Taxation - Income Taxes

Question 1

Types of Income for Accounting and Taxation Purposes

Answer 1

1. Fiduciary Accounting Income (governed by UPIA)
2. Trust’s Taxable Income (governed by IRC)

Question 2

Types of Trusts

Answer 2

1. Revocable v Irrevocable
2. Inter Vivos v Testamentary
3. Simple v Complex
4. Grantor v Non-grantor

Question 3

Grantor Trusts -

1. Definition
2. What Constitutes a Grantor Trust?
3. Taxation
4. Intentionally Defective Grantor Trusts

Answer 3

1. Definition – settlor is treated as owner of income and principal of trust for federal income tax purposes.
2. Grantor Trust if
   
   1. Revocable trust
   2. G retains power to distribute principal to himself or spouse
   3. G retains reversionary interest valued 5% of trust res at time of creation
   4. Court created trust
3. Taxation
   
   1. Disregarded by IRS
   2. Taxable income goes on Grantor’s personal tax return
   3. Assets generally included in Grantor’s estate for federal estate tax
      
      1. Unless IDGT
4. Intentionally Defective Grantor Trust (IDGT) – grantor retains right causing grantor trust rules to apply but not power that requires including trust in estate.
   
   1. Assets in trust grow tax free because grantor is paying them
   2. Assets can be sold to IDGT without income or capital gains taxes
   3. Usually utilized to sell businesses.

Question 4

Non-Grantor Trusts -

1. Definition
2. Taxation

Answer 4

1. Definition - if its not a grantor trusts, its a non-grantor trust, which includes most irrevocable trusts.
2. Taxation–
   
   1. Trust itself is taxed like estates and individuals
   2. Taxable year - calendar year (except charitable trusts are on fiscal year)
   3. All taxable income will be taxed at its final situs at year end:
      
      1. Trust pays tax on income not distributed.
      2. Beneficiaries pay tax on distributions received.

Question 5

Non-Grantor Trusts - Tax Rates/Deductions

1. Deductions/Exemptions
   
   1. Simple Trust
   2. Complex Trust
   3. Charitable Contributions
   4. Administration Expenses
2. Tax Rates for Trust Income

Answer 5

1. Deductions and Exemptions –
   
   1. Simple Trusts - $300 exemption
   2. Complex Trusts – $100 exemption
   3. Standard Deduction for Individuals - $12.55k
   4. Estates Exemption - $600
   5. Charitable Contributions Deduction
      
      1. Only complex trusts qualify
      2. 100% deduction
      3. May deduct contributions for year preceding actual year of payment
   6. Administrative Expenses
      
      1. 100% deduction for expenses only trust would incur
      2. Otherwise 2% deduction
2. Tax Rates – up to 37% on 13.05k

Question 6

Trust Capital Gains -

1. Definition
2. General Calculation

Answer 6

1. Definition – capital gains are realized when capital assets are sold by the trust.
2. Calculation – difference between the basis of the property and the sales price
   
   1. Testamentary Trust – step-up basis (cost to grantor at purchase plus appreciation when transferred to trust)
   2. Inter Vivos Trust – carry-over basis (cost to grantor at purchase)
   3. Asset Purchased by Trust – Purchase Price

Question 7

What is Not Taxable Income?

Answer 7

1. Principal contributions
2. Gifts
3. Inheritances
4. Proceeds from life insurance
5. Proceeds from casualty insurance
6. Tax exempt interest (muni bonds)
7. Income earned from Trust assets which is distributed to beneficiaries in the same tax year (IDD deduction)
   
   1. Beneficiaries pay the tax on income distributed (not trust)
   2. Trust issues K-1 to Beneficiary

Question 8

Income Distribution Deduction -

1. General Rule
2. Character of Distributions
3. 65 Day rule
   
   1. Complex Trusts
   2. Simple Trusts

Answer 8

1. General Rule – trusts can deduct income distributions to beneficiaires.
   
   1. Distributions maintain same character as when income acquired (ordinary, capital gains, etc)
   2. Deductions are pro rata based on character of income
2. 65 Day Rule for Complex Trusts– trustee can elect for income distributions to B’s to be taxed under prior year up to 65 days into current tax year.
   
   1. Simple trust doesn’t need because they distribute all income each year.

Question 9

State Tax Application to Out-of-State Trusts - Sup Ct Ruling

Answer 9

States can’t tax trusts because the beneficiary lives in their state. However, they can tax the income distributed from the trust to the bene.