Income Taxation of Trusts and Estates Flashcards
General issues
personal representative of an estate has similar duties and responsibilities as trustee to trust
Similarities between trusts and estates
- both have beneficiaries
- someone is responsible for creation of the estate or trust
- both transfer property
- both administer property in a fiduciary capacity
- both are distinct tax entities
Differences between trusts and estates
- estate comes into existence involuntarily upon death
- a trust is created intentionally and voluntarily during grantors lifetime
- estates operate for limited period *until assets transferred and taxes paid
- trust typically operate for many years *generations
- estate moves property to beneficiaries
- trust may retain property
- estate is supervised by court
- trustee operated under a private arrangement
Filing requirements
Estate
- estates file form 1041
- entitled to certain deductions: admin costs, fees, expenses to prepare return
- can claim deduction on 1041 0r 706
Trusts
- file form 1041
- beneficiary share of income is reported on K-1
Deadlines
- form 1041 due on 15th day of the fourth month after the entity’s year end
- must file if any exists: any taxable income for the year, gross income $600 or more, beneficiary is nonresident alien
Choice of taxable year
- for first return, estate can use same accounting period that decedent used or can choose a calendar/ fiscal year
- trusts must use a calendar year, (except 501a charitable)
- exemption of $600 is allowed on a short period return
Tax treatment of distributions to beneficiaries
- beneficiaries taxed on part of income distributed and estate/trust is taxed on portion that has accumulated and retained
- if estate/ trust must distribute all income the beneficiary must report their share of net income whether it was received in that year or not
Current income not required to be distributed
if trustee/fiduciary has choice to distribute all or part of current income the beneficiary must report:
- all income that is required to be distributed whether or not received
- all accounts actually paid or credited up to amount of the beneficiaries distributed net income
2023 trust/ estate rate structure
- these rates apply to income that is not distributed to beneficiaries
- given on test
Grantor trust
- maker holds too much control over property for tax purposes
- considering income or estate tax liability
- grantor will be taxed on income produced from trust
- a reversionary interest that exceeds 5% of the trust value at the time of creation is retained by the grantor
Defective trusts
- grantor trusts
- following violations create defective trust for tax purposes
- trust income distributed or accumulated for later distribution to either grantor or spouse
- trust income is used to discharge any legal obligation of grantor
- trust income is actually used to discharge a legal support obligation of grantor
- power to control beneficial enjoyment is held by grantor or spouse
- trust income is used to pay premiums on LI on the life of either grantor or spouse
ILIT
unfunded ILIT
- yearly gift to the trust pays the LI premium (not income taxable to grantor)
funded ILIT
- investment income from investments in trust pays the premium (taxable to grantor)
- only amount of premium paid is taxable, remainder is taxed to trust
Administrative power
- held by either the grantor or grantors spouse to deal with the trust property for less than full consideration
- to borrow from the trust without adequate interest or security
- or the right to vote the stock held in the trust corpus
Defective trust for estate tax purposes
if the grantor retains the following
- a right to income or the right to use or enjoy trust property
- a reversionary interest that exceeds 5% measured at the time of death
Simple trust
- conduit for forwarding income to the beneficiaries
- passes income through to the beneficiaries who then report the income
- beneficiaries pay taxes at the own marginal tax rates
- trust is separate tax entity but operates as as a tax conduit
- cannot make charitable gifts
Complex trust
- taxed as separate entity if it meets both requirements
- it is irrevocable and grantor has not retained any control
- income is accumulated
- irrevocable almost always complex
- can make charitable gifts
Revocable living trust
inter vivos or grantor trusts
- more popular alternative to probate
- at grantors death the trust becomes irrevocable and either terminated with the corpus distributed or continues until a later date
- no gift tax to fund (not complete)
- all income taxed to grantor
Irrevocable trust
- ## grantor gives up all rights: can no longer revoke, terminate, modify
Trust accounting income
Revocable
- grantor is responsible for any tax liability
Irrevocable
- can be taxed simple or complex depending on whether all the income is distributed
Trust taxable income
deductions available to a trust
- charitable deduction (complex only)
- depreciation, cost recoevery, depletion
- distributed income allocated between trust and beneficiary
- net operatig carryforward
- admin expenses
- deduction for all income required to distribute
Exemption
- complex trust required to distribute all its income has exemption of $300
- complex trust not required to distribute all income, exemption is $100
Distributable net income (DNI)
- limited the amount that trust/estate beneficiaries must report as gross income for tax purposes
- DNI rules allow:
- claim a deduction for amount distributed
- limit portion of the distribution that is taxable to beneficiaries
- ensure that the character of the distributions remains the same for the beneficiary as it was to the trust
- no double taxation of trust income because of deduction received on income distributed (equal to lesser of amount distributed or DNI)
