that portion of the trust. Prior law provided the following exceptions to this rule:

(1) the power to apply the income for the support of a dependent to the extent that the power was is not used to apply the income for the support of the dependent;

(2) any power to control beneficial enjoyment of the principal or income that takes effect only after 10 years from the transfer to the trust or after the death of the income beneficiary;

(3) a power exercisable solely by will other than powers which affect accumulated income in the trust;

(4) a power to allocate income of corpus among charitable beneficiaries;

(5) a power to distribute corpus (a) to beneficiaries within a fixed class of beneficiaries which is subject to a reasonably definite standard or (b) to income beneficiaries where the corpus distribution was an advancement of that beneficiary's proportionate share of the trust;

(6) a power to withhold income temporarily from a beneficiary within a fixed class of beneficiaries where the withheld income must have been distributed to that beneficiary or his estate or the beneficiary had a general power of appointment over that property; (7) a power to withhold income during the disability of a beneficiary within a fixed class of beneficiaries;

(8) a power to allocate items between income and corpus;

(9) a power held by an independent trustee to spray income and corpus among a fixed class of beneficiaries; and

(10) a power to allocate income or corpus to beneficiaries within a fixed class of beneficiaries that was subject to a reasonably definite external standard.

Administrative powers

Under both present and prior law, a grantor is treated as the owner of a portion of the trust with respect to which—

(1) the grantor or a nonadverse party has the power to deal with the trust for less than adequate and full consideration;

(2) the grantor or a nonadverse party has a power which enables the grantor to borrow trust income or corpus without adequate interest or without adequate security;

(3) the grantor has borrowed income or corpus of the trust and has not repaid that amount before the beginning of the taxable year, unless the loan provides for adequate interest and security and is made by an independent trustee; and

(4) the grantor has retained the power exercisable in a nonfiduciary capacity (a) to vote stock of a corporation in which the holdings of the trust and the grantor are significant from a viewpoint of voting control, (b) to control the investments of the trust in such corporations, or (c) to reacquire trust corpus by substituting other property of equivalent value.

Power to revoke

Under prior law, the grantor was treated as the owner of a portion of a trust where the grantor had the power to revest the title to that portion in the grantor, other than a power that cannot affect the beneficial enjoyment of the property until after 10 years

from the transfer to the trust or after the death of the income beneficiary.

Income for benefit of grantor

Under both present and prior law, the grantor is treated as the owner of a portion of a trust if the income from that portion is, or in the discretion of the grantor or a nonadverse party may be, (1) distributed to the grantor or the grantor's spouse, (2) held for future distribution to the grantor or the grantor's spouse, or (3) applied to the payment of premiums on life insurance on the life of the grantor or the grantor's spouse. Prior law provided an exception if the power could have been exercised only after 10 years from the transfer to the trust or the death of the income beneficiary and if the power could have been used to apply corpus or income of the trust to discharge the grantor's obligation of support of a dependent, unless the power was so exercised.

Foreign trusts having United States beneficiaries

Under both present and prior law, a grantor who is a United States person is treated as the owner of any foreign trust for any year that the trust has a United States person as a beneficiary. Alimony trusts

Present and prior law provides another exception to the grantor trust rules in the case of certain alimony trusts. Under those rules, the income of the trust will be taxable to the grantor's former spouse, and not the grantor, if the income of the trust is payable to the former spouse of the grantor pursuant to a written separation agreement or under a decree of divorce. This exception does not apply with respect to amounts paid by the trust for the support of minor children.

Reasons for Change

While the Congress believed that there are many nontax reasons for the creation of trusts, the Congress was concerned about the tax benefits arising under the grantor trust rules of present law. The prior rules relating to grantor trusts permitted the taxation of the stream of income from assets to be separated from the ownership of those assets. This was particularly true of trusts which took advantage of the so-called "10-year rule" which resulted in nonapplication of the grantor trust provisions where certain powers and interests which were retained by the grantor did not become effective in the grantor for a period of 10 years. In addition, many tax practitioners took the position that the application of the prior law grantor trust provisions could be avoided by having the prohibited powers or interests become effective in the spouse of the grantor (e.g., the spousal remainder trust).

In order to reduce the tax benefits arising from the use of trusts, the Congress believed that the so-called "10-year rule" should be repealed so that a trust would be treated as a grantor trust in all cases were there is any significant possibility that interests and powers in the trust may become effective in the grantor after the creation of the trust. Moreover, the Congress believed that inter

ests and powers of spouses of the grantor should be treated as held by the grantor for purposes of the grantor trust rules.

Explanation of Provision

The Act repeals the 10-year exception of present law and replaces that rule with a rule that treats a trust as a grantor trust where there is more than a 5 percent possibility that any of the proscribed powers or interests will become effective in the grantor after the transfer of property to the trust. For this purpose, the possibility that an interest may return to the grantor or his spouse solely under intestacy laws is to be ignored under this provision.In order to ease administration of this rule, the Act provides an exception under which the grantor is deemed not to have retained a proscribed power or interest if that interest or power can become effective in the grantor only after the death of a lineal descendant of the grantor who also is a beneficiary of that portion of the trust. In order for this rule to apply to all or a portion of a trust, the beneficiary whose life is used must have the entire present interest (as defined in sec. 2503(c)) in that trust or trust portion.

The Act also provides that, for purposes of the grantor trust provisions, the grantor is treated as holding any power or interest held by the grantor's spouse if that spouse is living with the grantor. For this purpose, a person is treated as a spouse of the grantor who is living with the grantor if that person and the grantor are eligible to file a joint return with respect to the period in which the transfer is made. The status of a person holding a power or interest as a spouse of the grantor with whom the grantor is living is to be determined at the time of the transfer of the property to the trust.

Effective Date

The provision applies to transfers in trusts made after March 1, 1986. The Act provides an exception under which the 10-year rule of present law would continue to apply to certain trusts created pursuant to binding property settlements entered into before March 1, 1986, which required the creation of a trust and the transfer to the trust of property by the grantor.

Revenue Effect

The provisions revising the rate schedule and grantor trust rules are estimated to increase fiscal year budget receipts by $69 million in 1987, $217 million in 1988, $234 million in 1989, $253 million in 1990, and $275 in 1991.

3. Taxable years of trusts (Sec. 1413 of the Act and sec. 645 of the Code)

Prior Law

Under both present and prior law, trusts generally are treated as conduits with respect to amounts that are distributed currently and taxed as individuals with respect amounts retained in the trust. The conduit treatment is achieved by allowing the trust a deduction for amounts that are distributed to beneficiaries during the

taxable year to the extent of the distributable net income of the trust for that taxable year. Such distributions are includible in the gross income of the beneficiaries to the extent of the distributable net income of the trust. Where the trust and the beneficiaries have different taxable years, the amounts includible in the gross income of the beneficiaries are determined by reference to income of the trust for its taxable year ending with or within the taxable year of the beneficiary.

Reasons for Change

In the case where the trust has a taxable year different than the taxable year of its beneficiaries, the present and prior law rules governing the taxation of trusts permit the deferral of taxation by one month for each month that the taxable year of the trust ends sooner than the taxable year of its beneficiaries. Thus, in the case of a taxable year of a trust ending on January 31 and the trust beneficiary on a calendar year, the taxation of trust income which is distributed to the beneficiary is deferred eleven months.

The Congress believed that the ability to defer taxation on income through the selection of taxable years of trusts should be limited. Accordingly, the Act requires all trusts to have a calendar year as its taxable year. Where the beneficiaries of the trust use a calendar year for their taxable year (which is typically the case), this rule will eliminate any deferral of taxation of income.

Explanation of Provision

The Act requires that all trusts (both existing and newly created) adopt a calendar year as its taxable year. However, the Act provides an exception under which tax-exempt trusts (described in sec. 501) and wholly charitable trusts (described in sec. 4947(a)(1)) are not required to adopt a calendar year.

Effective Date

The provision is effective for taxable years beginning after December 31, 1986. Thus, in the case of a trust with a taxable year ending on January 31, the trust must adopt a taxable year beginning on February 1, 1987, and ending on December 31, 1987. Consequently, the trust will have a short taxable year (i.e., a taxable year of less than 12 months) in 1987.

In order to alleviate the bunching of taxable income arising from the change in taxable years, the Act provides that the taxable income to the beneficiary attributable to any short taxable year required under the Act is to be spread over a four year period beginning with the year of change. Thus, in the above example, if the amount includible in the income of a beneficiary for the short year

3 Under both present and prior law, a decedent's estate is treated as a separate taxable entity, beginning as of the date of death. The estate may elect a taxable year different than the decedent's taxable year. The Congress recognized that the same possibilities of deferral also are present in the case of estates. Nonetheless, the duration of estates generally is much shorter than the duration of trusts and there often is a greater need for executors of estates to select an accounting period that coincides with the administration of the estate. The Act does not, therefore, affect the present law treatment of the taxable years of estates.

is $4,000, the beneficiary would include $1,000 in income in his taxable years 1987, 1988, 1989, and 1990.4

Revenue Effect

This provision is estimated to increase fiscal year budget receipts by $747 million in 1987, $83 million in 1988, $86 million in 1989, $88 million in 1990, and $90 million in 1991.

4. Requirement that trusts and estates make estimated payments of income tax (Sec. 1414 of the Act and secs. 6152 and 6654 of the Code)

Prior Law

Under prior law, trusts and estates were not required to make estimated tax payments (sec. 6654(k)). Trusts were required to pay their income tax at the time of filing of the income tax return (sec. 6151). Moreover, estates could have elected to pay their income tax in four equal installments beginning with the due date of the return and for each 3 month period thereafter (sec. 6152).

Reasons for Change

The Congress believed that trusts and estates should pay tax in the same manner as is required of individuals.

Explanation of Provision

The Act provides that both new and existing trusts and estates pay estimated tax in the same manner as individuals. In addition, the Act repeals the rules that permit estates to pay their tax over four equal installments.

In addition, the Act provides that, in the case of trusts making estimated payments, the trustee may elect to assign any amount of its quarterly payments to a beneficiary or beneficiaries. Such an election must be made on the income tax return of the trust which is filed within 65 days after the end of the trust's taxable year. If the trustee makes such an election, the amount of credits assigned to beneficiaries is considered a distribution under the 65-day rule of section 663. Thus, the beneficiary to whom the credit is assigned is deemed to receive a distribution on the last day of the trust's year for Federal income tax purposes. Nonetheless, the beneficiary treats the credit as received on the date the election is made for purposes of the beneficiary's estimated taxes.

Effective Date

The provision is effective for taxable years beginning after December 31, 1986.

This spreading of the inclusion of income applies to distributions of distributable net income of the trust. It does not apply to any accumulation distributions occurring during the short taxable year.