Chapter 14:
Income Taxation of Trusts &
Estates
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INCOME TAXATION OF
TRUSTS & ESTATES (1 of 2)
 Fiduciary
taxation
 Basic concepts and definitions
 Trust taxable income
 Distributable net income (DNI)
 Simple trusts
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INCOME TAXATION OF
TRUSTS & ESTATES (2 of 2)
 Complex
trusts
 Income in respect of a decedent
 Grantor Trusts
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Fiduciary Taxation
 Trusts and estates are
 No double taxation
separate taxpayers
Deductions
permitted for income
distributed to beneficiaries
 Distributed
income from trust retains its
character in hands of beneficiary
 Limited personal exemption available
and no dependency exemptions
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Basic Concepts and
Definitions (1 of 5)
 Estate
comes into existence upon
death of person whose assets are
being administered
 Trust is a legal entity created while a
person is alive or under direction of
a will following a person’s death
 Testamentary trust receives assets
from estate of decedent
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Basic Concepts and
Definitions (2 of 5)
 Principal
or corpus
Initial
assets transferred by grantor plus
certain additions/deductions required
by provisions of trust instrument
 Income
Earnings
derived from principal but
certain gains, losses or deductions may
be considered adjustments to principal
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Basic Concepts and
Definitions (3 of 5)
 Grantor
Party
that transfers assets to the trust
 Trustee
Party
that administers the trust
 Income
Beneficiary
Party
(or parties) who receives income
when distributed by Trustee under
provisions of trust instrument
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Basic Concepts and
Definitions (4 of 5)
 Remaindermen
Party
(or parties) who eventually
receives trust principal
Same person may receive both income
and principal
 Simple
Must
trust
distribute all income annually,
Does not distribute any principal AND
Makes no contributions to charities
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Basic Concepts and
Definitions (5 of 5)
 Complex
Any
trust
trust that is not a simple trust
 Personal
exemption
$300
if all income required to be
distributed annually
$100 if current income may be retained
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Trust Taxable Income
Gross Income
- Deductions for expenses
- Personal exemption
= Taxable income before distribution
- Distribution deduction
= Trust taxable income
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Distributable Net Income
(DNI) (1 of 2)
 DNI
is maximum distribution
deduction & income reportable by
beneficiaries
 No distribution deduction available for
portion of distribution deemed to
consist of tax-exempt income even
though net tax-exempt income
included in DNI
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Distributable Net Income
(DNI) (2 of 2)
Taxable income before distributions
+ Personal exemption already deducted
- Capital gains added to principal
+ Capital losses subtracted from principal
+ Tax exempt interest (net of expenses)
= Distributable Net Income
 See Topic Review C14-2
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Simple Trusts
(1 of 3)
 Must
distribute all of its net
accounting income currently
 Aggregate gross income reported by
beneficiaries cannot exceed DNI
 Income received by beneficiaries
retains its character
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Simple Trusts
(2 of 3)
 Allocation
income
Tax-exempt
income
(net of exp.
directly
attributable
thereto)
of expenses to tax-exempt
X
Accounting
income
(net of all
direct exp)
=
Indirect
expenses
allocable to
non-taxable
income
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Simple Trusts
(3 of 3)
 Tax
treatment of beneficiary if trust has
> 1 beneficiary
Beneficiary’s
share of gross income if DNI
lower than net accounting income is
following fraction of DNI
Income required to be distributed to such beneficiary
Income required to be distributed to all beneficiaries
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Complex Trusts
 Complex
activities
trusts permit the following
Making
distributions < current earnings
Distributing principal
Making charitable contributions
 Complex
trust’s DNI
 Impact on beneficiaries
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Complex Trust’s DNI
(1 of 2)
 Complex
DNI not reduced by
charitable contribution deduction
when determining maximum
distribution for mandatory
distributions
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Complex Trust’s DNI
(2 of 2)
 DNI
reduced when calculating
deductible discretionary distributions
 Distribution deduction is smaller of
DNI or sum of mandatory and other
amounts properly paid
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Impact on Beneficiaries
(1 of 2)
 In
general
Beneficiary
includes distributions as gross
income up to current DNI for the trust
 Accumulation
distribution or throwback
rules attempt to tax individual as if
distributions were made annually
 Higher trust tax rates make accumulation
less desirable
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Impact on Beneficiaries
(2 of 2)
 Tax
treatment of beneficiary if trust has
> 1 beneficiary
Beneficiary’s
share of gross income if total
income required to be distributed exceeds
DNI
Income required to be
distributed currently to beneficiary
Aggregate income required to be
distributed to all beneficiaries currently
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Income in Respect of a
Decedent (IRD) (1 of 3)
 Most
individuals use cash basis
 IRD is income constructively
received, but not actually received
before death
Interest
on CDs, bonds or savings
Salary, commissions or bonus
Dividends received after date of death
with record date before death
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Income in Respect of a
Decedent (IRD) (2 of 3)
 IRD
must be included
As
gross income on estate’s income tax
return AND
As part of the gross estate for transfer
tax purposes
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Income in Respect of a
Decedent (IRD) (3 of 3)
 Estate
may claim an income tax
deduction for the extra transfer tax
due because these items were
counted as part of the estate
 No step-up in basis for IRD items
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Grantor Trusts
(1 of 2)
 Grantor
does not give up enough
control or economic benefit to be a
completed transfer
 Grantor taxed on some or all of trusts
income
Even
if income distributed to beneficiaries
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Grantor Trusts
(2 of 2)
 Types
of grantor trusts
Revocable
trusts
Clifford Trusts
Post-1986 Reversionary interest trusts
 See
Topic Review C14-4
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Comments or questions about PowerPoint Slides?
Contact Dr. Richard Newmark at
University of Northern Colorado’s
Kenneth W. Monfort College of Business
richard.newmark@PhDuh.com
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