Taxation for Trusts and Estates Flashcards
What is a Grantor Retained Trust
A grantor retained trust, as its name implies, is an irrevocable trust into which the grantor places assets and retains an interest for a fixed number of years. The principal, at the end of the specified period of years, will pass to a non-charitable beneficiary, such as a child or grandchild of the grantor.
What is a Grantor Trusts
A grantor trust is a trust arrangement in which the grantor has retained too much control for the IRS to consider the trust to have independent existence for tax purposes. Any trust that is revocable is a grantor trust because the grantor can reclaim the trust assets whenever he wants. All of the income from the trust is taxed to the grantor at his personal tax rate, and the value of the trust assets is included in the grantor’s gross estate at death, which may be taxed as an estate tax. Even if a trust is irrevocable, it may be a grantor trust if the grantor retains the income from the trust, if the grantor has control of the amounts or times that distributions can be made to the beneficiaries, or when the grantor retains control of the trust assets.
Tax implication for Simple Trusts and Complex Trusts
Trusts and estates are treated as separate taxpayers who are required to file federal income tax returns each year. Income taxation of irrevocable trusts follows certain general rules. Beneficiaries are taxed on the trust income that is or can be distributed to them, while income that is accumulated in the trust is taxed to the trust. The trustee or the executor pays income tax on the income retained in the trust. This division of income taxes is known as the “sharing” concept.
Tax rates for Trusts
Trust income is taxed to the trust at the highest 37% bracket when trust income exceeds $15,200 in 2024. By comparison, individuals are taxed at the 37% bracket when their income exceeds $609,350 in 2024.
Choice of Taxable Year
An estate is created on death. The decedent’s executor is responsible for choosing the estate’s income tax year. All income tax years must be 12 months long except for the first and last tax years. This allows the executor to determine the number of months included in the first tax year of the estate.
For example, Tom died on April 1, 20X2. John, his executor, chooses a fiscal year end of January 31, 20X3. In July of 20X2, John makes a distribution to the heirs of $50,000 from the income of the estate. Since the estate’s taxable year ends on January 31, 20X3, the distribution to the heirs is deemed to have been made in 20X3 even though they got the distribution in 20X2. The income is taxable to the heirs in 20X3.
Distributable Net Income (DNI)
Distributable Net Income (DNI) is used to allocate taxable income of a trust or estate between the trust or estate and the beneficiaries. Distributable Net Income is an estimate of the actual benefit available to the income beneficiaries and is the maximum amount that can be taxed to beneficiaries. Distributions in excess of DNI are generally treated as tax-free distributions of principal.
Estate Tax
An estate tax is imposed on the transfer of the taxable estate of every decedent who is a citizen or resident of the United States who has an estate that exceeds $13,610,000 in 2024. Estate tax rates are higher than income tax rates at 40% and are an important consideration in financial planning.
Estate Income Tax
As a taxable entity, an estate must pay tax on its income. If the income of the estate consists of dividends from stock and interest from bonds, these items will comprise the gross income of the estate. Likewise, if there is rental income, royalty income, income from the sale or exchange of property, or income from a business carried on by the executor or administrator, then the income of the estate will include those items as well.
