substantially the same manner as an individual, but a [26] special deduction is allowed to the trustee for income distributed or distributable to the beneficiary during the taxable year, or within sixty-five days thereafter. Thus, income is taxable to the beneficiary, if it is in fact distributed during this period to the beneficiary, or if under the terms of the trust, the trustee is obligated to distribute it to the beneficiary, regardless of whether it is in fact distributed. "DISTRIBUTABLE" a State Law Question. The question whether income is distributable, with the consequence that it is taxable to the beneficiary, is primarily a state law question.--- TRUST INCOME AND BENEFICIARY INCOME. There is another rule which must be borne in mind which has to do with the manner in which the trust is administered and in wich payment is made, rather than with the precise terms of the trust indenture. Thus, for example, a trustee make make payments at the beginning of a taxable year at a time when the trust does not yet have income for that taxable year. Subsequently the trust earns income. The rule is that all payments made during the taxable year are presumed to have been paid out of income, if there is income of the trust during the taxable year. Any payments, therefore, to the extent of the income of the trust, made during [27] the taxable year, regardless of when made, will be considered income paid to the beneficiary. This is true, even though the trust contains a provision whereby the trustee has the power to advance principal to the beneficiary. Thus, if the trustee states that the exercise of the power to advance principal is being used for a particular payment, this will not be treated as an advance of principal for income tax purposes if in fact there is income earned during the taxable year. To the extent of such income, the payment will be considred an income payment." "The Law of Federal Income Taxation" (1949) , Jacob Mertens, Jr., Volume 6, 36.07, says, "---The several revenue acts in substance divide the income of estates and trusts into three principal categories.---it will be found that the general rules as to taxing trusts and estates may be roughly summarized as follows: (1) Income which the fiduciary is under a mandatory duty to accumulate and hold for future distribution under the terms of the will or trust is taxable to the fiduciary and not to the beneficiary. (2) Income which the fiduciary is under a mandatory duty to distribute CURRENTLY is taxable to the beneficiary whether or not the income is actually distributed. (3) Income which, in the discretion of the fiduciary, may be either distributed or accumulated is taxable to the fiduciary to the extent that he does not exercise his [28] discretion by either paying or crediting the income to the beneficiary. To the extent that such discretion is exercised and the income is properly paid or credited to the beneficiaries, the latter are taxable on such amounts." An interesting view of the matter was expressed before the enactment of the 1942 Act in "The Present Method of Taxing Trust Income", Henry A. Fenn, 51 Yale Law Journal 1143-1159, in part as follows: "Since the inception of the income tax in 1913 the taxation of trust income has been an ever-vexing porblem. Under the first income tax law a trust was not treated as a separate taxable entity. The Act levied a tax on the net income of all individuals but merely required fiduciaries to file ' a return of the net income of the person for whom they act, subject to this tax, coming into their custody' and to withhold the normal tax. Because of the lack of a taxable entity against which the tax could be levied, income collected by a trustee and held for the benefit of unborn or unascertained persons escaped the tax (Smietanka v., First Trust and Savings Bank, 257 U.S. 602, 1922). To remedy this casus omissus the 1916 Act specifically provided that income accumulated in trust for the benefit of unborn or unascertained persons should be taxed, :"the tax in each instance, except when the income is returned for the purposes of tax by the beneficiary, to be assessed to the --- trustee." (39 Statutes 756, 1916.). And by the 1917 Act the fiduciary was required to file a return "of the income of [29] the persons, TRUST, or ESTATE for whom or which they act." By these Acts the fiduciary was made a "taxable person" and the estate or trust a separate taxable entity (Merchants Loan & Trust Company v. Smietanka. 255 U.S. 509, 1921.


 


Commander Barrett 1953 trust tax master's thesis p 91-1391 text pp. 29-42

 

[29] The final step was taken in 1924 when the fiduciary was made primarily responsible for the tax on all income colllected by him and allowed deductions for the amounts of income distributed to or properly credited to the beneficiaries during the taxable year. (43 Statutes 275, 1924). This treatment of the trust as a separate taxable entity was thought necessary to assure the taxation of all the trust income once. The writer believes that such treatment is not necessary to assure this result, - that it is unrealistic-, and that in many cases it results in a loss of revenue and inequity.The purpose of this article is to point out the more glaring defects in the present method of taxing trust income, and to suggest a form of statute which, it is believed, would remedy these defects and afford a sound basis for the taxation of trust income. The treatment of a trust as a single entity,taxable as an individual, is unrealistic on its face.Most trusts consist of three distinct classes of persons, the trustee, the income beneficiaiary, and the remaindermen. The income beneficiary and the remaindermen are the persons who receive all the benefits; the trustee as such, although he has legal title, receives none.It is the purpose of tax laws [30] that the person who receives the benefits of income shall pay the tax and pay it at the rates applicable to him.This purpose is recognized to a limited extent in the case of trust income by the requirement that all income currently distributable or properly paid or credited to the beneficiary during the taxable year must be included in the return of the beneficiary whether he actually receives it or not.--Yet, in the case of all other trust income this purpose is completely ignored, and all such income is taxable to the trustee, regardless of who the beneficiary may be or what the rate would be if the beneificary were taxed. In other words, the one person connected with the trust, who receives no benefits from its income, is treated as the person to be taxed. The loss of revenue resulting from this treatment of the trust as a single tax entity results from the tax-consciousness of grantors and trustees. As long as the trust continues to be taxed as a single taxable entity, control of the tax effects will remain in the hands of the grantor and trustee, and they will endeavor to minimize the tax liability as far as possible." (Reference is made to Whitehouse, Pardee, and Dean cases, also to City Bank Farmers' Turst Co. v. Helvering 313 U.S. 121 91941) and Higgins v. Commissioner 312 U.S. 212 (1941).) ..The present method of taxing trust [31]income also gives rise to many inequalities of tax burden both as betwen individuals who are trust beneficiaries and those who are not, and as between individuals who are beneficiaries of different trusts. Yet achievement of at least approximate equality of tax burden betwen all taxpayers becomes increasingly important in the light of present high tax rates, and the prospect of even higher rates. The inequalities here discussed are due in part to the treatment of the trust as a single entity, rather than as a group of entities with spearate beneficial interests in the trust; they also stem from a failure to recognize the turst device as sui generis, and from attempts to apply to trusts, with certain minor exceptions, the provisions of tax laws designed for the taxation of individuals. It should be noted that none of the inequalities occur in straight income trusts where the tax law recognizes the separate beneficial interests of the income beneficiary and thee remaindermen. (One possible exception---deduction of income commissions--) -trusts should no longer be treated as individuals, and the statute should specifically provide for the deductions to be allowed to trusts.---Whether or not such deductions should be allowed is of secondary importance; the important thing is that as long as the trust is treated as an individual under the law, their allowance or disallowance cannot be decided on the merits--- [32} "To summarize again: To safeguard tax revenues, and to equalize the tax burden among the taxpayers, the trust should not be treated as a single taxable entity or taxed under statutory provisions promulgated to cover the taxation of individuals.The law should recognize that a trust is composed of a group of beneficial interests, separate as between income and principal; that these interests are property belonging to persons who are or may be made subject to the income tax statute as individulas or as classes of trust beneficiaries. The law should also abandon the application to trusts of rules dealing with deductions allowed to individuals and substitute express provisions covering trust deductions. It is apparent that these desirable results can only be achieved by a complete revision of the statutory scheme of trust taxation." The article thereafter proposed a statute for the taxation of trust income wherein gross income of a trust was to be defined by reference to Section 22(a) Internal Revenue Code, but with statutory provisions for deductions and credits specifically applicable to estates and trusts.It proposed that the trustees be required, in trust returns to allocate gross income and deductions and credits among each of four classes of income, including identification and addresses of beneificiaries in each class, thus;- (The following is abgrivated and paraphrased since tit is intended mere to outline the general scheme proposed.)[33](a) INCOME CURRENTLY DISTRIBUTABLE .- 1. Income which the beneficiary has the right to receive during the taxable year, whether distributed to the beneficiary or not; 2.Income, which, under the terms of the instrument creating the trust, may, in the discretion of the trustee, be either distributed to a beneficiary or accumulated, to the extent that such income is properly paid or credited to a beneficiary during the taxable year; 3. Income which,under the terms of the instrument creating the trust, is to be used, or may be used, to satisfy an annuity or other periodic payment of a fixed amount; and the annuitant or other payee shall be considered the beneficiary thereof. For the purpose of this section every distribution made to a beneficiary during the taxable year of the trust is deemed to have been made out of the income received by the trustee during such taxable year to the extent of such income without regard to the amount of income received by the trustee prior to the time such distribution is made. Thr proposed taxation of income of class (a) was that it be included in net income of beneficiary and tax paid by the beneficiary. (b)INCOME WHICH FORMS A PART OF THE PRINCIPAL OF THE TRUST.-(1) Income which --may only be distributed--- as principal of the trust.[34] (b) (continued) (2) Income which --- may only be distributed--- to the same person or persons, at the same time or times, and in the same proportion as the principal of the trust---. (3) Income which--- may, in the discretion of the trustee, be either distributed to a beneficiary or accumulated, and which is not properly paid or credited to a beneficiary during the taxable year of the trust, and which, under the terms---,may not be distributed after the end of such taxable year except to the same person or persons, at the same time--- as the principal of the trust is distributed. The proposed taxation for income of class (b) was that it be taxed on return filed by the trustee, as representative of remaindermen of the trust and paid from principal, with a formula for multiple trust situations. (c) INCOME ACCUMULATED IN TRUST FOR THE BENEFIT OF UNBORN OR UNASCERTAINED PERSONS .-The proposed taxation for income of class (c) was that return be filed by the trustee and tax paid from class (c) income. (d) INCOME ACCUMULATED IN TRUST FOR THE BENEFIT OF A PRESUMPTIVE BENEFICIARY .- In effect all income not included in classes (a) (b) and (c) was to be considered "accumulated in trust for the beneift of a presumptive beneficiary, i.e., the person (s) [35] (d) (continued) who would have been entitled if the requisite contingency had occurred just before the end of the trust's taxable year. The proposed taxation of income of class (d) would require that it be set out in a separate schedule in the return of the "presumptive beneficiary." This would be used in addition to his reported income to determine the TOTAL amount, rate and tax for the beneficiary as it WOULD HAVE BEEN if he had actually received the (d) class income in the taxable year for which return was made. His tax on actual income would be subtracted from this larger tax the WOULD HAVE BEEN imposed and the resulting difference in tax would be assessed to and paid by the trust. Special provision was to be made for adjusting refund within two years after actual distribution if subsequent events made this tax on trust excessive. Although this plan,particularly as to class (d) income, might be too unwieldly,it serves to direct attention to the entity problem and the defects arising from the makeshift development of the income taxation of trusts.The contention that taxation of trusts should be designed for trusts and that credits and deducations for trusts should be of such character as are suitable and proper for trusts in their normal status rather than ill-fitting ones designed for individuals seems eminently sound.[36] Without unnecessary divergence into examination of the question of modification of the present "taxable entity" status of trusts, recognition of its historical background and limitations is an element in orientation for consideration of the Sixty-Five Day Rules. Classification of income by Mertens (36.07) and Penn may be compared somewhat as follows: (Mertens) 1. Income required to be held and accumulated for future distribution. -- (Penn) (b) Income required to be or by discretion added to principal. (c) Income accululated for unborn or unascertained persons. (Mertens) 2. Income currently distributable.-- (Penn) (a) Income currently distributable. (Mertens) 3. Income to be distributed or acccumulated at fiduciary's discretion. -- (Penn) (d) Income accumulated for a presumptive beneficiary. The possibility of shifting items out of class Three (Mertens) into other classes by exercise of discretion, thereby varying taxability and rate of tax, seems to lie at the root of the practices at which the 1942 amendment to Internal Revenue Code 162 (b) and the addition of the Sixty-Five Day Rules of Section 162 (d) were aimed as well as the complexities since involved in their interpretation.[37]In addition to the theoretical aspects of trust entity, classification of income, effect of control of distribution by State law, and the essential justice of taxing the actual recipient of economic benefit, there are some less clearly defined areas to be explored. In a quotation from the article by Rabkin and Johnson, there was a statement, "If it is a cardinal principle of trust taxation that all trust income should be somehow taxed to the trust or to the beneficiary,the converse should be equally valid: the aggregate taxable income of trust and beneficiary should be limited to the net income realized by the trust." From this statement by itself, it does not appear that the theory advanced is a manifestly necessary consequence of the stated principle, but it is undeniable that its acceptance and establishment would greatly simplify trust taxatioon. If Congress can impose double taxation upon recipients of corporate income, it will not be easy to establish that it MUST accept the proposed limitation on the amount of trust distributions that is to be taxed.If acceptance of the theory is dependent upon gracious treatment bty Congress in recognition of the social utility of trusts, there is evidence that the mantle of graciousness is waeing thin. The inclusion of "fiduciary and beneficiary, legatee, or heir" in the definition of "related taxpayer" in [38] Section 3801 (a)(3)(d) of the Internal Revenue Code, although merely as to limitation periods, together with Fenn's view that treatment of the trust as a single entity, taxable as an individual,is unrealistic on its face, could be advanced to support a contention that there is really only one income of which the beneficiaries are the actual owners, - that the tax is paid from their said property, and that the trustee's function in holding legal title and administering the trust does not constitute the trust as an entity which is separable from the beneficiaries,- that there cannnot be a trust without definite beneficiaries, and that therefore,the total of amounts taxable to the beneficiaries must not exceed the amount taxable to the trust. At any rate, there is ample support for the proposition that the total amount taxable to the beneficiaries should not exceed the total income of the trust, e.e., in an article "Recent Developments in the Taxation of Estates and Trusts", by Lloyd W. Kennedy, 27 Taxes 1118 (1949), "At its September meting in St. Louis, the American Bar Association recommended legislation to amend the Code provisions dealing with the taxation of ordinary trusts and estates. It was recommended that Section 162 (b), 162(c), and 162 (d) be changed to accomplish four main objectives: (1) To eliminate the Sixty-Five Day and twelve-month rules now contained in Section 162 (d) without leaving any serious [39] loopholes for tax reduction or tax avoidance. (2) To limit the amounts includible in the income of the beneficiaries to the net income of the estate or trust. (3) To provide that income shall retain its character and identitiy in the hands of the beneficiaries and thus make it clear that the estate or trust is a conduit of property passing through it to a beneficiary. (4) To clarify the law relating to the ultimate tax on capital gains by providing that the net income of the estate or trust, for the purpose of limiting the amount taxable to the beneficiary, shall not include any item of gross income which, as between an income beneficiary and a remainderman, is not distributable under State law,unless the instrument makes specific provision for the distribution of such item or distributions which must necessarily include such item.--- The tax legislative division of the Treasury is content with the amendments of Section 162 proposed in H.R. 6712, which passed the House last year but was not acted upon by the Seante.In H.R. 6712, the Sixty-Five Day Rule is eliminated, and the beneficiary is not taxed upon amounts which were not gross income to the estate or trust, but the amount taxable to the beneficiary is not restricted to the statutory net income of the trust.[40]It is upon this latter point that the recommendations of the American Bar Association differ most markedly from the Treasury position.Representatives of the Treasury have exprssed the belief that a beneificary should be taxable on the amount distributed to him as income under the instrument even though this amount exceeds the net income of the trust. The resolution of thie basic conflict in tax philosophy will be up to Congress." Mr. Kennedy was chairman of the Committee on Taxation of Income of Estates and Trusts which prepared for presentation of Taxation Section, American Bar Association September 1949, a report and recommendation proposing that there be urged upon the proper Committees of Congress the following amendments, or their equivalent in purpose and effect: "Subsections (b),(c), and (d) of Section 162 of the Internal Revenue Code are amended to read aas follows: '(b) In computing the net income of an estate or trust an additional deduction shall be allowed equal to an amount which is to be distributed currently by the fiduciary to the beneficiaries. As used in this subsection, 'an amount which is to be distributed currently' means amounts which, within the taxable year of the estate or trust, become payable to the beneficiaries, whether distributed or not.An amount with respect to which a deduction is allowed under this subsection shall not at any time be allowed as a deduction under subsection (c), '(c) In the case of income received by estates of deceased [41] persons during the period of administration or settlement of the estates, and in the case of income which, in the discretion of the fiduciary, may be either distributed to the beneficiary or accumulated, an additional deduction shall be allowed in computing the net income of the estate or trust equal to an amount which is proerly paid or credited during its taxable year to the beneficiaries. '(d) For the purposes of subsections (b) and (c) - '(1) Amounts with respect to which an additional deduction is allowable shall be determined without reference to the amount of income realized by the estate or trust at the time the amount is paid, credited, or to be distributed, but the aggregate of such amounts shall not exceed the net income of the trust or estate for its taxable year computed before the aplication of subsections (b) and (c).As used in the preceding sentence,'net income' shall not include gains from the sale or exchange of capital assets unless paid, credited or to be distributed to a beneficiary in accordance with the terms of a will or trust instrument which makes specific provision for the distribution of such gains or which provides for distributions which must necesssarily include such gains. '(2)Amounts with respect to which an additional deduction is allowable shall not include amounts distributed under the terms of the will or trust instrument as a legacy or gift of [42] specific property or of a specific sum of money (not to be distributed at intervals). (3) An amount allowed as an additional deduction shall (except as otherwise provided in the following sentence) be included in the income of the beneficiary to whom such amount is paid, credited, or to be distributed. in computing the net income of the beneficiary such amount, if included in the gross income of the estate or trust, shall be considered to have the same character in his hands as such amount would have if such beneficiary were the owner of the property giving rise to such amount, and such amount had been received or realized directly by the beneficiary from the source from which such amount was received or realized by the estate or trust. If amounts in excess of the amount allowed as additional deductions are paid, credited or to be distributed to two or more beneficiaries, the amount allowed as an additional deduction shall first be attributed to the beneficiaries whose rights, determined in accordance with the terms of the will or trust instrument under the applicable State law, are limited to income of the estate or trust, in the proportions in which they share in such income, and the remaining portion of the amount, if any, allowed as an additional deduction shall be divided between the beneficairies whose rights are not limited to income, in the proportions in which they share in such remaining portion. [43]


 


CommanderBarrett TrustTax thesis 1953 pages 43-55 end web page 91-1392

 

[43](4) The term beneficiary includes heir, legatee, and devisee." (Dissent of one committee member, Jacob S. Seidman of New York, on the ground that the proposed legislation harbors technical shortcomings, was noted.) In "Tentative Draft No 7, FEDERAL INCOME TAX STATUTE, The American Law Institute, (Submitted for 29th Annual Meeting, May 1952), under "Organization of the Draft--- b. DISTRIBUTABLE NET INCOME" it is said in part, "The setion X815(a) definition reprsents a compromise between two theories as to the items which should go to make up distributable income. On the one hand, it is arguable that the net income of the trust as determined under the income statue should be the distributable net income.On the other hand, it is arguable that it is the income which State law and the trust instrument would apportion to an income beneficiary which should make up distributable net income. Neither of these theories has been consistently followed in the draft. Excluded from distributable net income are both items of income which are not includible in gross income under the tax and items of income, which, while includible in gross income, are not income under the applicable state law. (This means the abandonment of the rules of Johnston v. Helvering, 141 F2d 208 ---, and McCullough v. Commissioner, 153 F2d 345.---It was felt that the operation of [44] the trust sections should not have the effect of creating gross income.On the deduction side,distributable net income is decreased by all items which are deductible both under the income tax and state law, but the depreciation and depletion deduction may be taken regardless of how state law treats those items." In an article , "A PROPOSED REVISION OF THE FEDERAL INCOME TAX TREAMENT OF TRUSTS AND ESTATES- AMERICAN LAW INSTITUTE DRAFT", H. Brian Holland, Lloyd W. Kennedy, Stanley S. Surrey, and William C. Warren, 53 Columbia Law Review, No. 3, pp. 316-373, (March 1953), in describing the recommendations of the American Law Institute Draft in this area and the analysis underlying them, the article continues:- +---The problems of the income taxation of trusts and estates fall in four main categories: 1. The problem of allocation for tax purposes of trust income betwen the trust entity and a single current beneficiary - discussed in Part I of this article. 2. The problem of allocation for tax purposes of trust income among the trustees and several current beneficiaries- discussed in Part II. 3. The problem of allocation for tax purposes of trust income between, on the one hand, a grantor or another party having powers or interests respecting the trust and, on the other hand, the trust entity and its current beneficiaries, discussed in Part VI. [45] 4. The income tax treatment of estates in the light of the tax rules developed for trusts- discussed in Part V." In Part I,A, 1., there is a reference to double taxtion, "--but if nothing more were done the combination of Irwin v. Gavit and treatment of the trust as a taxable entity would produce a double tax on trust income.Whatever might be the merits of the double tax in the corporate relationship,they clearly do not extend to situations where present and future interests in property are created, and the property itself placed in the hands of a caretaker..---the solution adopted was that of preserving the taxable status of both trust and current beneficiary, but eliminating the double tax through the allowance to the trust of a special deduction for the income taxable to the beneficiary.This solution has been characterized as the conduit principle of trust taxation.----taxation of the beneficiary rests on the policy decision not to apply the gift exemption to the current income from the trust property." Later, in Part I,A, 2-d, "Statement of Suggested Test,- In the simplest situation, therefore,where the beneficiary is currently receiving all of the trust income under the trust instrument, his taxable income should be limited to the taxable net income of the trust, computed after excluding capital gains and capital losses unless capital gains are distributable. Any excess which the beneficary receives [46] over this amount represents either exempt items of gross income which should retain their exemption in his hands under the conduit principle or items which are to be regarded as amounts of corpus entitled to the gift exemption. Our test is thus a blending of state law and tax law to achieve the most sensible application of the conduit principle, as expressed in the gift exemption for the corpus and the3 special deduction for the trust for the income taxable to the beneficiary." Later portions of the article, dealing with allocation among several beneficiaries, charitable distributions, single and complex trusts and estates includes discussion of allocation of trust expenses, the substitution of the use of trust income of the current year as a measure of taxability of distributiuons instead of requiring tracing income to its source, and a plan for subdivision of income for allocation among severl beneficiaries but are not direcly involved in the proposition that the total amount taxable to beneficiaries should not exceed the net income of the trust. Any Congressional tendency to graciously liberal treatment should be tempered by considerations of fair treatment for other taxpayers and must be influenced by existing pressure for large revenues.Tax treatment of life insurance contracts has become less liberal, and more recently there have been other signs of a change. [47] An article "Federal Income Taxation of Mutual Savings Banks" by Sheldon R. Bard, 30 Taxes 436 et seq. (June 1952) includes the following:- "Recent tax legislation has reversed a trend as old as the Federal income tax.In the Revenue Act of 1950, Congress restricted the tax-exemption privilege of several classes of organizations exempt under Code Section 101, including labor, philanthropic,and educational organizations, business leagues, and chambers of commerce.---The exemption from tax of mutual savings banks dates back to the first income tax statute.The Revenue Act of 1951 repeals this exemption privilege and replaces it with hastily drafted and ill-considered provisions.The decisive factor has really been the pressing need of the government for revenue from new sources.This was indicated by Senator Walter George, who stated that this legislation "was designed to produce additional revenue." This point of view has been expressed by one commentator (Footnote; Magill, "The Taxable Income of Cooperatives," 49 Michigan Law Review 167, 190, 1950), as follows: Tax gratuities, or subsidies, in favor of worthwhile social experiments such as cooperatives, may have been sound or desirable---.They cannot be justified, however, in the political, economic, and tax climate of the 1950s." --"the attack on the tax exemption of mutual savings banks is not based on any abuses." [48] So, if, in Mr. Kennedy's words, "The resolution of this basic conflict in tax philosophy will be up to Congress", there may be stout opposition to any limiting of the amount upon which the beneficiary may be taxed to the statutory net income of the trust. Throughout the entire problem of the Sixty-Five Day Rules and "income for the taxable year" , there is a known and accepted but spectral and elusive difficulty inherent in any attempted precise allocation of income, cash or accrual, to a precise period of time, such as the taxable year. This has been a potent source of controversy and litigation in the administration of all parts of the income tax. Arbritrary and artificial definitions and boundaries are necessarily involved. The entire content of Section 162 (d) may be viewed as simply defining the boundaries for allocation of income to taxable years. Determination of the amount of the income to be taxed and the taxable year in which it is to be taxed are of the essence. The rate of tax will depend on the year and the identity of the taxpayer. Concluding consideration of theoretical aspects with some generalizations may aid in gaining perspective. What income is to be distributed to a beneficiary and when he is to receive it are determined by terms of the trust instrument and State law. Federal taxing power is very great, and the sweep of Section 22(a) is wide. If the trust and beneficiary are truly separate entities, it is [49] not inconceivable that each could be taxed for all income received that was not specifically tax-exempt. If they are but inseparable parts of a sngle entity, the total income taxable to the parts should not exceed the taxable net income of the trust as a whole. In such case, the character of items of income, such as capital gains and losses, stock dividends (non-taxable), and tax-exempt interest, should be precisely the same whether in the hands of the trustee or those of the beneficiary. There is another side to this coin! When does the income become taxable? If the trust and beneficiaries are to be treated as a single inseparable combination entity for tax purposes, should not the income be taxable as of the time of receipt by the trust and the rate, by proportional allocation, of each beneficiary who is to receive a share of it? It is apparent that complications could ensue from varied terms of instruments , (e.g. automatic addition of certain income to corpus at stated intervals or year's end, discretionary powers, and special provision as to remainders) or from delays in settlement of estates or orders of State courts. (Federal Income Taxation of Trusts and Estates, Lloyd W. Kennedy, 1953 Supplement, p. 10, 2.05, n.3, refers to case of Saulsbury v. U.S., 101 F. Supp. 280, USDC Fla 1951 wherein the beneficiary was held taxable on currently distributable income notwithstanding order of local probate court prohibiting its payment, incidental to $90,000 deficiency in estate tax. Court of Appeals, Fifth Circuit affirmed. [50]PRACTICAL ASPECTS .- In seeking to determine what is practicable as a substitute for Section 162 (d), changes in other sections of subsections may prove necessary, but, unless necessary for the desired result, will not be undertaken. Penn's statement, "It is the purpose of tax laws that the person who receives the benefits of income shall pay the tax and pay it at the rates applicable to him" seems an excellent controlling principle. Trust income of recent prior years which is paid or becomes payable to a beneficiary during the current year should not be allowed to escape taxation to the beneficiary at his rate of tax, but if practicable, credit for tax previously paid by the trust on such income should be provided, possibly subject to some charge for delay if the final tax was more than twenty per cent greater than the prior tax paid by the trust, unless the delay was a necessary result of applicable State law. Penalizing of trusts, however,seems likely to be fraught with complexities and therefore impracticable. It might sem logical to impose a penalty surtax on trusts for accumulation of income beyond "reasonable needs", analogous to that applied to the net income of corporations by Section 102, but practicable feasibility of such a plan seems extremely doubtful. The efect of Section 102 has not been an unqualified success as a deterent to corporations. Extension of such a measure to trusts would involve definition of "reasonable needs", resolution of extent of trustee's [51]discretion and its proper exercise by State law, conflicting interests of life beneficiaries and remaindermen, the elusive line of demarcation betwen income and principal, and possible acountability of the trustee for breach of duty in incurring the penalty. Beneficiaries should be taxed for amounts paid or which become payable to them during the year for which trust income was available and could be properly used therefor, even if payment out fo "other than income" was permissible under the instrument.It should be possible also to eliminate the Sixty-Five Day Rules by an arbitrary measure of "available distributable income" which includes the income of the current year plus so much income of the two immediately preceding years as may be properly paid or credited during the current year. The Treasury view that the beneficiary should be taxable on the amount distributable to him as income by State law and the terms of the instrument, even if it exceeds the net income of the trust, contrasted with the proposition that the amount taxable to the beneficiary should be limited to statutory net income of the trust requires fair consideration for remainder interests as well as those of income beneficiaries and the revenue.Tax treatment of capital gains and losses as a special kind of income has been subject to many attack and has varied from time to time. In most cases under State law these are items of corpus. In view of Baltzell v. Mitchell and Anderson v. Wilson, previously referred to, and the [52] indication by the Supreme Court in the latter case that statutory treatment of the trust for tax purposes as a separate entity required as result "not consonant with fairness and reason", the stubborn inisistence by the Treasury that capital gains constitute income must be restrained wthin reasonable limits at some point. The American Law Institute, Tentative Draft No. 7., previously referred to, seems to present a most reasonable compromise, whereby, "Excluded from distributable income are both items of income which are not includible in gross income under the tax statute and items of income, which, while includible in gross income, are not income under the applicable state law.--- On the deduction side, distributable net income is decreased by all items which are deductible both under the income tax and state law, but the depreciation and depletion deduction may be taken regardless of how state law treats these items." (The final reference to depreciation and depletion deduction seems to indicate a rather extreme position, but in other respects the result seems most reasonable.) In accepting the principle that the beneficiary recipient should pay the tax at his rate, it seems ovbious that insofar as allocable income can be identified he also should be accorded recognition of any special status of items of income that the trust was entitled to.[53] A PROPOSED SOLUTION.- It seems clear that the Sixty-Five Day Rules should be eliminated even at the risk of some disturbance to other parts of the structure of the taxation of esates and trusts. Probably complete revision of Section 162 must be made, but, since the proposed scope of discussion here was merely the replacement of the Sixty-Five Day Rules, only revision of Section 162 (d) is considered. Following the pattern of practical aspects indicated, as arbitrary measure of "available distributable income" is set up to reach reently accumulated income that was not required to be incorporated into corpus and thus remained available for distribution. Taxing distributions from this source to beneficiaries at their tax rate should achieve approximate equity for both the revenue and the taxpayer. Provision for credit for previously paid tax is included. Unless capital gain or loss were, by local law, includible in distribution determinations, these were not to be included in the components of this "available distributable income." Recognition of status of tax-emempt items or capital gain items was extended specifically to beneficiaries to same extent as for the fiduciary.On such a basis a proposed draft statute follows:[54] PROPOSED DRAFT STATUTE TO REPLACE SECTION 162 (d)(1),(2),(3)(A)(B) and (4), INTERNAL REVENUE CODE Subsection (d) of Section 162 of the Internal Revenue Code is amended to read as follows: "(d) For the purposes of subsections (b) and (c)-- (1) AMOUNTS DISTRIBUTABLE OUT OF INCOME OR CORPUS.- Amounts paid, credited, or to be distributed which could properly be paid, credited or distributed out of other than income, during a taxable year of the estate or trust, shall (except under a specific gift, bequest, devise, or inheritance not to be paid, credited or distributed at intervals) be considered as from income of the estate or trust to the extent of "available distributable income," as defined in this subsection, less deductions under subsections (b) and (c) including effect of paragraph (d)(2) hereunder where applicable.For the purposes of this subsection, "available distributable income" means: The net income for the current taxable year as determined under Section 162 and related portions of this chapter (but exclusive of capital gains or losses under Section 117 unless these items are properly distributable income under the trust instrument, will, or applicable local law) with the addition of so much of the net income thus determined of the two immediately preceding taxble years as remains available to be properly paid, credited, or distributed [55] during the current taxable year. (2)AMOUNTS DISTRIBUTABLE OUT OF INCOME OF A PRIOR PERIOD. Amounts paid, credited, or distributed during any taxable year from "available distributable income" as defined in (d)(1) above, shall be considered taxable income for the current taxable year to the beneficiary to whom they are properly paid or become payable, and allowed as deductions to the estate or trust accordingly.Credit for taxes previously paid by the estate or trust upon amounts therein included for income of the two immediately preceding years shall be allowed, without interest, as a refund or for credit against taxes of the estate or trust due within two years after the end of the current taxable year, as the fiduciary may elect. (3) RECOGNITION OF STATUS OF ITEMS INCLUDED IN DISTRIBUTIONS. - Items of distributions which, in the income of the estate or trust, were entitled to recognition as exempt from tax or subject to special treatment under Section 117, shall, if allocation or other adequate means makes their identification reasonably practicable, be given the same recognition or special treatment in behalf of the beneficiary to whom part or all of such items are paid or payable. END -55


 

 

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