In Private Letter Ruling 201409001 (Feb. 28, 2014), the Internal Revenue Service released a decision regarding four issues surrounding savings bonds that were transferred to a trust. 

A decedent and her husband bought paper U.S. Series I bonds.  One bond was registered to the decedent and one of three other individuals (A, B or C).  The other bond was registered to A and the decedent, B or C.  On a subsequent date, the bonds were re-registered in the name of a trust (the original trust) and later converted to electronic bonds that were held in a TreasuryDirect account.

On the death of either the decedent or A, the trustee was to divide the original trust into two parts, a decedent’s trust and a survivor’s trust.  The trustee was to distribute the assets of the decedent’s trust to the survivor’s trust, unless the decedent’s surviving spouse made a qualified disclaimer.  If so, the decedent’s trust would hold the disclaimed interest.  The original trust and the survivor’s trust were grantor trusts; the decedent’s trust wasn’t. 

After the decedent died, A, as trustee of the decedent’s trust, established a second TreasuryDirect account in the name of the decedent’s trust.  A plans to make a qualified disclaimer under the terms of the original trust, regarding the decedent’s share of the bonds.  Such disclaimer would result in the decedent’s share of the bonds remaining in the decedent’s trust.  A would also like to transfer the decedent’s share of the bonds into the second TreasuryDirect account. 

The decedent’s final tax return won’t include any interest earned on the bonds before the decedent’s death.  Moreover, the original trust will use the cash method of accounting and will not report the interest on the bonds annually.

 

Income in Respect of Decedent

The IRS first considered whether the interest earned on the bonds up to the date of the decedent’s death was income in respect of a decedent (IRD) under Internal Revenue Code Section 691.  The IRS concluded that the interest earned on the bonds up to the date of the decedent’s death will be IRD if: 1) the decedent’s final tax return didn’t include interest earned on the decedent’s share of the bonds before the decedent’s death; 2) as trustee of the survivor’s trust, A makes a qualified disclaimer to the original trust regarding the decedent’s share of the bonds; and 3) the decedent’s share of the bonds are transferred to the second TreasuryDirect account.

 

Deferral of Reporting Interest

The IRS next applied IRC Section 454(c) to consider whether the decedent’s trust could defer reporting interest on the bonds until they are disposed of, redeemed or reach maturity, whichever comes first.  The IRS concluded that the decedent’s trust may defer reporting if it uses the cash method of accounting and doesn’t elect to report interest income on the bonds annually.

 

Interest Characterization

Third, the IRS applied IRC Section 662 and concluded that any interest that the decedent’s trust reports and distributes to the beneficiaries will have the same character in the hands of the beneficiaries as in the hands of the decedent’s trust.

 

Taxable Income

Finally, the IRS concluded that on A’s death and the distribution by the decedent’s trust to the beneficiaries of any remaining unmatured bonds, the decedent’s trust won’t recognize any taxable income on the distribution.  Moreover, the beneficiaries may defer reporting accrued interest on the bonds until the bonds are disposed of, redeemed or mature, whichever comes first.