In a pre-need funeral (burial) contract where money is held in trust, who owes income tax on the interest the account earns — the customer or the trust?

Plain-English summary

When you buy a pre-need funeral (burial) contract, you pay a funeral home in advance and the money is held in trust until it's needed. Revenue Ruling 88-3 answers a basic question: while that money sits in trust and earns interest, who owes income tax on the earnings — you (the customer) or the trust?

The facts: a funeral home sold pre-need contracts, holding the proceeds in a constructive trust with a bank as trustee; each customer's subaccount received its share of earnings, and the customer could cancel at any time and take back the balance, including accruals.

Two South Carolina statutes pointed in opposite directions. The older pre-need burial law, § 32-7-20 (enacted 1962), said the "trust fund itself shall be solely liable for all taxes" on the fund and its earnings. But the newer income-tax provisions, §§ 12-7-410 and 12-7-425 (enacted 1985), determined income under the Internal Revenue Code — including IRC § 676(a), the grantor-trust rule, under which a person who can revoke a trust and get the property back is treated as the owner of the trust's income. The IRS had applied § 676(a) to exactly this kind of revocable pre-need arrangement in Revenue Rulings 73-140 and 87-127, taxing the customer.

Because the two statutes could not be reconciled, the Commission applied the "last legislative expression" rule from Jolly v. Atlantic Greyhound Corp. (1945): when two statutes irreconcilably conflict, the more recent one controls. Section 12-7-410 (1985) is newer than § 32-7-20 (1962), so the income-tax grantor rule won. Conclusion: the customer/beneficiary is the owner for income tax purposes and must include the account's interest and other income in gross income in the year it accrues.

What this means for you

Funeral homes and pre-need trustees

If you sell revocable pre-need contracts and hold the money in trust, the customer — not the trust or the trustee — is generally the taxpayer on the account's earnings under this ruling's reasoning. The trustee's role (as in the facts here) is to track each subaccount and deliver the customer the tax forms reporting the income earned. Don't assume the old "trust fund is solely liable" language of the burial statute controls the income tax result.

Customers who prepay funeral expenses

Because you can cancel and reclaim the balance, the tax law treats you as the owner of the money while it's in trust. That means the interest and earnings are your income in the year they accrue, even though you won't use the funds until later. Expect a tax reporting form from the trustee.

A note on current law

This 1988 ruling turned on the state income-tax sections and the federal grantor-trust rule as they existed then. South Carolina's income-tax code was later recodified (Title 12, Chapter 6), and both the state and federal provisions can change. Use the ruling for its principle — a revocable pre-need trust is a grantor trust taxed to the customer — but confirm the current statutes and any pre-need-specific rules for a live situation.

Common questions

Q: Who pays income tax on interest earned by a pre-need burial trust?
A: The customer/beneficiary. As the grantor who can revoke the contract and recover the funds, the customer is treated as the owner of the trust's income and reports the earnings in the year they accrue.

Q: Doesn't the burial statute say the trust fund is 'solely liable' for taxes?
A: The older § 32-7-20 said that, but the more recent income-tax statute adopting the federal grantor-trust rule controlled under the "last legislative expression" rule, so the customer is taxed.

Q: When is the income taxed — when I die or use the funds, or as it's earned?
A: As it's earned. The customer must include the interest and other income in gross income in the year of accrual, not when the contract is ultimately performed.

Citations and references

Statutes:

• S.C. Code Ann. §§ 12-7-410, 12-7-425 (and § 12-7-10, Supp. 1986) — determine individual and trust income under the Internal Revenue Code
• S.C. Code Ann. § 32-7-20 (1976) — pre-need burial contract law stating the trust fund is solely liable for taxes on the fund and its earnings
• IRC § 676(a) — grantor treated as owner of a trust the grantor can revoke

Federal guidance and case law referenced:

• IRS Revenue Rulings 73-140 and 87-127 — apply IRC § 676(a) so the pre-need customer is taxed on the account's earnings
• Jolly v. Atlantic Greyhound Corp., 207 S.C. 1, 35 S.E.2d 42 (1945) — where two statutes irreconcilably conflict, the later "legislative expression" prevails

Source

• Landing page: SC Advisory Opinion Search
• Original PDF: RR88-3.pdf

Original ruling text

SC REVENUE RULING #88-3

SUBJECT:

Taxation of Pre-need Burial Contract
Service Trust Arrangements

EFFECTIVE DATE:

Tax Years Beginning on or after January 1, 1988

SUPERSEDES:

All previous documents and any oral directives in conflict
herewith.

REFERENCE:

S.C. Code Ann. Section 12-7-10 (Supp. 1986)
S.C. Code Ann. Section 12-2-410 (Supp. 1986)
S.C. Code Ann. Section 32-7-20 (1976)

AUTHORITY:

S.C. Code Ann. Section 12-3-170 (1976)
SC Revenue Procedure #87-3

SCOPE:

A Revenue Ruling is the Commission's official interpretation of
how tax law is to be applied to a specific set of facts. A Revenue
Ruling is public information and remains a permanent document
until superseded by a Regulation or is rescinded by a subsequent
Revenue Ruling.

Question:
Whether the customer/beneficiary of a pre-need burial contract service trust arrangement is
responsible for the payment of taxes on income earned by his/her account in said trust or whether
such tax liability rests with the trustee of the account?
Facts:
XYZ, Inc., a funeral home, provides pre-need burial contract services to its customers. Under
these contracts, customers purchase services and some inventory of the funeral home in advance
of actual use. The proceeds are then held in constructive trust by the funeral home, and any
interest, earnings, etc. which accrue on the account are added to it. Upon the customer's death,
the amounts paid in and the amounts accrued are applied to the fixed amount agreed upon in the
contract. The balance remaining is then returned to the deceased's estate. The customers may
terminate the contract at any time and receive the balance of the account, including accruals.

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To aid in administration of these contracts, XYZ, Inc. has arranged for ABC Bank to act as
trustee. The accounts are held in a master trust and each account will receive, as a subaccount, its
pro rata share of earnings, income and expenses. At the close of the year, ABC Bank will
account to the customer and deliver to him/her the required tax forms regarding the income
earned on the individual's account.
Discussion:
South Carolina Section 32-7-20 which addresses pre-need burial contracts, states that the "trust
fund itself shall be solely liable for all taxes on the fund and its interest, dividends, increases and
accretions." Contradicting this are Sections 12-7-410 and 12-7-425 which state that the gross
income and taxable income of individuals and trusts are determined under the Internal Revenue
Code. (IRC Sections 665 through 668 relating to taxation of certain accumulation distributions
from trusts are spcifically not adopted.) One of the incorporated federal statutes, IRC Section
676(a), states that "the grantor [of the trust] shall be treated as owner...where at any time the
power to revest in the grantor title to such portion is exercisable by the grantor or a non adverse
party, or both."
The Internal Revenue Service has interpreted Section 676(a) in Revenue Ruling 73-140, and
more recently in Revenue Ruling 87-127, to mean that the customer in each of these pre-need
burial contracts is responsible for the taxes owed on the accrued earnings.
The issue then is which of the two conflicting statutes is controlling in the instant case. The
South Carolina Supreme Court said in Jolly v. Atlantic Greyhound Corporation et al., 207 S.C. 1,
35 S.E.2d 42 (1945), that where two sections of a statute are irreconcilable, the subsequent
section, or the "last legislative expression," prevails over the prior one. This rule is used only
where it is impossible to harmonize the two sections or statutes in some acceptable way. Such is
the case here where the two statutes are in conflict.
As for the enactmnt dates of the two statutes, Section 12-7-410 is the more recent of the two,
having been enacted in 1985. Section 32-7-20 was enacted in 1962.
Applying, then, the "last legislative expression" rule, Section 12-7-410 is the controlling statute.
As previously stated, Section 12-7-410 requires the grantor of the trust to be treated as owner of
it and therefore liable for taxes arising from accretions to his/her account.
Conclusion:
The customer/beneficiary of a pre-need burial contract in which the proceeds are held in trust
until the death of the customer or revocation of the contract is the owner for income tax purposes
and must include interest or other income to the account in his/her gross income for the year of
accrual. (April 13, 1988)

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SOUTH CAROLINA TAX COMMISSION

s/S. Hunter Howard Jr.
S. Hunter Howard, Jr., Chairman

s/John M. Rucker
John M. Rucker, Commissioner

s/A. Crawford Clarkson Jr.
A. Crawford Clarkson, Jr., Commissioner

Columbia, South Carolina
April 13
, 1988

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