Trusts and Estates

Trust and estates are treated as separate taxpayers. However, if the trust or estate makes distributions to the beneficiary or heirs, then they rather than the trust or estate will pay tax on that income. The beneficiary will never pay tax in excess of the trust’s DNI for the year. The following chart illustrates how this is calculated.

Trust Information

ITEMGROSSTAIDNICORPUSTAX INC.

"Income (Div., Int. etc.)12,500YesYes NoYes

Capital Gains 5,000NoNo YesYes

Deductions-Inc (400)YesYes NoYes

Deductions-Corpus(1,800)NoYes YesYes

Tax Exempt IncomeYesYes No No

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TOTAL15,300

Tax Exempt adjustment for

DNI deduction)

DNI DEDUCTION( )

LESS: PERS. EXEMPT ( )

TAXABLE INCOME

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Example of a Simple Trust

ITEMGROSSTAIDNICORPUSTAX INC.

Income12,50012,50012,50012,500

Capital Gains 5,000 0 5,000 5,000

Deductions-Inc( 400)( 400) (400) ( 400)

Deductions-Corpus(1,800)(1,800)(1,800)( 1,800)

Tax Exempt Income

TOTAL15,30012,100 10,300 3,20015,300

Tax Exempt

DNI DEDUCTION(10,300)(10,300)

LESS: PERS. EXEMPT ( 300)

TAXABLE INCOME 4,700

Complex Trust - Distribution of $7,000

ITEMGROSSTAIDNICORPUSTAX INC.

Income12,50012,50012,50012,500

Capital Gains 5,000 0 5,000 5,000

Deductions-Inc( 400)( 400) (400) ( 400)

Deductions-Corpus(1,800)(1,800)(1,800)( 1,800)

Tax Exempt Income

TOTAL15,30012,100 10,300 3,20015,300

Tax Exempt

DNI DEDUCTION( 7,000)( 7,000)

LESS: PERS. EXEMPT ( 100)

TAXABLE INCOME 8,200

TAI = Trust Accounting Income

DNI = Distributable Net Income

In the above simple trust, note that taxable income is almost always capital gain income less $300. That is because all other income (TAI) is required to be distributed to the beneficiary each year and therefore there is a deduction for up to that amount. The deduction however, is limited to DNI, which is generally the same as TAI, except that it is reduced by deductible expenses that are charged to corpus. This isn’t really fair in that it allows the current beneficiaries to reduce their taxable income by expenses (such as state tax on prior years capital gains) that do not reduce their cash flow. But, that is what Congress has dictated.

In the complex trust, there is only a deduction for the amounts required to be distributed and the amount actually distributed, here $7,000. That amount would have to be reduced if any portion of the $7,000 were tax exempt interest. Also, note that the exemption is reduced to $100. If this had been an estate, the same calculation would be made, except that the exemption would be $600.

  1. A trust is a separate taxpayer. –T-
  2. Decedent’s estates are not separate taxpayers, the income is included on the decedent’s tax return, until it is given to the heirs. –F-
  3. A fiduciary is usually either an executor, administrator or a trustee. –T-
  4. A trust return is due April 15th for a calendar year trust. –T-
  5. Generally trust are required to file on a calendar year. –T-
  6. Estates may select a fiscal year. –T-
  7. Beneficiaries may have to pay tax on trust income, so they receive a Form K-1 to tell them how much to report. –T-
  8. All estates and trust who owe tax must file estimated taxes. –F-
  9. A trust or estate pays tax but it receives a deduction for amounts required to be distributed or amounts actually distributed to its beneficiaries. –T-
  10. The gross income of an estate or trust is generally the same as that of an individual. –T-
  11. If property has appreciated prior to its being transferred to a beneficiary, the “gain” will be taxable when it is distributed. –F-
  12. Generally, trusts and estates receive the same deductions as individuals. –T-
  13. An estate or trust is allowed one personal exemption, as if it were single. –F-
  14. Administrative fees of the trust generally are not subject to the 2% limitation applicable to individuals. –T-
  15. If expenses relate to tax exempt income, they are not deductible. –T-
  16. Administrative expenses are either deductible on the estate tax return or on the trust or estate, but not both. –T-
  17. Losses during the administration of the estate are either deductible on the estate tax return, or on the trust or estate’s income tax return, but not on both. –T-
  18. An estate can claim an exemption of $600. –T-
  19. Trusts can claim an exemption of $300. –F-
  20. Unused losses can only be distributed to the beneficiary on the final return. –T-
  21. Charitable contributions are generally limited to 50%, the same as for individuals. –F-
  22. To claim the charitable contribution, contributions can be made from either income or principal, but it must actually be paid during the year. –F-
  23. A simple trust is one that must distribute all income each year and which does not have a charitable beneficiary. –T-
  24. Any trust other than a simple trust is a complex trust. –T-
  25. Income for purposes of determining if a trust is a simple trust, is taxable income. –F-
  26. Distributable Net Income (“DNI”) is the maximum amount for which a beneficiary can be required to pay tax. –T-
  27. DNI also is the maximum amount for which the trust can receive a deduction for distributions to a beneficiary. –T-
  28. In a simple trust, a deduction for distributions to a beneficiary is limited to the amount actually distributed each year. –F-
  29. In a complex trust, a deduction is allowed, if elected, for payments made within 65 days of year end. –T-
  30. Generally, the throwback rule is no longer applicable. –T-
  31. The purpose of the grantor trust rules is to tax the income from a trust to the grantor (rather then to the trust or the beneficiary). –T-
  32. If a trust will revert to the grantor or the grantor’s spouse, it is a grantor trust. –T-
  33. The power to revoke does not constitute a grantor trust, until the trust is actually revoked. –F-
  34. The benefit of a charitable remainder trust is that the taxpayer can fund the trust and still receive a present income tax deduction. –T-

Estate, Gift and Generation Skipping Transfer tax

  1. The estate and gift tax are a unified tax. –T-
  2. The estate tax is scheduled for repeal as is the gift tax. –F-
  3. For 2004/2005, the amount that can be passed estate tax free is $1,500,000. –T-
  4. The amount of gifts that can be made tax free for 2004/2005 is $1,500,000. –F-
  5. Property owned by a decedent is subject to the estate tax based on its tax cost. –F-
  6. Gifts can be direct or indirect, real or personal property, tangible or intangible. –T-
  7. The first $11,000 of a present interest each year is excluded for each donee. –T-
  8. A gift in trust qualifies for the annual exclusion if it is for a minor. –T-
  9. Two major exceptions to the gift tax are for direct payments of tuition and medical expenses. –T-
  10. The medical and tuition exceptions only apply if they are for a spouse, dependent or a child or grandchild. –F-
  11. The estate tax includes property that the decedent gave away before death if there was a retained interest in income during the decedent’s life. –T-
  12. If a gift was made within three years of death that went up in value prior to death, the appreciation is included in the decedent’s estate. –F-
  13. If a gift was made within three years of death, the gift tax paid is included in the decedent’s estate. –T-
  14. If the decedent had “incidents of ownership” over an insurance policy, it will be included in their estate even if it is payable to someone else. –T-
  15. If the decedent had a general power of appointment at death, the underlying property is included in his or her estate. –T-
  16. Half of any jointly owned property is included in the decedent’s estate. –F-
  17. All community property is included in the decedent’s estate, but a marital deduction of 50% is allowed for amounts payable to a spouse. –F-
  18. Fair market value is determined on the date of death or the alternative valuation date, six months after death. –T-
  19. The alternative valuation date can be elected so long as the value of the estate goes down during the six month period. –F-
  20. A deduction is allowed for funeral and administrative expenses. –T-
  21. The marital deduction can be taken up to 50% of the value of the estate. –F-
  22. A qualified terminable Interest Property transfer (QTIP) is an election to treat property placed in trust as property subject to the marital deduction. –T-
  23. The effect of the QTIP is to exclude the property from both the decedent’s and the spouse’s estate tax. –F-
  24. If a decedent did not want to pay estate tax, one solution is to give everything to charity. –T-
  25. A portion of the estate tax can be offset by a credit for state inheritance taxes. –T-
  26. An estate tax return is only required if tax is due. –F-