Final answer:
A testamentary trust designated as a Graduated Rate Estate (GRE) distributes income to the widow and son and retains a portion for itself. The income earned and retained by the GRE is taxed at the GRE's tax rate, while the income distributed to the widow and son is taxed in their hands at their own tax rates.
Step-by-step explanation:
A testamentary trust is designated as a Graduated Rate Estate (GRE) in accordance with the decedent's will, where the widow and the decedent's adult son each receive 40% of the GRE's income, and the remaining 20% of the income is retained in the GRE. The income earned and retained by the GRE is subject to income tax at the GRE's tax rate. The income distributed by the GRE to the widow and son is taxable in their hands at their respective income tax rates.
For example, if the GRE earns $100,000 in income, $20,000 would be retained in the GRE and subject to tax at the GRE's tax rate. The remaining $80,000 would be distributed to the widow and son, who would each be responsible for paying tax on their respective share of the income.