Income Taxation of Trusts and Estates

Question 1

Requirements for grantor retained trusts

Answer 1

-Establish irrevocable trust (GRAT/GRUT must specify number of years that grantor retains the right to annuity/unitrust payments). Longer the term, greater the value of retained interest and lower the taxable gift)
-Valuations of property shortly before placing in trust
-Grantor given mandatory annuity/unitrust interest (trustees can’t withhold payments from grantor) - payments at least annual
- Annuity can’t be more than 120% of previous year- exact amounts must be specified in trust instrument. Income payments greater than annuity/unitrust amounts are non-qualified and can’t reduce value of remainder trust
-If asset in GRIT is grantor’s residence, then a written lease should require grantor pay FM rental to remainder person
-Trustee should be someone other than the grantor or the grantor’s spouse, especially after the grantor’s retained interest has ended. Retention of an interest as a trustee could lead to additional income tax or estate tax exposure.

Question 2

Tax implications for grantor retained trust

Answer 2

-If grantor outlives specified term, none of the trust assets should be included in grantor’s estate since grantor has retained no interest at death
-Gift to remainder person a future interest so doesn’t qualify for annyal gift tax exclusion
-taxable portion made after 1976 is considered adjusted taxable gift, which will push up the rate at which other assets in the grantor’s estate will be taxed
-rapidly growing asset will have been transferred at low transfer tax cost which results in significant leveraging of unified credit
-100% of post gift appreciations in property’s values escapes estate, gift, and generation-skipping transfer tax. This makes a GRAT, GRUT, or QPRT an excellent “estate freezing” device with respect to post-transfer appreciation.
-At the grantor’s death beyond the specified term of years, no step-up in basis for the property will be allowed. Instead, the basis is fractionalized.
-This would result in a substantial gain if the remainder person disposes of the property. But the income tax rate on the gain will probably be well below the federal estate tax and GST tax rates that could have been imposed had the property been included in the widow’s estate. Furthermore, the potential for significant tax deferral exists.
-If the grantor dies before the specified term expires, the date of death value of the property will be included in the grantor’s gross estate. The reason for this reversionary interest is to have the trust assets be available to the estate to pay for debts, taxes, and estate administrative expenses at the grantor’s death.
-It is appropriate for a beneficiary to purchase insurance on the life of the grantor and carry that life insurance during the period of time in which the death of the grantor would cause estate tax inclusion. The insurance proceeds received estate-tax free, could then be used to purchase assets from the grantor’s estate and thereby provide the estate with the liquidity to pay the estate tax.
-If appreciated property is transferred to a GRAT, GRUT, or QPRT, the tax on any gain will eventually be paid by (a) the grantor, (b) the trust, or (c) the beneficiaries. Having taxes paid by the grantor may not, however, be a disadvantage, since the purpose of the trust is to “defund” the grantor’s estate and shift as much wealth as possible to the remainder person with minimal gift taxes.

Question 3

Implications on CP states

Answer 3

Each spouse may reserve right to payment for trust term as his/her community interest. If either dies during the trust term, the value of his or her community interest in the trust would be included in his or her taxable estate, either in whole or in part.

Question 4

Simple trust

Answer 4

• All income must be distributed currently
• Funds cannot be paid to/used for charitable purposes
• Amounts allocated to the corpus of the trust cannot be distributed/can’t distribute principal

Question 5

Complex Trust

Answer 5

• No need to distribute to beneficiaries
• Can distribute to charities
• Can distribute principal

Question 6

Trust filing requirements

Answer 6

Fiduciary must file Form 1041 for a taxable domestic trust that has:
- any taxable income for the tax year
- gross income of $600+
-beneficiary who is a non-resident alien

If foreign, must file 1041-NR . Form 3520-A

By 15th day of 4th month depending on calendar (taxable trusts must use)/fiscal year

Question 7

Distributable Net Income (DNI)

Answer 7

amount of the taxable trust income which is deemed to be the amount of trust income that is available to be paid to beneficiaries and can be used to reduce the trust’s taxable income

Taxable income
+ Income distribution deduction
+ Exemption ($300 for a simple trust)
+ Net tax-exempt income
+ Capital losses*
< Capital gains* >
< Extraordinary stock dividends >

Question 8

The beneficiary of a decedent’s estate or complex trust must include in his or her gross income

Answer 8

-amount of income required to be distributed currently, or, if the income required to be distributed currently exceeds the DNI (figured without taking into account the charitable deduction), his or her proportionate share of the DNI (as so figured), and
-All other amounts properly paid, credited, or required to be distributed, or if the sum of the income required to be distributed currently and other amounts properly paid, credited, or required to be distributed to all beneficiaries exceeds the DNI, his or her proportionate share of the excess of DNI over the income required to be distributed currently.

Question 9

The beneficiary of a simple trust must include

Answer 9

his or her gross income in the amount of income required to be distributed currently, whether or not distributed, or if the income required to be distributed currently to all beneficiaries exceeds the distributable net income (DNI), his or her proportionate share of the DNI.

Question 10

An estate has chosen a June 30, 2021 taxable year-end. If Ed Doyle, an heir of an estate, received a distribution of income from the estate in December, 2020, what year must he report the income on his individual tax return?

Answer 10

Distributions from an estate are deemed made on the last day of the estate’s tax year. In this case, Ed reports the income for 2021, even though the distribution occurred in the calendar year 2020.

Question 11

remainder beneficiaries

Answer 11

principal preserved for

Question 12

income beneficiaries

Answer 12

income on annual basis

Question 13

Trust accounting income

Answer 13

income and expense items that are used to determine the amount the income beneficiaries are entitled to receive from the trust or estate each year. (Items of income and expense that are allocated to the principal are not used in calculating trust accounting income)

Question 14

Taxable trust income

Answer 14

includes income allocated to principal, such as capital gain

Question 15

Taxable trust income

Answer 15

includes income allocated to principal, such as capital gain

Question 16

estate tax

Answer 16

tax that is levied on the estate before transfer of the taxable estate of every decedent who is a citizen or resident of the United States, if value exceeds an exclusion limit

Question 17

If appreciated property is transferred to a GRAT, GRUT, or QPRT, the tax on any gain will eventually be paid by the

Answer 17

the grantor,
the trust, or
the beneficiaries

Having taxes paid by the grantor may not, however, be a disadvantage, since the purpose of the trust is to “defund” the grantor’s estate and shift as much wealth as possible to the remainder person with minimal gift taxes.

Question 18

complex trust

Answer 18

accumulate income,
have a charitable beneficiary, and/or
distribute principal.

Question 19

A __________________________ is useful when a client wants to purchase certain tangible assets such as a work of art, retain the right to display it in his or her own home, and have it pass to a specified person immediately and without probate at death.

Answer 19

A grantor retained income trust (GRIT) is a useful technique when a client wants to purchase certain tangible assets such as a work of art, retain the right to display it in his or her own home and have it pass to a specified person immediately and without probate at death.
If the grantor is unable to establish the value of the retained interest through comparable rentals, the gift of the transferred remainder will equal 100% of the value of the transferred property.

Question 20

The fiduciary must file Form 1041 for a taxable domestic trust that has gross income of ______ or more.

Answer 20

$600 or more (regardless of taxable income)

Question 21

The fixed annuity amount paid to a grantor from a grantor trust must not exceed ____ of the amount paid the prior year

Answer 21

120%

Question 22

If appreciated property is transferred to a GRAT, GRUT, or QPRT, the tax on any gain will eventually be paid by the:

Answer 22

the grantor,
the trust, or
the beneficiaries.

Question 23

Brittany is 14 years old and has a 2503(b) trust that distributes $3,500 of income in the current year. In addition, she earned a total of $5,000 babysitting this year. Brittany is in the 10% marginal bracket this year while her parents are in the 24% marginal bracket.

Calculate the total tax due to Brittany and her parents.

Answer 23

Earned income = $5,000; Unearned income = $3,500

Step 1:
The child’s taxable income = [Gross income – standard deduction (greater of $1,250 or amount of earned income + $400)]
[$8,500 gross income ($5,000 + $3,500) - $5,400 standard deduction ($5,000 + $400)] = $8,500 - $5,400 = $3,100

Step 2:

Parent’s tax (amount taxed at parent’s marginal rate) = (Unearned income – first $1,250 – second $1,250)
$3,500 (unearned income) - $1,250 - $1,250 = $1,000 x 0.24 = $240

Step 3:

Amount taxed at child’s rate = (Child’s taxable income – amount taxed at parents’ marginal rate) x Child’s rate
$3,100 - $1,000 = $2,100 x 0.10 = $210

TOTAL TAX = $240 + $210 = $450