Fiduciary Income Tax

Question 1

What are the grantor trust rules?

Answer 1

IRC §§671-679.
Simply put, if the grantor,or another individual, has too much control over a trust, then that trust is not considered a separate taxable entity.

Common one that makes it a grantor trust - Power to Revoke

Question 2

Who is a related or subordinate party under grantor trust rules?

Answer 2

Under IRC §672(c) the term related or subordinate party includes any nonadverse party who is

(1) the grantor’s spouse if living with the grantor;
(2) the grantor’s father, mother, issue, brother, sister, an employee of the grantor (among others).

Question 3

How is income reported under grantor trust rules?

Answer 3

Option 1:
The trustee does not need to obtain an EIN for the trust. The grantor must provide a signed W-9 to the trustee.

Options 2 and 3: The trustee obtains an EIN for the trust.
◦ The trustee provides the EIN to the payors of income.
◦ The trustee issues 1099s to the grantor(s).
◦ The trustee does not file a Grantor 1041 for the trust.
The difference between Option 2 and 3 is that Option 2 is when the trust is owned by one Grantor and Option 3 is when the trust is owned by more than one Grantor.

Question 4

What type of grantor trust can’t use 1099 income tax reporting?

Answer 4

Not all grantor trusts can use 1099 reporting, for example a trust that has any assets located outside the United States or a qualified subchapter S trust.

Question 5

What are the grantor trust rules?

Answer 5

Trusts over which Grantor has a reversionary interest exceeding 5%.
This can be a partial interest, such as a fractional interest in the trust or a reversionary interest over a specific asset.

• A trust for which the grantor or a non-adverse party holds the power to determine who will receive the corpus or income without the consent or approval of any adverse party.
• A trust with which the grantor or a non-adverse party has the power to deal for less than full and adequate consideration, or to borrow without adequate interest or security.
• A trust that the grantor can revoke.
• A trust whose income may be distributed or held for future distribution to the grantor or grantor’s spouse or be used for the payment of life insurance premiums on policies of insurance on the life of the grantor or grantor’s spouse. [ILITS specifically bar this to preclude being a grantor trust]

Question 6

Who is an “adverse party” under 672?

Answer 6

Under IRC §672(a) an adverse party is any person having a substantial beneficial interest in the trust which would be adversely affected by the exercise or non-exercise of the power which he possesses respecting the trust.

A person having a general power of appointment over the trust property shall be deemed to have a beneficial interest.

Question 7

How might a beneficiary be deemed a partial grantor under 678?

Answer 7

Crummey notice right to withdraw as to that asset

5x5 power as to that right to withdraw.

Settlor could retain a partial ownership - eg, right to withdraw one-half of trust; or income only.

**Even if beneficiary does not exercise right to withdraw, he will be treated as grantor for that asset.

Question 8

What is IDGT?

Answer 8

Grantor trust for income tax purposes.

But completed gift for FET purposes (not included in ht estate)

Question 9

What is Income in Respect of a Decedent?

Answer 9

Items of income in respect of a decedent (“IRD”) are taxed twice in a relatively short period of time, IF a FET is owed.

Treated as principal of the estate.

B/c of this, the estate or trust gets to take a deduction on 1041 of the amount FET attributable to the IRD.

Remember: if there is no FET paid, there will be no
IRD deduction!

Question 10

What deductions are allowed on a 1041?

Answer 10

Reg. 1.641(b)-1 states that generally the deductions and

credits allowed to individuals are also allowed to estates and trusts.

Question 11

What is the TCJA?

Answer 11

Tax Cuts and Jobs Act - 2017

Question 12

Is FET deductible on 1041?

Answer 12

No

Question 13

What taxes are deductible on 1041?

Answer 13

◦ State fiduciary income taxes (subject to the limitations
imposed by the TCJA)
◦ Real estate taxes not deducted elsewhere (such as on
Schedule E)

Question 14

What are the exemptions on 1041?

Answer 14

$600 for estate
$300 for simple trust
$100 for complex trust

Question 15

What is the distribution deduction on 1041?

Answer 15

Fiduciary return takes a deduction for the amounts passed out to the beneficiaries - k-1

Question 16

What is the effect of TCJA?

Answer 16

Under the TCJA (2017) the deduction for miscellaneous itemized deductions was eliminated.

This may result in taxes being owed even when all net income is distributed, because the items are still deducted in calculating net income even though they are not deductible for income tax purposes.

◦ The elimination of a deduction for investment advisory fees, and
◦ The limitation on the amount that can be deducted for state and local taxes, “SALT” to $10,000.

Question 17

What is the special basis rule for transfer of an asset to a trust where the basis is less than FMV at time of transfer?

Answer 17

If at the time of the transfer the property’s FMV is LESS than the donor’s basis, then the trust’s basis for determining loss is the fair market value, but for determining gain it is the donor’s basis.

Question 18

What happens to basis if donor pays gift tax at time of transfer of asset to trust?

Answer 18

If there is gift tax paid on the gift, then the trust’s basis is
increased by the portion of the gift taxes attributable to the “net appreciation” – with “net appreciation” being the
difference between the fair market value and the transferor’s cost basis.

Question 19

What is the basis for a gift to trust?

Answer 19

Carry-over basis. Generally there is a carryover of basis and holding period from the transferor to the trust receiving the property.

cf. Gift tax is paid on the FMV

Question 20

What is FMV?

Answer 20

Fair market value is what a willing seller will pay a
willing buyer when neither is under a compulsion
to or sell and both are fully apprised of the relevant
facts.

If there are no trades on the date of death (for example, the decedent died on a weekend), then the value is determined by taking a weighted average of the means between the highest and lowest sales on the nearest date before and the nearest date after the date of death

Question 21

What is FMV of marketable securities?

Answer 21

The average of the highest and lowest trading price on the date of death. It is not the closing value.

Question 22

Can you use AVD if there is no FET due?

Answer 22

No. Have to be required to pay tax in order to use AVD.

Question 23

How is the gain/loss from sale of an asset rec’d from a decedent categorized, even if sale occurs w/in one year of death?

Answer 23

Gain or loss from the sales of an asset received from a decedent is treated as long term gain/loss, even if the sale occurs within one year of the date of death.

Often the sales price of real estate, if it occurs within a reasonable amount of time after the decedent’s date of death establishes the cost basis (i.e. willing seller, willing buyer…)

Question 24

What is the difference b/n simple and complex trusts?

Answer 24

A simple trust is one which is REQUIRED to distribute all its net income currently, does NOT make any principal distributions, and does not provide that any amounts are to be paid, permanently set aside, or used for charitable purposes.

A complex trust that is required to distribute all its income currently, but which makes principal distributions during the year receives the $300 exemption.

Question 25

How do you allocate deductions on 1041?

Answer 25

Deductions are to be allocated among the various classes of income.

Items directly attributable to one class of income are
allocated to that class first. If they exceed that class of
income, then the excess may to allocated to other classes.

Deductions not directly attributable to a specific class of income may be allocated to any item, including capital gains, included in computing distributable net income (“DNI”)

A portion of deductions must be allocated to tax-exempt income and may not be deducted on the 1041.

If you have an estate with federal estate taxes, the portion of expenses allocated to tax-exempt income can be deducted on the 706.

Question 26

How do excess deductions work for 1041?

Answer 26

1. Only pass out in the FINAL year of the estate or trust.

2. If make distributions w/in 65 days of final year, can still make one return - pull into one year.

Question 27

What’s the history with “miscellaneous deductions” on beneficiary’s use of excess deductions on individual income tax return?

Answer 27

Lost them from the TCJA. But:

On October 19, 2020 IRS issued a new regulation on this issue to clarify that the character of each deduction comprising the excess deductions retains, in the hands of the beneficiary, its character. In other words,
those deductions are not miscellaneous itemized deductions (because the estate/trust is not able to use those deductions). [So, can identify what they are - fiduciary fees, taxes, etc]
**They are an “above the line” deduction.

The effect of the new regulation is that excess deductions are allowed to be passed out to the beneficiaries in the trust/estate’s final year and
that the beneficiaries may use those deductions in arriving at adjusted gross income (i.e. an “above the line” deduction).

The new regulations apply to taxable years beginning after 10/19/2020.

Taxpayers may elect to apply the amendments to taxable years beginning after 12/21/2017 and on or before 10/20/2020.

Remember, however, that in a year other than the year of termination, excess deductions are lost!
◦ They do not carry out to the beneficiaries.
They do not carry forward.

Question 28

What is Distributable Net Income?

Answer 28

DNI is defined in IRC §643(e) as the TAXABLE income of the trust with the following modifications:

◦ No deduction is allowed for distributions.
◦ No personal exemption is allowed.
◦ Capital gains are excluded to the extent allocated to corpus and not paid, credited, or required to be distributed to any beneficiary, or paid or permanently set aside for charity.
◦ Capital losses are excluded except to the extent they enter into a determination of capital gains paid, credited or required to be distributed to a beneficiary.
◦ Net tax-exempt interest is included

Question 29

For tax accounting purposes (UPIA) what is Net Accounting Income per UPIA?

Answer 29

Dividends and interest less ½ the trustee’s fee.

UPIA says allocate trustee’s fees 1/2 income and 1/2 principal.
Note that the trust instrument could be different - could say allocate 100% to income and then DNI would match trust accounting income.

Question 30

For computing the Trust’s TAXABLE income (NOT UPIA) what is trust’s net income - DNI??

Answer 30

For computing TAXABLE income, 100% of the trustee’s fee is deductible against gross income (DNI)

Question 31

What is the result of DNI and trust net accounting income not being the same?

Answer 31

As a result, DNI is less than the trust’s net accounting income, and the distribution (to beneficiary) deduction will be limited to DNI. (Unless trust provides otherwise)

Question 32

What happens to the DNI if some of the income distributed to a beneficiary (UPIA) is tax-exempt?

Answer 32

ONLY TAXABLE income is used to calculate DNI.
AND, deductions have to be allocated b/n exempt and non-exempt income (equal allocation) for DNI. So, while $$ to beneficiary is more, DNI may be far less with tax exempt income.

Question 33

What is relationship b/n net accounting income, DNI, and DD?

Answer 33

• Net Accounting income is per trust terms and UPIA - the ACTUAL net income DISTRIBUTED to a beneficiary
• DNI is the TAXABLE net income (less certain deductions) of the TRUST

– DD is the “distribution deduction” that the TRUST gets to take on its fiduciary income tax return.

They may NOT be the same number.
*The DD is limited to the LESSOR of trust accounting income and DNI in a simple trust.

So, b/c of TCJA, trust could end up paying tax on assets distributed.

Question 34

What is “carry out” of income?

Answer 34

Estate or trust income is “carried out” to the beneficiary.

Question 35

Are specific bequests carried out to the beneficiaries for income tax?

Answer 35

No

Question 36

How is does DD work for complex trusts and estates?

Answer 36

Tier system.

Under this tier system, DNI is allocated first to those beneficiaries who receive income that is required to be distributed currently. The balance of DNI is allocated to other beneficiaries who receive distributions, on a pro-rata basis.

Question 37

Can a trust avoid passing out income to a beneficiary by

accumulating income and making payments out of principal?

Answer 37

No. To the extent the trust has DNI a distribution of principal will carry out income

Question 38

What is the ESTATE (estate ONLY or TRUST electing under 645 to be treated as an ESTATE) exception to the related parties rule?

Answer 38

Exception to “related parties” for that b/n an executor and a beneficiary (or trustee and beneficiary if electing to be treated as an estate)

IF an estate uses appreciated or depreciated property to satisfy a distribution of a SPECIFIC BEQUEST, estate or trust can realize the gain or loss.

Question 39

What is the ESTATE (estate ONLY OR Trust electing to be treated as an ESTATE) exception to the related parties rule?

Answer 39

Exception to “related parties” for that b/n an executor and a beneficiary (or trustee and beneficiary if electing to be treated as an estate)

IF an estate uses appreciated or depreciated property to satisfy a distribution of a SPECIFIC BEQUEST, estate or trust can realize the gain or loss.

Question 40

How do “distributions in kind” work on fiduciary income tax return?

Answer 40

Two options with respect to distributions in kind and how they affect the amount of DNI carried out by the distribution and the basis of the distributed property in the hands of the beneficiary.

Question 41

How do “distributions in kind” work on fiduciary income tax return if ELECTION is MADE?

Answer 41

If the 643(e)(3) election is made, then:
◦ The distribution deduction is the FMV of the property at the time of distribution (but not exceeding DNI) and
◦ The basis of the property in the hands of the beneficiary is adjusted to reflect the gain or loss recognized.
◦ But remember, losses cannot be recognized on sales between related taxpayers!

The election, when made, shall apply to all distributions
made during the taxable year.

Question 42

What is a 645 election?

Answer 42

Elect for trust to be filed with estate during duration of estate. What are advantages:

◦ Selection of a fiscal year end
◦ Not required to make estimated tax payments for 2 years
◦ $600 exemption
◦ Potentially a longer time period for holding Subchapter S Corporation stock.
◦ Allowance of the passive loss deduction of $25,000 for rental real estate activities under IRC §469(i)(4)
◦ Recognizing loss for satisfaction of a pecuniary bequest with depreciated property.
◦ Charitable set aside deduction under IRC §267(b)(13)

Question 43

What is a 645 election?

Answer 43

Elect for trust to be filed with estate during duration of estate. What are advantages:

◦ Selection of a fiscal year end
◦ Not required to make estimated tax payments for 2 years
◦ $600 exemption
◦ Potentially a longer time period for holding Subchapter S Corporation stock.
◦ Allowance of the passive loss deduction of $25,000 for rental real estate activities under IRC §469(i)(4)
◦ Recognizing loss for satisfaction of a pecuniary bequest with depreciated property.
◦ Charitable set aside deduction under IRC §267(b)(13)

Question 44

What happens once 645 election made?

Answer 44

Irrevocable
Can be made even if no probate estate
Election ends two years after death or six months after date of final determination of FET

Question 45

What is the IN IT-41 fiduciary income tax rate for trusts and estates?

Answer 45

3.4%