Bryant - Course 4. Tax Planning. 9. Income Taxation of Trusts and Estates

Question 1

Name the trust that the grantor retains a right to payment of a fixed amount for a fixed number of years.

Answer 1

Grantor Retained Annuity Trust (GRAT)

Question 2

Name the trust that the grantor retains the right to payment of a fixed percentage of the value of the trust property (determined annually) for a number of years.

Answer 2

Grantor Retained Unitrust (GRUT)

Question 3

Name the trust that is now limited to transfers of a personal residence or certain tangible property, such as a painting, in situations where the grantor retains the use of the property during the term of the trust.

Answer 3

Grantor Retained Income Trust (GRIT)

Question 4

Name the trust that is a personal residence GRIT

Answer 4

Qualified Personal Residence Trust (QPRT)

Question 5

QPRT in Practice Example:

Assume a widow places her $200,000 personal residence into an irrevocable trust. The trust provides that she will live in the personal residence for a 10-year term. At the end of that time, the personal residence will pass to her children. This trust is known as a Qualified Personal Residence Trust (QPRT).

The present value of her right to live in the personal residence for 10 years is $98,330 (0.491651 × $200,000). The 0.491651 comes from IRS Publication 1457. Since the entire value of the personal residence placed in trust is $200,000 and the income interest retained by the grantor is $98,330, the value of the future interest gift being made at that point to the remainder person is the difference, $101,670. This entire amount ($101,670) is a taxable gift because the gift tax annual exclusion is allowed only for gifts of a present interest. Of course, up to $12,920,000 (2023) in gift taxes and estate taxes can be sheltered by her unified credit which means that the widow will pay no gift tax. Assuming the widow has gifted over $12,920,000, and a minimum 40% gift tax bracket applies, the gift tax would be $40,668.

If the $200,000 property appreciates at an after-tax rate of 5%, the property will be worth $325,779 by the end of the 10-year term.

Answer 5

Should the widow die before the term expires, the trust assets would be included in her estate at their values as of her date of death. It is treated as if the trust never existed in the first place so there would be no federal death tax savings.

But if the widow survived the 10-year period (no matter by how short a period of time), none of the trust assets would be in her estate. At a 40% estate tax bracket, the savings would be approximately $89,644 [40% × ($325,779 - $101,670)]. Furthermore, because the property would not pass through probate, probate costs on $325,779 would be avoided.

GRATs and GRUTs can provide similar gift, estate, and generation-skipping transfer tax discounts. A married couple could each establish GRATs and GRUTs (or split gifts) so as to utilize both spouses’ unified credits and marginal gift and estate tax brackets.

Question 6

Finnegan and Maeve are a married couple living in a community property state. They decide to transfer their community property to a GRAT. Finnegan passes away during the term of the GRAT.
Where is the value of the community interest allocated?
* Left in the GRAT.
* Included in Maeve’s estate.
* Included in Finnegan’s estate.

Answer 6

Included in Finnegan’s estate.

If a couple transfers community property to a Grantor Retained Annuity Trust (GRAT) or Grantor Retained Unitrust (GRUT), each may reserve the right to the payment for the trust term as to his or her respective community interest. If either dies during the trust term, the value of his or her community interest in the trust would be included in his or her taxable estate, either in whole or in part.

Question 7

A trust may qualify as a simple trust if:

Answer 7

• All income must be distributed currently,
• Funds cannot be paid, permanently set aside, or used for charitable purposes, and
• Amounts allocated to the corpus of the trust cannot be distributed.

Question 8

A complex trust is any trust that does not qualify as a simple trust. It is allowed to:

Answer 8

• accumulate income,
• have a charitable beneficiary, and/or
• distribute principal.

Question 9

A trust may qualify as a simple trust if it complies with which of the following? (Select all that apply)
* The trust instrument requires that all income must be distributed currently.
* The trust instrument does not provide that any amounts are to be paid, permanently set aside, or used for charitable purposes.
* The trust does not distribute amounts allocated to the corpus of the trust.
* The trust does distribute amounts allocated to the corpus of the trust.

Answer 9

The trust instrument requires that all income must be distributed currently.
The trust instrument does not provide that any amounts are to be paid, permanently set aside, or used for charitable purposes.
The trust does not distribute amounts allocated to the corpus of the trust.

To qualify as a simple trust, the trust instrument must require that all income be distributed currently, does not provide that any amounts are to be paid, permanently set aside, or used for charitable purposes, and does not distribute amounts allocated to the corpus of the trust.

Question 10

Which type of trust is a useful technique when a client wants to purchase certain tangible assets, such as a work of art, then retain the right to display it in his or her own home and have it pass to a specified person immediately and without probate at death?
* Grantor retained income trust (GRIT)
* Grantor retained annuity trust (GRAT)
* Grantor retained unitrust (GRUT)
* Qualified personal residence trust (QPRT)

Answer 10

Grantor retained income trust (GRIT)

A grantor retained income trust (GRIT) is a useful technique when a client wants to purchase certain tangible assets, such as a work of art, then retain the right to display it in his or her own home and have it pass to a specified person immediately and without probate at death.

However, if the grantor is unable to establish the value of the retained interest, the gift of the transferred remainder will equal 100% of the value of the transferred property.

Question 11

A GRAT, GRUT, or QPRT is an excellent “estate freezing” device with respect to post-transfer appreciation.
* False
* True

Answer 11

True

100% of post-gift appreciation in a property’s value escapes estate, gift, and generation-skipping transfer tax. This makes a GRAT, GRUT, or QPRT an excellent “estate freezing” device with respect to post-transfer appreciation.

Question 12

The fiduciary (or one of the joint fiduciaries) must file Form 1041 for a taxable domestic trust that has:

Answer 12

• Any taxable income for the tax year,
• Gross income of $600 or more (regardless of taxable income), or
• A beneficiary who is a non-resident alien.

Question 13

Which IRS Form grants taxpayers an automatic six-month extension without the need to file intervening forms?

Answer 13

Form 7004

Question 14

Which IRS Form is to apply for an automatic 6-month extension of time to file Form 706, Form 706-A, Form 706-NA, Form 706-QDT?

Answer 14

Form 4768

Question 15

Trusts must use which calander as taxable year.

Estates use which calander as taxable year.

Answer 15

A taxable trust must use the calendar year (i.e., the tax year ending December 31).

An estate is created on death and may choose any tax year it chooses. This ability to choose a tax year allows the executor to determine the number of months in the first tax year of the estate. More importantly, the use of a fiscal year allows the estate to make income distributions to heirs which will not be subject to taxation until the following calendar year.

A distribution from a trust or estate is deemed to have been made on the last day of the trust’s or estate’s taxable year, regardless of when during the tax year the distribution was actually made.

Question 16

Taxable Year Selection Example:

Tom died on April 1, 2022. John, his executor, chooses a fiscal year-end of January 31, 2023. In July of 2022, 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, 2023, the distribution to the heirs is deemed to have been made in 2023 even though they got the distribution in 2022.

When is the income is taxable to the heirs?

Answer 16

The income is taxable to the heirs in 2023.

Question 17

What is the Tax Treatment of Distributions to Beneficiaries?

Answer 17

The beneficiary of a simple trust must include in his or her gross income the amount of income required to be distributed currently, whether or not distributed, or if the income required to be distributed currently to all beneficiaries exceeds the Distributable Net Income (DNI), his or her proportionate share of the DNI. Distributable Net Income (DNI) is the amount of the taxable trust income which, by a complex IRS calculation, is deemed to be the amount of trust income that is available to be paid to beneficiaries and can be used to reduce the trust’s taxable income.

Question 18

Trust Taxation Calculation Example:

Jane and Macy Jones’ living trust has a taxable income of $30,000. What is their living trust’s estimated taxes?

Answer 18

Base Tax + (Rate x Amount Over)
$3,491 + [0.37 x ($30,000 - $14,450)]
$3,491 + (0.37 x $15,550)
$3,491 + $5,753.50
$9,244.50

Question 19

Jack has a calendar year trust. When must he file his Form 1041 for 2023?
* December 31, 2023
* January 1, 2024
* April 1, 2024
* April 15, 2024

Answer 19

April 15, 2024

For calendar year estates and trusts, Form 1041 and Schedule K-1 must be filed on or before April 15, 2024, for 2023.

Question 20

A fiduciary must file Form 1041 for a domestic trust taxable under Section 641 if it meets which of the following requirements? (Select all that apply)
* Any taxable income for the tax year
* Gross income of $1,000 or more (regardless of taxable income)
* A beneficiary who is a nonresident alien
* Gross income of $600 or more (regardless of taxable income)
* Taxable income of $600 or more

Answer 20

Any taxable income for the tax year
A beneficiary who is a nonresident alien
Gross income of $600 or more (regardless of taxable income)

A fiduciary must file Form 1041 for a domestic trust taxable under Section 641 that has:
* any taxable income for the tax year,
* gross income of $600 or more (regardless of taxable income), or
* a beneficiary who is a nonresident alien.

Question 21

An estate has chosen a June 30, 2021 taxable year-end. If Ed Doyle, an heir of an estate, received a distribution of income from the estate in December, 2020, what year must he report the income on his individual tax return?
* 2020
* Half in 2020; half in 2021
* 2021
* Prorated over the tax year of the estate

Answer 21

2021

Distributions from an estate are deemed made on the last day of the estate’s tax year. In this case, Ed reports the income for 2021, even though the distribution occurred in the calendar year 2020.

Question 22

What refers to the income and expense items that are used to determine the amount the income beneficiaries are entitled to receive from the trust or estate each year?

Answer 22

Trust accounting income

Question 23

Items of income and expense that are allocated to ____________ are not used in calculating accounting income.
* principal
* depreciation
* interest
* capital gains

Answer 23

principal

Items of income and expense that are allocated to principal are not used in calculating trust accounting income.

Question 24

Describe Trust Taxable Income

Answer 24

Trust and estate taxable income is the total taxable income of the trust or estate for the tax year. With some exceptions, taxable income for trusts and estates is calculated as individual and corporate taxable income. Taxable trust income is not the same as trust accounting income. Taxable trust income, as distinguished from trust accounting income, includes income allocated to principal, such as capital gain.

A trust must figure taxable income using the method of accounting regularly used in keeping the trust’s or estate’s books and records. Generally, permissible methods include the cash method, the accrual method, or any other method authorized by the Internal Revenue Code. In all cases, the method used must clearly reflect income. To change the accounting method, a trust or estate must get consent by filing Form 3115.

Question 25

What is the amount of trust income that can be included in the gross income of the beneficiaries and deducted from the gross income of the trust is called?

Answer 25

Distributable net income (DNI). Importantly, the character of the income (e.g., whether income is taxed at ordinary or capital gain
rates) carries out with the distribution.

A complex trust or an estate is taxable on the income it retains and the beneficiaries are taxed on the trust income they receive (or are deemed to have received). For that reason, the trust is entitled to a deduction for amounts distributed to beneficiaries. The distribution deduction prevents trust income from being taxed twice, i.e., to the trust and the beneficiaries.

Question 26

What is the formula to calculate Distributable Net Income (DNI)?

Answer 26

Taxable income
* + Income distribution deduction
* + Exemption ($300 for a simple trust)
* + Net tax-exempt income
* + Capital losses*
* < Capital gains* >
* < Extraordinary stock dividends >
= Distributable Net Income (DNI)

*These adjustments are not made in the year of termination or if capital gains are included in fiduciary accounting income.

Question 27

What is the tax that is imposed on the transfer of the taxable estate of every decedent who is a citizen or resident of the United States called?

Answer 27

Estate tax.
It is levied on the estate before any transfers.

Gift tax laws are generally intended to prevent complete tax avoidance by making gifts prior to death to avoid the estate tax. The Federal Estate Tax is incorporated with the Federal Gift Tax so that large estates cannot be shielded from taxation by lifetime giving. Many states also impose an estate tax.

The estate tax is scheduled to be phased out at the federal level, but the current status of the estate tax is unclear due to the convoluted status of the law. Estate tax rates are much higher than income tax rates and are an important consideration in financial planning.

Question 28

Which of the following statements best describes distributable net income (DNI)?
* An estimate of the actual benefit available to the income beneficiaries of an estate or trust and is the maximum amount that can be taxed to beneficiaries.
* A tax imposed on the transfer of the taxable estate of every decedent who is a citizen or resident of the United States.
* A trust’s or estate’s share of all taxable income that was received during the tax year.
* The income and expense items that are used to determine the amount the income beneficiaries of an estate or trust are entitled to receive from the trust or estate each year.

Answer 28

An estimate of the actual benefit available to the income beneficiaries of an estate or trust and is the maximum amount that can be taxed to beneficiaries.

Distributable Net Income is an estimate of the actual benefit available to the income beneficiaries of an estate or trust 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.

Question 29

Which of the following are examples of trust accounting income? (Select all that apply)
* Stock dividends
* Interest on notes, loans and mortgages
* Interest on U.S. Treasury bills, notes, and bonds
* Capital gains

Answer 29

Stock dividends

Trust accounting income does not include capital gains, which are allocated to principal. The other income items are all ordinary income items and allocated to income.

Question 30

Trustees of foreign trusts must file __ ____??____ __.
* Form 1041
* Form 1041-NR
* Form 709
* Form 3520-A

Answer 30

Form 1041-NR

A trust that is not a domestic trust is treated as a foreign trust. Trustees of foreign trusts must file Form 1041-NR instead of Form 1041.

Question 31

Each of the following is a characteristic of a complex trust EXCEPT:
* Amounts allocated to the corpus of the trust cannot be distributed.
* The trust may accumulate income.
* The trust may have a charitable beneficiary.
* The trust can distribute principal.

Answer 31

Amounts allocated to the corpus of the trust cannot be distributed.

The rules preventing corpus distributions are characteristic of simple trusts.

Question 32

The fiduciary must file Form 1041 for a taxable domestic trust that has gross income of __ ____??____ __ or more.
* $300
* $600
* $1,200
* $250

Answer 32

$600

The fiduciary (or one of the joint fiduciaries) must file Form 1041 or a taxable domestic trust that has:
* Any taxable income for the tax year,
* Gross income of $600 or more (regardless of taxable income), or
* A beneficiary who is a non-resident alien.

Question 33

With a __ ____??____ __, the grantor retains a right to payment of a fixed amount for a fixed number of years.
* Grantor Retained Income Trust (GRIT)
* Grantor Retained Unitrust (GRUT)
* Grantor Retained Annuity Trust (GRAT)
* Qualified Personal Residence Trust (QPRT)

Answer 33

Grantor Retained Annuity Trust (GRAT)

In a Grantor Retained Annuity Trust (GRAT), the grantor retains a right to payment of a fixed amount for a fixed number of years.

Question 34

A __ ____??____ __ is useful when a client wants to purchase certain tangible assets such as a work of art, retain the right to display it in his or her own home, and have it pass to a specified person immediately and without probate at death.
* Grantor Retained Income Trust (GRIT)
* Qualified Personal Residence Trust (QPRT)
* Grantor Retained Unitrust (GRUT)
* Grantor Retained Annuity Trust (GRAT)

Answer 34

Grantor Retained Income Trust (GRIT)

A grantor retained income trust (GRIT) is a useful technique when a client wants to purchase certain tangible assets such as a work of art, retain the right to display it in his or her own home and have it pass to a specified person immediately and without probate at death.

However, if the grantor is unable to establish the value of the retained interest through comparable rentals, the gift of the transferred remainder will equal 100% of the value of the transferred property.

Question 35

The gift to the remainder person is a gift of a __ ____??____ __.
* present interest
* disclaimed amount
* future interest
* lump sum

Answer 35

future interest

The gift to the remainder person is a gift of a future interest. It therefore cannot qualify for the annual gift tax exclusion.

Question 36

The fixed annuity amount paid to a grantor from a grantor trust must not exceed ____ of the amount paid the prior year.
* 125%
* 150%
* 110%
* 120%

Answer 36

120%

There is no requirement that the fixed annuity amount be the same for each year. The only requirement is that the annuity paid in a given year not exceed 120% of the amount paid the prior year.

Question 37

Identify the type of trust with the following characteristics:
* All income must be distributed currently,
* Funds cannot be paid, permanently set aside, or used for charitable purposes, and
* Amounts allocated to the corpus of the trust cannot be distributed.

simple trust
grantor trust
testamentary trust
complex trust

Answer 37

simple trust

A trust may qualify as a simple trust if:
* All income must be distributed currently,
* Funds cannot be paid, permanently set aside, or used for charitable purposes, and
* Amounts allocated to the corpus of the trust cannot be distributed.

Question 38

If appreciated property is transferred to a GRAT, GRUT, or QPRT, the tax on any gain will eventually be paid by the __ ____??____ __.
* beneficiaries
* trust
* grantor
* any of these

Answer 38

any of these

If appreciated property is transferred to a GRAT, GRUT, or QPRT, the tax on any gain will eventually be paid by:
* the grantor,
* the trust, or
* the beneficiaries.

Question 39

For calendar year estates and trusts, Form 1041 and Schedule K-1 must be filed on or before __ ____??____ __ for the prior year.
* December 31st
* April 30th
* June 30th
* April 15th

Answer 39

April 15th

For calendar year estates and trusts, Form 1041 and Schedule K-1 must be filed on or before April 15, 20XX for the prior year.