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distributable net income." Sec. 1.652(a)-2(b), Income Tax Regs.
If a beneficiary has gross income under subchapter J, the
character of the income to the beneficiary is the same as the
character would be in the hands of the trust. Sec. 1.662(b)-1,
Income Tax Regs. Under the character rule, when a trust earns
income from various sources, the income is:
treated as consisting of the same proportion of each
class of items entering into the computation of
distributable net income as the total of each class
bears to the total distributable net income of the
estate or trust unless the terms of the governing
instruments specifically allocate different classes of
income to different beneficiaries * * * [Id.]
Thus, to determine whether petitioner is subject to income
tax on his receipt of the $46,936 distribution, we must first
determine whether Trust C had DNI for its taxable year ended
February 28, 1985. If Trust C had DNI equal to or greater than
$46,936 for its taxable year ended February 28, 1985, then
petitioner must include a percentage of the $46,936 distribution
in his 1985 gross income, equal to the proportion of Trust C's
DNI that consists of taxable items.
Respondent determined that the trusts earned income from
three sources during the years in question: (1) Interest on
municipal bonds, (2) interest on the loans from the trusts to the
estate, and (3) interest on the La Playa and Blue Grass
mortgages. Petitioner contests respondent's determination; he
alleges that Trust C did not have sufficient DNI for the year in
issue. Since respondent concedes that the trusts earned $252,408
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