Foreign Accumulation Trusts and the Tax Reform Act of 1976

Abstract

If the foreign trust is not a grantor trust under the Grantor Trust Provisions (sections 671-679), then the new Act creates several new disparities in the tax treatment between it and a corresponding domestic accumulation trust. Domestic accumulation trusts are no longer subjected to a capital gains throw back, while capital gains of foreign trusts are included in DNI, subject to throw back, and then taxed as ordinary income to the beneficiary because of the abolition of the character rules upon accumulation distribution. Foreign trusts are subjected to throw back of accumulation distributions even though the accumulation was during the beneficiary's minority or prior to his birth; domestic trusts are excepted from such throw back. Finally, foreign accumulation trusts are affirmatively penalized by the six percent interest charge on accumulation. Thus, in its fervor to end the tax avoidance possibilities of foreign accumulation trusts, Congress may have overreacted, producing an unjustifiable inequity against those persons who, for non-tax reasons, need a foreign trust in their estate plan. The result, then, of the TRA '76 seems to be an improvement in the administration of the income taxation of domestic trusts and, to a lesser extent, foreign trusts. Further, the clear accumulation advantage of the foreign trust has been removed, and the tables have now turned so as to possibly produce an inequitable favoring of domestic trusts. If such an inequity actually results from the new Act, the congressional solution has just become a new problem.