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Tax Notes (a publicaion of Tax Analysts)

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In this report, Blattmachr and Gans explain how new regulations promulgated in January make reaching and fundamental changes to some tax rules that are dependent on the concept of fiduciary accounting income (FAI) under local law. The new regulations, they write, generally will respect a determination of income made by (1) a trustee's power granted under state law to adjust from the income account to the corpus account or the reverse, (2) a conversion of a pay all income trust to a unitrust one pursuant to state law, or (3) an allocation of capital gain to FAI in some cases. The regulations also provide that those conversions will not cause a beneficiary to be treated as having made a gift or any party to have made an income taxable exchange if the powers are exercised or the conversion occurs pursuant to a state statute. But, the authors note, the regulations indicate that adverse consequences may ensue if the safe harbor boundaries in defining income under the new regulations are not followed. In addition, the regulations probably have created a substantial advantage for administering trusts pursuant to a power of adjustment rather than converting them to unitrusts, in many cases.

Blattmachr and Gans believe it is hard to overemphasize the importance of the new regulations. Unfortunately, they write, the new regulations appear to contain direct contradictions on important matters, which will likely perplex trustees and their advisors until clarifications are made. Also, although the new regulations provide significant new guidance as to when capital gain of a trust may form part of DNI and, therefore, may be taxed to a beneficiary, no guidance is provided as to when, how, and to what degree the exercise of a power to adjust from the corpus account to the income account may result in capital gain becoming part of DNI. The authors conclude that this omission means it will be difficult for trustees and their advisors to determine, in some situations, how much the adjustment should be.



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