Taxation on Estates, Trusts, & Exempt Organizations Flashcards
What occurs with a trust?
The trustee has legal title to the beneficiary’s property, and has a fiduciary duty to use it properly
Rights and duties outlined in a trust instrument
What are the four elements of a trust?
(1) settlor/trustor
(2) trustee
(3) trust property
(4) beneficiary
What is a trustor?
Whoever causes the trust to exist
Can be same person as trustee or beneficiary
What can a trustee not delegate?
Control over the trust property
What occurs if a trustee becomes incapable to perform (or unwilling)?
The trust is not thereby dissolved – usually the court will appoint a trustee
What is another term for the property held in the trust?
Trust res
Under what circumstances can future property be held in trust?
Only insofar as the settlor/trustor has a present interest in it
If the trustee has legal ownership over the trust property, what does the beneficiary have?
Equity ownership
Does a trust need written documentation to exist?
No – all that is needed is an expressed intention
Sometimes the Statute of Frauds will require writing (e.g. with real property)
Is consideration needed to form a trust?
Not a present one, but it is needed to bind an agreement to form a future one
How can a trust be terminated?
It depends on what the trust instrument specifies, e.g. who it enables to terminate the trust
Oftentimes it will terminate when its purpose has been completed or made impossible
What is the merger doctrine?
If one person becomes the sole trustee and sole beneficiary, then the trust is terminated simply because there’s no purpose to it – someone caring for property for his own sake doesn’t need a trust
This is because the legal title and equitable title have merged into one
What is the difference between an active trust and a passive trust?
Active = trustee has positive duties to manage the property
Passive = trustee doesn’t have any duties but to hold title to the property until the beneficiary can attain ownership
Depending on the type of beneficiary, what are the two main kinds of trusts?
Charitable and private
Charitable = beneficiary is the public in general, or a large portion of it
What different rules apply to charitable trusts?
(1) the cy-près doctrine can be applied to them
(2) they are valid even when the specified beneficiaries are indefinite
(3) they are not under the rule against perpetuities
What is the cy-près doctrine?
If a charitable trust has an impracticable or impossible purpose, the court can direct the trust res to a very similar purpose
“cy-près” = French for “so near” or “so close”
What is the rule against perpetuities?
Designed to limit the length of time during which someone can exercise power over property intended for a beneficiary – particularly if the person is already deceased
Generally this restricts any contingencies that would allow the deceased title-holder to have control (i.e. to not give the property to a beneficiary) for 21 years
What are express and implied trusts, and what are the different types of implied trusts?
Express = created by the trustor’s expressed intention
Implied = created implicitly by circumstances and actions as the law infers
-the two types are resulting trusts and constructive trusts
What is the difference between a resulting trust and a constructive trust?
Resulting = the trust exists when the intention of a settlor to create a trust is inferred from his actions (e.g. giving property to someone else without consideration)
Constructive = the trust exists to remedy a wrong, where someone who wrongly acquired property (e.g. by violating a fiduciary duty) ought to transfer ownership to another
What is the difference between an inter vivos trust and a testamentary trust?
Inter vivos = trust is created during trustor’s lifetime
Testamentary trust = trust is created upon trustor’s death, usually by a will
What is a spendthrift trust?
A trust where the property rights cannot be transferred at all, not even to the beneficiary, until the trust ceases to exist (whether by the settlor’s revoking, by time, or by beneficiary’s death)
Usually exists if the beneficiary is financially irresponsible, or to protect his assets from creditors
What is a tentative trust?
A bank account opened by the trustor in his own name, but designating himself “as trustee” for a beneficiary – this becomes irrevocable if the trustor dies
Also called a Totten trust
What is the Uniform Principal and Income Act (UPAIA)?
If a trust has assets that generate income and some beneficiaries are to receive the principal and others to receive rights to income, the distribution of assets can get complicated. Where this is not dealt with in the trust instrument itself (e.g. saying that the trustee has sole authority in the matter), the UPAIA applies
What is the general rule in allocating income between income beneficiaries and principal beneficiaries?
Ordinary inflows are deemed income; extraordinary inflows are deemed as additions to capital
- ordinary examples: cash dividends, interest, rent revenue, net income from a non-corporate business managed by the trustee
- extraordinary examples: stock dividends or splits, cash from selling trust assets
What is the general rule in allocating expenses between income beneficiaries and principal beneficiaries?
Ordinary expenses for the trust are paid out of income; extraordinary expenses out of principal
- ordinary examples: depreciation expense, cost to preserve and maintain trust assets, ordinary taxes on income or real estate, insurance on trust assets
- extraordinary examples: net losses from a non-corporate business managed by the trustee, capital improvements, principal repayments on loans, costs to buy or sell trust assets
How do estate and trust taxes avoid double taxation?
Beneficiaries can be taxed just as the estates and trusts can, but if there is income generated by the estate/trust which is then distributed to the beneficiary, only one party need pay tax on it – the other can deduct it
Usually the parties can choose in any circumstances who pays taxes on how much income
What is a very important distinction in taxation for estates and trusts?
The assets (or trust res) and the income generated by those assets
The assets can also be called the principal or corpus
Under what circumstances would assets transferred to a trust be taxed at the settlor’s tax rates, rather than the trust’s?
If the assets are appreciated in value and the trust sells them within two years
This is to keep such taxes in the higher brackets of the settlor who intends to get a tax break by having a trust sell his assets
What occurs if a trust or estate has deductions or loss carryovers that haven’t been applied by the time the trust ends?
They can be transferred to the beneficiaries
What is the difference between a simple trust and a complex trust?
Simple = all annual income is distributed each year, no distributions are made except out of income, and no charitable donations are made
Complex = every other trust – and these are mostly subject to the same rules as simple trusts
For complex trusts that accumulate income (rather than doling it out yearly), how does the income tax work?
A problem arises from the fact that income can be earned one year, held in trust, distributed later, and then taxed at that later rate rather than when it was earned
There is thus a “throwback rule,” where the income is taxed as it would have been when originally earned
How does the income tax calculation for estates and trusts compare to individuals’?
The same – both get deductions, credits, and so on
What is the personal exemption amount for estates and trusts?
As of 2013, these amounts are:
- $600 for estates
- $300 for simple trusts
- $100 for complex trusts
When is a beneficiary liable for a simple trust’s income?
In the year that income ought to be distributed, regardless of whether it actually is distributed
Do estates and trusts all need to have calendar years as their tax years?
No, estates can elect a fiscal year, as can charitable trusts and trusts qualifying as 501(a) tax-exempt organizations
What is the minimum gross income which would require a trust or estate to pay income tax?
$600 (as of 2013)
How often are trusts and estates required to make tax payments?
Trusts – every quarter (estimated payments)
Estates – the taxable year which is two years following the decedent’s death
What is distributable net income (DNI)?
The total taxable income passed on to the beneficiary, and thus the total income which the estate or trust can deduct for itself
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Are specific bequests of property taxable to the estate/trust?
No, but if they are fulfilled with substitute property, then they are taxable
What is a real estate investment trust (REIT)?
A trust where the trustee has title to and manages real estate for the beneficiaries
Yet this is not just any real estate trust – it must qualify as a REIT in order to avoid being taxed like a corporation
What are the qualifications for a trust to be a REIT?
(1) certificates of ownership are freely transferable
(2) 100 or more certificate holders each year, and the majority of the certificates cannot be concentrated in 5 or fewer people
(3) trust’s primary business is not real estate
(4) majority of trust’s income comes from real estate
(5) trustee has centralized control
(6) >=90% of taxable income is distributed to certificate holders
What liability do certificate holders for a REIT have?
Limited liability
REIT certificates can be traded as securities, so they have limited liability
What is a funeral trust?
A trust where funeral services are prepaid, the money paid being held in trust
What is the general rule for funeral trust taxation?
The trust is treated as a “grantor trust” – i.e. all annual income earned by the trust assets is taxable to the trustor, not to the trust
Under what circumstances can a funeral trust not be treated as a grantor trust?
(1) trust is created by contract with funeral business
(2) all beneficiaries have themselves contracted with funeral business
(3) trust’s purpose is to manage assets solely for funeral or burial
(4) all contributions are either from the beneficiary or for his benefit
(5) trustee elects for trust to be a qualified funeral trust
This all would mean that the trust tax rate applies and that the trustee is liable for the tax, rather than the trustor
Is there any limitation on contributions to a funeral trust?
No, though there used to be a $9,000 limitation before 2008
What is a Coverdell Education Savings Account (CESA)?
A trust where the trustor pays for the education expenses of a beneficiary who is at most 18, handled by an approved trustee
Also can be called education IRAs, because they behave so similarly to IRAs
As related to a CESA, what are qualified educational expenses?
Not merely college expenses, but also expenses for (e.g.) elementary school, even public schools
Also includes special needs services related to education
What is the maximum contribution for a CESA?
As of 2013, the max is $2,000 per beneficiary per contributor, though multiple people can contribute to one beneficiary
This is phased out for MAGIs from $190k - $220k for married filing jointly taxpayers, and $95k - $110k for everybody else
Are CESA contributions tax-deductible?
No
What occurs if CESA funds are distributed for non-educational expenses (or in excess of educational expenses)?
They are then taxed and subject to a 10% penalty
This penalty is inapplicable if the beneficiary dies or becomes disabled
What occurs if a beneficiary turns 30 and there are still undistributed CESA funds?
They are automatically taxed and penalized 10%
Before he turns 30, the funds can still avoid this tax by transferring the funds to a family member’s CESA, including cousins
How does CESA relate to tax credits?
If a taxpayer does not already claim a credit on the student, he can claim a Lifetime Learning credit or American Opportunity credit instead
The taxpayer can also exclude distributions from taxable income in the same year
How do CESA rules change for a special-needs beneficiary (SNB)?
Contributions can be made even if he is older than 18, and he can turn 30 without forcing any taxation or penalty
What are qualified tuition programs (QTPs)?
Plans to prepay for tuition at current rates
Also called 529 plans
Which kinds of plans can qualify as QTPs?
Ones established by a state, ones established by an eligible educational institution, or qualified accounts
Can someone contribute non-cash contributions to QTPs?
No, only cash contributions are permitted
How do QTP contributions relate to the gift tax?
Any contributions are treated as gifts and thus can be placed under that exemption – they also are exempt from generation-skipping transfer taxes
The same applies to CESA contributions
How are distributions on QTPs taxed?
All deferred income (i.e. amounts gained beyond the original contribution) are taxable to the beneficiary
How do QTPs relate to tax credits?
If a taxpayer does not already claim a credit on the student, he can claim a Lifetime Learning credit or American Opportunity credit instead
The taxpayer can also exclude distributions from taxable income in the same year
This is the same as with CESA
According to IRC Section 501(c), what are the first three of ten types of organizations entirely exempt from income tax?
(1) corporations organized under a congressional act that exempts them
(2) organizations formed for religious, educational, charitable, etc. purposes
(3) organizations which facilitate amateur sports competitions without providing facilities or equipment
According to IRC Section 501(c), what are the second three of ten types of organizations entirely exempt from income tax?
(4) organizations whose aim is to prevent cruelty towards animals and children
(5) business leagues, chambers of commerce, real estate boards, labor organizations, etc.
(6) nonprofit football leagues
According to IRC Section 501(c), what are the last four of ten types of organizations entirely exempt from income tax?
(7) social clubs supported only by membership fees
(8) trusts for employee pensions and profit-sharing
(9) private foundations
(10) some condo management associations
Which organizations cannot qualify for tax-exempt status?
Any organization which:
- seeks to influence laws
- makes a profit, even if all profit goes towards tax-exempt organizations
What must a qualifying organization do to achieve tax-exempt status?
(1) Apply for it and (2) maintain it by refraining from forbidden transactions
At what point in time is an organization deemed to be tax-exempt?
If it files with the IRS within fifteen months of the end of the month of the organization’s inception, then it is deemed to be tax-exempt retroactively to its inception
Otherwise, it is deemed to be tax-exempt once it receives notice that its filing for tax-exempt status is valid
Can the IRS retroactively revoke tax-exempt status?
Yes
What does a tax-exempt organization need to file annually?
A return which provides information about the organization
Private foundations must always file this, but it is not required for (1) organizations with under $25,000 in gross receipts or (2) churches, church-affiliated schools, corporations exempt by an act of Congress, and some state organizations
When is a tax-exempt organization’s annual return due?
On the 15th of the fifth month after the organization’s accounting period – usually May 15
What is unrelated business taxable income (UBTI)?
Income on which a tax-exempt organization must nonetheless pay taxes
When are the taxes on UBTI due?
Ordinarily, by the time the annual return is due
If there is more than $1k in UBTI, the return must be filed within 2 1/2 months of its fiscal year-end – usually March 15
When does income qualify as UBTI?
If it occurs from some operation that is both (1) regular to the organization and (2) not substantially related to its tax-exempt purpose
What cannot be classified as UBTI?
(1) income from activities done predominantly by volunteers
(2) royalties, dividends, interest, and annuities
(3) selling items received by donation
(4) income from a business conducted for the convenience of people in the organization
(5) income from games of chance
Exception to (2): annuities and interest from debt-financed investments can still be UBTI
How is UBTI taxed?
The tax will be the same as for a corporation or a trust, depending on the nature of the tax-exempt organization (usually a corporation)
However, a special deduction for UBTI deducts the first $1,000 in UBTI
