"Fred Williams" <fred.williamss[at]yahoo.com> wrote:

- quote -

It's not vague, it's "flexible." And lawyers do like it
that way, in appropriate situations, because flexible can
deal with unexpected events better than inflexible can.

On the other hand a bypass trust for which the surviving
spouse is a trustee, many of the provisions have to be a lot
more specific. The [estate tax] purpose of this is that
some of the property in the bypass trust might be better off
considered as passing to the surviving spouse and some and
some not. So you have to be very careful so that you can
get it just the way you want it.

Stu

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ed wrote:
- quote -

You can read and study all the books and then find out the
trust document's wording is so vague as to allow almost any
withdrawal by the trustee. Terms in a bypass trust document
include phrases such as "pay to my wife as much of the net
income and principal of the family trust as the trustee may
deem necessary for health, maintenance and support in her
accustomed manner of living." I'm sure examples of this
are in court cases but it seems in trust documents, books,
etc. it's not too clear on what the terms mean -- and i
think the lawyers want it this way.

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oeu2004[at]hotmail.com wrote:

snip
- quote -

I am sorry that I was not clear. This forum is for
educational purposes. However some things just can't be
handled here. The question you asked depends not only on
state law but also on what the document says. Trusts are
extremely flexible documents. So without the document in
front of me I can't tell you the answer. Plus I would still
need to know the governing state(s) law.

---
Drew Edmundson, CPA
Cary, NC

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Drew Edmundson <drewsbeagles[at]hotmail.com> wrote:
- quote -

OOPS, I meant part income and part principal.

Sorry.

---
Drew Edmundson, CPA
Cary, NC

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nomail1983[at]hotmail.com wrote:
- quote -

First, heed Herb's comments, above and let me add thereto.
If the survivor is the trustee of the bypass trust she has a
fiduciary duty to preserve it for the children (or ultimate
beneficiaries). Otherwise, the trustee has this
responsibility. What you are suggesting is akin to theft.
Would you condone paying my electrical bill out of your
checking account?

Now, all the income, and that usually does NOT include
principal and Capital Gains Distributions and long term
realized and unrealized gains are usually considered
principal, so don't try to make them "income". Short term
trading gains "could" be considered income depending on the
circumstances. I doubt if any State Trust laws contradict
this, but if they do, you have found your answer.

The survivor is allowed. and often required, to get all the
"income" from the bypass trust in order for it to qualify
for the estate tax exemption, and there is often a specific
5% principal optional distribution to the survivor. The
availability of principal to the survivor for education,
health, and maintenance "allows" the trustee to invade
principal in an emergency and AFTER the survivor's own funds
are exhausted. She canot just arbitrarily pay her bills
from the bypass trust account.

So, to allow her to steal from the trust for her own benefit
is a no-no, leading to a lawsuit by the ultimate
beneficiaries when they find out, and possibly a
dissallowance of the Federal Estate Tax Exemption for the
bypass trust (which was the only reason it was created),

I strongly suggest you read and study the Trust document as
the lawyer writing it *usually* doesn't make a mistake in
these matters. I suggest you get a couple of books on
living trust from the library and study them, including on
how to settle a living trust.

ed

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Drew Edmundson wrote:

- quote -

Thanks. That is a real epiphany for me. I was certainly
thinking in terms of tax accounting, not trust accounting.

- quote -

That is another important revelation. Every time I included
the name of the state in my trust inquiries "in case state
law might apply", I was shot down as if the idea was
ludicrous. It might have been incorrect in that context,
but you have demonstrated that it is not ludicrous in
general.

- quote -

Absolutely! My inquiries were never intended to substitute
professional advice. But in my experience, it is useful to
have some knowledge before discussing a subject with a
professional, if possible. That ensures that I ask the
proper questions and interpret what he/she tells me in the
proper context.

For example, the CPA who handles the trust taxes (and who
has many years of experience practicing in the state) told
the surviving spouse that she could not have more than
$10,000 outside the trust in order to "avoid probate". That
was causing the surviving spouse some consternation because
she wanted to maintain as much as $15,000 in a savings
account outside the trust (and that is the only major asset
outside the trust). Based on my research, I discovered that
the limit was indeed $10,000 several years ago, but the
current limit is $100,000 for the state. When I asked the
CPA about that, he did some research of his own and
confirmed that I was right.

My point is: this newsgroup provides an important
educational service, not an advisory one. Just because
someone asks a question, that does not mean that he/she is
taking the answer in lieu of consulting a professional. I
will try to include the following disclaimer at the end of
my future postings to avoid confusion.

DISCLAIMER: I appreciate your response for educational
purposes. It will not be interpreted as professional advice,
and it will not be used in lieu of seeking professional
advice if I deem that the situation warrants it.

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"tobe" <ybotkaSPM[at]cinci.rr.com> wrote:

- quote -

True. But in theory if an audit shows that the terms of a
trust don't comply with the requirements of section 2056,
the marital deduction could be denied as a terminable
interest.

I don't think that's likely to happen in this case. The law
actually encourages the decedent's trust to be set up so
that the surviving spouse can deplete it. The reason (in my
synical opinion) is that doing so results in a likely
increase of estate taxes on the death of the surviving
spouse.

Stu

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<nomail1983[at]hotmail.com> wrote

- quote -

The answer is typically "no", but the trust document will
dictate what actually is allowed.

Generally, capital gain from the selling of stock or other
assets within the trust remains as principal within the
trust (even if it is put into a 'cash' account within the
fund). Generally, the only income distributable to the
survivor is income from stocks, bonds, etc, and capital
gains distributions (i.e. a fund pays a capital gain
distribution to the trust - there are no shares sold). The
trust could say almost anything about part of the principal
being distributed to the survivor, but usually reasons for
such distribution are hardship and the like, as you stated
in your original post. Your original post states what the
trust says on this issue, and then what the survivor wants
to do. If both of these are stated correctly, this would
not be allowed under the terms of the trust.

The IRS rules only are involved to the extent of who (trust
or survivor) pays taxes on income, capital gains etc.

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snipped
- quote -

Given a similar situation several years ago I consulted 3
different CPA's who worked with attorneys who either either
specialized in tax or estate planning law I got the
following answers

a) given the date of the trust and absent any special
wording income meant the proceedings from interest and
dividends only

b) the second told me the same thing but suggested that no
one would object if I interpreted income as any taxable
gain.

c) the third one told me that if it was taxable as income,
it was income.

I elected option (a) and the trust kept the capital gain and paid tax on
it. (If my financial condition was different I might have chosen (b))

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omail1983[at]hotmail.com wrote:

- quote -

The IRS follows state law on this. Income for income taxes
is not necessarily the same as trust income for accounting
purposes. State law and the trust document control
accounting income which is the beginning for calculating the
income tax distribution deduction. By default capital gains
are not part of trust accounting income and would be added
to principal. But this is the typical rule, there are
exceptions.

Another example, if an IRA is in a trust then the IRA
balance when added to the trust is considered principal. So
each IRA distribution is typically part interest and part
principal for accounting purposes. Unless there is IRA basis
(e.g. from nondeductible contributions) the IRS considers it
all income for income tax purposes but not for deductible
distribution purposes.

From your questions either you need to spend some time and
money getting an education on trust accounting, trustee
responsibilities, and trust income taxes or you need to hire
professional help. The money to learn can be professional
fees or purchasing some good books. The typical books you
find at your local book store will probably not be adequate.
CCH, RIA, West and BNA, among others, all have excellent
materials on the subject.

---
Drew Edmundson, CPA
Cary, NC

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nomail1983[at]hotmail.com wrote:

- quote -

Drew's information is excellent - it depends on the laws of
your state. You need to talk to a local lawyer or accountant
familiar with those requirements.

- quote -

In general capital gains would be considered principal, not
income. But again, it depends on exactly what the trust says
and what the law is.

You said the survivor is "entitled" to all income from the
trust - but did she take it all as time went along, or did
she take only some income? If some, she might be able to
justify taking what she didn't take earlier as income. If
not, probably not.

You say it's a long story why she wants to take the money
out and invest it herself rather than having the trust do
it. Long complicated stories often lead to trouble. Talk
to a local tax lawyer before you do this transaction - it
could come back to haunt you.

You also say you believe you can justify her withdrawing the
principal for her health, educatior or support. But if she
uses it for an investment rather than for one of those
purposes, then it's unlikely to qualify.

Stu

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I wrote:

- quote -

Maybe not so over-simplified after all :-(.

- quote -

My question might betray a fundamental misunderstanding.
So perhaps I should go back to the basics and ask....

Is the surviving spouse entitled to take capital gains from
the sale of assets as "income", that is free of the
technical restrictions that the IRS applies to withdrawing
"principal"?

If the answer is typically "no", is it possible that the
trust document permits this? In other words, do I need to
study the trust document, or is this simply verboten by the
IRS?

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omail1983[at]hotmail.com wrote:

- quote -

What does the trust say is income and what is principal? If
the trust is silent then state law will control. Does the
trust tell you which state's laws apply? Where was the
trust formed?

Snipped the rest since without the above information there
is no way to say for sure. You can find the Revised Uniform
Principal & Income Act here:

http://www.law.upenn.edu/bll/ulc/ulc.htm

Be careful, not all states have adopted RUPIA and most/all
have made some changes.

---
Drew Edmundson, CPA
Cary, NC

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nomail1983[at]hotmail.com wrote:

- quote -

One of the purposes of a ByPass Trust you describe is to
preserve the decedent's assets for the ultimate
beneficiaries (usually his children), while at the same time
providing an income source for the surviving spouse.
Distribution of some of the principal (or "corpus") may be
allowed in some cases, for the reasons you gave.

Even though the surviving spouse may assume the function of
custodian, it is important to realize that she is NOT the
owner of the Trust and it is not part of her estate.

Distributable income is the sum of the dividends, capital
gain distributions and interest (from cash account) received
by the Trust during the year, even those might be
automatically reinvested in additional shares of the mutual
fund(s). Nevertheless, this income is still taxable to
either the Trust or, more likely, the survivor beneficiary
(via 1041/K-1).

Annual distributions of income from the Trust would normally
be made from the cash account portion of the trust. If there
is not enough cash available to make the distribution, then
shares of the mutual fund(s) need to be sold. The tax on any
capital gains is usually paid by the trust, as such capital
gains are not usually included in the definition of
distributable income.

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I know that the Survivor is entitled to the "income" from a
Decedent's Trust. And I know that the Survivor can dip into
the principal of a Decedent's Trust for limited purposes
(viz. for "health, education, support, or maintenance in
accordance with his or her accustomed manner of living").
All of this is stipulated in the trust document.

I think my question is: what is considered "income" v.
"principal"?

That might be a little over-simplified. Here are the
specifics.

The Survivor wants to take cash out of the Decedent's Trust
in order to purchase an investment for herself (i.e. not for
the Decedent's Trust). For the sake of argument, assume that
the purchase does not qualify as one of the reasons above to
permit the use of principal. (Although I might argue that
it does.)

(It is too complicated to explain why she does not want the
Decedent's Trust to purchase the investment and simply
collect the income.)

The Decedent's Trust consists of a cash account and a mutual
fund. Taken together, there is more value in the Decedent's
Trust now than when it was funded originally. (It was
originally funded to the exemption limit at the time of the
first spouse's death.) However, the value of the cash
account is about the same as it was when the trust was
originally funded. Thus, the increased value ("income")
would be the capital gains if the securities were sold.

Is the Survivor required to sell the securities in order to
count the gain as "income"? Or can the Survivor treat the
value of the trust principal in toto and take the increased
value ("income") from the easiest source -- in this case,
the cash account?

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