Rev. Rul. 64-101 (1964-1 — Internal Revenue Bulletin 2000-2

Rev. Rul. 71-167 (1971-1 C.B. 163).

Special Analyses

It has been determined that these final regulations are not a significant regulatory action as defined in Executive Order 12866. Therefore, a regulatory assessment is not required. It also has been determined that section 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5) does not apply to these regulations and, because these final regulations

do not impose a collection of information requirement on small entities, the Regulatory Flexibility Act (5 U.S.C. chapter 6) does not apply. Pursuant to section 7805(f) of the Internal Revenue Code, the notice of proposed rulemaking preceding these regulations was submitted to the Chief Counsel for Advocacy of the Small Business Administration for comment on its impact on small business.

Drafting Information

The principal author of these regulations is Laura Howell of the Office of Assistant Chief Counsel (Passthroughs and Special Industries). However, other personnel from the IRS and Treasury Department participated in their development.

Adoption of Amendments to the Regulations

Accordingly, 26 CFR part 1 is amended as follows:

PART 1—INCOME TAXES

Paragraph 1. The authority citation for part 1 is amended by adding an entry in numerical order to read in part as follows:

Authority: 26 U.S.C. 7805 * * * Sections 1.663(c)-1, 1.663(c)-2, 1.663(c)3, 1.663(c)-4, 1.663(c)-5, and 1.663(c)-6 also issued under 26 U.S.C. 663(c).

- Par. 2. In §1.663(a)-1, paragraph (b)(3) is amended by revising Example 1, Exam- ple 2, and Example 3 to read as follows: §1.663(a)-1 Special rules applicable to sections 661 and 662; exclusion; gifts, be- quests, etc.

(b) * * * (3) * * *

Example 1 . Under the terms of a will, a legacy of $5,000 was left to A, 1,000 shares of X company stock was left to W, and the balance of the estate was to be divided equally between W and B. No provision was made in the will for the disposition of income of the estate during the period of administration. The estate had income of $25,000 during the taxable year 1954, which was accumulated and added to corpus for estate accounting purposes. During the taxable year, the executor paid the legacy of $5,000 in a lump sum to A, transferred the X company stock to W, and made no other distributions to beneficiaries. The distributions to A and W qualify for the exclusion under

section 663(a)(1).

Example 2 . Under the terms of a will, the testator’s estate was to be distributed to A. No provision was made in the will for the distribution of the estate’s income during the period of administration. The estate had income of $50,000 for the taxable year. The estate distributed to A stock with a basis of $40,000 and with a fair market value of $40,000 on the date of distribution. No other distributions were made during the year. The distribution does not qualify for the exclusion under section 663(a)(1), because it is not a specific gift to A required by the terms of the will. Accordingly, the fair market value of the property ($40,000) represents a distribution within the meaning of sections 661(a) and 662(a) (see §1.661(a)-2(c)).

Example 3 . Under the terms of a trust instrument, trust income is to be accumulated for a period of 10 years. During the eleventh year, the trustee is to distribute $10,000 to B, payable from income or corpus, and $10,000 to C, payable out of accumulated income. The trustee is to distribute the balance of the accumulated income to A. Thereafter, A is to receive all the current income until the trust terminates. Only the distribution to B would qualify for the exclusion under section 663(a)(1).

Par. 3. Section 1.663(c)-1 is amended as follows:

The section heading is revised.
Paragraph (a) is amended by revising the words “trust” and “trusts” to read “trust (or estate)” and “trusts (or estates)”, respectively, in the first through fourth sentences.
Paragraph (b)(2) is removed and paragraphs (b)(3) and (b)(4) are redesignated as paragraphs (b)(2) and (b)(3), respectivel y.
Paragraphs (b) through (d) are amended by revising the words “trust” and “trusts” to read “trust (or estate)” and “trusts (or estates)”, respectively.

The revision reads as follows: §1.663(c)-1 Separate shares treated as separate trusts or as separate estates; in general.

Par. 4. Section 1.663(c)-2, is revised to read as follows: §1.663(c)-2 Rules of administration.

(a) When separate shares come into existence. A separate share comes into existence upon the earliest moment that a fiduciary may reasonably determine, based upon the known facts, that a separate economic interest exists.

2000–2 I.R.B. 247 January 10, 2000

or bequest of a specific sum of money or of property as defined in section 663(a)(1) is not a separate share. (b) Special rule for certain types of bene- ficial interests . Notwithstanding the provisions of paragraph (a) of this section, a surviving spouse’s elective share that under local law is determined as of the date of the decedent’s death and is not entitled to income or any appreciation or depreciation is a separate share. Similarly, notwithstanding the provisions of paragraph (a) of this section, a pecuniary formula bequest that, under the terms of the governing instrument or applicable local law, is not entitled to income or to share in appreciation or depreciation constitutes a separate share if the governing instrument does not provide that it is to be paid or credited in more than three installments.

(c) Shares with multiple beneficiaries and beneficiaries of multiple shares. A share may be considered as separate even though more than one beneficiary has an interest in it. For example, two beneficiaries may have equal, disproportionate, or indeterminate interests in one share which is economically separate and independent from another share in which one or more beneficiaries have an interest. Moreover, the same person may be a beneficiary of more than one separate share.

Par. 8. Newly designated §1.663(c)-5 is amended by:

Revising the section heading and introductory text.
Redesignating the Example as Ex- ample 1 and, in newly designated Exam- ple 1, redesignating paragraphs (a) through (e) as paragraphs (i) through (v), respectively.
Adding Example 2, Example 3, Ex- ample 4, Example 5, Example 6, Example 7, Example 8, Example 9, Example 10, and Example 11 .

The revisions and additions read as follows: §1.663(c)-5 Examples.

Section 663(c) may be illustrated by the following examples:

Example 1 . * * *

Example 2 (i) Facts . Testator, who dies in 2000, is survived by a spouse and two children. Testator’s will contains a fractional formula bequest dividing the residuary estate between the surviving spouse and a trust for the benefit of the children. Under the fractional formula, the marital

(b) Computation of distributable net income for each separate share —(1) General rule . The amount of distributable net income for any share under section 663(c) is computed as if each share constituted a separate trust or estate. Accordingly, each separate share shall calculate its distributable net income based upon its portion of gross income that is includible in distributable net income and its portion of any applicable deductions or losses.

(2) Section 643(b) income . This paragraph (b)(2) governs the allocation of the portion of gross income includible in distributable net income that is income within the meaning of section 643(b). Such gross income is allocated among the separate shares in accordance with the amount of income that each share is entitled to under the terms of the governing instrument or applicable local law.

(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 income within the meaning of section 643(b). Such gross income is allocated among the separate shares that could potentially be funded with these amounts irrespective of whether the share is entitled to receive any income under the terms of the governing instrument or applicable local law. The amount of such gross income allocated to each share is based on the relative value of each share that could potentially be funded with such amounts.

(4) Gross income not attributable to cash. This paragraph (b)(4) governs the allocation of the portion of gross income includible in distributable net income that is not attributable to cash received by the estate or trust (for example, original issue discount, a distributive share of partnership tax items, and the pro rata share of an S corporation’s tax items). Such gross income is allocated among the separate shares in the same proportion as section 643(b) income from the same source would be allocated under the terms of the governing instrument or applicable local law.

(5) Deductions and losses . Any deduction or any loss which is applicable solely to one separate share of the trust or estate is not available to any other share

of the same trust or estate.

(c) Computations and valuations. For purposes of calculating distributable net income for each separate share, the fiduciary must use a reasonable and equitable method to make the allocations, calculations, and valuations required by paragraph (b) of this section.

Par. 5. Section 1.663(c)-3 is amended by revising the section heading and the first sentence of paragraph (a), and removing paragraph (f) to read as follows: §1.663(c)-3 Applicability of separate share rule to certain trusts .

(a) The applicability of the separate share rule provided by section 663(c) to trusts other than qualified revocable trusts within the meaning of section 645(b)(1) will generally depend upon whether distributions of the trust are to be made in substantially the same manner as if separate trusts had been created.

§1.663(c)-4 [Redesignated as §1.663(c)-5]

Par. 6. Section 1.663(c)-4 is redesignated as §1.663(c)-5.

Par. 7. A new §1.663(c)-4 is added to read as follows: §1.663(c)-4 Applicability of separate share rule to estates and qualified revoca- ble trusts.

(a) General rule . The applicability of the separate share rule provided by section 663(c) to estates and qualified revocable trusts within the meaning of section 645(b)(1) will generally depend upon whether the governing instrument and applicable local law create separate economic interests in one beneficiary or class of beneficiaries of such estate or trust. Ordinarily, a separate share exists if the economic interests of the beneficiary or class of beneficiaries neither affect nor are affected by the economic interests accruing to another beneficiary or class of beneficiaries. Separate shares include, for example, the income on bequeathed property if the recipient of the specific bequest is entitled to such income and a surviving spouse’s elective share that under local law is entitled to income and appreciation or depreciation. Furthermore, a qualified revocable trust for which an election is made under section 645 is always a separate share of the estate and may itself contain two or more separate shares. Conversely, a gift

January 10, 2000 248 2000–2 I.R.B.

bequest constitutes 60% of the estate and the chil dren’s trust constitutes 40% of the estate. During

the year, the executor makes a partial proportion ate distribution of $1,000,0000, ($600,000 to the

surviving spouse and $400,000 to the children’s

trust) and makes no other distributions. The estate

receives dividend income of $20,000, and pays ex penses of $8,000 that are deductible on the estate’s

federal income tax return.

(ii) Conclusion . The fractional formula be quests to the surviving spouse and to the children’s

trust are separate shares. Because Testator’s will

provides for fractional formula residuary bequests,

the income and any appreciation in the value of the

estate assets are proportionately allocated between

the marital share and the trust’s share. Therefore,

in determining the distributable net income of each

share, the income and expenses must be allocated

60% to the marital share and 40% to the trust’s

share. The distributable net income is $7,200

(60% of income less 60% of expenses) for the

marital share and $4,800 (40% of income less 40%

of expenses) for the trust’s share. Because the

amount distributed in partial satisfaction of each

bequest exceeds the distributable net income of

each share, the estate’s distribution deduction

under section 661 is limited to the sum of the dis tributable net income for both shares. The estate is

allowed a distribution deduction of $12,000

($7,200 for the marital share and $4,800 for the

trust’s share). As a result, the estate has zero tax able income ($20,000 income less $8,000 ex penses and $12,000 distribution deduction).

Under section 662, the surviving spouse and the

trust must include in gross income $7,200 and

$4,800, respectiv ely.

Example 3 . The facts are the same as in Exam-

ple 2, except that in 2000 the executor makes the

payment to partially fund the children’s trust but

makes no payment to the surviving spouse. The

fiduciary must use a reasonable and equitable

method to allocate income and expenses to the

trust’s share. Therefore, depending on when the

distribution is made to the trust, it may no longer

be reasonable or equitable to determine the distrib utable net income for the trust’s share by allocat ing to it 40% of the estate’s income and expenses

for the year. The computation of the distributable

net income for the trust’s share should take into

consideration that after the partial distribution the

relative size of the trust’s separate share is reduced

and the relative size of the spouse’s separate share

is increased.

Example 4 (i) Facts . Testator, who dies in

2000, is survived by a spouse and one child. Tes tator’s will provides for a pecuniary formula be quest to be paid in not more than three install ments to a trust for the benefit of the child in the

amount needed to reduce the estate taxes to zero

and a bequest of the residuary to the surviving

spouse. The will provides that the bequest to the

child’s trust is not entitled to any of the estate’s in come and does not participate in appreciation or

depreciation in estate assets. During the 2000 tax able year, the estate receives dividend income of

$200,000 and pays expenses of $15,000 that are

deductible on the estate’s federal income tax re turn. The executor partially funds the child’s trust

by distributing to it securities that have an adjusted

basis to the estate of $350,000 and a fair market

value of $380,000 on the date of distribution. As a

result of this distribution, the estate realizes long term capital gain of $30,000.

(ii) Conclusion. The estate has two separate

shares consisting of a formula pecuniary bequest

to the child’s trust and a residuary bequest to the

surviving spouse. Because, under the terms of the

will, no estate income is allocated to the bequest to

the child’s trust, the distributable net income for

that trust’s share is zero. Therefore, with respect

to the $380,000 distribution to the child’s trust, the

estate is allowed no deduction under section 661,

and no amount is included in the trust’s gross in come under section 662. Because no distributions

were made to the spouse, there is no need to com pute the distributable net income allocable to the

marital share. The taxable income of the estate for

the 2000 taxable year is $214,400 ($200,000 (divi dend income) plus $30,000 (capital gain) minus

$15,000 (expenses) and minus $600 (personal ex emption)).

Example 5 . The facts are the same as in Exam-

ple 4, except that during 2000 the estate reports on

its federal income tax return a pro rata share of an

S corporation’s tax items and a distributive share

of a partnership’s tax items allocated on Form K 1s to the estate by the S corporation and by the

partnership, respectively. Because, under the

terms of the will, no estate income from the S cor poration or the partnership would be allocated to

the pecuniary bequest to child’s trust, none of the

tax items attributable to the S corporation stock or

the partnership interest is allocated to the trust’s

separate share. Therefore, with respect to the

$380,000 distribution to the trust, the estate is al lowed no deduction under section 661, and no

amount is included in the trust’s gross income

under section 662.

Example 6 . The facts are the same as in Exam-

ple 4, except that during 2000 the estate receives a

distribution of $900,000 from the decedent’s indi vidual retirement account that is included in the

estate’s gross income as income in respect of a

decedent under section 691(a). The entire

$900,000 is allocated to corpus under applicable

local law. Both the separate share for the child’s

trust and the separate share for the surviving

spouse may potentially be funded with the pro ceeds from the individual retirement account.

Therefore, a portion of the $900,000 gross income

must be allocated to the trust’s separate share. The

amount allocated to the trust’s share must be based

upon the relative values of the two separate shares

using a reasonable and equitable method. The es tate is entitled to a deduction under section 661 for

the portion of the $900,000 properly allocated to

the trust’s separate share, and the trust must in clude this amount in income under section 662.

Example 7 (i) Facts . Testator, who dies in

2000, is survived by a spouse and three adult chil dren. Testator’s will divides the residue of the es tate equally among the three children. The surviv ing spouse files an election under the applicable

state’s elective share statute. Under this statute, a

surviving spouse is entitled to one-third of the

decedent’s estate after the payment of debts and

expenses. The statute also provides that the sur viving spouse is not entitled to any of the estate’s

income and does not participate in appreciation or

depreciation of the estate’s assets. However,

under the statute, the surviving spouse is entitled

to interest on the elective share from the date of

the court order directing the payment until the ex ecutor actually makes payment. During the es tate’s 2001 taxable year, the estate distributes to

the surviving spouse $5,000,000 in partial satisfac tion of the elective share and pays $200,000 of in terest on the delayed payment of the elective

share. During that year, the estate receives divi dend income of $3,000,000 and pays expenses of

$60,000 that are deductible on the estate’s federal

income tax return.

(ii) Conclusion . The estate has four separate

shares consisting of the surviving spouse’s elective

share and each of the three children’s residuary be quests. Because the surviving spouse is not entitled

to any estate income under state law, none of the es tate’s gross income is allocated to the spouse’s sepa rate share for purposes of determining that share’s

distributable net income. Therefore, with respect to

the $5,000,000 distribution, the estate is allowed no

deduction under section 661, and no amount is in cluded in the spouse’s gross income under section

The $200,000 of interest paid to the spouse

must be included in the spouse’s gross income under

section 61. Because no distributions were made to

any other beneficiaries during the year, there is no

need to compute the distributable net income of the

other three separate shares. Thus, the taxable in come of the estate for the 2000 taxable year is

$2,939,400 ($3,000,000 (dividend income) minus

$60,000 (expenses) and $600 (personal exemption)).

The estate’s $200,000 interest payment is a nonde ductible personal interest expense described in sec

2000–2 I.R.B. 249 January 10, 2000

tion 163(h).

Example 8 . The will of Testator, who dies in 2000, directs the executor to distribute the X stock and all dividends therefrom to child A and the residue of the estate to child B. The estate has two separate shares consisting of the income on the X stock bequeathed to A and the residue of the estate bequeathed to B. The bequest of the X stock meets the definition of section 663(a)(1) and therefore is not a separate share. If any distributions, other than shares of the X stock, are made during the year to either A or B, then for purposes of determining the distributable net income for the separate shares, gross income attributable to dividends on the X stock must be allocated to A’s separate share and any other income must be allocated to B’s separate share.

Example 9 . The will of Testator, who dies in 2000, directs the executor to divide the residue of the estate equally between Testator’s two children, A and B. The will directs the executor to fund A’s share first with the proceeds of Testator’s individual retirement account. The date of death value of the estate after the payment of debts, expenses, and estate taxes is $9,000,000. During 2000, the $900,000 balance in Testator’s individual retirement account is distributed to the estate. The entire $900,000 is allocated to corpus under applicable local law. This amount is income in respect of a decedent within the meaning of section 691(a). The estate has two separate shares, one for the benefit of A and one for the benefit of B. If any distributions are made to either A or B during the year, then, for purposes of determining the distributable net income for each separate share, the $900,000 of income in respect of a decedent must be allocated to A’s share.

Example 10 . The facts are the same as in Exam- ple 9, except that the will directs the executor to fund A’s share first with X stock valued at $3,000,000, rather than with the proceeds of the individual retirement account. The estate has two separate shares, one for the benefit of A and one for the benefit of B. If any distributions are made to either A or B during the year, then, for purposes of determining the distributable net income for each separate share, the $900,000 of gross income attributable to the proceeds from the individual retirement account must be allocated between the two shares to the extent that they could potentially be funded with those proceeds. The maximum amount of A’s share that could potentially be funded with the income in respect of decedent is $1,500,000 ($4,500,000 value of share less $3,000,000 to be funded with stock) and the maximum amount of B’s share that could potentially be funded with income in respect of decedent is $4,500,000. Based upon the relative values of these amounts, the gross income attributable to the proceeds of the individual retirement account is allocated $225,000 (or one-fourth) to A’s share

and $675,000 (or three-fourths) to B’s share.

Example 11 . The will of Testator, who dies in 2000, provides that after the payment of specific bequests of money, the residue of the estate is to be divided equally among the Testator’s three children, A, B, and C. The will also provides that during the period of administration one-half of the income from the residue is to be paid to a designated charitable organization. After the specific bequests of money are paid, the estate initially has three equal separate shares. One share is for the benefit of the charitable organization and A, another share is for the benefit of the charitable organization and B, and the last share is for the benefit of the charitable organization and C. During the period of administration, payments of income to the charitable organization are deductible by the estate to the extent provided in section 642(c) and are not subject to the distribution provisions of sections 661 and 662.

Par. 9. Section 1.663(c)-6 is added to read as follows: §1.663(c)-6 Effective dates.

Sections 1.663(c)-1 through 1.663(c)-5 are applicable for estates and qualified revocable trusts within the meaning of section 645(b)(1) with respect to decedents who die after December 28, 1999. However, for estates and qualified revocable trusts with respect to decedents who died after the date that section 1307 of the Tax Reform Act of 1997 became effective but before December 28, 1999, the IRS will accept any reasonable interpretation of the separate share provisions, including those provisions provided in 1999-11 I.R.B. 41 (see §601.601(d)(2)(ii)(b) of this chapter). For trusts other than qualified revocable trusts, §1.663(c)-2 is applicable for taxable years of such trusts beginning after December 28, 1999.

Approved December 13, 1999.

Jonathan Talisman, Acting Assistant Secretary

for the Treasury.

(Filed by the Office of the Federal Register on December 27, 1999, 8:45 a.m., and published in the issue of the Federal Register for December 28, 1999, 64 F.R. 72540)

Section 807.—Rules for Certain Reserves

Robert E. Wenzel, Deputy Commissioner of

Internal Revenue.

The adjusted applicable federal short-term, midterm, and long-term rates are set forth for the month of January 2000. See Rev. Rul 2000–1, page 250.

Section 846.—Discounted Unpaid Losses Defined

The adjusted applicable federal short-term, midterm, and long-term rates are set forth for the month of January 2000. See Rev. Rul. 2000–1, page 250.

Section 1274.—Determination of Issue Price in the Case of Certain Debt Instruments Issued for Property

(Also Sections 42, 280G, 382, 412, 467, 468, 482, 483, 642, 807, 846, 1288, 7520, 7872.)

Federal rates; adjusted federal rates; adjusted federal long-term rate, and the long-term exempt rate. For purposes of sections 1274, 1288, 382, and other section of the Code, tables set forth the rates for January 2000.