Your SlideShare is downloading. ×
0
Chapter 18                           Income Taxation of                            Trusts and Estates©2012 CCH. All Rights...
Chapter 18 Exhibits    1.   Five Key Elements of Every Trust    2.   Trust Life Cycle Illustrated    3.   Definition of Te...
Chapter 18 Exhibits  13.     Distribution Deduction—Simple Trusts  14.     The Distribution Deduction—Step 1: Computing St...
Five Key Elements of Every Trust   1. Grantor. The grantor is the person who transfers      property to the trust. The gra...
Five Key Elements of Every Trust 3. Trustee. The trustee is the person responsible for managing and    administering a tru...
Five Key Elements of Every Trust  4. Beneficiary. It’s important to know that the persons who are     beneficiaries can be...
Five Key Elements of Every Trust5. Intent of Trust. Every trust has a purpose which motivates the grantor to   set the tru...
Trust Life Cycle Illustrated(a) Grandma has her attorney prepare a trust agreement.(b) Grandma then transfers $100,000 in ...
Trust Life Cycle Illustrated    Legal title. The $100,000 Grandma transferred is owned by    Tressie, as trustee of the tr...
Definition of TermsInter vivos trust. A trust created during the life of the grantor.Testamentary trust. A trust created b...
Definition of TermsSimple trusts. The following characteristics are required:       (a) 100% of state law/accounting incom...
Definition of Terms   Grantor trust. This is any trust in which the grantor is the   constructive beneficiary. Income from...
Definition of Terms   Beneficiary exposure. On certain fiduciary income, the   beneficiaries of these fiduciary entities, ...
Computing Tax Liability—Fiduciary vs.                      Nonfiduciary           Estates and Trust (Fiduciary)           ...
Computing Tax Liability—Fiduciary vs.                      Nonfiduciary           Estates and Trust (Fiduciary)           ...
Computing Tax Liability—Fiduciary vs.                      Nonfiduciary           Estates and Trust (Fiduciary)           ...
Computing Tax Liability—Fiduciary vs.                      Nonfiduciary           Estates and Trust (Fiduciary)           ...
Gross Income—Income in Respect of Decedent    Gross income (GI). GI for trusts and estates is similar to GI for    individ...
Gross Income—Income in Respect of Decedent                         Examples of IRD for Cash Basis Decedents:    Before Dea...
Income in Respect of Decedent—Tax Treatment    Double taxation. Income in respect of decedent (IRD) is    taxable as gross...
Income in Respect of Decedent—Tax Treatment    IRD amount realized. IRD is valued at fair market value on    the date of d...
Income in Respect of Decedent—Tax TreatmentDeductions in respect of decedent (DRDs). DRDs are expensesconnected with IRD t...
Gross Income—Property Distributions  Tax Treatment       An estate or trust may, from time to time, distribute property to...
Gross Income—Property DistributionsTax Treatment (i) Property distributions WITHOUT election to be taxed. An     estate or...
Deductions—Depreciation and Depletion  General Rule. As a general rule, deductions for and from AGI are  treated the same ...
Deductions—Depreciation and Depletion      Either an estate or trust may be entitled to a depreciation or      depletion d...
Deductions—Depreciation and Depletion    Trusts. Trusts are permitted greater flexibility than estates in    receiving dep...
Deductions—Depreciation and DepletionExample: Determining the Trust Depreciation Deduction.  George creates a trust, namin...
Deductions—Capital Losses    Capital losses. Same treatment as for individual taxpayer. In    most cases, capital losses a...
Deductions—Miscellaneous Itemized                          Deductions       Assignment between entity and income beneficia...
Deductions—Miscellaneous Itemized                          DeductionsDisallowed deductions. The portion of fiduciary and o...
Deductions—Miscellaneous Itemized                          Deductions       No 2% AGI floor. Fiduciary fees and other expe...
Deductions—Casualty Losses and Charitable                 Contributions         Casualty or Theft Losses. The tax treatmen...
Deductions—Casualty Losses and Charitable                 Contributions       Charitable Contributions. Bequests to qualif...
Deductions—Casualty Losses and Charitable                 Contributions   Entire interest must be donated. The entire int...
Personal Exemptions       Allowable Amounts.           Estates: $600           Complex trusts: $100           Simple tr...
Distribution Deduction—Simple Trusts    Explanation of Distribution Deduction. Any trust, complex or simple,    or estate,...
Distribution Deduction—Simple Trusts Steps in computing the distribution deduction:   1. Compute state law/accounting inco...
The Distribution Deduction—Step 1: Computing State Law/Accounting Income  This is the amount of income governed by state l...
The Distribution Deduction—Step 1: Computing State Law/Accounting Income   Controlling the assignments to corpus and incom...
Assignments to Corpus and Income—                     Default Designations           State laws provide default designatio...
Assignments to Corpus and Income—                     Default Designations                          Typical Assignments to...
Assignments to Corpus and Income—                     Default Designations        Notes        These designations are prov...
The Distribution Deduction—      Step 2: Computing Taxable Income Before                Distribution Deduction   Computati...
The Distribution Deduction—      Step 3: Computing Distributable Net Income       Function of Distributable Net Income (DN...
The Distribution Deduction—      Step 3: Computing Distributable Net IncomeFormula for Computing DNIStart with: taxable in...
The Distribution Deduction—      Step 3: Computing Distributable Net IncomeObservation Since taxable income before distrib...
The Distribution Deduction—    Step 4: Computing the Distribution DeductionComputation     Distributable net income (DNI) ...
Computing Taxable Income of Simple Trusts—Example  FACTS: The Caligari trust is required to distribute its  current accoun...
Computing Taxable Income of Simple Trusts—Example                    Rental income                                        ...
Computing Taxable Income of Simple Trusts—Example   QUESTIONS:   (1) Determine trust accounting income.   (2) Determine ta...
Computing Taxable Income of Simple Trusts—Example         Item              Totals       Step 1:                 Step 2 & ...
Computing Taxable Income of Simple Trusts—Example             Item              Totals       Step 1: Accounting           ...
Computing Taxable Income of Simple Trusts—Example          Item            Totals    Step 1:             Step 2 & 5:      ...
Computing Taxable Income of Simple Trusts—Example Notes 1. Trust Accounting Income, $320,000. This includes the tax-exempt...
Computing Taxable Income of Simple Trusts—Example  3.    DNI, $300,000. This amount reflects the required adjustments.  4....
Filing Requirements for Estates and Trusts                                               Estates                          ...
Filing Requirements for Estates and Trusts                                         Estates                            Trus...
Upcoming SlideShare
Loading in...5
×

2013 cch basic principles ch18

384

Published on

Published in: Technology, Business
0 Comments
1 Like
Statistics
Notes
  • Be the first to comment

No Downloads
Views
Total Views
384
On Slideshare
0
From Embeds
0
Number of Embeds
0
Actions
Shares
0
Downloads
31
Comments
0
Likes
1
Embeds 0
No embeds

No notes for slide

Transcript of "2013 cch basic principles ch18"

  1. 1. Chapter 18 Income Taxation of Trusts and Estates©2012 CCH. All Rights Reserved.4025 W. Peterson Ave.Chicago, IL 60646-60851 800 248 3248www.CCHGroup.com
  2. 2. Chapter 18 Exhibits 1. Five Key Elements of Every Trust 2. Trust Life Cycle Illustrated 3. Definition of Terms 4. Computing Tax Liability—Fiduciary vs. Nonfiduciary 5. Gross Income—Income in Respect of Decedent 6. Income in Respect of Decedent—Tax Treatment 7. Gross Income—Property Distributions 8. Deductions—Depreciation and Depletion 9. Deductions—Capital Losses 10. Deductions—Miscellaneous Itemized Deductions 11. Deductions—Casualty Losses and Charitable Contributions 12. Personal ExemptionsChapter 18, Exhibit Contents A CCH Federal Taxation Basic Principles 2 of 58
  3. 3. Chapter 18 Exhibits 13. Distribution Deduction—Simple Trusts 14. The Distribution Deduction—Step 1: Computing State Law/ Accounting Income 15. Assignments to Corpus and Income—Default Designations 16. The Distribution Deduction—Step 2: Computing Taxable Income Before Distribution Deduction 17. The Distribution Deduction—Step 3: Computing Distributable Net Income 18. The Distribution Deduction—Step 4: Computing the Distribution Deduction 19. Computing Taxable Income of Simple Trusts—Example 20. Filing Requirements for Estates and TrustsChapter 18, Exhibit Contents B CCH Federal Taxation Basic Principles 3 of 58
  4. 4. Five Key Elements of Every Trust 1. Grantor. The grantor is the person who transfers property to the trust. The grantor often referred to as trustor, settlor or donor. 2. Trust property. Property must be transferred to the trust. It can be transferred during life, after death through the grantor’s will, through a gift, or by the exercise of a power of appointment (“POA”). It can be cash, a life insurance policy, stock, or any other asset that serves the intent of the grantor.Chapter 18, Exhibit 1a CCH Federal Taxation Basic Principles 4 of 58
  5. 5. Five Key Elements of Every Trust 3. Trustee. The trustee is the person responsible for managing and administering a trust. The trustee may be the grantor, a trusted friend, a family member, a bank trust department, or any combination of these and other persons. The trustee generally will hold legal title to the assets in the trust but not beneficial title. (a) Legal title means the trust assets are owned in the name of the trustee, the trustee has specific duties and responsibilities for the trust property, or has certain powers concerning the disposition of the trust property. (b) Beneficial title to the trust property is held by the beneficiaries of the trust.Chapter 18, Exhibit 1b CCH Federal Taxation Basic Principles 5 of 58
  6. 6. Five Key Elements of Every Trust 4. Beneficiary. It’s important to know that the persons who are beneficiaries can be determined; that is, the description should be clear and certain. If “my descendants” are the named beneficiaries, there must be a time for making the determination of who the descendants are. Otherwise, it would be impossible to know when to make distributions from the trust. (a) Possible issue. A possible issue might be: Are grandchildren born after the trust had been established to be included as beneficiaries? (b) Remainderman. When the trust has fulfilled its purpose, the money and assets it holds are distributed to the remainderman and the trust is terminated.Chapter 18, Exhibit 1c CCH Federal Taxation Basic Principles 6 of 58
  7. 7. Five Key Elements of Every Trust5. Intent of Trust. Every trust has a purpose which motivates the grantor to set the trust up in the first place. The intent can relate to one or a combination of the following intents: (a) Benefiting a particular beneficiary. (b) Providing for the maintenance of certain assets, such as the old family homestead. (c) Achieving certain tax benefits, such as through charitable remainder trusts or marital trusts. Chapter 18, Exhibit 1d CCH Federal Taxation Basic Principles 7 of 58
  8. 8. Trust Life Cycle Illustrated(a) Grandma has her attorney prepare a trust agreement.(b) Grandma then transfers $100,000 in bonds to her daughter, Tressie, as trustee of the trust.(c) Tressie is required by the terms of the trust document to invest the $100,000 in bonds and use all of the interest each year to pay for the college expenses of Tressie’s two sons, Grandma’s grandchildren.(d) When the youngest of Tressie’s two sons reaches the age of 25, Tressie is instructed to divide the money in the trust equally and distribute it to each of the two boys.(e) When the distribution is completed, the trust is terminated.Chapter 18, Exhibit 2a CCH Federal Taxation Basic Principles 8 of 58
  9. 9. Trust Life Cycle Illustrated Legal title. The $100,000 Grandma transferred is owned by Tressie, as trustee of the trust. Thus, Tressie holds legal title to the bonds “in trust” for the beneficiaries. Beneficial title. Tressie’s two sons hold beneficial title. Only they have the right to benefit from the interest and principal value of the bonds.Chapter 18, Exhibit 2b CCH Federal Taxation Basic Principles 9 of 58
  10. 10. Definition of TermsInter vivos trust. A trust created during the life of the grantor.Testamentary trust. A trust created by the will of a decedent.Chapter 18, Exhibit 3a CCH Federal Taxation Basic Principles 10 of 58
  11. 11. Definition of TermsSimple trusts. The following characteristics are required: (a) 100% of state law/accounting income must be distributed currently. This term is explained later in this chapter. (b) None of the corpus,(often referred to as res or principal) may be distributed. (c) No charitable contributions may be made by the trust.Complex trust. This is any trust other than a simple trust.Chapter 18, Exhibit 3b CCH Federal Taxation Basic Principles 11 of 58
  12. 12. Definition of Terms Grantor trust. This is any trust in which the grantor is the constructive beneficiary. Income from the res of a trust that constructively benefits the grantor is taxed to the grantor on his/her personal return. The trust is disregarded for income tax purposes. Reversionary interest. If the grantor retains the remainder interest, the interest is known as a reversionary interest. In other words, the res, i.e., property, reverts to the grantor when the trust terminates.Chapter 18, Exhibit 3c CCH Federal Taxation Basic Principles 12 of 58
  13. 13. Definition of Terms Beneficiary exposure. On certain fiduciary income, the beneficiaries of these fiduciary entities, and not the fiduciary (i.e., estate or trust), are personally subject to income tax. Contrast with estate and gift taxes. Estate and gift taxes are not income taxes. They are taxes on the transfer of assets from one person to another. The donor or estate, not the recipient, must generally pay the tax.Chapter 18, Exhibit 3d CCH Federal Taxation Basic Principles 13 of 58
  14. 14. Computing Tax Liability—Fiduciary vs. Nonfiduciary Estates and Trust (Fiduciary) Individuals (Non-fiduciary) Income “From Whatever Source Income “From Whatever Source Derived,” including Income in Derived” Respect of Decedent (IRD) – Exclusions – Exclusions – Cost of Goods Sold – Cost of Goods Sold = Gross Income = Gross Income – Deductions For AGI – Deductions For AGI = AGI = AGIChapter 18, Exhibit 4a CCH Federal Taxation Basic Principles 14 of 58
  15. 15. Computing Tax Liability—Fiduciary vs. Nonfiduciary Estates and Trust (Fiduciary) Individuals (Non-fiduciary) – Itemized Deductions – Greater Of: (standard deduction. is not allowed)  Standard Deduction,  Itemized Deductions – Personal Exemptions: – Personal Exemptions Estate: $600 total. $3,800 in 2012 per Simple trust: $300 total. exemption Complex trust: $100 total. = Taxable Income Before Distribution DeductionChapter 18, Exhibit 4b CCH Federal Taxation Basic Principles 15 of 58
  16. 16. Computing Tax Liability—Fiduciary vs. Nonfiduciary Estates and Trust (Fiduciary) Individuals (Non-fiduciary) – Distribution Deduction: N/A Lesser of: (1) Distributed amount. (For simple trusts, this is the same as the trust accounting income); (2) Deductible “DNI.” = Taxable Income = Taxable Income x Fiduciary Tax Rate x Personal Tax Rates (same for estates and trusts) (based on filing status) = Gross Regular Tax Liability = Gross Regular Tax LiabilityChapter 18, Exhibit 4c CCH Federal Taxation Basic Principles 16 of 58
  17. 17. Computing Tax Liability—Fiduciary vs. Nonfiduciary Estates and Trust (Fiduciary) Individuals (Non-fiduciary) – Credits & Prepayments (Apportioned – Credits & Prepayments between fiduciary entity & beneficiaries) = Net Regular Tax Liability Or = Net Regular Tax Liability Or Receivable Receivable + Alt. Min. Tax (If Any) + Alt. Min. Tax (If Any) + FICA Taxes + FICA Taxes = Net Tax Due Or Refund = Net Tax Due Or RefundChapter 18, Exhibit 4d CCH Federal Taxation Basic Principles 17 of 58
  18. 18. Gross Income—Income in Respect of Decedent Gross income (GI). GI for trusts and estates is similar to GI for individuals, except for (1) income in respect of decedent (IRD) and (2) property distributions to beneficiaries. GI from income in respect of decedent (IRD). The gross income of an estate or trust may include IRD that the entity received, if the property from which the IRD is related has not been willed to a named beneficiary. However, if a decedent’s will names an individual as heir to specified property, then any IRD resulting from that property is taxable to the individual, not to the estate or trust. IRD is all amounts to which a decedent was entitled as gross income but which were not includible in computing taxable income on the decedent’s final return. For cash basis decedents, the income was earned but not received (e.g., payroll check). For accrual basis decedents, the income was not properly accrued. Most decedents follow the cash basis of accounting.Chapter 18, Exhibit 5a CCH Federal Taxation Basic Principles 18 of 58
  19. 19. Gross Income—Income in Respect of Decedent Examples of IRD for Cash Basis Decedents: Before Death: After Death: Salary earned. Salary received. Credit sales. Collection on A/R. Gain on sale of property. Proceeds from sale received. Rent accrued. Rent received. Interest accrued on installment note. Interest received on installment note. Cash dividends declared and recorded Cash dividends received. (i.e., decedent was a stockholder on date of record).Chapter 18, Exhibit 5b CCH Federal Taxation Basic Principles 19 of 58
  20. 20. Income in Respect of Decedent—Tax Treatment Double taxation. Income in respect of decedent (IRD) is taxable as gross income to the recipient (i.e., estate or heir) AND includible in the gross estate at asset value. Such treatment may seem harsh. However, it is consistent with the treatment of earned income for all taxpayers. For example, if a taxpayer makes a cash gift derived from previously taxed earned income, the cash gift would be subject to gift tax after the appropriate exclusions.Chapter 18, Exhibit 6a CCH Federal Taxation Basic Principles 20 of 58
  21. 21. Income in Respect of Decedent—Tax Treatment IRD amount realized. IRD is valued at fair market value on the date of death (or alternative valuation date). Basis in IRD received by recipient. The basis of recipients (i.e., estate or heirs) is the same as the decedent’s basis. Gain or loss to recipient. Gain on IRD is taxable upon receipt, on the difference between IRD value and IRD basis. Character of gain or loss. Same as if recognized by the decedent.Chapter 18, Exhibit 6b CCH Federal Taxation Basic Principles 21 of 58
  22. 22. Income in Respect of Decedent—Tax TreatmentDeductions in respect of decedent (DRDs). DRDs are expensesconnected with IRD that were not reported on the decedent’sfinal return. (a) Examples. Examples include interest expense and state income taxes, accrued but unpaid by decedent; and fiduciary fees incurred after death but in connection with IRD. (b) Tax treatment. IRD expenses are deductible by both the recipient and the estate. This slightly mitigates the double taxation of IRD explained above. The deduction is for or from AGI, depending upon the character of the related IRD.Chapter 18, Exhibit 6c CCH Federal Taxation Basic Principles 22 of 58
  23. 23. Gross Income—Property Distributions Tax Treatment An estate or trust may, from time to time, distribute property to a beneficiary under the provisions of the will or trust document. The tax treatment for property distributions depends on whether the estate or trust elects to be taxed.Chapter 18, Exhibit 7a CCH Federal Taxation Basic Principles 23 of 58
  24. 24. Gross Income—Property DistributionsTax Treatment (i) Property distributions WITHOUT election to be taxed. An estate or trust does not recognize gain or loss upon its distribution of property to a beneficiary under the provisions of the will or trust document. The distributed property has the same basis to the beneficiary as it did to the estate or trust. (ii) Property distributions WITH election to be taxed. An executor or trust can elect to recognize gain or loss on in-kind property distributions (i.e., property specified in the will or trust document for distribution). If the election is made, the beneficiaries get a step-up basis equal to the FMV at date of distribution.Chapter 18, Exhibit 7b CCH Federal Taxation Basic Principles 24 of 58
  25. 25. Deductions—Depreciation and Depletion General Rule. As a general rule, deductions for and from AGI are treated the same as for individuals. Postponed Loss Rules. Certain losses realized by the estate or trust may be disallowed, as they are for individual taxpayers. Examples include postponed losses under the Code Sec. 267 related party rules, and postponed losses under the Code Sec. 1091 wash sale rules.Chapter 18, Exhibit 8a CCH Federal Taxation Basic Principles 25 of 58
  26. 26. Deductions—Depreciation and Depletion Either an estate or trust may be entitled to a depreciation or depletion deduction if it holds qualified property. Computations are the same as for individuals. However, the special rules below explain how much of a deduction can actually be taken by an estate or trust. Estates. The allowable deduction for depreciation or depletion must be apportioned between the estate and the heirs on the basis of fiduciary income allocable to each.Chapter 18, Exhibit 8b CCH Federal Taxation Basic Principles 26 of 58
  27. 27. Deductions—Depreciation and Depletion Trusts. Trusts are permitted greater flexibility than estates in receiving depreciation and depletion deductions. A trust may deduct depreciation or depletion from gross income to the extent a reserve is required or permitted under the trust instrument or local law, and income is set aside for the reserve and it actually remains in the trust. Any part of the deduction in excess of the reserve is then allocated between the income beneficiaries and the trust in the same manner as with estates, i.e., on the basis of the fiduciary income allocable to each. If all of the current accounting income is distributed to the beneficiaries, e.g., in the case of simple trusts, then the trust is not entitled to a depreciation deduction.Chapter 18, Exhibit 8c CCH Federal Taxation Basic Principles 27 of 58
  28. 28. Deductions—Depreciation and DepletionExample: Determining the Trust Depreciation Deduction. George creates a trust, naming Billy and Betty as income beneficiaries. The property transferred to the trust is income producing depreciable property. Pursuant to the trust instrument, the income from the trust is to be distributed 60% to Billy and 40% to Betty. In addition, the trustee is permitted to set aside income as a depreciation reserve. In the current year, depreciation on the trust property amounts to $25,000, and the trustee allocates $15,000 of trust income as a depreciation reserve. As a result, the trust can claim a $15,000 depreciation deduction; Billy can claim $6,000 ($6,000 = 60% x [$25,000 – $15,000]); and Betty can claim $4,000 ($4,000 = 40% x [$25,000 – $15,000]).Chapter 18, Exhibit 8d CCH Federal Taxation Basic Principles 28 of 58
  29. 29. Deductions—Capital Losses Capital losses. Same treatment as for individual taxpayer. In most cases, capital losses are allowable only on the fiduciary income tax return, i.e., not on the estate tax return.Chapter 18, Exhibit 9 CCH Federal Taxation Basic Principles 29 of 58
  30. 30. Deductions—Miscellaneous Itemized Deductions Assignment between entity and income beneficiary. As with depreciation, the amount of fiduciary and other miscellaneous itemized expenses deductible to an estate or trust is based on the assignment of related income specified in the trust instrument or by state law. Only the portion of expenses related to income assigned to the estate or trust is deductible by the entity.Chapter 18, Exhibit 10a CCH Federal Taxation Basic Principles 30 of 58
  31. 31. Deductions—Miscellaneous Itemized DeductionsDisallowed deductions. The portion of fiduciary and othermiscellaneous expenses attributable to tax-exempt income isnot deductible. Often this requires an allocation based on thefollowing formula: (a) ÷ (b) x (c), where (a) = Total expense; (b) = Exempt income (c) = Total accounting income (This is the amount that the income beneficiaries of a simple trust are eligible to receive from the entity.)Chapter 18, Exhibit 10b CCH Federal Taxation Basic Principles 31 of 58
  32. 32. Deductions—Miscellaneous Itemized Deductions No 2% AGI floor. Fiduciary fees and other expenses that would NOT be incurred by an individual taxpayer are NOT subject to the 2%-of-AGI floor. All investment expenses are subject to the tracing rules, i.e., any portion allocable to tax- exempt income are not deductible. (Recall that miscellaneous itemized deductions that could be incurred by an individual taxpayer are subject to a 2%-of-AGI floor. These include investment counseling fees and safe deposit boxes.)Chapter 18, Exhibit 10c CCH Federal Taxation Basic Principles 32 of 58
  33. 33. Deductions—Casualty Losses and Charitable Contributions Casualty or Theft Losses. The tax treatment for these losses is the same as for individual taxpayers.  Election by executor. In some instances, casualty and theft losses may be allowable deductions for either fiduciary income tax purposes or estate tax purposes under Code Sec. 2054. In this case, the fiduciary income tax deduction is NOT allowed unless the executor elects to waive the estate tax deduction.Chapter 18, Exhibit 11a CCH Federal Taxation Basic Principles 33 of 58
  34. 34. Deductions—Casualty Losses and Charitable Contributions Charitable Contributions. Bequests to qualified charitable organizations are deductible from fiduciary gross income if the will or trust instrument states that contributions are payable out of income.  No ceiling. The deduction is not subject to the usual 50%/30%/20% AGI ceilings for individuals, rather, 100% of the estate income is deductible, regardless of the source (ordinary or long-term capital gain) and regardless of the charity (public or private).Chapter 18, Exhibit 11b CCH Federal Taxation Basic Principles 34 of 58
  35. 35. Deductions—Casualty Losses and Charitable Contributions Entire interest must be donated. The entire interest of the decedent in the underlying property must generally be donated. Trust interests may enable deductible transfers of partial interests in underlying property. An inter vivos contribution (as opposed to a bequest) may result in exclusion of the property value from the GE and a current deduction for regular taxable income. Nondeductible if paid out of corpus. If contributions are paid out of corpus, they are deductible for estate tax and NOT for fiduciary income tax purposes. Complex trust characterization. If a trust makes a charitable contribution, it is, by definition, a complex trust since simple trusts are required to distribute all income currently and cannot set aside any amount for charitable contributions.Chapter 18, Exhibit 11c CCH Federal Taxation Basic Principles 35 of 58
  36. 36. Personal Exemptions Allowable Amounts.  Estates: $600  Complex trusts: $100  Simple trusts: $300 A personal exemption is not allowable for the year the estate or trust terminates.Chapter 18, Exhibit 12 CCH Federal Taxation Basic Principles 36 of 58
  37. 37. Distribution Deduction—Simple Trusts Explanation of Distribution Deduction. Any trust, complex or simple, or estate, is allowed a deduction for some or all of a distribution to an income beneficiary (the “distribution deduction”). The income beneficiary must report as gross income all or some portion of the distribution. Corporate Wages Analogy. Recall that a corporation is allowed a deduction for employee wages; the employee receives gross income in the form of compensation. To this extent, corporations and employees are analogous to fiduciary entities and income beneficiaries. In the case of the simple trust, the basic issue is the allocation of fiduciary income between trust and beneficiaries.Chapter 18, Exhibit 13a CCH Federal Taxation Basic Principles 37 of 58
  38. 38. Distribution Deduction—Simple Trusts Steps in computing the distribution deduction: 1. Compute state law/accounting income; 2. Compute taxable income before the distribution deduction; 3. Compute distributable net income (DNI); 4. Compute the distribution deduction. (Students may find the second and fourth steps to be conceptually easy; the first and third steps conceptually difficult.)Chapter 18, Exhibit 13b CCH Federal Taxation Basic Principles 38 of 58
  39. 39. The Distribution Deduction—Step 1: Computing State Law/Accounting Income This is the amount of income governed by state law that is used for fiduciary accounting purposes. For simple trusts, it’s the amount distributed to income beneficiaries. (Recall that a simple trust requires current distribution of all its accounting income, while a complex trust can accumulate income.)Chapter 18, Exhibit 14a CCH Federal Taxation Basic Principles 39 of 58
  40. 40. The Distribution Deduction—Step 1: Computing State Law/Accounting Income Controlling the assignments to corpus and income. State law governs what is principal and income of an estate or trust for federal income tax purposes. However, many states have adopted the Revised Uniform Principal and Income Act. The Act and state laws provide that the estate or trust instrument controls how revenues and expenditures will be assigned to corpus and fiduciary income. Thus, the calculation of accounting income is virtually under the control of the decedent (for estates) or grantor (for trusts), through a properly drafted will or trust instrument. By allocating specific items of revenue and expenditures either to corpus (i.e., accumulated income) or to income beneficiaries (i.e., distributed income), the desires of the decedent or grantor are put into effect.Chapter 18, Exhibit 14b CCH Federal Taxation Basic Principles 40 of 58
  41. 41. Assignments to Corpus and Income— Default Designations State laws provide default designations in the event that the will or trust instrument fails to assign revenue and expenditures to corpus and income beneficiaries. Typical default assignments are shown in the following slide.Chapter 18, Exhibit 15a CCH Federal Taxation Basic Principles 41 of 58
  42. 42. Assignments to Corpus and Income— Default Designations Typical Assignments to Corpus and Income Beneficiaries. Increasing Corpus Increasing Accounting Income Proceeds from sale of rental property Rental income Insurance proceeds for assets lost in casualties Insurance proceeds for lost profits Nontaxable stock dividends Taxable stock dividends Nontaxable stock rights Taxable stock rights Liquidating dividends Cash dividends Decreasing Corpus Decreasing Accounting Income Principal payments on business loans Interest expense on business loans Capital expenditures Depreciation Fiduciary fees Rent collection fees Federal and state tax on capital gains Federal and state tax on fiduciary incomeChapter 18, Exhibit 15b CCH Federal Taxation Basic Principles 42 of 58
  43. 43. Assignments to Corpus and Income— Default Designations Notes These designations are provided for by the Revised Uniform Principal and Income Act; however, they can be modified in a will or trust instrument. The net of increases and decreases to accounting income represents the amount that the income beneficiaries of an estate or simple trust are eligible to receive from the entity. It is often based on the desires of the decedent or grantor rather than federal income tax law. Therefore, entity accounting income does not affect the determination of taxable income before the distribution deduction. It does however, effect how much of a distribution deduction the estate or trust is entitled to receive.Chapter 18, Exhibit 15c CCH Federal Taxation Basic Principles 43 of 58
  44. 44. The Distribution Deduction— Step 2: Computing Taxable Income Before Distribution Deduction Computation. These items are determined in much the same way as for individual taxpayers: Gross Income Less: Exclusions Less: Cost of goods sold Less: Deductions for and from AGI Less: Personal exemptions Equal: Taxable income before distribution deductionChapter 18, Exhibit 16 CCH Federal Taxation Basic Principles 44 of 58
  45. 45. The Distribution Deduction— Step 3: Computing Distributable Net Income Function of Distributable Net Income (DNI). DNI is the value necessary to determine any estate or trust’s distribution deduction and therefore its taxable income for the year. It serves two primary functions:  DNI is the maximum amount of a distribution that is taxable to beneficiaries.  DNI is also the maximum amount that the estate or trust can use as a distribution deduction for the year.Chapter 18, Exhibit 17a CCH Federal Taxation Basic Principles 45 of 58
  46. 46. The Distribution Deduction— Step 3: Computing Distributable Net IncomeFormula for Computing DNIStart with: taxable income before the distribution deduction + Personal exemptions (estates: $600, simple trusts: $300; complex trusts: $100). + Tax exempt interest, net of related expenses. + Net capital losses. – Net capital gains allocable to corpus. (In other words, the only net capital gains included in DNI are those attributable to income beneficiaries (or to charitable contributions in the case of estates and complex trusts). Capital gains not included in DNI will be taxable to the estate or trust. = DNIChapter 18, Exhibit 17b CCH Federal Taxation Basic Principles 46 of 58
  47. 47. The Distribution Deduction— Step 3: Computing Distributable Net IncomeObservation Since taxable income before distribution deduction (TIBDD) is computed by deducting all of the allowable deductions (whether allocated to corpus or entity accounting income), these items must be “purged” from TIBDD to arrive at DNI. The effect is to decrease the taxable income of the beneficiaries. The actual distribution to the beneficiaries may exceed DNI because the distributions are not reduced by expenses allocable to corpus.Chapter 18, Exhibit 17c CCH Federal Taxation Basic Principles 47 of 58
  48. 48. The Distribution Deduction— Step 4: Computing the Distribution DeductionComputation Distributable net income (DNI) includes the net tax-exempt income of the trust or estate. That amount must be removed from DNI in computing the distribution deduction. Computation of distribution deduction: DNI - net tax exempt income.Chapter 18, Exhibit 18 CCH Federal Taxation Basic Principles 48 of 58
  49. 49. Computing Taxable Income of Simple Trusts—Example FACTS: The Caligari trust is required to distribute its current accounting income annually to its two beneficiaries, Bob and Bertha. Capital gains and losses and all other expenses are allocable to corpus, pursuant to the trust instrument. No provision is made for depreciation in the trust instrument. Therefore, it will follow income. During the taxable year, the Caligari trust incurs the following items:Chapter 18, Exhibit 19a CCH Federal Taxation Basic Principles 49 of 58
  50. 50. Computing Taxable Income of Simple Trusts—Example Rental income $250,000 Rental expenses 80,000 Depreciation on rental property 70,000 Dividend income 60,000 Taxable interest income 50,000 Tax-exempt interest income 40,000 Net long-term capital gains 30,000 Fiduciary fees 20,000Chapter 18, Exhibit 19b CCH Federal Taxation Basic Principles 50 of 58
  51. 51. Computing Taxable Income of Simple Trusts—Example QUESTIONS: (1) Determine trust accounting income. (2) Determine taxable income before the distribution deduction. (3) Determine DNI. (4) Determine distribution deduction. (5) Determine taxable income to the Caligari trust.Chapter 18, Exhibit 19c CCH Federal Taxation Basic Principles 51 of 58
  52. 52. Computing Taxable Income of Simple Trusts—Example Item Totals Step 1: Step 2 & 5: Step 3 & 4: Accounting Taxable Income (TI) Before DNI & Income & After Distrib. Deduction Distribution DeductionRental income 250,000 250,000 * 250,000Rental expenses 80,000 (80,000) (80,000)Depreciation on 70,000 0 0rental property (Amount is not (Deduction is available only a distributable to beneficiaries since no item) accounting income is accumulated.)Dividend income 60,000 60,000 * 60,000Taxable int. inc. 50,000 50,000 * 50,000Tax-exempt 40,000 40,000 * 0interest income (since tax-exempt)Chapter 18, Exhibit 19d CCH Federal Taxation Basic Principles 52 of 58
  53. 53. Computing Taxable Income of Simple Trusts—Example Item Totals Step 1: Accounting Step 2 & 5: Step 3 & 4: Income Taxable Income (TI) Before & DNI & Distribution After Distrib. Deduction Deduction Net long-term capital gains 30,000 0 30,000 (Allocable to corpus, not income) Fiduciary fees 20,000 0 (18,000 ) (Allocable to corpus, (20m-2m, where 2m = not income) 20m x [40m÷400m*]) Acctg. Income 320,000 Exemption (300) (for simple trusts) Taxable inc. before 291,700 ⇒⇒ ⇒⇒ 291,700 distribution. ded. Exemption 300 Corpus capital gain/loss (30,000)Chapter 18, Exhibit 19e CCH Federal Taxation Basic Principles 53 of 58
  54. 54. Computing Taxable Income of Simple Trusts—Example Item Totals Step 1: Step 2 & 5: Step 3 & 4: Acctg. Taxable Income (TI) Before & DNI & Distribution Deduction Income After Distrib. Deduction Addback: “Net” 38,000 tax-exempt interest (40m-2m) income [$2m fid. exp. is related to tax exempt income] DNI 300,000 Less: “Net” tax- 38,000 exempt interest (40m-2m) income [$2m fid. exp. is related to tax exempt income] Distribution ded. (262,000) ⇐⇐ 262,000 Taxable income 29,700 * These income elements of trust accounting income are used to allocate fiduciary expenses between deductible and nondeductible portions.Chapter 18, Exhibit 19f CCH Federal Taxation Basic Principles 54 of 58
  55. 55. Computing Taxable Income of Simple Trusts—Example Notes 1. Trust Accounting Income, $320,000. This includes the tax-exempt interest income, but not the fiduciary fees or capital gains, since, pursuant to the trust document, they are assigned to corpus. Bob and Bertha receive $160,000 each from the trust for the current year. 2. Taxable Income Before The Distribution Deduction, $291,700. This amount is computed as directed by the Code. Tax-exempt interest is excluded under Code Sec. 103. The trust properly does not deduct any depreciation for the rental property. The depreciation deduction is available only to the recipients of the Caligari trust’s accounting income for the year. Thus, the deduction will be split equally between Bob and Bertha. Only a portion of the fiduciary fees are deductible because some of the fees are traceable to the tax-exempt income.Chapter 18, Exhibit 19g CCH Federal Taxation Basic Principles 55 of 58
  56. 56. Computing Taxable Income of Simple Trusts—Example 3. DNI, $300,000. This amount reflects the required adjustments. 4. Distribution Deduction, $262,000. The distribution deduction is the lesser of the distributed amount, $320,000, or the deductible portion of DNI, $262,000. This represents both a deduction to Caligari trust and gross income to Bob and Bertha ($131,000 each). 5. Taxable Income Of Caligari Trust, $29,700. This amount can be verified by a quick check. Caligari has distributed all of its taxable income to Bob and Bertha except the $30,000 capital gain. The $300 exemption reduces taxable income to $29,700.Chapter 18, Exhibit 19h CCH Federal Taxation Basic Principles 56 of 58
  57. 57. Filing Requirements for Estates and Trusts Estates TrustsMinimum Gross Income Filing Gross income Gross income (GI)Requirements ≥ $600 ≥ $600Minimum Taxable Income Only gross income ≥ $600 Any taxable inc. requires filing,Filing Requirements requires filing. even if GI < $600IRS form for reporting income Form 1041 Form 1041estate/trust incomeIRS form for reporting estate Form 706 N/AtaxFiling deadline for trust income 3-1/2 months after taxable 3-1/2 months after taxabletax year-end year-endFiling deadline for estate tax 9 months after death N/AChapter 18, Exhibit 20a CCH Federal Taxation Basic Principles 57 of 58
  58. 58. Filing Requirements for Estates and Trusts Estates Trusts Tax year Calendar or fiscal Calendar only Accounting method Cash or accrual Cash or accrual Standard deduction Not available Not available Personal exemptions $600 $300 (simple trust) $100 (complex trust)Chapter 18, Exhibit 20b CCH Federal Taxation Basic Principles 58 of 58
  1. A particular slide catching your eye?

    Clipping is a handy way to collect important slides you want to go back to later.

×