Rev. Rul. 86-76

1986-1 C.B. 284, 1986-21 I.R.B. 5.

INCOME FROM SOURCES WITHIN THE UNITED STATES

Published: May 27, 1986

Section 861.-Income From Sources Within The United States 26 CFR 1.861-2: Interest. (Also Sections 661, 871, 1441; 1.661(a)-2, 1.871-7, 1.1441-4.)

  Income from sources within the United States. Interest income from savings deposits with a domestic branch of a United States bank that is received by a domestic estate and is distributed to nonresident alien beneficiaries in the year of receipt is not from United States sources and is not subject to United States sources and is not subject to United States taxation in the hand of the beneficiaries. If such income is not distributed in the year of receipt, it is income to the estate an subject to United States taxation. Rev. Rul. 81-244 amplified.

ISSUE

  Under the circumstances described below, if interest income from a savings deposit account with a domestic branch of a United States bank is received by a domestic estate, is that interest income taxable to the estate or to its nonresident alien beneficiaries?

FACTS

  Situation (1). A was a resident of the United States who died in 1980. At the time of death, A maintained a savings deposit account with a domestic branch of a United States bank. Subsequent to A's death, the savings deposit account was transferred to E, the domestic estate of A, which is administered by a public administrator. The savings account is the only asset of E. All the beneficiaries of E are nonresident alien individuals residing in foreign country FC with which the United States does not have an income tax treaty.

  Pursuant to the terms of A's will, E distributes all of the income earned by E from the savings deposit account (100x dollars) to the nonresident alien beneficiaries in the taxable year of receipt. The interest income is not effectively connected with the conduct by E of a trade or business within the United States, and is the only income of E.

  Situation (2). The facts are the same except that, pursuant to the terms of A's will, E does not distribute income received from the savings deposit account (100x dollars) to the nonresident alien beneficiaries in the taxable year of receipt (year 1). In the subsequent taxable year (year 2), E earns 50x dollars of interest and distributes 150x dollars to the nonresident alien beneficiaries. The distributable net income of E in year 2 is equal to 50x dollars under section 643 of the Internal Revenue Code.

LAW AND ANALYSIS

  Section 641 of the Code provides for the taxation of estates and trusts, including the computation of their taxable income.

  Section 661(a) of the Code provides that an estate is entitled to a deduction in computing taxable income in any taxable year, equal to the sum of (1) any amount of income required to be distributed currently (including any amount required to be distributed which may be paid out of income or corpus to the extent such amount is paid out of income for such taxable year); and (2) any other amounts properly paid or credited or required to be distributed for such taxable year. The deduction is limited to the distributable net income of the estate, as defined under section 643 . Distributable net income is the table income of the trust or estate for the taxable year with certain modifications as provided in section 643.

  Section 662(a) of the Code provides, in general, that the beneficiaries of the estate must include in gross income (1) amounts specified in section 661(a) required to be distributed currently; and (2) other amounts properly paid, credited, or required to be distributed to them for the taxable year. The amount of income that beneficiaries must include in any particular taxable year is limited to the distributable net income of the estate with respect to such year. Application of section 662 is not limited to citizens or residents of the United States.

  Section 662(b) of the Code provides, in general, that the amounts within the scope of section 662(a) shall have the same character in the hands of the beneficiary as in the hands of the estate. Section 1.665(a)-OA(d) of the In ome Tax Regulations provides that Subpart D, which contains the 'throw-back' rules, does not apply to any estate.

  Section 861(a)(1) of the Code provides, in part, that interest from the United States, or the District of Columbia, and interest on bonds, notes, or other interest-bearing obligations of residents, corporate or otherwise, shall be treated as income from sources within the United States. However, section

861(a)(1)(A) further provides that interest on amounts described in section

861(c) received by a nonresident alien individual shall not be treated as income from sources within the United States, if such interest is not effectively connected with the conduct of a trade or business within the United States.

  Section 861(c) of the Code provides, in part, that for purposes of section

861(a)(1)(A) the amounts described in section 861(c) are deposits with persons carrying on the banking business, and deposits or withdrawable accounts with savings institutions chartered and supervised as savings and loan or similar associations under federal or state law.

  Except in the case of portfolio interest attributable to certain debt obligations, section871(a)(1)(A) of the Code provides, in part, that a nonresident alien individual is subject to a tax of 30 percent on amounts received as interest from sources within the United States (other than original issue discount as defined in section 1273), but only to the extent the amount so received is not effectively connected with the conduct of a trade or business within the United States.

  Section 1441(a) of the Code provides, in part, that any person having control, receipt, custody, disposal, or payment of the items of income specified in section 1441(b) (to the extent that these items constitute gross income from sources within the United States) of any nonresident alien individual, must deduct and withhold from these items a tax of 30 percent. Section 1441(b) lists interest (other than original issue discount as defined in section 1273) as an item of income subject to the withholding of tax under section 1441(a). However, section 1441(c)(9) provides that portfolio interest within the meaning of section 871(h)(2) attributable to certain debt obligations is not subject to the withholding requirements of section 1441(a).

  In Rev. Rul. 81-244, 1981-2 C.B. 151, the trustee of a domestic simple trust distributed interest income received from United States bank deposits to the trust's nonresident alien beneficiaries in the year such interest was received. The interest income was not effectively connected with a trade or business in the United States. Rev. Rul. 81-244 holds that the interest income received by the nonresident alien beneficiaries is not United States source income within the meaning of section 861(a)(1)(A) of the Code. Accord Isidro Martin-Montis Trust v. Commissioner, 75 T.C. 381 (1980), acq. 1981-2 C.B. 2.

  Rev. Rul. 81-244 recognizes that Congress intended to incorporate the conduit theory of trust and estate taxation into the 1954 Code. In connection with the taxation of estates and trusts under the 1954 Code, the House Committee on Ways and Means stated:

  The bill adheres to the conduit theory of the existing law. This means that an estate or trust is in general treated as a conduit through which income passes to the beneficiary. (H.R. Rep. No. 1337, 83d Cong., 2d Sess. 61 (1954).)

  In Maximov v. United States, 373 U.S. 49 (1963), a complex trust created in the United States with beneficiaries resident in the United Kingdom was held to be taxable on capital gains it realized that were not distributed to the beneficiaries by the trust during the same taxable year. An exemption from United States capital gains tax was provided for residents of the United Kingdom under the United States-United Kingdom Income Tax Convention in effect at that time. The Court noted the separate taxable entity status of a trust, apart from its beneficiaries, and that a trust is taxable on income it receives that is not distributed to the beneficiaries, nor otherwise taxable directly to the beneficiaries.

  Thus, with respect to Situation 2, the 100x dollars of interest that E receives in year 1 is includible in E's gross income. The 50x dollars of interest received by E in year 2 is includible in the gross income of E in that year, and is deductible by E in computing its taxable income in that year under section 661(a)(2) of the Code. The amount of the 150x dollar distribution from E potentially includible in the beneficiaries' gross income in year 2 is limited by E's distributable net income for such year under section 662(a)(2). Thus, only 50x dollars of the 150x dollar distribution is potentially includible in the gross income of the beneficiaries in year 2. However, pursuant to section 662(b), the 50x dollars will retain its character as interest in the hands of the beneficiaries, and, under sections 861(a)(1)(A) and 861(c), is not United States source income and is not subject to the 30 percent tax and withholding provisions in sections 871 and 1441, respectively. Further, since the 100x dollars is not included in the beneficiaries' gross income in year 2, the 100x dollars is not subject to the 30 percent tax and withholding provisions in sections 871 and 1441, respectively.

HOLDINGS

  SITUATION (1). Interest from a savings deposit account with a domestic branch of a United States bank received and distributed by a domestic estate to nonresident alien beneficiaries in the same taxable year it is received is includible in the gross income of the estate in the taxable year of receipt, and is deductible by the estate in computing its taxable income in that year under section 661(a)(2) of the Code. The interest in the hands of the beneficiaries is not United States source income by reason of section

861(a)(1)(A), and thus is not subject to the 30 percent tax and withholding provisions in sections 871 and 1441, respectively.

  SITUATION (2). Interest from a savings deposit account with a domestic branch of a United States bank received by a domestic estate in one taxable year and distributed to nonresident alien beneficiaries in a subsequent taxable year is includible in the gross income of the estate in the taxable year of receipt. No deduction is allowable to the estate with respect to such interest under section 661(a)(2), nor is any of such interest includible in the gross income of the nonresident alien beneficiaries under section 662, because no interest was distributed or was required to be distributed by the estate to the nonresident alien beneficiaries in the taxable year of receipt.

EFFECT ON OTHER REVENUE RULINGS

  Rev. Rul. 81-244 is amplified.

Rev. Rul. 86-76, 1986-1 C.B. 284, 1986-21 I.R.B. 5.