1. 1 Chapter 14: Income Taxation of Trusts & Estates

2. 2 INCOME TAXATION OF TRUSTS & ESTATES (1 of 2)  Fiduciary taxation  Basic concepts and definitions  Trust taxable income  Distributable net income (DNI)  Simple trusts

3. 3 INCOME TAXATION OF TRUSTS & ESTATES (2 of 2)  Complex trusts  Income in respect of a decedent  Grantor Trusts

4. 4 Fiduciary Taxation  Trusts and estates are separate taxpayers  No double taxation  Deductions permitted for income distributed to beneficiaries  Distributed income from trust retains its character in hands of beneficiary  Limited personal exemption available and no dependency exemptions

5. 5 Basic Concepts and Definitions (1 of 5)  Estate comes into existence upon death of person whose assets are being administered  Trust is a legal entity created while a person is alive or under direction of a will following a person’s death  Testamentary trust receives assets from estate of decedent

6. 6 Basic Concepts and Definitions (2 of 5)  Principal or corpus  Initial assets transferred by grantor plus certain additions/deductions required by provisions of trust instrument  Income  Earnings derived from principal but certain gains, losses or deductions may be considered adjustments to principal

7. 7 Basic Concepts and Definitions (3 of 5)  Grantor  Party that transfers assets to the trust  Trustee  Party that administers the trust  Income Beneficiary  Party (or parties) who receives income when distributed by Trustee under provisions of trust instrument

8. 8 Basic Concepts and Definitions (4 of 5)  Remaindermen  Party (or parties) who eventually receives trust principal  Same person may receive both income and principal  Simple trust  Must distribute all income annually,  Does not distribute any principal AND  Makes no contributions to charities

9. 9 Basic Concepts and Definitions (5 of 5)  Complex trust  Any trust that is not a simple trust  Personal exemption  $300 if all income required to be distributed annually  $100 if current income may be retained

10. 10 Trust Taxable Income Gross Income - Deductions for expenses - Personal exemption = Taxable income before distribution - Distribution deduction = Trust taxable income

11. 11 Distributable Net Income (DNI) (1 of 2)  DNI is maximum distribution deduction & income reportable by beneficiaries  No distribution deduction available for portion of distribution deemed to consist of tax-exempt income even though net tax-exempt income included in DNI

12. 12 Distributable Net Income (DNI) (2 of 2) Taxable income before distributions + Personal exemption already deducted - Capital gains added to principal + Capital losses subtracted from principal + Tax exempt interest (net of expenses) = Distributable Net Income  See Topic Review C14-2

13. 13 Simple Trusts (1 of 3)  Must distribute all of its net accounting income currently  Aggregate gross income reported by beneficiaries cannot exceed DNI  Income received by beneficiaries retains its character

14. 14 Simple Trusts (2 of 3)  Allocation of expenses to tax-exempt income Tax-exempt income (net of exp. directly attributable thereto) X Accounting income (net of all direct exp) = Indirect expenses allocable to non-taxable income

15. 15 Simple Trusts (3 of 3)  Tax treatment of beneficiary if trust has > 1 beneficiary  Beneficiary’s share of gross income if DNI lower than net accounting income is following fraction of DNI Income required to be distributed to such beneficiary Income required to be distributed to all beneficiaries

16. 16 Complex Trusts  Complex trusts permit the following activities  Making distributions < current earnings  Distributing principal  Making charitable contributions  Complex trust’s DNI  Impact on beneficiaries

17. 17 Complex Trust’s DNI (1 of 2)  Complex DNI not reduced by charitable contribution deduction when determining maximum distribution for mandatory distributions

18. 18 Complex Trust’s DNI (2 of 2)  DNI reduced when calculating deductible discretionary distributions  Distribution deduction is smaller of DNI or sum of mandatory and other amounts properly paid

19. 19 Impact on Beneficiaries (1 of 2)  In general  Beneficiary includes distributions as gross income up to current DNI for the trust  Accumulation distribution or throwback rules attempt to tax individual as if distributions were made annually  Higher trust tax rates make accumulation less desirable

20. 20 Impact on Beneficiaries (2 of 2)  Tax treatment of beneficiary if trust has > 1 beneficiary  Beneficiary’s share of gross income if total income required to be distributed exceeds DNI Income required to be distributed currently to beneficiary Aggregate income required to be distributed to all beneficiaries currently

21. 21 Income in Respect of a Decedent (IRD) (1 of 3)  Most individuals use cash basis  IRD is income constructively received, but not actually received before death  Interest on CDs, bonds or savings  Salary, commissions or bonus  Dividends received after date of death with record date before death

22. 22 Income in Respect of a Decedent (IRD) (2 of 3)  IRD must be included  As gross income on estate’s income tax return AND  As part of the gross estate for transfer tax purposes

23. 23 Income in Respect of a Decedent (IRD) (3 of 3)  Estate may claim an income tax deduction for the extra transfer tax due because these items were counted as part of the estate  No step-up in basis for IRD items

24. 24 Grantor Trusts (1 of 2)  Grantor does not give up enough control or economic benefit to be a completed transfer  Grantor taxed on some or all of trusts income  Even if income distributed to beneficiaries

25. 25 Grantor Trusts (2 of 2)  Types of grantor trusts  Revocable trusts  Clifford Trusts  Post-1986 Reversionary interest trusts  See Topic Review C14-4

26. 26 Comments or questions about PowerPoint Slides? Contact Dr. Richard Newmark at University of Northern Colorado’s Kenneth W. Monfort College of Business richard.newmark@PhDuh.com