V. Federal Taxation of Entities - 6. Fiduciary Taxation Flashcards
V. Federal Taxation of Entities
- Income Taxation of Fiduciaries
I. Fiduciaries
Trusts and estates can be taxed on the income that accrues during the administration of the fiduciary. The trust/estate is taxed on income retained by the fiduciary and not distributed currently to beneficiaries. Income distributed to beneficiaries is reported as income during the beneficiary’s tax year in which the estate year ends.
V. Federal Taxation of Entities
- Income Taxation of Fiduciaries
III. Income Concepts
A. Single Taxation—Income is taxed only once to either the fiduciary or the beneficiary.
- A distribution deduction for fiduciary prevents double taxation.
- Income taxed to beneficiaries retains its character (a conduit approach).
V. Federal Taxation of Entities
- Income Taxation of Fiduciaries
III. Income Concepts
B. Income Computation—Individual income tax rules generally apply to determining the taxable income for fiduciaries.
- Fiduciaries get a personal exemption depending on the type of fiduciary: $600 for estates, $300 for simple trusts and for complex trusts that distribute all of their income currently, and $100 for all other complex trusts.
Definitions
Simple Trust: A trust that (1) must distribute all income currently, (2) make no distributions of corpus currently, and (3) make no current charitable contributions. Any trust that does not qualify as simple must be complex.
Grantor Trust: A trust controlled by the grantor through retained powers or the possibility the property in the trust will revert to the grantor.
V. Federal Taxation of Entities
- Income Taxation of Fiduciaries
III. Income Concepts
B. Income Computation—Individual income tax rules generally apply to determining the taxable income for fiduciaries.
- A trust may be simple in some years and complex in others.
- Fiduciaries get no standard deduction, but can deduct interest, taxes, charitable contributions, and trustee’s fees. Section 179 cannot be used by trusts or estates.
- Investment advisory fees of nongrantor trusts and estates generally are subject to the 2% of AGI floor as miscellaneous itemized deductions, unless the fees are not “commonly incurred” by individuals. 2% miscellaneous itemized deductions are no longer deductible. Expenses described below that are not subject to the 2% rule are still deductible.
- Fees that are classified as 2% miscellaneous itemized deductions are not deductible by the trust or estate.
- Costs that are unique to an estate or trust and not commonly incurred by an individual are not subject to the 2% of AGI floor. Costs not subject to the 2% of AGI floor include the costs of preparing the estate and generation-skipping transfer tax returns, fiduciary income tax returns, and the decedent’s final individual tax return.
- Also, appraisal fees to determine the FMV of the decedent’s assets as of date of death (or alternate valuation date), to determine the value for purposes of making distributions, or as otherwise required to properly prepare the estate or trust’s tax returns are not subject to the 2% floor. Additionally, some fiduciary expenses are not subject to the 2% floor, including probate costs, fiduciary bond premiums, legal publication costs of notices to creditors or heirs, and the cost of certified copies of the decedent’s death certificate.
V. Federal Taxation of Entities
- Income Taxation of Fiduciaries
III. Income Concepts
C. Administrative expenses can be deducted on the estate income tax return (Form 1041) if the estate irrevocably waives the right to take the deduction on the federal estate tax return (Form 706).
- Examples of administrative expenses are fiduciary fees, legal fees, accounting fees, and court costs.
- Administrative expenses may be divided between the estate income tax return and the federal estate tax return in any manner desired by the fiduciary (i.e., executor or administrator) of the estate, as long as a waiver is filed for the portion of the administrative expenses that are allocated to the estate income tax return.
V. Federal Taxation of Entities
- Income Taxation of Fiduciaries
IV. Distributable Net Income (DNI)
A. Distributions of Income—Create a distribution deduction for the fiduciary.
- The distribution deduction cannot exceed the distributable net income.
- Property distributions are not generally treated as dispositions of assets, but instead as distributions of DNI.
- Beneficiaries are taxed on the receipt of distributions (to the extent of DNI).
- Beneficiaries report income for the beneficiary’s tax year in which the estate’s or the trust’s year-ends.
V. Federal Taxation of Entities
- Income Taxation of Fiduciaries
IV. Distributable Net Income (DNI)
B. Calculation of DNI—Requires adjusting taxable income.
- Add back personal exemption, net tax-exempt income, and net capital loss.
- Subtract net capital gains allocable to corpus (keep net capital gains allocable to income beneficiaries or charity).
- For estates and complex trusts, there is a two-tier system of allocating income and deductions and a “throwback” rule to discourage tax avoidance by timing trust distributions.
Example
This year an estate reports $50k of capital gains (allocable to corpus), $100k of interest income, $25k of administrative expenses (allocable to income), and $12k of real estate taxes. Taxable income (before the distribution deduction) is $112,400 ($50,000 + $100,000 − $25,000 − $12,000 − $600). DNI is $63,000 calculated by adding back the personal exemption of $600 and subtracting out the net capital gains of $50k.
V. Federal Taxation of Entities
- Income Taxation of Fiduciaries
V. Procedural Rules
- Trusts must use a calendar year, but estates may choose any year-end. Both must file by the 15th day of the fourth month after the year-end (if the 15th falls on the weekend or holiday, the due date is the next business day following the 15th). Beginning in 2016, an automatic extension of five and one-half months is allowed to file income tax returns for Form 1041.
- Trusts must pay estimated income taxes, but estates need only pay estimated income taxes after their first two tax years of operation.
- Fiduciaries must file an income tax return (Form 1041) if gross income exceeds $600, if the fiduciary has taxable income, or if a nonresident alien is a beneficiary.
- The alternative minimum tax applies to estates and trusts and is computed in the same manner as for individuals. The AMT exemption for an estate or trust is $25,000 for 2019.
- An estate or trust is subject to the 3.8% Medicare Contribution Tax on net investment income. The tax is imposed on the lessor of (a) an estate or trust’s undistributed net investment income, or (b) the excess of an estate or trust’s AGI over the dollar amount at which an estate or trust’s highest income tax bracket begins.
V. Federal Taxation of Entities
- Income Taxation of Fiduciaries
VI. Income in Respect of a Decedent
Definition
Income in Respect of a Decedent(IRD): Income earned by the decedent but not included in the decedent’s final return.
- The income is included in both the estate income tax return and the estate tax return.
- Accrued expenses paid after the date of death attributed to income in respect of a decedent are deducted on both the estate income tax return and the estate tax return.
- Estates (or beneficiaries) that are taxed on income in respect of a decedent are entitled to deduct the estate tax on this property.
V. Federal Taxation of Entities
- Income Taxation of Fiduciaries
VIII. Treatment of Complex Trust and Beneficiaries
- A two-tier income distribution system is used.
- First tier: Distributions of the first tier are income amounts that are required to be distributed and include distributions that can be paid out of income or corpus, to the extent paid out of income.
- Second tier: Distributions of the second tier are all other amounts that are actually paid during the year or are required to be paid.
- DNI is first allocated to distributions in the first tier. Any remaining DNI is prorated to distributions in the second tier.
Example
A trust has DNI of $9,000. The trust instrument requires that $6,000 of income be distributed annually to Alan. Further, it permits distributions to Baker and Carr of income or corpus at the trustee’s discretion. For the current year, the trustee distributes $6,000 to Alan, $4,000 to Baker, and $2,000 to Carr.
Since Alan’s distribution is a first tier distribution, all $6,000 distributed is taxable to Alan. This leaves only $3,000 of DNI to be allocated to the second tier distributions to Baker and Carr. Since DNI would be allocated in proportion to the amounts distributed, $2,000 of Baker’s distribution and $1,000 of Carr’s distribution would be taxable.
V. Federal Taxation of Entities
- Income Taxation of Fiduciaries
Which of the following fiduciary entities are required to use the calendar year as their taxable period for income tax purposes?
Estates__Trusts (except those that
are tax exempt)
- Yes Yes
- No No
- Yes No
- No Yes
D.
Estates may use either the calendar year or a fiscal year for its tax year. Trusts, except those that are tax-exempt, are required to use the calendar year for its tax year. This response correctly indicates that estates are not required to use the calendar year as its tax year and that trusts, except those that are tax-exempt, are required to use the calendar year.
V. Federal Taxation of Entities
- Income Taxation of Fiduciaries
Astor, a cash-basis taxpayer, died on February 3. During the year, the estate’s executor made a distribution of $12,000 from estate income to Astor’s sole heir and adopted a calendar year to determine the estate’s taxable income.
The following additional information pertains to the estate’s income and disbursements for the year:
Estate income
Taxable interest $65,000
Net long-term capital gains allocable to corpus 5,000
Estate disbursements:
Administrative expenses attributable to taxable income 14,000
Charitable contributions from gross income to a public charity made under the terms of the will 9,000
For the calendar year, what was the estate’s distributable net income (DNI)?
- $39,000
- $42,000
- $58,000
- $65,000
B.
- An estate qualifies for a deduction for amounts of gross income paid or permanently set aside for qualified charitable organizations. The adjusted gross income limits for individuals do not apply. However, to be deductible by an estate, the contribution must be specifically provided for in the decedent’s will. If there is no will, or if the will makes no provision for the payment to a charitable organization, then a deduction will not be allowed even though all of the beneficiaries may agree to the gift.
- Expenses of administering an estate can be deducted either from the gross estate in figuring the federal estate tax on Form 706 or from the estate’s gross income in figuring the estate’s income tax on Form 1041. However, these expenses cannot be claimed for both estate tax and income tax purposes.
- Taxable income would be $41,400 (computation shown above less the $600 exemption). Once the $600 exemption is added back to taxable income, DNI would be $42,000.
V. Federal Taxation of Entities
- Income Taxation of Fiduciaries
At the close of the prior year, an individual taxpayer transferred assets into an irrevocable trust, retaining the right to the income from the trust for life. During the year, the assets earned ordinary dividends and interest income. The tax liability on the income earned will be paid
- Entirely by the trust.
- Entirely by the individual taxpayer.
- By the trust on the interest income only, and by the individual taxpayer for the dividend income.
- By the trust on the dividend income only, and by the individual taxpayer for the interest income.
B.
Income earned by a trust that is distributed to the income beneficiary, such as the dividends and interest, is taxed to the income beneficiary. If the income is retained by the trust, it is taxed to the trust.
V. Federal Taxation of Entities
- Income Taxation of Fiduciaries
Pat created a trust, transferred property to this trust, and retained certain interests. For income tax purposes, Pat was treated as the owner of the trust. Pat has created which of the following types of trusts?
- Simple
- Grantor
- Complex
- Pre-need funeral
B.
When the individual creating a trust retains certain interests in the trust, the trust is known as a grantor trust and the income from the trust is taxed to the grantor.
V. Federal Taxation of Entities
- Income Taxation of Fiduciaries
Income in respect of a cash basis decedent
- Covers income earned before the taxpayer’s death but not collected until after death.
- Receives a stepped-up basis in the decedent’s estate.
- Must be included in the decedent’s final income tax return.
- Cannot receive capital gain treatment.
A.
Income is only included on a cash-basis taxpayer’s final income tax return if the taxpayer had actually or constructively received the income before death. After death income with respect to the decedent is reported by the decedent’s estate. Thus, income in respect of a cash-basis decedent covers income earned before the taxpayer’s death but not collected until after death.
