Life and Death Planning for Retirement Benefits

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328 Life and Death Planning for Retirement Benefits
The separate share regulations have the following special rule regarding the allocation of
IRD that is “corpus” (principal) for trust accounting purposes: “(3) Income in respect of a decedent.
This paragraph (b)(3) governs the allocation of the portion of gross income includible in
distributable net income that is income in respect of a decedent within the meaning of section
691(a) and is not ...[trust accounting income]. Such gross income is allocated among the separate
shares that could potentially be funded with these amounts.... based on the relative value of each
share that could potentially be funded with such amounts.” Reg. Emphasis
added.
Here’s how the separate share rule would apply to a retirement plan distribution that is
corpus for trust accounting purposes:
Jody Example: Jody dies in Year 1, leaving his $1 million 401(k) plan, $1 million of real estate,
and $1 million of marketable securities to a trust. At Jody’s death, the trust is to be divided into
two equal shares, one for each of Jody’s children Brad and Angelina, so each child is to receive a
total of $1.5 million. Each child’s share is to be distributed outright to the child upon attaining age
35. Angelina is already age 36; Brad is 33. In Year 1, the 401(k) plan sends the trustee a check for
the entire plan balance of $1 million, creating $1 million of gross income to the trust. The trustee
immediately distributes the $1 million it received from the 401(k) plan to Angelina in partial
fulfillment of her 50 percent share. The trust has no other income, and makes no other distributions,
in Year 1. What is the trust’s DNI deduction for the distribution to Angelina?
Step 1: Does the separate share rule apply? The separate share rule applies here because
distributions to Jody’s children are made “in substantially the same manner as if separate trusts
had been created” for them. Reg. If this had been a “spray” trust, with the trustee
having discretion to pay income and/or principal of the entire fund to either child at any time
(instead of having to give each child an equal amount) the separate share rule would not apply.
Step 2: Is the plan distribution corpus? The regulation next requires that we determine
whether the 401(k) plan is “corpus” for trust accounting purposes. Assume that it is; se
Step 3: Does the trust instrument or state law dictate to which share(s) this plan
distribution shall be allocated? If either the trust instrument or state law mandates that the plan
distribution be allocated to a particular share, that allocation will be followed for purposes of
allocating the resulting DNI among the separate shares. To carry out Step 3, therefore, we must
look at the terms of Jody’s particular trust and/or state law:
Scenario 1: If Jody’s trust required the trustee to allocate the 401(k) plan proceeds to
Angelina’s share, then all the income arising from that plan distribution is allocated to Angelina’s
“separate share” and the $1 million cash distribution from the trust carries out $1 million of DNI
to Angelina. Reg. Example 9.