Rev. Rul. 54-516

Advice is requested whether the income of a trust is taxable to the grantor under the following circumstances.

A transferred to a trust for the benefit of B and C, his children, certain real estate against which there is a mortgage. The trust instrument names A as donor and trustee, and states that the trust shall be deemed a gift in equal shares to B and C. The instrument provides that the trustee shall receive and add to the corpus of the trust, any property which at any time may be transferred, assigned, delivered, bequeathed or devised to the trustee for the trust by the donor or by any other person, or which may otherwise be acquired by him, or which he may receive under any insurance policies made payable to him by the donor or any other person.

The trust instrument provides further that the income from the real estate shall be used first to pay the necessary expenses of the trustee in the administration of the trust, taxes on the real estate, interest and principal on the mortgage, and expenses of maintaining the property. The balance of the income from all trust properties shall be accumulated and added to the principal of the trust.

Notwithstanding the provisions directing the accumulation of income in the trust, the trustee has the power, when he deems that the income from the trust is sufficient to effectuate the purpose of the trust and to meet its current obligations, to pay any or all of the income of the trust (whether accumulated from prior years or received during the current year) to a duly appointed guardian for either or both of the beneficiaries of the trust. Should the trustee make such a distribution of income, such distributed income shall be the property of the beneficiary outright, under the control of his guardian.

The trust will continue until C, the youngest of the children, becomes 21 years of age. Should either beneficiary die before C becomes 21 years of age, the trust will, nevertheless, continue until the survivor of the beneficiaries becomes 21 years of age, and in such event the surviving beneficiary upon reaching the age of 21 years shall receive the entire corpus and accumulated income of the trust. Should both beneficiaries die before the trust is terminated, the trustee shall convey the entire trust estate to the lawful heirs of the beneficiary who dies last. Broad powers of management are granted to the trustee. However, the trustee may not make loans of trust money to himself nor convey trust assets to himself. In no event shall any of the trust income ever be used to pay the legal obligations of the donor-trustee. The donor has no right or power to revoke the trust, and he may amend the trust instrument only for the purpose of granting additional powers to the trustee. Such additional powers, however, may not extend to include the power to grant any right or benefit to the donor.

Section 39.22(a)-21 of Regulations 118 provides that income of a trust is taxable to the grantor under section 22(a) of the Internal Revenue Code of 1939 where (1) the grantor has a reversionary interest in the corpus or the income therefrom which will or may reasonably be expected to take effect in possession or enjoyment within a relatively short term of years (see section 39.22(a)-21(c) of Regulations 118), or (2) the beneficial enjoyment of the corpus or the income therefrom is subject to a power of disposition (other than certain excepted powers) exercisable by the grantor or another person lacking a substantial adverse interest in such disposition, or both, or (3) the corpus or the income therefrom is subject to administrative control, exercisable primarily for the benefit of the grantor. Where any one or more of the above conditions is present the income of such trust is taxable to the grantor.

Under the trust agreement, the grantor has not retained a reversionary interest in the trust corpus or income within the meaning of section 39.22(a)-21 of Regulations 118. The beneficial enjoyment of the trust corpus or income is not subject to a power of disposition by the grantor or other person. Although broad powers of administration are granted to the grantor-trustee, the trust instrument specifically provides that neither the corpus nor the income of the trust is subject to administrative control exercisable primarily for the benefit of the grantor.

Accordingly, it is held that the income of the trust is taxable to the trust and not to the grantor. However, if any of the income of the trust is used for the support of either of the beneficiaries during the period that the grantor is legally obligated to support such beneficiaries, the income so used will be taxable to the grantor under section 167 of the Code. Furthermore, if the grantor remains liable in any capacity, other than as trustee, for the mortgage on the real estate transferred to the trust, any income of the trust which is used to pay principal or interest on such mortgage will be taxable to him. See section 39.167-2 of Regulations 118.