PROPOSALS FOR INCOME AND GRATUITOUS TRANSFER TAX LAW REFORMS, A COMBINED ANNUAL MARK-TO-MARKET AND WEALTH TAX, AND A UNIFORM STATE FIDUCIARY INCOME TAX LAW

Written by Richard S. Kinyon, Esq.^*

I. SYNOPSIS

Good tax policy relating to estate planning and estate and trust administration should be based on parallelism or correlation between federal income and gratuitous transfer (estate, gift, and generation-skipping transfer) tax laws, and between federal and state income and gratuitous transfer tax laws; and that policy should be reflected in comprehensive general rules and limited exceptions to those rules. One such general rule is that earned income from an individual’s personal efforts is (and should be) taxed to that individual.⁰¹ In the seminal case of Lucas v. Earl (1930) 281 U.S. 111, the U.S. Supreme Court decided that although an individual can assign the right to receive their earned income, that income is nevertheless taxable to the individual who earned it.⁰² A related general rule is that net income with respect to property generally is (and should be) taxable to the person who is the beneficial owner of the property and whose income it is. Net income with respect to property owned by an individual is (and should be) taxed to that individual; and if that individual makes a gratuitous transfer of that property, the net income with respect to that property thereafter generally is (and should be) taxable to the transferees who are the beneficial owners of that property and its net income.

If a completed lifetime gift of property is made to a trust, the person to whom the net income with respect to the trust property is taxable under current law is either the grantor, the trust, one or more beneficiaries of the trust, and/or a person other than the grantor who is treated as the owner of the property because of powers exercisable or previously exercised by that other person. In order to determine who should be taxed on the net income with respect to property owned by an irrevocable trust, it seems logical and appropriate to tax the net income to the beneficiaries, if possible, and to (1) correlate the income and gratuitous transfer tax grantor trust rules relating to transfers of property in trust, in furtherance of the principal referred to above that the net income with respect to property generally should be taxable to the persons who are the beneficial owners of the property, and (2) revise and simplify the way in which beneficial ownership of property is determined for both income and gratuitous tax purposes.