T3-M4 Trust Taxation

Question 1

what is a trust?

Answer 1

• a trust is a separate legal entity created under state law to manage and distribute property for the benefit of one or more beneficiaries named in the trust agreement
• a trust is created by a grantor, who:
  + transfers property to the trust (trust corpus, or principal)
  + appoints a trustee
  + identified the terms of the trust agreement
• trustee:
  + manages the trust property for the benefit of the beneficiaries
  + administers the trust according to the terms of the trust agreement
• on an annual basis, the trust’s corpus (principal) may be used to generate taxable income
• this income passes through to either the trust’s grantor or beneficiaries for recognition annually

Question 2

what are types of trusts?

Answer 2

1. Grantor trusts:
   - are trusts in which the grantor retains certain ownership powers or control over the property transferred to the trust
   - a common type of grantor trust is a revocable living trust
   - are NOT required to file separate income tax returns
2. Non-grantor trusts
   - are separate taxpaying entities
   - trust income is taxable either to trust or to beneficiaries, depending on the amount of distributions to beneficiaries, type of income, and type of trusts
   - 2 types:
   + Simple trusts: 3 requirements
   - they are required to distribute all of their income to beneficiaries annually
   - they cannot make distributions from trust principal (corpus)
   - they cannot make distributions (contributions) to charitable organizations
   + Complex trusts:
   - non-grantor trusts that do not meet all 3 requirements of simple trusts
   * a trust may be a simple trust one year and a complex trust another year depending on if the trust meets the 3 requirements every year

Question 3

what is the taxation of non-grantor trust income?

Answer 3

• file form 1041 and report taxable distributions to beneficiaries on sch K-1s
• is taxed to either the trust or beneficiaries but not both
  + a trust is taxed on trust taxable income retained by the trust
  + a beneficiary is taxed on trust taxable income distributed to beneficiary (subject to certain limitation)

Question 4

what is trust accounting income (TAI)?

Answer 4

• is the book income of the trust, which must be calculated in accordance with the terms of the trust agreement and state law
• is used to determined the amount required to be distributed to beneficiaries each year
• trust income and expenses are allocated to either principal (corpus) or accounting income
  + most income and expenses (operating income/expenses, taxable and tax-exempt interest, dividends, rents, and royalties => allocated to accounting income
  + capital gains/losses on disposition of trust assets and casualty gain/loss => allocated to principal (corpus)
  + trust administrative expenses such as trustee fees => allocated between corpus and accounting income as stipulated in the trust agreement, or state law if there is no stipulation

Question 5

what are trust exemptions?

Answer 5

• simple trust: $300 exemption
• complex trust: $100 exemption

Question 6

how to calculate taxable income before distribution deduction?

Answer 6

+ trust taxable gross income (including capital gains)
- deductible trust expenses
= adjusted total income
- exemption amount
= trust taxable income before distribution deduction

Question 7

what is distributable net income (DNI) and its taxation?

Answer 7

• is a limitation on both the amount of distributions included in:
  + beneficiaries’ taxable income
  + the amount of the trust’s distribution deduction in calculating trust income
• includes both taxable and nontaxable income and expenses, including 100% of trust administrative expenses, but excludes capital gain/loss
• formula:
  + trust taxable income (before distribution deduction)
  + exemption
• capital gain allocated to corpus
  + capital loss allocated to corpus
  + tax-exempt interest
• expenses allocated to tax-exempt interest
  = distributable net income

Question 8

what is trust taxable income?

Answer 8

+ trust taxable gross income (including capital gains)
- deductible trust expenses
= adjusted total income
- exempt amount
= trust taxable income before distribution deduction
- income distribution deduction
= trust taxable income