[Code of Federal Regulations]
[Title 26, Volume 18]
[Revised as of April 1, 2004]
From the U.S. Government Printing Office via GPO Access
[CITE: 26CFR301.7701-4]

[Page 617-621]
 
                       TITLE 26--INTERNAL REVENUE
 
    CHAPTER I--INTERNAL REVENUE SERVICE, DEPARTMENT OF THE TREASURY 
                               (CONTINUED)
 
PART 301_PROCEDURE AND ADMINISTRATION--Table of Contents
 
                               Definitions
 
Sec. 301.7701-4  Trusts.

    (a) Ordinary trusts. In general, the term ``trust'' as used in the 
Internal Revenue Code refers to an arrangement created either by a will 
or by an inter vivos declaration whereby trustees take title to property 
for the purpose of protecting or conserving it for the beneficiaries 
under the ordinary rules applied in chancery or probate courts. Usually 
the beneficiaries of such a

[[Page 618]]

trust do no more than accept the benefits thereof and are not the 
voluntary planners or creators of the trust arrangement. However, the 
beneficiaries of such a trust may be the persons who create it and it 
will be recognized as a trust under the Internal Revenue Code if it was 
created for the purpose of protecting or conserving the trust property 
for beneficiaries who stand in the same relation to the trust as they 
would if the trust had been created by others for them. Generally 
speaking, an arrangement will be treated as a trust under the Internal 
Revenue Code if it can be shown that the purpose of the arrangement is 
to vest in trustees responsibility for the protection and conservation 
of property for beneficiaries who cannot share in the discharge of this 
responsibility and, therefore, are not associates in a joint enterprise 
for the conduct of business for profit.
    (b) Business trusts. There are other arrangements which are known as 
trusts because the legal title to property is conveyed to trustees for 
the benefit of beneficiaries, but which are not classified as trusts for 
purposes of the Internal Revenue Code because they are not simply 
arrangements to protect or conserve the property for the beneficiaries. 
These trusts, which are often known as business or commercial trusts, 
generally are created by the beneficiaries simply as a device to carry 
on a profit-making business which normally would have been carried on 
through business organizations that are classified as corporations or 
partnerships under the Internal Revenue Code. However, the fact that the 
corpus of the trust is not supplied by the beneficiaries is not 
sufficient reason in itself for classifying the arrangement as an 
ordinary trust rather than as an association or partnership. The fact 
that any organization is technically cast in the trust form, by 
conveying title to property to trustees for the benefit of persons 
designated as beneficiaries, will not change the real character of the 
organization if the organization is more properly classified as a 
business entity under Sec. 301.7701-2.
    (c) Certain investment trusts--(1) An ``investment'' trust will not 
be classified as a trust if there is a power under the trust agreement 
to vary the investment of the certificate holders. See Commissioner v. 
North American Bond Trust, 122 F. 2d 545 (2d Cir. 1941), cert. denied, 
314 U.S. 701 (1942). An investment trust with a single class of 
ownership interests, representing undivided beneficial interests in the 
assets of the trust, will be classified as a trust if there is no power 
under the trust agreement to vary the investment of the certificate 
holders. An investment trust with multiple classes of ownership 
interests ordinarily will be classified as a business entity under Sec. 
301.7701-2; however, an investment trust with multiple classes of 
ownership interests, in which there is no power under the trust 
agreement to vary the investment of the certificate holders, will be 
classified as a trust if the trust is formed to facilitate direct 
investment in the assets of the trust and the existence of multiple 
classes of ownership interests is incidental to that purpose.
    (2) The provisions of paragraph (c)(1) of this section may be 
illustated by the following examples:

    Example 1. A corporation purchases a portfolio of residential 
mortgages and transfers the mortgages to a bank under a trust agreement. 
At the same time, the bank as trustee delivers to the corporation 
certificates evidencing rights to payments from the pooled mortgages; 
the corporation sells the certificates to the public. The trustee holds 
legal title to the mortgages in the pool for the benefit of the 
certificate holders but has no power to reinvest proceeds attributable 
to the mortgages in the pool or to vary investments in the pool in any 
other manner. There are two classes of certificates. Holders of class A 
certificates are entitled to all payments of mortgage principal, both 
scheduled and prepaid, until their certificates are retired; holders of 
class B certificates receive payments of principal only after all class 
A certificates have been retired. The different rights of the class A 
and class B certificates serve to shift to the holders of the class A 
certificates, in addition to the earlier scheduled payments of 
principal, the risk that mortgages in the pool will be prepaid so that 
the holders of the class B certificates will have ``call protection'' 
(freedom from premature termination of their interests on account of 
prepayments). The trust thus serves to create investment interests with 
respect to the mortgages held by the trust that differ significantly 
from direct investment in the mortgages. As a consequence, the existence 
of multiple classes of trust ownership is not incidental to any purpose 
of the trust to

[[Page 619]]

facilitate direct investment, and, accordingly, the trust is classified 
as a business entity under Sec. 301.7701-2.
    Example 2. Corporation M is the originator of a portfolio of 
residential mortgages and transfers the mortgages to a bank under a 
trust agreement. At the same time, the bank as trustee delivers to M 
certificates evidencing rights to payments from the pooled mortgages. 
The trustee holds legal title to the mortgages in the pool for the 
benefit of the certificate holders, but has no power to reinvest 
proceeds attributable to the mortgages in the pool or to vary 
investments in the pool in any other manner. There are two classes of 
certificates. Holders of class C certificates are entitled to receive 90 
percent of the payments of principal and interest on the mortgages; 
class D certificate holders are entitled to receive the other ten 
percent. The two classes of certificates are identical except that, in 
the event of a default on the underlying mortgages, the payment rights 
of class D certificate holders are subordinated to the rights of class C 
certificate holders. M sells the class C certificates to investors and 
retains the class D certificates. The trust has multiple classes of 
ownership interests, given the greater security provided to holders of 
class C certificates. The interests of certificate holders, however, are 
substantially equivalent to undivided interests in the pool of 
mortgages, coupled with a limited recourse guarantee running from M to 
the holders of class C certificates. In such circumstances, the 
existence of multiple classes of ownership interests is incidental to 
the trust's purpose of facilitating direct investment in the assets of 
the trust. Accordingly, the trust is classified as a trust.
    Example 3. A promoter forms a trust in which shareholders of a 
publicly traded corporation can deposit their stock. For each share of 
stock deposited with the trust, the participant receives two 
certificates that are initially attached, but may be separated and 
traded independently of each other. One certificate represents the right 
to dividends and the value of the underlying stock up to a specified 
amount; the other certificate represents the right to appreciation in 
the stock's value above the specified amount. The separate certificates 
represent two different classes of ownership interest in the trust, 
which effectively separate dividend rights on the stock held by the 
trust from a portion of the right to appreciation in the value of such 
stock. The multiple classes of ownership interests are designed to 
permit investors, by transferring one of the certificates and retaining 
the other, to fulfill their varying investment objectives of seeking 
primarily either dividend income or capital appreciation from the stock 
held by the trust. Given that the trust serves to create investment 
interests with respect to the stock held by the trust that differ 
significantly from direct investment in such stock, the trust is not 
formed to facilitate direct investment in the assets of the trust. 
Accordingly, the trust is classified as a business entity under Sec. 
301.7701-2.
    Example 4. Corporation N purchases a portfolio of bonds and 
transfers the bonds to a bank under a trust agreement. At the same time, 
the trustee delivers to N certificates evidencing interests in the 
bonds. These certificates are sold to public investors. Each certificate 
represents the right to receive a particular payment with respect to a 
specific bond. Under section 1286, stripped coupons and stripped bonds 
are treated as separate bonds for federal income tax purposes. Although 
the interest of each certificate holder is different from that of each 
other certificate holder, and the trust thus has multiple classes of 
ownership, the multiple classes simply provide each certificate holder 
with a direct interest in what is treated under section 1286 as a 
separate bond. Given the similarity of the interests acquired by the 
certificate holders to the interests that could be acquired by direct 
investment, the multiple classes of trust interests merely facilitate 
direct investment in the assets held by the trust. Accordingly, the 
trust is classified as a trust.

    (d) Liquidating trusts. Certain organizations which are commonly 
known as liquidating trusts are treated as trusts for purposes of the 
Internal Revenue Code. An organization will be considered a liquidating 
trust if it is organized for the primary purpose of liquidating and 
distributing the assets transferred to it, and if its activities are all 
reasonably necessary to, and consistent with, the accomplishment of that 
purpose. A liquidating trust is treated as a trust for purposes of the 
Internal Revenue Code because it is formed with the objective of 
liquidating particular assets and not as an organization having as its 
purpose the carrying on of a profit-making business which normally would 
be conducted through business organizations classified as corporations 
or partnerships. However, if the liquidation is unreasonably prolonged 
or if the liquidation purpose becomes so obscured by business activities 
that the declared purpose of liquidation can be said to be lost or 
abandoned, the status of the organization will no longer be that of a 
liquidating trust. Bondholders' protective committees, voting trusts, 
and other agencies formed to protect the

[[Page 620]]

interests of security holders during insolvency, bankruptcy, or 
corporate reorganization proceedings are analogous to liquidating trusts 
but if subsequently utilized to further the control or profitable 
operation of a going business on a permanent continuing basis, they will 
lose their classification as trusts for purposes of the Internal Revenue 
Code.
    (e) Environmental remediation trusts. (1) An environmental 
remediation trust is considered a trust for purposes of the Internal 
Revenue Code. For purposes of this paragraph (e), an organization is an 
environmental remediation trust if the organization is organized under 
state law as a trust; the primary purpose of the trust is collecting and 
disbursing amounts for environmental remediation of an existing waste 
site to resolve, satisfy, mitigate, address, or prevent the liability or 
potential liability of persons imposed by federal, state, or local 
environmental laws; all contributors to the trust have (at the time of 
contribution and thereafter) actual or potential liability or a 
reasonable expectation of liability under federal, state, or local 
environmental laws for environmental remediation of the waste site; and 
the trust is not a qualified settlement fund within the meaning of Sec. 
1.468B-1(a) of this chapter. An environmental remediation trust is 
classified as a trust because its primary purpose is environmental 
remediation of an existing waste site and not the carrying on of a 
profit-making business that normally would be conducted through business 
organizations classified as corporations or partnerships. However, if 
the remedial purpose is altered or becomes so obscured by business or 
investment activities that the declared remedial purpose is no longer 
controlling, the organization will no longer be classified as a trust. 
For purposes of this paragraph (e), environmental remediation includes 
the costs of assessing environmental conditions, remedying and removing 
environmental contamination, monitoring remedial activities and the 
release of substances, preventing future releases of substances, and 
collecting amounts from persons liable or potentially liable for the 
costs of these activities. For purposes of this paragraph (e), persons 
have potential liability or a reasonable expectation of liability under 
federal, state, or local environmental laws for remediation of the 
existing waste site if there is authority under a federal, state, or 
local law that requires or could reasonably be expected to require such 
persons to satisfy all or a portion of the costs of the environmental 
remediation.
    (2) Each contributor (grantor) to the trust is treated as the owner 
of the portion of the trust contributed by that grantor under rules 
provided in section 677 and Sec. 1.677(a)-1(d) of this chapter. Section 
677 and Sec. 1.677(a)-1(d) of this chapter provide rules regarding the 
treatment of a grantor as the owner of a portion of a trust applied in 
discharge of the grantor's legal obligation. Items of income, deduction, 
and credit attributable to an environmental remediation trust are not 
reported by the trust on Form 1041, but are shown on a separate 
statement to be attached to that form. See Sec. 1.671-4(a) of this 
chapter. The trustee must also furnish to each grantor a statement that 
shows all items of income, deduction, and credit of the trust for the 
grantor's taxable year attributable to the portion of the trust treated 
as owned by the grantor. The statement must provide the grantor with the 
information necessary to take the items into account in computing the 
grantor's taxable income, including information necessary to determine 
the federal tax treatment of the items (for example, whether an item is 
a deductible expense under section 162(a) or a capital expenditure under 
section 263(a)) and how the item should be taken into account under the 
economic performance rules of section 461(h) and the regulations 
thereunder. See Sec. 1.461-4 of this chapter for rules relating to 
economic performance.
    (3) All amounts contributed to an environmental remediation trust by 
a grantor (cash-out grantor) who, pursuant to an agreement with the 
other grantors, contributes a fixed amount to the trust and is relieved 
by the other grantors of any further obligation to make contributions to 
the trust, but remains liable or potentially liable under the applicable 
environmental

[[Page 621]]

laws, will be considered amounts contributed for remediation. An 
environmental remediation trust agreement may direct the trustee to 
expend amounts contributed by a cash-out grantor (and the earnings 
thereon) before expending amounts contributed by other grantors (and the 
earnings thereon). A cash-out grantor will cease to be treated as an 
owner of a portion of the trust when the grantor's portion is fully 
expended by the trust.
    (4) The provisions of this paragraph (e) may be illustrated by the 
following example:

    Example. (a) X, Y, and Z are calendar year corporations that are 
liable for the remediation of an existing waste site under applicable 
federal environmental laws. On June 1, 1996, pursuant to an agreement 
with the governing federal agency, X, Y, and Z create an environmental 
remediation trust within the meaning of paragraph (e)(1) of this section 
to collect funds contributed to the trust by X, Y, and Z and to carry 
out the remediation of the waste site to the satisfaction of the federal 
agency. X, Y, and Z are jointly and severally liable under the federal 
environmental laws for the remediation of the waste site, and the 
federal agency will not release X, Y, or Z from liability until the 
waste site is remediated to the satisfaction of the agency.
    (b) The estimated cost of the remediation is $20,000,000. X, Y, and 
Z agree that, if Z contributes $1,000,000 to the trust, Z will not be 
required to make any additional contributions to the trust, and X and Y 
will complete the remediation of the waste site and make additional 
contributions if necessary.
    (c) On June 1, 1996, X, Y, and Z each contribute $1,000,000 to the 
trust. The trust agreement directs the trustee to spend Z's 
contributions to the trust and the income allocable to Z's portion 
before spending X's and Y's portions. On November 30, 1996, the trustee 
disburses $2,000,000 for remediation work performed from June 1, 1996, 
through September 30, 1996. For the six-month period ending November 30, 
1996, the interest earned on the funds in the trust was $75,000, which 
is allocated in equal shares of $25,000 to X's, Y's, and Z's portions of 
the trust.
    (d) Z made no further contributions to the trust. Pursuant to the 
trust agreement, the trustee expended Z's portion of the trust before 
expending X's and Y's portion. Therefore, Z's share of the remediation 
disbursement made in 1996 is $1,025,000 ($1,000,000 contribution by Z 
plus $25,000 of interest allocated to Z's portion of the trust). Z takes 
the $1,025,000 disbursement into account under the appropriate federal 
tax accounting rules. In addition, X's share of the remediation 
disbursement made in 1996 is $487,500, and Y's share of the remediation 
disbursement made in 1996 is $487,500. X and Y take their respective 
shares of the disbursement into account under the appropriate federal 
tax accounting rules.
    (e) The trustee made no further remediation disbursements in 1996, 
and X and Y made no further contributions in 1996. From December 1, 
1996, to December 31, 1996, the interest earned on the funds remaining 
in the trust was $5,000, which is allocated $2,500 to X's portion and 
$2,500 to Y's portion. Accordingly, for 1996, X and Y each had interest 
income of $27,500 from the trust and Z had interest income of $25,000 
from the trust.

    (5) This paragraph (e) is applicable to trusts meeting the 
requirements of paragraph (e)(1) of this section that are formed on or 
after May 1, 1996. This paragraph (e) may be relied on by trusts formed 
before May 1, 1996, if the trust has at all times met all requirements 
of this paragraph (e) and the grantors have reported items of ,income 
and deduction consistent with this paragraph (e) on original or amended 
returns. For trusts formed before May 1, 1996, that are not described in 
the preceding sentence, the Commissioner may permit by letter ruling, in 
appropriate circumstances, this paragraph (e) to be applied subject to 
appropriate terms and conditions.
    (f) Effective date. The rules of this section generally apply to 
taxable years beginning after December 31, 1960. Paragraph (e)(5) of 
this section contains rules of applicability for paragraph (e) of this 
section. In addition, the last sentences of paragraphs (b), (c)(1), and 
(c)(2) Example 1 and Example 3 of this section are effective as of 
January 1, 1997.

[32 FR 15241, Nov. 3, 1967, as amended by T.D. 8080, 51 FR 9952, Mar. 
24, 1986; T.D. 8668, 61 FR 19191, May 1, 1996; T.D. 8697, 61 FR 66592, 
Dec. 18, 1996]