irc department 72 governs the income taxation of annuity contracts. Irc department 72(u)(1) taxes the income on an annuity contract owned by a “non-natural” individual by treating it as though it was obtained by the non-natural owner. If, however, a non-natural individual is simply keeping the contract as an “agent” for a natural individual, the income on the contract wouldn’t be so treated. Unfortunately, neither the internal revenue code nor the regulatings explain when an agency arrangement will be deemed to subsist.

for 2010, irrevocable trusts reach the most eminent income tax rate (35%) at $11,200 of taxable income. In examination and comparison, married couples filing jointly and single taxpayers do not reach the 35% income tax rate until $357,700 of taxable income! Therefore, wealthier individuals tend to invest in trusts for growth rather than for income. This is in particular unfeigned for credit protection trusts (similarly known as family trusts and residuary trusts) where the surviving spouse neither needs nor wants current income, but wants to grant the trust pluses to develop – estate tax free – for the benefit of children and grandchildren. If an annuity contract is to be applied as a trust investment, the unsmiling and critical question to keep out of the way of current income taxation becomes whether the trust, a non-natural individual, may be an agent for its natural individual beneficiaries.

single beneficiary trusts

in plrs 9204010 and 9204014, the irs determined that a trust was acting as an agent for a natural individual when it bought an annuity for the solitary beneficiary of the trust. Under the terms of the trust, the trustee had judgment and prudence to compensate income and corpus to the beneficiary until the beneficiary attains age 40, at which point the complete trust corpus (including the annuity contract) was to be circulated to the beneficiary. The irs simply concluded that the trustee’s ownership of the annuity contract was nominal compared to that of the beneficiary and, therefore, the beneficiary was the exhilarating and advantageous owner of the annuity contract. The plrs didn’t presence and address what bearing, if any, there would be on the ruling if the beneficiary passed away prior to age 40 and the trust property passed to a occasional and contingent balance beneficiary.

in plrs 200449011, 200449013, 200449014, 200449015, 200449016 and 200449017, with closely identical facts, the irs determined that the trust was acting as an agent for a natural individual when it bought an annuity contract for the solitary benefit of the grantor’s grandchild. In those rulings, the annuity contracts were to be circulated in-kind. The plrs didn’t presence and address, however, what the tax aftermaths would be under irc department 72 if any distribution from the trusts were in cash.

multiple beneficiary trusts

in plr 9752035, the irs determined, with no discussion, that a trust was acting as an agent for a natural individual when it bought an annuity contract. In plr 9752035, there was a life income beneficiary (who was similarly the annuitant) and remaindermen. Though the result of plr 9752035 was favorable, it provides small guidance as to when a trust is acting as an agent for a natural individual.

trust distributions

irc department 72(e)(4)(c) provides, in portion, that if somebody transfers an annuity contract without full and adequate contemplation, the individual will be taxed on the quantity in excess of the contract’s surrender validity and value. However, in plr 199905015 and plr 9204014, the irs ruled that irc department 72(e)(4)(c) does not utilise when an annuity is transferred in-kind from a trust to the beneficiary. The trust beneficiary would simply become the owner of the annuity contract, would inherit its cost substance and basis, and would proceed to take pleasure in its tax-deferred status.

other department 72 issues

required distributions. Irc department 72(s) sets forth the required distribution rules which an annuity contract should satisfy upon the death of the holder of the annuity contract. Following is a summary of those rules:

• if the holder dies after the annuity starting date, the remaining intentness and interest should be circulated at least as speedily as the method of distributions being applied at the date of the holder’s death.



• generally, if the holder dies before the annuity starting date, the complete intentness and interest should be circulated within 5 years of the holder’s death.



• an exception to the 5-year rule allows a indicated beneficiary to elect, within 1 year of the holder’s death, to take distribution of the continues over his/her life expectancy. A indicated beneficiary is somebody named by the holder as the beneficiary of the annuity contract. A trust does not qualify as a indicated beneficiary.



• if the holder’s surviving spouse is the indicated beneficiary, the surviving spouse has the ability and ability to proceed the decedent’s contract as though it were his/her own.



with a trust-owned annuity contract, the annuitant is defined to be the holder. Therefore, it’s the annuitant’s death that triggers a required distribution under irc department 72(s)(6). If, as is usual, the trust is the beneficiary of the contract, then the 5-year rule applies. Since a indicated beneficiary should be somebody, the time and opportunity for a life expectancy compensate-out seems being unavailable. But under irc department 401(a)(9), which governs distributions from qualified retirement plans and iras, the beneficiaries of a the right way designed trust which name trusts as beneficiaries (called a “see-through trust” by the irs) will be treated as having been indicated as the beneficiaries of the plan or ira. Does the same hold unfeigned for trust-owned annuities, thereby allowing a life expectancy payout for annuities that name see-through trusts as the beneficiaries? Unfortunately, this issue has not yet been addressed by the courts or the irs.

what if the irrevocable trust is a “grantor” trust for income tax intents and the grantor and annuitant (normally the trust beneficiary) are not the same individual? While not clear, arguably the grantor should be treated as the holder of the contract. If so, then it is going to be the grantor’s death (not the annuitant’s) that would find out when distributions from the contract should be made.

penalty for untimely distributions. Irc department 72(q) imposes a 10% penalty tax on untimely distributions from an annuity contract. In general, the penalty tax applies to distributions to the “taxpayer” prior to attaining age 59 ½. If the annuity contract is owned by a trust, then who is the “taxpayer” for intents of irc department 72(q)?

as discussed above, the annuitant is treated as the holder of a trust-owned annuity for intents of the required distributions upon the death of the holder. Therefore, it’s rightful and logical to consider the annuitant for intents of applying the age 59 1/2 exception for the untimely distribution penalty. Assuming the annuitant’s age is not the applicable measure, then presumably it should be the beneficiary’s or beneficiaries’ age. If so, should all the beneficiaries be over age 59 1/2 for the exception to utilise? Furthermore, if the irrevocable trust is a grantor trust, is the penalty then based on the grantor’s age? Unfortunately, each of these questions remains unanswered. To keep out of the way of these issues, contemplation should be given to propagating the contract outright to the beneficiary before the date withdrawals are to get started.

designing the trust

keeping in mind that the plrs quoted above are only binding on taxpayers who requested the ruling, they do suggest that an annuity contract acquired by an irrevocable trust or credit protection trust may allow for tax deferral. But great care should be done to ascertain that both the trust and annuity contract are the right way structured. Consider these elements when setting up a trust-owned annuity:

• the trust agreement ought not require its pluses be invested in income-developing property.



• the trust agreement should distinctively authorize the trustee to invest in an annuity contract.



• the trust agreement should distinctively grant distribution of the annuity contract in-kind to keep out of the way of adverse income tax aftermaths. If distinguished contracts are traditional for each trust beneficiary, with each beneficiary named as the annuitant for his or her respective contract, the in-kind distribution of the contract to the beneficiary-annuitant should be a non-taxable event.



• to keep out of the way of gift taxes, the trust should buy the annuity contract directly.



• the trust should be the owner and beneficiary of the annuity contract.



• if the grantor of the trust is named the annuitant, his or her death will likely trigger a entire and complete and taxable liquidation of the contract within five years.



• if the annuitant were to die while the annuity contract was hushed and still kept in trust, the contract will likely have to be liquidated in five years. Therefore, contemplation should be given to propagating the annuity contract to the beneficiary-annuitant before his or her death. By doing so, the beneficiary-annuitant, as the new owner, will proceed to take pleasure in all of the contract’s benefits and warrantees, and may name a new indicated beneficiary.



• avoid the 10% early distribution penalty when possible.



• the named annuitant should never be changed. Otherwise, the contract should be liquidated within 5 years.



although trust-owned annuities implicate a significant degree of complexity and vacillation and uncertainty, they may be exceedingly exhilarating and advantageous. This is in particular so for credit protection trusts where it’s possible to pass on an heritage and not an income tax bill.

this article may not be applied for penalty protection.