Trusts And Estates

March 13, 2024

796 / Are trusts and estates required to pay estimated tax?

<div class="Section1">Estates are required to file estimated tax for taxable years ending two years or more after the date of the decedent’s death.<a href="#_ftn1" name="_ftnref1">1</a> Trusts are generally also required to pay estimated tax (see Q <a href="javascript:void(0)" class="accordion-cross-reference" id="648">648</a>). However, there are two exceptions to this rule: (1) with respect to any taxable year ending before the date that is two years after the decedent’s death, trusts owned by the decedent (under the grantor trust rules) and to which the residue of the decedent’s estate will pass under his will need not file estimated tax (if no will is admitted to probate, this rule will apply to a trust which is primarily responsible for paying taxes, debts and administration expenses); and (2) charitable trusts (as defined in IRC Section 511) and private foundations are not required to file estimated tax.<a href="#_ftn2" name="_ftnref2">2</a> A trustee may elect to treat any portion of a payment of estimated tax made by the trust for any taxable year as a payment made by a beneficiary of the trust. Any amount so treated is treated as paid or credited to the beneficiary on the last day of the taxable year.<a href="#_ftn3" name="_ftnref3">3</a><div class="refs"> <hr align="left" size="1" width="33%"> <a href="#_ftnref1" name="_ftn1">1</a>.  IRC § 6654(l). <a href="#_ftnref2" name="_ftn2">2</a>.  IRC § 6654(l). <a href="#_ftnref3" name="_ftn3">3</a>.  IRC § 643(g). </div></div>

March 13, 2024

795 / How is the federal income tax computed for trusts and estates?

<div class="Section1"> Taxable income for trusts and estates is computed by subtracting the following from gross income: allowable deductions; amounts distributable to beneficiaries; and the exemption. Estates are allowed a $600 exemption. For trusts that are required to distribute all their income currently, the exemption is $300; for all other trusts, $100. Certain trusts that benefit disabled persons may continue to use the personal exemptions that were available to individuals for tax years beginning before 2018 and after 2025.<a href="#_ftn1" name="_ftnref1">1</a> A standard deduction is not available.<a href="#_ftn2" name="_ftnref2">2</a> Rates are determined from a table for estates and trusts. <hr> Planning Point: The United States Supreme Court ruled in North Carolina Dep’t of Revenue v. Kimberley Rice Kaestner 1992 Family Trust, No. 18-457 (U.S. June 21, 2019) that the due process clause prevents states from imposing a state-level tax on undistributed trust income based solely on the fact that a trust beneficiary resides in the state. <hr> For estates of decedents dying after August 5, 1997, an election may be made to treat a qualified revocable trust as part of the decedent’s estate for income tax purposes. The election must be made by both the executor of the estate and the trustee of the qualified revocable trust. A qualified revocable trust is a trust that was treated as a grantor trust during the life of the decedent due to his power to revoke the trust (see Q <a href="javascript:void(0)" class="accordion-cross-reference" id="797">797</a>). If such an election is made, the trust will be treated as part of the decedent’s estate for tax years ending after the date of the decedent’s death and before the date that is two years after his death (if no estate tax return is required) or the date that is six months after the final determination of estate tax liability (if an estate tax return is required).<a href="#_ftn3" name="_ftnref3">3</a> Generally, income that is accumulated by a trust is taxable to the trust, and income that is distributable to beneficiaries is taxable to the beneficiaries.<a href="#_ftn4" name="_ftnref4">4</a> A beneficiary who may be claimed as a dependent by another taxpayer may not use a personal exemption (prior to 2018), and his standard deduction may not exceed the greater of (1) $500, as indexed ($1,350 in 2025, $1,300 in 2024, $1,250 in 2023, $1,150 in 2022, $1,100 in 2019-2021); or (2) $250, as indexed ($450 in 2024-2025, $400 in 2022-2023, $350 in 2013-2021) plus earned income.<a href="#_ftn5" name="_ftnref5">5</a> The amount of trust income which can be offset by the basic standard deduction will be reduced if the beneficiary has other income (see Q <a href="javascript:void(0)" class="accordion-cross-reference" id="728">728</a>, Q <a href="javascript:void(0)" class="accordion-cross-reference" id="752">752</a>). Also, trust income taxable to a beneficiary under nineteen years of age (24 for certain students) may be taxed at the parents’ marginal tax rate (see Q <a href="javascript:void(0)" class="accordion-cross-reference" id="679">679</a>) prior to 2018 (for tax years beginning after in 2018 and 2019, taxpayers had the option of electing to apply trusts and estates tax rates to the unearned income of minors).<a href="#_ftn6" name="_ftnref6">6</a> A charitable remainder trust is generally not subject to income tax (see Q <a href="javascript:void(0)" class="accordion-cross-reference" id="8102">8102</a>). However, beneficiaries of a charitable remainder trust are taxable on distributions (see Q <a href="javascript:void(0)" class="accordion-cross-reference" id="8099">8099</a>). A charitable lead trust is generally taxable as a grantor trust (see Q <a href="javascript:void(0)" class="accordion-cross-reference" id="797">797</a>) if an upfront charitable deduction is claimed (see Q <a href="javascript:void(0)" class="accordion-cross-reference" id="8105">8105</a>). Otherwise, a charitable lead trust is generally taxed as described here. Proposed regulations would treat annuity distributions from charitable lead annuity trusts (CLATs) and unitrust distributions from charitable lead unitrusts (CLUTs) as made proportionately from all categories of trust income. State law or trust provisions providing otherwise would be ignored. The regulations would prevent such a provision from being used, for example, to allocate all taxable income to the charitable distribution with capital gain and tax-exempt income retained by the trust.<a href="#_ftn7" name="_ftnref7">7</a> Editor’s Note: All miscellaneous itemized deductions subject to the 2 percent floor were suspended for tax years beginning after 2017 and before 2026. However, the IRS finalized regulations in 2020 clarifying that trusts and estates will continue to be permitted to deduct certain expenses. The rules clarify that the following deductions are allowable in figuring adjusted gross income (so are not miscellaneous itemized deductions): (1) costs paid in connection with the administration of the estate or trust which would not have been incurred otherwise, (2) deductions concerning the personal exemption of an estate or non-grantor trust, (3) deductions for trusts distributing current income, and (4) deductions for trusts accumulating income.<a href="#_ftn8" name="_ftnref8">8</a> Estates, non-grantor trusts and their beneficiaries can rely upon the regulations retroactively, for tax years beginning after December 31, 2017. Deductions available to an estate or trust are generally subject to the 2 percent floor on miscellaneous itemized deductions (prior to 2018 and before 2026).<a href="#_ftn9" name="_ftnref9">9</a> However, deductions for costs incurred in connection with the administration of an estate or trust that would not have been incurred if the property were not held by the estate or trust are fully deductible from gross income.<a href="#_ftn10" name="_ftnref10">10</a> Deductions excepted from the 2 percent floor include only those costs that would not have been incurred if held by an individual (those costs that would be uncommon for a hypothetical investor). Investment advisory fees incurred by a trust were subject to the 2 percent floor.<a href="#_ftn11" name="_ftnref11">11</a> Final regulations have been issued on the proper treatment of costs incurred by trusts and estates. The regulations provide that if a cost is unique to a trust or estate, it is not subject to the 2 percent floor, but if the cost is not unique to a trust or estate, it is subject to the 2 percent floor.<a href="#_ftn12" name="_ftnref12">12</a> For taxable years beginning before 2009, taxpayers can deduct the full amount of bundled fiduciary fees without regard to the 2 percent floor.<a href="#_ftn13" name="_ftnref13">13</a> For taxable years beginning after December 31, 2014, bundled fiduciary fees must be allocated between fully deductible expenses and those subject to the 2 percent floor.<a href="#_ftn14" name="_ftnref14">14</a> Any reasonable method may be used to allocate a bundled fee. For distributions in taxable years beginning after August 5, 1997, the throwback rule for accumulation distributions from trusts in IRC Sections 665-667 has been eliminated for domestic trusts, except for domestic trusts that were once foreign trusts, and except in the case of trusts created before March 1, 1984, which would be aggregated with other trusts under the multiple trust rules.<a href="#_ftn15" name="_ftnref15">15</a> Generally, for those trusts subject to the throwback rule, if a trust distributes income which it has accumulated after 1968, all of the income is taxed to the beneficiary upon distribution. The amounts distributed are treated as if they had been distributed in the preceding years in which the income was accumulated, but are includable in the income of the beneficiary for the current year. The “throwback” method of computing the tax in effect averages the tax attributable to the distribution over three of the five preceding taxable years of the beneficiary, excluding the year with the highest and the year with the lowest taxable income.<a href="#_ftn16" name="_ftnref16">16</a> Excess taxes paid by the trust may not be refunded, but the beneficiary may take a credit to offset any taxes (other than the alternative minimum tax) paid by the trust. However, a beneficiary who receives accumulation distributions from more than two trusts may not take such an offset for taxes paid by the third and any additional trusts. But if distributions to a beneficiary from a trust total less than $2,000 for the year, this penalty will not apply to distributions from that trust.<a href="#_ftn17" name="_ftnref17">17</a> Distributions of income accumulated by a trust before the beneficiary is born or before he attains age 21 are not considered accumulation distributions and thus are not generally subject to the throwback rules.<a href="#_ftn18" name="_ftnref18">18</a> The 2020 final regulations also address the treatment of excess deductions under Section 642(h)(2). The regulations preserve the tax character of the three categories of expenses, rather than grouping all non-Section 67(e) expenses together, to allow for such expenses to be separately stated and to facilitate reporting to beneficiaries. Under the regulations, each deduction comprising the Section 642(h)(2) excess deduction retains its separate character: (1) as an amount allowed in arriving at adjusted gross income, (2) as a non-miscellaneous itemized deduction, or (3) as a miscellaneous itemized deduction. The character of these deductions does not change when succeeded to by a beneficiary on termination of the estate or trust. The regulations also require that the fiduciary separately state deductions that may be limited when claimed by the beneficiary as provided in the instructions to Form 1041 and Schedule K-1. The regulations use the principles under Treasury Regulation Section 1.652(b)-3 to allocate each item of deduction among the classes of income in the year of termination for purposes of determining the character and amount of the excess deductions under Section 642(h)(2). Deductions directly attributable to one class of income are allocated to that income.<a href="#_ftn19" name="_ftnref19">19</a> Any remaining deductions that are not directly attributable to a specific class of income, as well as any deductions that exceed the amount of directly attributable income, may be allocated to any item of income (including capital gains), but a portion must be allocated to tax-exempt income, if any.<a href="#_ftn20" name="_ftnref20">20</a> The character and amount of each deduction remaining after application of Treasury Regulation Section 1.652(b)-3 comprises the excess deductions available to the beneficiaries succeeding to the property as provided under Section 642(h)(2). <div class="refs"> <hr align="left" size="1" width="33%"> <a href="#_ftnref1" name="_ftn1">1</a>. IRC § 642(b). <a href="#_ftnref2" name="_ftn2">2</a>. IRC § 63(c)(6). <a href="#_ftnref3" name="_ftn3">3</a>. IRC § 645. <a href="#_ftnref4" name="_ftn4">4</a>. IRC §§ 641(a), 652(a). <a href="#_ftnref5" name="_ftn5">5</a>. IRC §§ 151(d)(2), 63(c)(5); Rev. Proc. 2014-61, 2014-47 IRB 860, Rev. Proc. 2015-53, Rev. Proc. 2016-55, Rev. Proc. 2017-58, Rev. Proc. 2018-57, Rev. Proc. 2019-44, Rev. Proc. 2020-45, Rev. Proc. 2021-45, Rev. Proc. 2022-38, Rev. Proc. 2023-34, Rev. Proc. 2024-40. <a href="#_ftnref6" name="_ftn6">6</a>. IRC §§ 651-652, 661-663. <a href="#_ftnref7" name="_ftn7">7</a>. Prop. Treas. Reg. §§ 1.642(c)-3(b), 1.643(a)-5(b). <a href="#_ftnref8" name="_ftn8">8</a>. Treas. Reg. § 1.67-4. <a href="#_ftnref9" name="_ftn9">9</a>. IRC § 67(a). <a href="#_ftnref10" name="_ftn10">10</a>.  IRC § 67(e). <a href="#_ftnref11" name="_ftn11">11</a>.  Knight v. Commissioner, 128 S. Ct. 782 (2008), 2008-1 USTC ¶ 50,132 (U.S. 2008). <a href="#_ftnref12" name="_ftn12">12</a>.  Treas. Reg. § 1.67-4. <a href="#_ftnref13" name="_ftn13">13</a>.  Notice 2008-32, 2008-11 IRB 593; Notice 2008-116, 2008-52 IRB 1372. <a href="#_ftnref14" name="_ftn14">14</a>.  Treas. Reg. § 1.67-4(c). <a href="#_ftnref15" name="_ftn15">15</a>.  IRC § 665(c). <a href="#_ftnref16" name="_ftn16">16</a>.  IRC §§ 666-667. <a href="#_ftnref17" name="_ftn17">17</a>.  IRC §§ 666-667, Treas. Reg. § 1.665(b)-1(a). <a href="#_ftnref18" name="_ftn18">18</a>.  IRC § 665(b). <a href="#_ftnref19" name="_ftn19">19</a>.  Treas. Reg. § 1.652(b)-3(a). <a href="#_ftnref20" name="_ftn20">20</a>.  Treas. Reg. § 1.652(b)-3(b) and (d). </div></div>

March 13, 2024

797 / What is a grantor trust? How is a grantor trust taxed?

<div class="Section1">A grantor who retains certain interests in a trust he creates may be treated as the “owner” of all or part of the trust and thus taxed on the income of the trust in proportion to his ownership. There are five categories of interests for which the IRC gives detailed limits as to the amount of control the grantor may have without being taxed on the trust income. These categories are: reversionary interests, power to control beneficial enjoyment, administrative powers, power to revoke, and income for benefit of grantor.<a href="#_ftn1" name="_ftnref1">1</a> With respect to any taxable year ending within two years after a grantor/decedent’s death, any trust, all of which was treated under these grantor trust rules as owned by the decedent, is not required to file an estimated tax return (see Q <a href="javascript:void(0)" class="accordion-cross-reference" id="795">795</a>).<a href="#_ftn2" name="_ftnref2">2</a> Reversionary Interests Generally, a grantor will be treated as the owner of any portion of a trust in which he has a reversionary interest in either the corpus or the income, if, as of the date of inception of that portion of the trust, the value of such interest exceeds 5 percent of the value of the trust.<a href="#_ftn3" name="_ftnref3">3</a> There is an exception to this rule where the reversionary interest will take effect at the death before age 21 of a beneficiary who is a lineal descendant of the grantor.<a href="#_ftn4" name="_ftnref4">4</a> For transfers in trust made prior to March 2, 1986, the reversionary interest was not limited to a certain percentage, and so long as it took effect after 10 years it did not result in taxation of the grantor.<a href="#_ftn5" name="_ftnref5">5</a> Using a 6 percent valuation table, the value of the reversionary interest of a term trust falls below 5 percent if the trust runs more than about 51 years. The value of a reversion will depend on the interest rate and the valuation tables required to be used. Power to Control Beneficial Enjoyment If the grantor has any power of disposition over the beneficial enjoyment of any portion of the trust, and such power is exercisable without the approval of an adverse party, he will be treated (i.e., taxed) as the owner of that portion.<a href="#_ftn6" name="_ftnref6">6</a> A grantor may do any of the following without such action resulting in his being treated as the owner of that portion of the trust: (1) reserve the power to dispose of the trust corpus by will, (2) allocate corpus or income among charitable beneficiaries (so long as it is irrevocably payable to the charities), (3) withhold income temporarily (provided the accumulated income must ultimately be paid to or for the benefit of the beneficiary), (4) allocate receipts and disbursements between corpus and income, and (5) distribute corpus by a “reasonably definite standard.”<a href="#_ftn7" name="_ftnref7">7</a> An example of a “reasonably definite standard” is found in Treasury Regulation Section 1.674(b)-1(b)(5): “for the education, support, maintenance and health of the beneficiary; for his reasonable support and comfort; or to enable him to maintain his accustomed standard of living; or to meet an emergency.” A grantor also may retain the power to withhold income during the disability or minority of a beneficiary.<a href="#_ftn8" name="_ftnref8">8</a> However, if any person has the power to add or change beneficiaries, other than providing for the addition of after-born or after-adopted children, the grantor will be treated as the owner.<a href="#_ftn9" name="_ftnref9">9</a> IRC Section 674(c) allows powers, solely exercisable by a trustee or trustees (none of whom is the grantor, and no more than half of whom are related or subordinate parties who are subservient to the wishes of the grantor), to distribute, apportion, or accumulate income to or for beneficiaries or pay out trust corpus to or for a beneficiary without the grantor being considered the owner of the trust. A related or subordinate party is a person who is not an adverse party and who is the grantor’s spouse if living with the grantor; the grantor’s father, mother, issue, brother or sister; an employee of the grantor; or a corporation or employee of a corporation if the grantor and the trust have significant voting control of the corporation.<a href="#_ftn10" name="_ftnref10">10</a> An adverse party is any person having a substantial beneficial interest in a trust which would be adversely affected by the exercise or non-exercise of the power the person possesses respecting the trust.<a href="#_ftn11" name="_ftnref11">11</a> The grantor will also not be considered the owner of the trust due to a power solely exercisable by a trustee or trustees, none of whom are the grantor or the grantor’s spouse living with the grantor, to distribute, apportion, or accumulate income to or for a beneficiary as long as the power is limited to a reasonably definite external standard set forth in the trust instrument.<a href="#_ftn12" name="_ftnref12">12</a> Regulations treat a reasonably definite external standard as synonymous with a reasonably definite standard, described above.<a href="#_ftn13" name="_ftnref13">13</a> Income for Benefit of Grantor If the trust income is (or, in the discretion of the grantor or a nonadverse party, or both, may be) distributed or held for the benefit of the grantor or his spouse, he will be treated as the owner of it.<a href="#_ftn14" name="_ftnref14">14</a> This provision applies to the use of trust income for the payment of premiums for insurance on the life of the grantor or his spouse, although taxation does not result from the mere power of the trustee to purchase life insurance. This provision is also invoked any time trust income is used for the benefit of the grantor, to discharge a legal obligation. Thus, when trust income is used to discharge the grantor’s legal support obligations, it is taxable income to the grantor.<a href="#_ftn15" name="_ftnref15">15</a> State laws vary as to what constitutes a parent’s obligation to support; however, such a determination may be based in part on the background, values and goals of the parents, as well as the children.<a href="#_ftn16" name="_ftnref16">16</a> The mere power of the trustee to use trust income to discharge a legal obligation of the grantor will not result in taxable income to the grantor. Under IRC Section 677(b), there must be an actual distribution of trust income for the grantor’s benefit in order for the grantor to be taxable on the amounts expended. Other Grantor Powers A grantor’s power to revoke the trust will result in his being treated as owner of it. This may happen by operation of law in states requiring that the trust instrument explicitly state that the trust is irrevocable. Such a power will also be inferred where the grantor’s powers are so extensive as to be substantially equivalent to a power of revocation, such as a power to invade the corpus.<a href="#_ftn17" name="_ftnref17">17</a> Certain administrative powers retained by the grantor will result in his being treated as owner of the trust; these include the power to deal with trust funds for less than full and adequate consideration, the power to borrow without adequate interest or security, or borrowing from the trust without completely repaying principal and interest before the beginning of the taxable year.<a href="#_ftn18" name="_ftnref18">18</a> <div class="refs"> <hr align="left" size="1" width="33%"> <a href="#_ftnref1" name="_ftn1">1</a>. IRC §§ 673-677. <a href="#_ftnref2" name="_ftn2">2</a>. IRC § 6654(l)(2)(B). <a href="#_ftnref3" name="_ftn3">3</a>. IRC § 673(a). <a href="#_ftnref4" name="_ftn4">4</a>. IRC § 673(b). <a href="#_ftnref5" name="_ftn5">5</a>. IRC § 673(a), prior to amendment by TRA ’86. <a href="#_ftnref6" name="_ftn6">6</a>. IRC § 674(a). <a href="#_ftnref7" name="_ftn7">7</a>. IRC § 674(b). <a href="#_ftnref8" name="_ftn8">8</a>. IRC § 674(b)(7). <a href="#_ftnref9" name="_ftn9">9</a>. IRC § 674(c). <a href="#_ftnref10" name="_ftn10">10</a>.  IRC § 672(c). <a href="#_ftnref11" name="_ftn11">11</a>.  IRC § 672(a). <a href="#_ftnref12" name="_ftn12">12</a>.  IRC § 674(d). <a href="#_ftnref13" name="_ftn13">13</a>.  Treas. Reg. § 1.674(d)-1. <a href="#_ftnref14" name="_ftn14">14</a>.  IRC § 677(a). <a href="#_ftnref15" name="_ftn15">15</a>.  IRC § 677(b). <a href="#_ftnref16" name="_ftn16">16</a>.  Stone v. Commissioner, TC Memo 1987-454; Braun v. Commissioner, TC Memo 1984-285. <a href="#_ftnref17" name="_ftn17">17</a>.  IRC § 676. <a href="#_ftnref18" name="_ftn18">18</a>.  IRC § 675. </div></div>