Income Taxation of Trusts and Estates

Question 1

General issues

Answer 1

personal representative of an estate has similar duties and responsibilities as trustee to trust

Question 2

Similarities between trusts and estates

Answer 2

• both have beneficiaries
• someone is responsible for creation of the estate or trust
• both transfer property
• both administer property in a fiduciary capacity
• both are distinct tax entities

Question 3

Differences between trusts and estates

Answer 3

• estate comes into existence involuntarily upon death
• a trust is created intentionally and voluntarily during grantors lifetime
• estates operate for limited period *until assets transferred and taxes paid
• trust typically operate for many years *generations
• estate moves property to beneficiaries
• trust may retain property
• estate is supervised by court
• trustee operated under a private arrangement

Question 4

Filing requirements

Answer 4

Estate
- estates file form 1041
- entitled to certain deductions: admin costs, fees, expenses to prepare return
- can claim deduction on 1041 0r 706

Trusts
- file form 1041
- beneficiary share of income is reported on K-1

Question 5

Deadlines

Answer 5

• form 1041 due on 15th day of the fourth month after the entity’s year end
• must file if any exists: any taxable income for the year, gross income $600 or more, beneficiary is nonresident alien

Question 6

Choice of taxable year

Answer 6

• for first return, estate can use same accounting period that decedent used or can choose a calendar/ fiscal year
• trusts must use a calendar year, (except 501a charitable)
• exemption of $600 is allowed on a short period return

Question 7

Tax treatment of distributions to beneficiaries

Answer 7

• beneficiaries taxed on part of income distributed and estate/trust is taxed on portion that has accumulated and retained
• if estate/ trust must distribute all income the beneficiary must report their share of net income whether it was received in that year or not

Question 8

Current income not required to be distributed

Answer 8

if trustee/fiduciary has choice to distribute all or part of current income the beneficiary must report:
- all income that is required to be distributed whether or not received
- all accounts actually paid or credited up to amount of the beneficiaries distributed net income

Question 9

2023 trust/ estate rate structure

Answer 9

• these rates apply to income that is not distributed to beneficiaries
• given on test

Question 10

Grantor trust

Answer 10

• maker holds too much control over property for tax purposes
• considering income or estate tax liability
• grantor will be taxed on income produced from trust
• a reversionary interest that exceeds 5% of the trust value at the time of creation is retained by the grantor

Question 11

Defective trusts

Answer 11

• grantor trusts
• following violations create defective trust for tax purposes
• trust income distributed or accumulated for later distribution to either grantor or spouse
• trust income is used to discharge any legal obligation of grantor
• trust income is actually used to discharge a legal support obligation of grantor
• power to control beneficial enjoyment is held by grantor or spouse
• trust income is used to pay premiums on LI on the life of either grantor or spouse

Question 12

ILIT

Answer 12

unfunded ILIT
- yearly gift to the trust pays the LI premium (not income taxable to grantor)

funded ILIT
- investment income from investments in trust pays the premium (taxable to grantor)
- only amount of premium paid is taxable, remainder is taxed to trust

Question 13

Administrative power

Answer 13

• held by either the grantor or grantors spouse to deal with the trust property for less than full consideration
• to borrow from the trust without adequate interest or security
• or the right to vote the stock held in the trust corpus

Question 14

Defective trust for estate tax purposes

Answer 14

if the grantor retains the following
- a right to income or the right to use or enjoy trust property
- a reversionary interest that exceeds 5% measured at the time of death

Question 15

Simple trust

Answer 15

• conduit for forwarding income to the beneficiaries
• passes income through to the beneficiaries who then report the income
• beneficiaries pay taxes at the own marginal tax rates
• trust is separate tax entity but operates as as a tax conduit
• cannot make charitable gifts

Question 16

Complex trust

Answer 16

• taxed as separate entity if it meets both requirements
• it is irrevocable and grantor has not retained any control
• income is accumulated
• irrevocable almost always complex
• can make charitable gifts

Question 17

Revocable living trust

Answer 17

inter vivos or grantor trusts
- more popular alternative to probate
- at grantors death the trust becomes irrevocable and either terminated with the corpus distributed or continues until a later date
- no gift tax to fund (not complete)
- all income taxed to grantor

Question 18

Irrevocable trust

Answer 18

• ## grantor gives up all rights: can no longer revoke, terminate, modify

Question 19

Trust accounting income

Answer 19

Revocable
- grantor is responsible for any tax liability

Irrevocable
- can be taxed simple or complex depending on whether all the income is distributed

Question 20

Trust taxable income

Answer 20

deductions available to a trust
- charitable deduction (complex only)
- depreciation, cost recoevery, depletion
- distributed income allocated between trust and beneficiary
- net operatig carryforward
- admin expenses
- deduction for all income required to distribute

Exemption
- complex trust required to distribute all its income has exemption of $300
- complex trust not required to distribute all income, exemption is $100

Question 21

Distributable net income (DNI)

Answer 21

• limited the amount that trust/estate beneficiaries must report as gross income for tax purposes
• DNI rules allow:
• claim a deduction for amount distributed
• limit portion of the distribution that is taxable to beneficiaries
• ensure that the character of the distributions remains the same for the beneficiary as it was to the trust
• no double taxation of trust income because of deduction received on income distributed (equal to lesser of amount distributed or DNI)