Chapter 27 - Income Taxation of Trusts and Estates

1. Chapter 27 - Income Taxation of Trusts and Estates (Subchapter J)

2. INTRODUCTION • Trusts and Estates - separate taxable entities • TI similar to individual - 1041 (OH) • I.E., Forms, formula, vocabulalry • conduit to B: similar to pship, S Corp - K-1 • Distrib deduction reduces TI of Trust • Dist to B’s taxable based on DNI

3. Uses of Trusts • Tax planning • financial goals • asset mngmt

4. E.g.,Types of Trusts (OH) • life insurance (irrevocable) • living (revocable) • minors • blind • QRP • Alimony • liquidating

5. This Chap - Ordinary Trusts • (not g’or, spec, alim, bankr, QRP) • Grantor trust: entity ignored for tax - 1 person • G (Grantor), B (Beneficiary), T (Trustee)

6. Definitions of Trust • 7701 reg (not code) • = arrangement by will or inter vivos: transfer • declaration by which T takes title to protect or conserve assets for B’s

7. Terms – Trust (Vocabulary) • grantor (settlor, donor) (G) • trustee (T), beneficiary (B) • corpus (assets transferred to trust) • income; income interest • remainder interest, reversionary interest • simple, complex, can change yr to yr • Sprinkling trust

8. complex - (1) not a simple trust (2) year of termination (because of corpus distribution) • simple = • (1) Required to distribute AI • (2) no B’s = charitable organization • (3) no distributions of corpus

9. Terms – Estate (more Vocabulary) • Definitions of Estate • purpose - collect & conserve assets, pay liabs distribute assets under will or law (intestacy)

10. Decedent • executor (trix) • administrator (trix) • B’s • probate

11. Form 1041 • Who must file • Estate: GI> 600 • Trust: any TI or, if none, GI>600 • & when - 15th day of 4th month

12. methods - choice • periods • estate: choice • trust - calendar (except tax exempt)

13. rates: compressed; CG, AMT, BIG • exemptions • est - 600 • tr - 300 (distrib all inc) (not same as simple trust • or tr - 100

14. Taxable Income • AI = accounting income = “income” in IRC = income inc B eligible to receive • GI - similar to individual • Basis - step up/down, c/o, cost • prop distribs - usually no G or L on distrib, DNI & DD = lesser of FMV or basis, election

15. IRD • IRD (Inc in Respect of Decedent) Cash basis - accrued salary, interest, rent etc • accrual basis + cash - QRP, deferred Comp

16. Ord deducs & losses • Ord deducs & losses: 2% rule (not 2% rule fiduc fees) (AGI used - greater of grantor or trust or estate as if individual) • apportion expenses to tax exempt (TE): TE/AI; AI = TE + GI possibly • cost recov - apportioned – proportionately to inc B’s

17. Charitable Contribution Deduction • year paid and if paid year following • limits: GI for year, apportioned • trust or will can specify from what income (avoid tax exempt)

18. Losses - CL & NOL • CL - in trust, indiv rules (3000/yr after netting CL & CG) until termination • NOL - in trust, CB & CF (2 & 20), indiv rules, until termination

19. Deduction for Distrb to B’s (DD) see chart in Chapter (OH) • DNI determines • TI b4 distrib = GI & deducs & exemps • modify TI b4 to det DNI • TI - DD = TI after distrib • DD = DNI - TE

20. Modifications: TI b4 DD to DNI • add back exemp • add back net tax exempt income • add back net CL • subtract net CG allocated to corpus

21. DNI/AI/DD - Recap • DNI based on TI maybe less than distribs based on AI • DNI = broad definition; economic term • AI = measure of that which can be distrib’d to income B’s • DNI = taxability of what B receives • DD = DNI - TE (tax exempt)

22. Complex Trust (& Estate) v. Simple Trust • with discretionary distributions • deduct (DD) lesser of deductible DNI or amount actually distributed • simple trust: • assume distribution & deduction in year required even if not made (ex 19)

23. Taxation of B’s • TI and character to B’s det’d by DNI; Timing - inclusion • Simple Trust: TI to B lim’d to DNI; DNI incl TE (tax exempt, so TI maybe<DNI) • Ests & Complex Tr (not covered in depth): 2 tiers - 1st: inc req’d to be distrib’d curr; 2nd: all other income

24. (1) tier 1 only distrib: 1st to B/1st to all x DNI = B DNI • (2) 1st & 2nd, 1st>DNI, same formula, no 2nd taxed • (3) 1st & 2nd, 1st<DNI, 1st & 2nd <DNI; 2nd to B/2nd to all x DNI remg after 1st = B DNI; DNI = max distrib, distrib<DNI then B rec = distrib for DD (ex 25)

25. Separate share rule (not covered in depth); (DNI alloc’d to sep share & remains there) EX 28) • (to prevent inequity in corpus payments)

26. Character of Income Flow Thru • B DNI / total DNI x total DNI element (e.g., tax exempt) • total distrib/total DNI x DNI element = total DNI element (if only portion of DNI distrib’d) (ex 29)

27. Losses - Year of Termination • NOL & CL not to B’s (CF) except term yr • at entity level normally, NOL CB 2 & CF 20 • CL CF indef (3000/yr) (indiv’s rule)

28. Throwback Computation • Beyond scope of this course • To discourage tax minimization by accumulating trust income • Computation: what would have owed if distributed earlier (DNI max) • Repealed for domestic trusts (97 new law)

29. Trust Deductions - Summary • Depreciation - Charitable - 212 - Trustee fees • (1) AI = income which inc B eligible to receive (if CG allocated to corpus, not in AI) • (2) other deducs and deprec can be allocated to corpus or income (by trust, will, or state law) p 27-15 ex 14-15 (2002 text)

30. (3) but for tax, deprec allocated to inc B’s • (4) also not allocated to corpus for tax: trustee fees & 212 exps p. 27-15 • (5) Charitable, 212, trustee fees reduced by tax exempt fraction - p 27-15; (TE/(TE + GI)) x deduc = allowable deduc; where GI + TE = AI

31. (6) And charitable deduction – will or trust can select income from which donat made (i.e., not tax exempt) to avoid reduction

32. (7) Adm exps if estate claimed on 706 (cannot be claimed on 1041; but can allocate between 706 & 1041; i.e., no double deduction • (8) but double deduc allowed for exps in respect of a decedent