[Code of Federal Regulations]
[Title 26, Volume 8]
[Revised as of April 1, 2004]
From the U.S. Government Printing Office via GPO Access
[CITE: 26CFR1.643(b)-1]

[Page 60-61]
 
                       TITLE 26--INTERNAL REVENUE
 
    CHAPTER I--INTERNAL REVENUE SERVICE, DEPARTMENT OF THE TREASURY 
                               (CONTINUED)
 
PART 1_INCOME TAXES--Table of Contents
 
Sec. 1.643(b)-1  Definition of income.

    For purposes of subparts A through D, part I, subchapter J, chapter 
1 of the Internal Revenue Code, ``income,'' when not preceded by the 
words ``taxable,'' ``distributable net,'' ``undistributed net,'' or 
``gross,'' means the amount of income of an estate or trust for the 
taxable year determined under the terms of the governing instrument and 
applicable local law. Trust provisions that depart fundamentally from 
traditional principles of income and principal will generally not be 
recognized. For example, if a trust instrument directs that all the 
trust income shall be paid to the income beneficiary but defines 
ordinary dividends and interest as principal, the trust will not be 
considered one that under its governing instrument is required to 
distribute all its income currently for purposes of section 642(b) 
(relating to the personal exemption) and section 651 (relating to simple 
trusts). Thus, items such as dividends, interest, and rents are 
generally allocated to income and proceeds from the sale or exchange of 
trust assets are generally allocated to principal. However, an 
allocation of amounts between income and principal pursuant to 
applicable local law will be respected if local law provides for a 
reasonable apportionment between the income and remainder beneficiaries 
of the total return of the trust for the year, including ordinary and 
tax-exempt income, capital gains, and appreciation. For example, a state 
statute providing that income is a unitrust amount of no less than 3% 
and no more than 5% of the fair market value of the trust assets, 
whether determined annually or averaged on a multiple year basis, is a 
reasonable apportionment of the total return of the trust. Similarly, a 
state statute that permits the trustee to make adjustments between 
income and principal to fulfill the trustee's duty of impartiality 
between the income and remainder beneficiaries is generally a reasonable 
apportionment of the total return of the trust. Generally, these 
adjustments are permitted by state statutes when the trustee invests and 
manages the trust assets under the state's prudent investor standard, 
the trust describes the amount that may or must be distributed to a 
beneficiary by referring to the trust's income, and the trustee after 
applying the state statutory rules regarding the allocation of receipts 
and disbursements to income and principal, is unable to administer the 
trust impartially. Allocations pursuant to methods prescribed by such 
state statutes for apportioning the total return of a trust between 
income and principal will be respected regardless of whether the trust 
provides that the income must be distributed to one or more 
beneficiaries or may be accumulated in whole or in part, and regardless 
of which alternate permitted method is actually used, provided the trust 
complies with all requirements of the state statute for switching 
methods. A switch between methods of determining trust income authorized 
by

[[Page 61]]

state statute will not constitute a recognition event for purposes of 
section 1001 and will not result in a taxable gift from the trust's 
grantor or any of the trust's beneficiaries. A switch to a method not 
specifically authorized by state statute, but valid under state law 
(including a switch via judicial decision or a binding non-judicial 
settlement) may constitute a recognition event to the trust or its 
beneficiaries for purposes of section 1001 and may result in taxable 
gifts from the trust's grantor and beneficiaries, based on the relevant 
facts and circumstances. In addition, an allocation to income of all or 
a part of the gains from the sale or exchange of trust assets will 
generally be respected if the allocation is made either pursuant to the 
terms of the governing instrument and applicable local law, or pursuant 
to a reasonable and impartial exercise of a discretionary power granted 
to the fiduciary by applicable local law or by the governing instrument, 
if not prohibited by applicable local law. This section is effective for 
taxable years of trusts and estates ending after January 2, 2004.

[T.D. 9102, 69 FR 19, Jan. 2, 2004]