Hello and thank you for your question. I had the pleasure of
answering your earlier question on Google Answers, and here we are
again!
We should start with the premise of your question, that "a non-grantor
trust [can be] considered a "pass through" device under the Kitner
case and IZRR 301.7701-4(b)."
Leaving the Kitner/Kintner case aside for the moment, Treasury Reg.
Section 301.7701-4 distinguishes between ordinary trusts and business
trusts.
(a) Ordinary trusts. In general, the term ``trust'' as used in the
Internal Revenue Code refers to an arrangement created either by a
will or by an inter vivos declaration whereby trustees take title to
property for the purpose of protecting or conserving it for the
beneficiaries under the ordinary rules applied in chancery or probate
courts. Usually the beneficiaries of such a trust do no more than
accept the benefits thereof and are not the voluntary planners or
creators of the trust arrangement. However, the beneficiaries of such
a trust may be the persons who create it and it will be recognized as
a trust under the Internal Revenue Code if it was created for the
purpose of protecting or conserving the trust property for
beneficiaries who stand in the same relation to the trust as they
would if the trust had been created by others for them. Generally
speaking, an arrangement will be treated as a trust under the Internal
Revenue Code if it can be shown that the purpose of the arrangement is
to vest in trustees responsibility for the protection and conservation
of property for beneficiaries who cannot share in the discharge of
this responsibility and, therefore, are not associates in a joint
enterprise for the conduct of business for profit.
(b) Business trusts. There are other arrangements which are known
as trusts because the legal title to property is conveyed to trustees
for the benefit of beneficiaries, but which are not classified as
trusts for purposes of the Internal Revenue Code because they are not
simply arrangements to protect or conserve the property for the
beneficiaries. These trusts, which are often known as business or
commercial trusts, generally are created by the beneficiaries simply
as a device to carry on a profit-making business which normally would
have been carried on through business organizations that are
classified as corporations or partnerships under the Internal Revenue
Code. However, the fact that the corpus of the trust is not supplied
by the beneficiaries is not sufficient reason in itself for
classifying the arrangement as an ordinary trust rather than as an
association or partnership. The fact that any organization is
technically cast in the trust form, by conveying title to property to
trustees for the benefit of persons designated as beneficiaries, will
not change the real character of the organization if the organization
is more properly classified as a business entity under Sec.
301.7701-2.
http://a257.g.akamaitech.net/7/257/2422/12feb20041500/edocket.access.gpo.gov/cfr_2004/aprqtr/26cfr301.7701-4.htm
This is where the Kintner case and regulations come in. Back in 1954
there was some controversy about whether a business entity could style
itself alternatively as a partnership or a corporation. Following the
Kintner case the IRS issued regulations describing the attributes they
would look at (there were four of them) in deciding how a business
entity should be taxed.
Happily this is of only historical interest, since we now have "check
the box" regulations that clearly allow a business entity to choose
how it will be taxed.
http://www.findarticles.com/p/articles/mi_qa3655/is_199707/ai_n8781080
http://www.scbar.org/pdf/SCL/Sep97/stanley.pdf
http://www.mmblaw.com/articles_and_updates/entity_choice/12.html
So yes, assuming that the trust in question is a business trust and
not an ordinary trust, it can readily be classified as a pass-through
entity.
But unfortunately your other assumption, that a pass-through entity
"therefore [is] not subject to tax before distribution of profits" is
not the whole story. The reason that pass-through entities
(partnerships and the like) are not subject to tax is that their
owners are subject to tax on the entities' income. So if the business
trust has 1,000 of income, and even without making any distribution of
that income, its owners are required to pay tax on that 1,000.
Here is the partnership tax form
http://www.irs.gov/pub/irs-pdf/f1065.pdf
Schedule K to Form 1065 is where the partnership income is set forth
in each category. These figures are then carried via Form K-1 and
imported into Schedule E of the partners' individual returns,
regardless of whether the partnership made any distribution of income.
http://www.irs.gov/pub/irs-pdf/f1040se.pdf
So if in the same year that a business trust earns $10,000 of taxable
income and instead of distributing it, uses that $10,000 to capitalize
a limited partnership as a limited partner, and receives $10,000 worth
of
limited partnership shares in exchange for the $10,000 in cash, the
owners of that business trust nonetheless must report that 10,000 of
income proportionately on Schedule E of their personal returns.
Which leads to the conclusion that no, the business trust does not
qualify for a deferral, and even though there is indeed no tax due by
the trust in that year (which would be the same result even if the
business trust had made any distributions), the tax is due by the
owners of the business trust.
Search terms used:
"kintner regulations
partnership tax site:irs.gov
I hope you find this answer to be clear and useful. If not, please
feel free to request clarification.
Sincerely,
Google Answers Researcher
Richard-ga |
Request for Answer Clarification by
droger-ga
on
15 Mar 2005 21:00 PST
The non-grantor trust is a common law complex estate trust based on
contract--(see Schumann-Heink v. Folsom, 328 III 321, 159 NE 250, 58
ALR 485 (R102) and Navarro Savings Assn. v. Lee, 446 U.S. 458) It has
a Trustee, a Trust Protector, a Trustor who created it and UBI (unit
of beneficial interest) or CBI (certificate of beneficial interest)
holders. However, the Trust is not "owned" by anyone--it effectively
owns itself, files its own tax return, and is run by the Trustee who
administers it for the eventual benefit of the UBI holders. The
UBI's/CBI's do not convey ownership in the trust, they do not
represent any legal title or vested income rights, and they do not
confer beneficiary status--(This insures fee simple ownership by the
trustee of all the assets in the trust) UBI/CBI holders receive
distributions at the sole discretion of the trustee, but they can make
no demands whatsoever on the trust.
Since the UBI holders do not own the trust, and have no legal claim on
the trust and its assets, can they possibly be responsible for taxes
in a pass through event?
Also, does PLR 9509025 support a deferral to the grantor?
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Clarification of Answer by
richard-ga
on
16 Mar 2005 05:00 PST
I'd like to hear more about the rights and obligations of the UBI
(unit of beneficial interest) or CBI (certificate of beneficial
interest) holders. These rights and obligations are probably
described in the trust document. Can you type out for me the
operative words of the trust that apply to them?
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Clarification of Answer by
richard-ga
on
16 Mar 2005 11:58 PST
Searches on the Schumann-Heink case point to a number of websites that
promote dubious "pure trust" tax avoidance strategies. Please
consider what the reputable Tax Prophet site and the IRS itself have
to say about these.
"Can you really avoid income taxes by placing your assets in a "Pure,"
"Pure Equity" or "Constitutional" Trust? What about an
"Unincorporated Business Organization?" Has any court ever approved
such a trust as a legitimate tax planning vehicle? .... What about
convicted tax felon Irwin Schiff and his "Zero-Income" scam, or the
"Foreign-Source Income" nonsense being peddled by Thurston Bell and
his cohorts? Read the following articles before you fall prey to tax
and trust scam artists."
Tax and Trust Scam Bulletin Board
http://www.taxprophet.com/hot/Trustscam.shtml
EXAMPLES OF ABUSIVE TRUST ARRANGEMENTS
"1. The Business Trust. The owner of a business transfers the business
to a trust (sometimes described as an unincorporated business trust)
in exchange for units or certificates of beneficial interest,
sometimes described as units of beneficial interest or UBI?s (trust
units). The business trust makes payments to the trust unit holders or
to other trusts created by the owner (characterized either as
deductible business expenses or as deductible distributions) that
purport to reduce the taxable income of the business trust to the
point where little or no tax is due from the business trust. In
addition, the owner claims the arrangement reduces or eliminates the
owner?s self-employment taxes on the theory that the owner is
receiving reduced or no income from the operation of the business. In
some cases, the trust units are supposed to be canceled at death or
"sold" at a nominal price to the owner?s children, leading to the
contention by promoters that there is no estate tax liability."
IRS Cumulative Bulletin Notice 97-24, , I.R.B. 1997-16, 6, April 3, 1997
http://www.taxprophet.com/hot/IRSNotice.htm
I do understand that the arrangment described in your question is
different from the business trust scheme described by the IRS. But I
do not see any reason that yours shouldn't be taxed as a partnership
flow-through entity under Code Section 702 to the holders of its UBI
or CBI shares.
I never addressed Section 721(a) in your original question. Like PLR
9509025, this simply stands for the proposition that the business
trust like any investor can in most cases contribute property to a
limited partnership investment vehicle without recognition of gain.
But nonetheless, the business trust or further flow-through entity in
which it invests will be required to report income that it earns on
Form 1065, and to issue Forms K-1 to its owners so that they can pay
tax currently on their share of such income, whether or not
distributed to them. [In this case the limited partnership would
issue a K-1 to the business trust, and the business trust would report
such income on its Form 1065 and issue a further K-1 passing that
income down to its owners.]
-R
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Clarification of Answer by
richard-ga
on
16 Mar 2005 15:49 PST
Hello again:
I've been looking further into the "pure" trust devices that are so
heavily promoted on various websites. A good place to see them
encapsulated on one page is the Real Solution Handbook
http://trustedbusiness.com/realsolutionhand.html
Unfortunatly the tax content on the above page is misleading at best.
Here's a useful rundown of the pure trust claims:
MSN Money: Never trust a 'pure trust'
http://moneycentral.msn.com/content/RetirementandWills/P43424.asp
Does this help?
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Request for Answer Clarification by
droger-ga
on
22 Mar 2005 13:43 PST
You are right--the tax info on that page is misleading @ best--
UBI/CBI language might read something like;
"This certificate does not confer ant interest in, or to, trust
assests, or in any management or control thereof...there shall be no
benefits to the issuance of this certificate other than receipt of
such trust income as the Trustee thereof may determine...This
certificate confers no rights, powers, privileges, or interest except
those specifically stated in the declaration of trust"
So these UBI's/CBI's do not confer ownership in the trust--in fact,
they specifically preclude ownership--
For case law on UBI/CBI--Estate of Monroe D. Anderson v. Commissioner
of Internal Revenue, & Tax Court 706.721(R117); Burnet v. Logan 284
U.S. 404 51 S. Ct. 550 75 L Ed 1143 (1931)(R126); C.I.R. v. Marshman
279 F2d 27 (1960); Goodhue v. State Street Trust Co. 267 MASS 28 165
NE701(R146); Elm Street Realty v. Commissioner, 76 TC No 68, 814
(1981)
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Clarification of Answer by
richard-ga
on
22 Mar 2005 15:46 PST
Of the cases you cite, the one that's really worth considering is Elm
Street Realty.
Although Elm Street Realty is sometimes cited by pure trust advocates, e.g.
http://ira-wg.com/library/significant_advantages_of_common_law_contract_trusts.html
http://www.svpvril.com/ubo.html
Please read the following article closely. It cites Elm Street in
explaining the dichotomy between ordinary trusts and business trusts,
and how they (or their beneficiaryies/members) are taxed:
Business Law Today
Trusts, taxes and business
http://www.abanet.org/buslaw/blt/2003-11-12/bishop.shtml
Believe me when I tell you that the arrangement you have in mind is
EITHER an "ordinary trust" under part (a) of the 7701 regulation that
I quoted in my original answer, or it's a "business trust" under part
(b).
If it's an ordinary trust, it will be taxed under Code Section 641
("Imposition of Tax"), whereby that the trust will owe income tax on
everything it earns, except that in years when it distributes money to
the certificate holders, that income tax liability will be shifted to
them to the extent of what the law calls "distributable net income."
If it's a business trust, then unless it qualifies as and elects to be
treated as a corporation under the check the box rules (which would be
a mistake tax-wise), the certificate holders will be taxed currently
per Section 701 ("Partners, Not Partnership, Subject To Tax") on its
income whether or not they receive distributions.
But either way, somebody will pay the tax on income as earned.
The remaining cases that you cite are not really helpful to the
question. I review them below for the sake of completeness:
The Anderson case is cited in
http://www.assetpro.us/busting_the_trust_busters.htm for the
proposition that "Even bad bargains in genuine business transactions
do not result in taxable gifts." This is certainly true, but not
really relevant to the income tax issues raised by your question.
See also http://www.asaprotection.com/caselaw.htm , another of the
"pure trust" sites.
The Anderson case also rightly stands for the proposition that there
should be no income tax cost to setting up the business trust, nor to
the business trust's making its investment in the LLC that you
describe.
See http://www.gtlaw.com/pub/articles/2000/heschj00b.pdf (page 15).
Burnet v. Logan is a U.S. Supreme Court case from 1931, back in the
day when the courts were trying to figure out what constituted income,
and in when income was recognized.
http://www2.gsu.edu/~accerl/taxrelated/BU.html
The 'open transaction' doctrine is now pretty much subsumed by
Internal Revenue Code Section 453, leaving the case primarily of
historic interest.
Marshman is another case that the 'pure trust' websites like to quote
http://www.webtrust.com/courtcases.htm
Marshman is related to the Davis case,
http://caselaw.lp.findlaw.com/scripts/getcase.pl?court=us&vol=370&invol=65
which cites it, in which the Supreme Court considered a transfer
between spouses incident to a divorce.
Here again the court decisions are pretty much superceded by
provisions of the Internal Revenue Code, but since your question does
not involve a divorce they're really irrelevant.
Goodhue is another favorite of the pure trust folks: "Certificates are
not chattels, but are evidences of intangible rights".
http://www.assetpro.us/federal_contract_trust_law.htm
http://ira-wg.com/library/significant_advantages_of_common_law_contract_trusts.html
http://www.protectyourstuff.com/case.law.html
Clearly a true statement, but what does it prove?
The scheme you describe is well within the range of bogus 'pure trust'
and 'contract trust' arguments - - Don't believe them!
Sincerely,
Richard-ga
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