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Unsurprisingly, Congress has long chosen to tax a married grantor on trust income, so long as the grantor's spouse is included in the class of beneficiaries.1 The grantor of a trust, Congress apparently reasoned, does not truly surrender access to income if the grantor can continue to benefit from it indirectly through a spouse.2 In addition — and this time rather surprisingly — Congress has chosen to tax the grantor on trust income so long as even a former spouse remains in the class of beneficiaries.3 In other words, if one spouse creates a trust for the other, and the spouses later divorce, acrimoniously or otherwise, the grantor remains obligated to report and pay tax on income paid over to or held for the benefit of the ex-spouse.4
Absurd as it sounds, the attribution of one exspouse's trust income to the other ex-spouse follows from a literal reading of section 672(e). Enacted in 1986,5 that section, known as the spousal unity rule, provides that "a grantor shall be treated as holding any power or interest held by . . . any individual who was the spouse of the grantor at the time of the creation of such power or interest" (emphasis added).6 In other words, the grantor is deemed to have personally retained any power or interest that in fact belongs to a spouse or an ex-spouse, provided that the power or interest came into existence when the grantor and the spouse or ex-spouse were married. As the grantor is generally treated as the owner of any trust of which the grantor himself is a beneficiary,7 the effect of the spousal unity rule is to cause virtually any trust for a spouse or ex-spouse,8 if created while the spouses were married, to be taxed to the grantor. That the spouses later divorce makes no difference.
Few individuals contemplating divorce welcome the prospect of paying tax on an exspouse's income. Unfortunately, the prospect arises all too frequently. Wealthy individuals, in their estate tax planning, often create irrevocable trusts in which a spouse has a beneficial interest (perhaps along with others, such as the grantor's descendants). They do so for the very reason that Congress anticipated when it chose, for income tax purposes, to treat the grantor as the owner of a trust for the benefit of a spouse: By naming a spouse as a beneficiary, a grantor can make an irrevocable transfer of property yet retain enjoyment indirectly through the spouse. For estate tax purposes — in contrast to the income tax rules — the inclusion of the spouse as a beneficiary does not cause trust property to be included in the grantor's gross estate.9 Thus, by creating an irrevocable trust for the benefit of a spouse, the grantor can pass on wealth, including post-gift appreciation, outside of the grantor's estate yet still benefit indirectly from the trust. In short, irrevocable trusts for the benefit of spouses — in recent years, dubbed spousal lifetime access trusts or SLATs — enable grantors both to have their estate tax planning cake and eat it too.
A SLAT can work as planned and even succeed brilliantly, so long as the spouses remain happily married. But if the marriage sours, SLAT planning can turn disastrous. Under the spousal unity rule, divorce does not terminate the attribution of the beneficiary spouse's interests back to the grantor spouse.10 Thus, if the beneficiary spouse continues to be eligible for distributions, the grantor continues to be taxed on the income. Moreover, the grantor doesn't need to have retained any control or influence over the trust for the spousal unity rule to apply. The trustee, for example, could invest the entire portfolio in high-income, tax-inefficient investments, and the grantor can do nothing to stop it or avoid the resulting income tax attribution.
Fortunately, there is a remedy. Congress undoubtedly has broad powers to attribute income — including from a trust — back to the grantor,11 but those powers are not unlimited. On the contrary, as the Supreme Court reaffirmed last year in Moore, 12 the Fifth Amendment's due process clause proscribes arbitrary attributions. Exactly what attributions are arbitrary remains unclear. But if any attribution is arbitrary, it is surely the attribution of one ex-spouse's trust income to the other. In our view, grantors of trusts for the benefit of former spouses have a constitutional right not to be taxed on the trust income merely because of the ex-spouse's access to trust income. This article explains why.
Constitutional Limits on Attribution: The Doctrine After Moore
Moore was not supposed to be a case about attribution. According to the taxpayers' petition for certiorari, the question presented was "whether the Sixteenth Amendment authorizes Congress to tax unrealized sums without apportionment among the states."13 But though it agreed to take up the case, the Supreme Court declined to answer the question (or, as the dissenting justices wrote,14 it simply changed the subject). The Court instead focused on the plain reality that the income at issue in Moore was in fact realized, if not by the individual taxpayers, then by the foreign corporation of which they were shareholders. Thus, reasoned the majority, the question was not whether Congress could tax unrealized income but rather whether it could attribute income realized by the corporation to its shareholders.
The answer to the latter question was yes. The Court held that Congress does indeed have broad power to attribute income from a corporation to its shareholders, including the taxpayers in Moore. Thus, in attributing a corporation's income to the taxpayers, Congress had not imposed a direct tax on the corporate shares — which, under Article I's apportionment clause,15 would require apportionment among the states based on population. Rather, the tax was an indirect tax on realized corporate income, which merely requires that the tax be uniform throughout the United States. Whether a tax on unrealized income must be apportioned was left for another day.
In sidestepping the realization question, the majority reaffirmed that there are at least some limitations on Congress's attribution power. In particular, the Court cautioned that the Fifth Amendment's due process clause "proscribes arbitrary attributions."16 But after laying down that principle, the majority did not elaborate on exactly what attributions would count as arbitrary. The majority's opinion, as Justice Amy Coney Barrett observed in her concurrence, provides no more than a preview of some future analysis.17
And as a preview, Moore does offer at least some insight into what the Court views as arbitrary. At least three sources of guidance can be gleaned from the majority's opinion. First and most obviously, Moore announces, as a "clear rule" established by "this Court's precedents," that Congress may attribute the undistributed income of a business entity to its owners, at least when the entity has not itself been taxed on the same income.18
Second, Moore indicates, albeit somewhat obliquely,19 that Wells20 supplies the test for determining whether an attribution is arbitrary. Importantly for estate planners, Wells happens to address whether income realized by an irrevocable trust could be attributed back to the grantor.21 Thus, while the meaning of arbitrariness may be unclear in many contexts, the Supreme Court has provided direct guidance on the extent to which trust income may be attributed back to the grantor.
Finally, in deciding Moore for the government, the Court gave "great weight" to Congress's "long settled and established practice" of attributing corporate income to its shareholders.22 Closely related to the Court's deference to Congress was the Court's admitted reluctance to trigger a "fiscal calamity" by rendering large swaths of the IRC unconstitutional.23 After Moore, a congressional practice of attributing income in a particular way supports the conclusion that attribution is constitutional.
In summary, Moore affirms a general principle, namely, that the Fifth Amendment's due process clause prohibits Congress from arbitrarily attributing income from one person to another. It further holds that Congress does not act arbitrarily when it attributes an entity's income to its shareholders or partners (provided, at least, that Congress has not also taxed the entity on that income). As for other situations, Moore adopts Wells as the test for determining whether an attribution is permitted. Finally, the Court advises that it will give great weight to a long-settled and established practice of attribution. That, in short, is the attribution doctrine to be applied after Moore.
Additional Limits on Attribution
Moore leaves much unanswered. The majority opinion provides no examples of an arbitrary attribution, beyond, perhaps, a hypothetical attribution of corporate income to shareholders when Congress had already taxed the income.24 The Court leaves uncertain whether Wells should be extended, qualified, or modified in any way. In her concurrence, Barrett also raises the intriguing possibility that the 16th Amendment independently imposes a limit — conceivably, a more stringent limit than the one imposed by the Fifth Amendment — on Congress's attribution authority.
Barrett's concurrence helpfully pointed to two possible sources of further guidance. First, she cited Hoeper, 25 a case that involved the taxation of married couples in which the Court held that a tax statute had impermissibly attributed income from one taxpayer to another. Second, Barrett pointed future courts to the factors suggested by the government for determining whether an attribution of income is arbitrary. At oral argument, Justice Neil Gorsuch asked the government what factors the Court should consider in determining arbitrariness.26 The government responded with a list of three, which Barrett recited in her concurrence and for which she added helpful citations.
The government's suggested arbitrariness factors are:
- whether the taxpayer has sufficient power and control over the income that it is reasonable to treat him as the recipient of the income for tax purposes;27
- whether the taxpayer receives a special privilege or benefit from the entity that earns the income;28 and
- whether the entity is foreign and thus outside the reach of an accumulated earnings tax.29
For better or worse, the majority chose not to adopt any of those factors in its own attribution analysis. Still, Barrett advised that the factors may prove useful to courts determining the constitutional limits of attribution.30
Footnotes
1 A spouse's interests in income were added as a grantor trust trigger by the Tax Reform Act of 1969, section 332(a)(1). An exception to spousal attribution applies if distributions or accumulations of income for the spouse can only be made with the consent of an adverse person. See section 677(a) of the IRC of 1986, as amended (generally treating the grantor as the owner of any trust whose income may be distributed or accumulated for a spouse).
2 H.R. Rep. No. 91-413 at 97 (part 1), 91st Cong., 1st Sess. (1969), 1969- 3 C.B. 261.
3 Section 672(e).
4 A distribution from a grantor trust to a beneficiary is treated as a taxfree gift to the beneficiary under section 102(a). Rev. Rul. 69-70, 1969-1 C.B. 182 (providing that an individual beneficiary is not taxable on the income distributed to him from a trust in which the income is taxed to the grantor).
5 TRA 1986, section 1401(a). The text of section 672(e) was modified two years later by the Technical and Miscellaneous Revenue Act of 1988, section 1014(a)(1).
6 Section 672(e)(1).
7 Section 677(a)(1)-(2).
8 In principle, grantor trust status can be defeated if income can only be distributed or accumulated with the consent of an adverse person. Section 677(a). That condition is rarely satisfied in practice.
9 Cf. Rev. Rul. 70-155, 1970-1 C.B. 189 (acknowledging that property transferred during the taxpayer's lifetime is not pulled back into the transferor's gross estate at death merely because the donee spouse permits the transferor to use the property as the spouse's guest); Estate of Gutchess v. Commissioner, 46 T.C. 554 (1966), acq. 1967-2 C.B. 2.
10 As discussed in the text, historically the spousal unity rule's application to ex-spouses was largely mitigated by section 682. That section, before its repeal by the Tax Cuts and Jobs Act in 2017, section 11051(b)(1)(C), caused income paid, credited, or required to be distributed to an ex-spouse to be taxed to the ex-spouse (and not to the grantor), despite any attribution to the grantor under the grantor trust rules.
11 See, e.g., Burnet v. Wells, 289 U.S. 670, at 678-679 (1933).
12 Moore v. United States, 602 U.S. 572 (2024).
13 Petition for Writ of Certiorari at i, Moore, 602 U.S. 572.
14 Moore, 602 U.S. at 621 (Thomas, J., dissenting).
15 U.S. Constitution Art. I.
16 Moore, 602 U.S. at 599.
17 Id. at 618 (Barrett, J., concurring).
18 Id. at 586. Conversely, the Court strongly indicates, without so holding, that it would be unconstitutional to tax both the entity and its shareholders on the same income.
19 See text at infra notes 35-48.
20 Wells, 289 U.S. 670.
21 See infra note 39 et passim.
22 Moore, 602 U.S. at 592.
23 Id. at 597.
24 Id. at 599. Even then, the Court declines to say definitively that the attribution would be unconstitutional. Id. at 584, n.2.
25 Hoeper v. Tax Commission of Wisconsin, 284 U.S. 206 (1931).
26 Transcript of Oral Arguments at 118-123, Moore, 602 U.S. 572 (2024) (No. 22-800).
27 Moore, 602 U.S. at 619 (Barrett, J., concurring); Commissioner v. Sunnen, 333 U.S. 591, 604 (1948). 28 Moore, 602 U.S. at 619 (Barrett, J., concurring); Wells, 289 U.S. at 679.
29 Moore, 602 U.S. at 619 (Barrett, J., concurring); cf. Ivan Allen Co. v. United States, 422 U.S. 617, 624 (1975).
30 Moore, 602 U.S. at 619 (Barrett, J., concurring).
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Originally published by Tax Notes
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