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Authors

Dennis E. Bires

Abstract

A great deal of the complexity of the rules dealing with income taxation of trusts and estates' can be attributed to the imperfect compatibility of two different regimes of law: the federal taxation of income and local rules of trust accounting. Just as the confluence of two rivers may generate turbulence exceeding that of either branch, the meeting of federal tax law and state trust law in Subchapter J of the Internal Revenue Code generates problems that neither discipline would present by itself.

In 1972, a New York Surrogate's Court introduced the Holloway adjustment to fiduciary accounting. This equitable adjustment was seen as necessary to restore the balance between the interests of income and principal beneficiaries of certain trusts after that balance had been upset by the effects of Subchapter J, particularly where executors had utilized a popular tax-saving technique known as the "trapping distribution."' In these instances, the first element of the federal/local law interaction would be the Subchapter J tax rules that make "trapping distributions" possible. The second level, the response of local trust law to a tax-induced inequity, is the Holloway adjustment itself. The third level, and the subject of this article, is the federal tax law's treatment of the new relationships created by the Holloway adjustment. At this point, an introduction to trapping distributions and to the Holloway adjustment is necessary.

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