Capital and Income in Trusts Flashcards
What is the key distinction between capital and income in a trust?
A) Capital is the principal asset of the trust, while income is the profit generated from the capital.
B) Capital and income are the same and can be used interchangeably.
C) Income is always reinvested into the trust fund, while capital is distributed to beneficiaries.
D) Only the trustee decides how capital and income are used, without considering the trust document.
A) Capital is the principal asset of the trust, while income is the profit generated from the capital.
Explanation: Capital refers to the core assets of the trust (e.g., land, shares, money in a bank), while income is the financial return generated by those assets (e.g., rent, dividends, interest).
Which of the following is NOT considered capital in a trust?
A) Land
B) Shares
C) Rental income
D) Money in a bank account
C) Rental income
Explanation: Rental income is considered income because it is generated from a capital asset (land). Capital consists of assets held by the trust.
If a trustee holds shares on trust for a beneficiary, what type of trust property does the beneficiary have an interest in?
A) Capital
B) Income
C) A discretionary interest
D) A contingent interest
A) Capital
Explanation: Shares are a capital asset because they are the principal property of the trust. Any dividends generated by the shares would be income.
What happens to trust income if the beneficiary is under 18?
A) It is automatically reinvested into the trust as capital.
B) It is paid out to the minor beneficiary.
C) It may be applied for their benefit under the trustee’s power of maintenance.
D) It must be distributed to the beneficiary’s guardian.
C) It may be applied for their benefit under the trustee’s power of maintenance.
Explanation: Trustees have discretion to use trust income for the minor’s education, health, and maintenance, rather than directly transferring funds to them.
What is meant by “intermediate income” in a trust?
A) Income that is lost due to trustee mismanagement.
B) Income arising before a vested interest becomes possessory.
C) Income that is reinvested in the trust permanently.
D) The capital gains from a sale of trust property.
B) Income arising before a vested interest becomes possessory.
Explanation: Intermediate income refers to income generated before the beneficiary’s interest vests in possession (e.g., income received by the trustee before a minor turns 18).
A trust holds an apartment that is rented out. What is the capital and what is the income?
A) The apartment is capital, and the rental income is income.
B) The apartment is income, and the rental income is capital.
C) Both the apartment and the rental income are capital.
D) Both the apartment and the rental income are income.
A) The apartment is capital, and the rental income is income.
Explanation: The apartment itself is a capital asset, and the money earned from renting it out is income.
A trust states: “My trustees must hold my house on trust for my daughter if she reaches 21.” What type of interest does the daughter have?
A) Vested in possession
B) Contingent
C) Discretionary
D) Reversionary
B) Contingent
Explanation: The daughter’s right to the house depends on her reaching 21. If she does not reach 21, she never receives the property, making it a contingent interest.
A trust states: “Income to A for life, remainder to B.” Who is entitled to what?
A) A gets capital, B gets income.
B) A gets income, B gets capital.
C) A gets both capital and income.
D) A and B both get income.
B) A gets income, B gets capital.
Explanation: A has a life interest, meaning they receive income for life. B has a remainder interest, meaning they will receive capital after A dies.
A trustee holds shares that produce dividends. The trust states: “My trustees must hold my shares on trust for my son if he reaches 25.” What happens to the dividends before the son turns 25?
A) The son receives them immediately.
B) The dividends are accumulated and added to the capital.
C) The dividends are given to another beneficiary.
D) The dividends are lost.
B) The dividends are accumulated and added to the capital.
Explanation: Since the son’s interest is contingent on reaching 25, the trustees accumulate the income until the condition is met.
A trust states: “My trustees must hold my house on trust for my son until he turns 21 and then transfer it to him absolutely.” What interest does the son have in the income before 21?
A) He has no entitlement to income.
B) He is automatically entitled to the income.
C) He is only entitled to the income if he turns 21.
D) The trustees may use the income for his benefit under the power of maintenance.
D) The trustees may use the income for his benefit under the power of maintenance.
Explanation: The son’s interest is vested in interest but not in possession. Trustees may apply income for his benefit before he turns 21.
If a trust does not specify who receives trust income, what happens to it?
A) It belongs to the trustee.
B) It is automatically added to capital.
C) It remains undistributed indefinitely.
D) The court decides how it should be distributed.
B) It is automatically added to capital.
Explanation: If there is no express income beneficiary, trust income accumulates and becomes part of capital.
A life tenant of a trust mismanages income. Who can take legal action?
A) The trustee
B) The remainderman
C) The court
D) The settlor
B) The remainderman
Explanation: The remainderman has an interest in the capital and can take legal action if the life tenant depletes trust income.
Which statement about contingent interests is correct?
A) They are the same as vested interests.
B) The beneficiary must be alive to receive them.
C) They do not become vested under any circumstances.
D) They automatically pass to the settlor upon failure.
B) The beneficiary must be alive to receive them.
Explanation: A contingent interest only vests if the beneficiary meets the required condition (e.g., surviving to a certain age).
If a trust grants income to a minor but does not allow immediate distribution, what must the trustee do?
A) Give the income to the minor anyway.
B) Invest and accumulate the income.
C) Return the income to the settlor.
D) Ignore the income.
B) Invest and accumulate the income.
Explanation: Income must be accumulated or applied for the minor’s benefit under trustee powers.
Who owns the capital of a trust where A has a life interest and B has a remainder interest?
A) A and B jointly
B) A only
C) B only
D) The trustee
D) The trustee
Explanation: The trustee holds legal title to the capital and manages it for the benefit of both A (income) and B (capital upon A’s death).
