New Regulations May Require Amendment of Pooled Income Funds

New Regulations May Require Amendment of Pooled Income Funds

News story posted in Pooled Income Fund on 21 January 2004| comments
audience: National Publication | last updated: 18 May 2011
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Summary

On December 30, 2003, the Treasury Department issued final regulations under Internal Revenue Code Section 643(b) which defines trust accounting income. David Wheeler Newman of Mitchell Silberberg & Knupp LLP and Susan Termohlen, Managing Director-Tax at Kaspick & Company have reported that an important provision of the regulations may require existing Pooled Income Fund trusts to be amended, and that the deadline for doing so is very tight.

By David Wheeler Newman, J.D., LL.M., Mitchell Silberberg & Knupp LLP

On December 30, 2003, the Treasury Department issued final regulations under Internal Revenue Code Section 643(b) which defines trust accounting income for purposes of the provisions of the Code dealing with the income taxation of trusts and estates. Among other things, these final regulations, which are generally effective January 2, 2004, contain provisions which are specific to pooled income funds.

Susan Termohlen, Managing Director-Tax at Kaspick & Company, has pointed out that an important provision of the regulations may require existing PIF trusts to be amended, and that the deadline for doing so is very tight.

One tax feature of a PIF allows a deduction for long-term capital gains permanently set aside for the charitable beneficiary of the PIF. The typical result is that existing PIFs pay out only traditional income items - interest and dividends. PIFs could have been made more attractive if total return investing could be used to enhance the amount distributable to income beneficiaries by defining income as a unitrust amount (a fixed percentage of the value of PIF assets).

The final regulations make it clear that a PIF will not be eligible for a charitable deduction for long-term capital gains permanently set aside for charity if a unitrust formula is used to define income. The problem is that many PIF trust documents look to state law to determine what trust income is and the laws of many states allow the trustee to determine income using a unitrust formula as an alternative to traditional income items.

Many states that have adopted the 1997 version of the Uniform Principal and Income Act have also adopted a provision allowing trustees to apply a unitrust formula to determine income, assuming the trust invests for total return. For example, the statutes of Oregon, Washington, Colorado, New York, Illinois and Maryland all allow use of the unitrust formula. PIFs that are governed by the laws of these and other states will lose the ability to take a charitable deduction for long-term capital gains unless the PIF's trust agreement is amended or reformed to prohibit use of the unitrust formula. The regulations provide that, to avoid the loss of the deduction, a judicial proceeding to reform the PIFs governing instrument must be commenced, or a non-judicial reformation that is valid under state law must be completed, and no later than October 1, 2004. The reformation is required even though a PIF does not use a unitrust formula.

Each charity that sponsors a PIF should review the PIF trust document to determine whether the trustee looks to state law to determine trust income and, if so, whether the principal and income law of the state allows the trustee to utilize a unitrust formula to determine income. If it does, the PIF trust agreement must be amended no later than the October 1 deadline to preserve the charitable deduction for long-term capital gains.

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