[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: 26CFR1.671-2]

[Page 273-276]
 
                       TITLE 26--INTERNAL REVENUE
 
    CHAPTER I--INTERNAL REVENUE SERVICE, DEPARTMENT OF THE TREASURY 
                               (CONTINUED)
 
PART 1_INCOME TAXES--Table of Contents
 
Sec. 1.671-2  Applicable principles.

    (a) Under section 671 a grantor or another person includes in 
computing his taxable income and credits those items of income, 
deduction, and credit against tax which are attributable to or included 
in any portion of a trust of which he is treated as the owner. Sections 
673 through 678 set forth the rules for determining when the grantor or 
another person is treated as the owner of any portion of a trust. The 
rules for determining the items of income, deduction, and credit against 
tax that are attributable to or included in a portion of the trust are 
set forth in Sec. 1.671-3.
    (b) Since the principle underlying subpart E (section 671 and 
following), part I, subchapter J, chapter 1 of the Code, is in general 
that income of a trust over which the grantor or another person has 
retained substantial dominion or control should be taxed to the grantor 
or other person rather than to the trust which receives the income or to 
the beneficiary to whom the income may be distributed, it is ordinarily 
immaterial whether the income involved constitutes income or corpus for 
trust accounting purposes. Accordingly, when it is stated in the 
regulations under subpart E that ``income'' is attributed to the grantor 
or another person, the reference, unless specifically limited, is to 
income determined for tax purposes and not to income for trust 
accounting purposes. When it is intended to emphasize that income for 
trust accounting purposes (determined in accordance with the provisions 
set forth in Sec. 1.643(b)-1 is meant, the phrase ``ordinary income'' 
is used.
    (c) An item of income, deduction, or credit included in computing 
the taxable income and credits of a grantor or another person under 
section 671 is treated as if it had been received or paid directly by 
the grantor or other person (whether or not an individual). For example, 
a charitable contribution made by a trust which is attributed to the 
grantor (an individual) under sections 671 through 677 will be 
aggregated with his other charitable contributions to determine their 
deductibility under the limitations of section 170(b)(1). Likewise, 
dividends received by a trust from sources in a particular foreign 
country which are attributed to a

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grantor or another person under subpart E will be aggregated with his 
other income from sources within that country to determine whether the 
taxpayer is subject to the limitations of section 904 with respect to 
credit for the tax paid to that country.
    (d) Items of income, deduction, and credit not attributed to or 
included in any portion of a trust of which the grantor or another 
person is treated as the owner under subpart E are subject to the 
provisions of subparts A through D (section 641 and following), of such 
part I.
    (e)(1) For purposes of part I of subchapter J, chapter 1 of the 
Internal Revenue Code, a grantor includes any person to the extent such 
person either creates a trust, or directly or indirectly makes a 
gratuitous transfer (within the meaning of paragraph (e)(2) of this 
section) of property to a trust. For purposes of this section, the term 
property includes cash. If a person creates or funds a trust on behalf 
of another person, both persons are treated as grantors of the trust. 
(See section 6048 for reporting requirements that apply to grantors of 
foreign trusts.) However, a person who creates a trust but makes no 
gratuitous transfers to the trust is not treated as an owner of any 
portion of the trust under sections 671 through 677 or 679. Also, a 
person who funds a trust with an amount that is directly reimbursed to 
such person within a reasonable period of time and who makes no other 
transfers to the trust that constitute gratuitous transfers is not 
treated as an owner of any portion of the trust under sections 671 
through 677 or 679. See also Sec. 1.672(f)-5(a).
    (2)(i) A gratuitous transfer is any transfer other than a transfer 
for fair market value. A transfer of property to a trust may be 
considered a gratuitous transfer without regard to whether the transfer 
is treated as a gift for gift tax purposes.
    (ii) For purposes of this paragraph (e), a transfer is for fair 
market value only to the extent of the value of property received from 
the trust, services rendered by the trust, or the right to use property 
of the trust. For example, rents, royalties, interest, and compensation 
paid to a trust are transfers for fair market value only to the extent 
that the payments reflect an arm's length price for the use of the 
property of, or for the services rendered by, the trust. For purposes of 
this determination, an interest in the trust is not property received 
from the trust. In addition, a person will not be treated as making a 
transfer for fair market value merely because the transferor recognizes 
gain on the transaction. See, for example, section 684 regarding the 
recognition of gain on certain transfers to foreign trusts.
    (iii) For purposes of this paragraph (e), a gratuitous transfer does 
not include a distribution to a trust with respect to an interest held 
by such trust in either a trust described in paragraph (e)(3) of this 
section or an entity other than a trust.
    For example, a distribution to a trust by a corporation with respect 
to its stock described in section 301 is not a gratuitous transfer.
    (3) A grantor includes any person who acquires an interest in a 
trust from a grantor of the trust if the interest acquired is an 
interest in certain investment trusts described in Sec. 301.7701-4(c) 
of this chapter, liquidating trusts described in Sec. 301.7701-4(d) of 
this chapter, or environmental remediation trusts described in Sec. 
301.7701-4(e) of this chapter.
    (4) If a gratuitous transfer is made by a partnership or corporation 
to a trust and is for a business purpose of the partnership or 
corporation, the partnership or corporation will generally be treated as 
the grantor of the trust. For example, if a partnership makes a 
gratuitous transfer to a trust in order to secure a legal obligation of 
the partnership to a third party unrelated to the partnership, the 
partnership will be treated as the grantor of the trust. However, if a 
partnership or a corporation makes a gratuitous transfer to a trust that 
is not for a business purpose of the partnership or corporation but is 
for the personal purposes of one or more of the partners or 
shareholders, the gratuitous transfer will be treated as a constructive 
distribution to such partners or shareholders under federal tax 
principles and the partners or the shareholders will be treated as the 
grantors of the trust. For example, if a

[[Page 275]]

partnership makes a gratuitous transfer to a trust that is for the 
benefit of a child of a partner, the gratuitous transfer will be treated 
as a distribution to the partner under section 731 and a subsequent 
gratuitous transfer by the partner to the trust.
    (5) If a trust makes a gratuitous transfer of property to another 
trust, the grantor of the transferor trust generally will be treated as 
the grantor of the transferee trust. However, if a person with a general 
power of appointment over the transferor trust exercises that power in 
favor of another trust, then such person will be treated as the grantor 
of the transferee trust, even if the grantor of the transferor trust is 
treated as the owner of the transferor trust under subpart E of part I, 
subchapter J, chapter 1 of the Internal Revenue Code.
    (6) The following examples illustrate the rules of this paragraph 
(e). Unless otherwise indicated, all trusts are domestic trusts, and all 
other persons are United States persons. The examples are as follows:

    Example 1. A creates and funds a trust, T, for the benefit of her 
children. B subsequently makes a gratuitous transfer to T. Under 
paragraph (e)(1) of this section, both A and B are grantors of T.
    Example 2. A makes an investment in a fixed investment trust, T, 
that is classified as a trust under Sec. 301.7701-4(c)(1) of this 
chapter. A is a grantor of T. B subsequently acquires A's entire 
interest in T. Under paragraph (e)(3) of this section, B is a grantor of 
T with respect to such interest.
    Example 3. A, an attorney, creates a foreign trust, FT, on behalf of 
A's client, B, and transfers $100 to FT out of A's funds. A is 
reimbursed by B for the $100 transferred to FT. The trust instrument 
states that the trustee has discretion to distribute the income or 
corpus of FT to B and B's children. Both A and B are treated as grantors 
of FT under paragraph (e)(1) of this section. In addition, B is treated 
as the owner of the entire trust under section 677. Because A is 
reimbursed for the $100 transferred to FT on behalf of B, A is not 
treated as transferring any property to FT. Therefore, A is not an owner 
of any portion of FT under sections 671 through 677 regardless of 
whether A retained any power over or interest in FT described in 
sections 673 through 677. Furthermore, A is not treated as an owner of 
any portion of FT under section 679. Both A and B are responsible 
parties for purposes of the requirements in section 6048.
    Example 4. A creates and funds a trust, T. A does not retain any 
power or interest in T that would cause A to be treated as an owner of 
any portion of the trust under sections 671 through 677. B holds an 
unrestricted power, exercisable solely by B, to withdraw certain amounts 
contributed to the trust before the end of the calendar year and to vest 
those amounts in B. B is treated as an owner of the portion of T that is 
subject to the withdrawal power under section 678(a)(1). However, B is 
not a grantor of T under paragraph (e)(1) of this section because B 
neither created T nor made a gratuitous transfer to T.
    Example 5. A transfers cash to a trust, T, through a broker, in 
exchange for units in T. The units in T are not property for purposes of 
determining whether A has received fair market value under paragraph 
(e)(2)(ii) of this section. Therefore, A has made a gratuitous transfer 
to T, and, under paragraph (e)(1) of this section, A is a grantor of T.
    Example 6. A borrows cash from T, a trust. A has not made any 
gratuitous transfers to T. Arm's length interest payments by A to T will 
not be treated as gratuitous transfers under paragraph (e)(2)(ii) of 
this section. Therefore, under paragraph (e)(1) of this section, A is 
not a grantor of T with respect to the interest payments.
    Example 7. A, B's brother, creates a trust, T, for B's benefit and 
transfers $50,000 to T. The trustee invests the $50,000 in stock of 
Company X. C, B's uncle, purportedly sells property with a fair market 
value of $1,000,000 to T in exchange for the stock when it has 
appreciated to a fair market value of $100,000. Under paragraph 
(e)(2)(ii) of this section, the $900,000 excess value is a gratuitous 
transfer by C. Therefore, under paragraph (e)(1) of this section, A is a 
grantor with respect to the portion of the trust valued at $100,000, and 
C is a grantor of T with respect to the portion of the trust valued at 
$900,000. In addition, A or C or both will be treated as the owners of 
the respective portions of the trust of which each person is a grantor 
if A or C or both retain powers over or interests in such portions under 
sections 673 through 677.
    Example 8. G creates and funds a trust, T1, for the benefit of G's 
children and grandchildren. After G's death, under authority granted to 
the trustees in the trust instrument, the trustees of T1 transfer a 
portion of the assets of T1 to another trust, T2, and retain a power to 
revoke T2 and revest the assets of T2 in T1. Under paragraphs (e)(1) and 
(5) of this section, G is the grantor of T1 and T2. In addition, because 
the trustees of T1 have retained a power to revest the assets of T2 in 
T1, T1 is treated as the owner of T2 under section 678(a).
    Example 9. G creates and funds a trust, T1, for the benefit of B. G 
retains a power to

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revest the assets of T1 in G within the meaning of section 676. Under 
the trust agreement, B is given a general power of appointment over the 
assets of T1. B exercises the general power of appointment with respect 
to one-half of the corpus of T1 in favor of a trust, T2, that is for the 
benefit of C, B's child. Under paragraph (e)(1) of this section, G is 
the grantor of T1, and under paragraphs (e)(1) and (5) of this section, 
B is the grantor of T2.

    (7) The rules of this section are applicable to any transfer to a 
trust, or transfer of an interest in a trust, on or after August 10, 
1999.

[T.D. 6500, 25 FR 11814, Nov. 26, 1960; 25 FR 14021, Dec. 31, 1960, as 
amended by T.D. 8831, 64 FR 43274, Aug. 10, 1999; T.D. 8890, 65 FR 
41333, July 5, 2000]