SUBCHAPTER J: THE PROPOSED SECTION 643(B) REGULATIONS, THE DEFINITION OF INCOME AND THE ALLOCATION OF CAPITAL GAINS¹

By James R. Chisholm, Esq.^*

Sections 641 thro ugh 668 of the Internal Revenue Code ("IRC" or the "Code")², known as Subchapter J, set forth the basic rules for taxing the income of estates and many trusts.³ Estates and trusts are generally taxed like individuals with the fiduciary responsible for the payment of the tax, but numerous special rules apply to trusts that do not apply to individuals. The most important difference between the income taxation of estates and trusts and the income taxation of individuals is that estates and trusts deduct certain distributions made to beneficiaries who, in turn, are required to include such distributions in gross income. This article discusses the basic concepts of what is considered income of an estate or ordinary trust under Subchapter J and the impact of the new proposed regulations under § 643(b).

I. FIDUCIARY ACCOUNTING INCOME

The concept of "income" occupies a central role in Subchapter J. At the very heart of Subchapter J are the rules governing characterization of distributions. These rules determine the distribution deduction available to an estate or trust and limit the amount on which a beneficiary is subject to taxation. In essence, these rules allocate liability for payment of the taxes, if any, on the entity’s income between the entity and its beneficiaries. Under IRC § 651 or § 661, a trust that is required to distribute "income" currently is entitled to a distribution deduction equal to the amount of such income.⁴ Similarly, in certain situations, IRC § 652 or § 662 provides that the amount on which a trust beneficiary is subject to taxation cannot exceed the amount of "income" to which he or she is entitled.⁵ Therefore, an entity’s "income" must be determined.