Rev. Rul. 80-75

1980-1 C.B. 314, 1980-10 I.R.B. 26.

                       Internal Revenue Service
                                 Revenue Ruling

         TRUST TREATED AS ASSOCIATION; INCOME BENEFICIARIES' DEDUCTIONS

                           Published: March 10, 1980

26 CFR 301.7701-2: Associations.

(Also Section 167; 1.167(h)-1.)

  Trust treated as associatin; income beneficiaries; deductions. An example is provided of a business arrangement that is a trust under local law, but is classified as an association taxable as a corporation for federal tax purposes. The income beneficiaries of such an arrangement may not deduct any depreciation or amortization on any property held by the association.

ISSUE

  How will the trust arrangement described below be classified for federal tax purposes?

FACTS

  A promoter established a trust that was funded by contributions from various individuals designated as income beneficiaries.  Each individual contributed 100x dollars for an income interest in the trust, with the remainder interest passing to other persons designated by them.  The trust agreement provides that the income of the trust is distributable to the income beneficiaries for a period of 12 years, at which time it will terminate and its remaining assets will be distributed to the remaindermen. No beneficiary has a power under local law to terminate the trust, nor will the death, insanity, bankruptcy, retirement, resignation or expulsion of any beneficiary cause the trust to be dissolved.  The trustee has, in addition to other powers, the power to engage in business, and has continuing exclusive authority to make the management decisions necessary for the conduct of the trust business.  The agreement further provides that the beneficiaries may not transfer, pledge or assign their beneficial interests in the trust. Under local law the beneficiaries are not personally liable for the debts of the trust.

  The trustee used the contributed funds as a downpayment to purchase from the inventor a patent for exploitation by the trust in a business activity described in section 465(c) of the Internal Revenue Code.  The balance of the stated purchase price for the patent was financed by giving a full-recourse note to the inventor, with the properties as security.  The promoter and the trustee selected by the promoter represent that the trust qualifies as an ordinary trust under the provisions of subparts A, B, C, and D, (section 641 and following), part I, subchapter J, chapter 1 of the Code, and that the income beneficiaries are entitled to deduct, under section 167(h), any depreciation or amortization of the trust as if they were absolute owners of the properties held by the trust.  The promoter further represents that the beneficiaries are not subject to the loss limiting rules of section 465 with respect to such depreciation.

LAW AND ANALYSIS

  Section 7701(a)(3) of the Internal Revenue Code provides that the term  'corporation' includes associations, joint-stock companies, and insurance companies.

  In general, the term 'trust' as used in the Internal Revenue Code refers to an arrangement created by a will or 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. See section 301.7701-4(a) of the Procedure and Administration Regulations.

  There are other arrangements which while trusts under local law are not classified as trusts under the Internal Revenue Code because they are not arrangements to protect and conserve property for the beneficiaries.  Rather, these trusts, which are often known as business or commercial trusts, are created by the beneficiaries as a device to carry on a profit-making business.

  Section 301.7701-2(a)(1) of the regulations provides that an 'association' is an organization whose characteristics require it to be classified for purposes of taxation as a corporation rather than as another type of organization such as a partnership or trust.  An organization will be treated as an association if its corporate characteristics are such that the organization more nearly resembles a corporation than a partnership or trust.  The regulations refer to six characteristics ordinarily found in a pure corporation that, taken together, distinguish it from other organizations. These are: (1) associates, (2) an objective to carry on business and divide the gains therefrom, (3) continuity of life, (4) centralization of management, (5) liability for corporate debts limited to corporate property, and (6) free transferability of interests.  Section 301.7701-2(a)(3) provides that an unincorporated organization will not be classified as an association unless such organization has more corporate characteristics than noncorporate characteristics. However, in determining whether an organization has more corporate characteristics than

noncorporate characteristics, all characteristics common to both types of organizations shall not be considered.

  Because centralization of management, continuity of life, free transferability of interests, and limited liability are generally common to trusts and corporations, the determination of whether a trust that has such characteristics is to be treated for tax purposes as a trust or as an association depends on whether there are associates and an objective to carry on business and divide the gains therefrom.  This trust arrangement has associates and an objective to carry on business and divide the gains therefrom. Thus, under the regulations, it will be classified as an association for federal tax purposes.  However, it should be noted that if, under the regulations, the arrangement could have been classified as a trust, it would have been a grantor trust pursuant to Rev. Rul. 78-175, 1978-1 C.B. 144, each grantor would have been treated as engaged in the section 465 activity of the trust and therefore subject to the loss limitations of that section.

HOLDING

  The arrangement is classified as an association taxable as a corporation for federal tax purposes.  Therefore, the income beneficiaries may not deduct any depreciation or amortization on any property held by the association.

Rev. Rul. 80-75, 1980-1 C.B. 314, 1980-10 I.R.B. 26.