Opinion ID: 3010690
Heading Depth: 2
Heading Rank: 3

Heading: Effect on Appellant's Tax Liability

Text: Section 662(b) of the Internal Revenue Code provides that income which is taxable in the hands of a trust is taxable in the hands of the trust's beneficiary. Thus, when a trust receives both taxable and non-taxable income, the trust's distributions to its beneficiaries are treated as consisting of both taxable and non-taxable elements, in the same proportion as the taxable and non-taxable elements of the trust's net income. See 26 U.S.C. S 662(b); Treas. Reg. 37 S 1.662(b)-1. The Tax Court found that 36% of the distribution to Geftman was taxable, based on its conclusion that 36% of Trust C's net income consisted of taxable interest income generated by the margin transactions and the La Playa and Blue Grass mortgages, while the remainder consisted of tax-exempt income earned on the trusts' municipal bonds. See app. at 436-38.30 However, for the reasons discussed above, we find that the Tax Court erred in characterizing the transfers to the trusts of $82,764 in connection with the E.F. Hutton margin transaction and $59,000 in connection with the mortgages as taxable income. Because these amounts were not paid to the trusts as a bona fide creditor or a bona fide holder of the mortgages, the transfers can be characterized only as non-taxable distributions from an estate which had no distributable net income, rendering all of the trusts' income, and thus all of the distribution to Geftman, nontaxable. See 26 U.S.C. S 652(a); Treas. Reg. S 1.652(a)-2(b).