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§ 12.5 TAX TREATMENT OF DISTRIBUTIONSThe IRS proposed regulations to revise these rules to take into account theselaw changes. 347 These proposed regulations incorporate previous guidance fromthe IRS. 348 The proposal also provides rules for netting different classes of capitalgains and losses, based on prior guidance. 349The proposed regulations reflect these three categories of CRT income. 350 Asnoted, there may be assignments of items, within the ordinary income and capitalgains categories, to classes based on the applicable federal income tax rate. 351For example, the ordinary income category may include a class of qualified dividendincome 352 and a class of all other ordinary income. Likewise, the capitalgains category may include separate classes for short-term capital gains andlosses, for 28-percent rate gain, 353 for certain unrecaptured gain, 354 and for allother long-term capital gains and losses.After items are assigned to a class, the tax rates may change so that items intwo or more classes would be taxed at the same rate if distributed during a year. Ifthe changes to the tax rates are permanent, the undistributed items in those classesare combined into one class. If, however, the changes to the tax rates are temporary(such as when a rate for a class is scheduled to sunset), the classes are kept separate.The categories and classes of income are used to determine the character ofan annuity or unitrust amount distribution from the trust in the hands of therecipient (irrespective of whether the CRT is tax-exempt for the year of the distribution).The determination of the character of amounts distributed must be madeas of the end of the tax year of the CRT. The recipient is taxed on the distributionbased on the tax rates applicable in the year of the distribution to the classes ofincome that are deemed distributed from the trust. The character of the distributionin the hands of the annuity or unitrust amount recipient is determined bytreating the distribution as being made from each category in the followingorder: (1) from ordinary income to the extent of the sum of the trust’s ordinaryincome for the tax year and its undistributed ordinary income for prior years, (2)from capital gain to the extent of the trust’s capital gains, (3) from other incomeof the CRT to the extent of the sum of the trust’s other income for the tax year andits undistributed other income for prior years, and (4) from trust corpus. 355If the CRT has different classes of income in the ordinary income category,the distribution from that category is treated as being made from each class, inturn, until exhaustion of the class, beginning with the class subject to the highestfederal income tax rate and ending with the class subject to the lowest federalincome tax rate. If the CRT has different classes of net gain in the capital gainscategory, the distribution from that category is treated as being made first fromthe short-term capital gain class and then from each class of long-term capitalgain, in turn, until exhaustion of the class, beginning with the class subject to the347 REG-110896-98.348 See text accompanied by notes 309 and 310.349 See § 2.16(b), text accompanied by note 79.350 Prop. Reg. § 1.664-1(d)(1)(i)(a).351 Prop. Reg. § 1.664-1(d)(1)(i)(b).352 IRC § 1(h)(11).353 IRC § 1(h)(4).354 IRC § 1(h)(6). This gain is the subject of IRC § 1250.355 Prop. Reg. § 1.664-1(d)(1)(ii)(a). 461