TOPIC 62: INCOME TAXATION OF TRUSTS AND ESTATES in VS .NET

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TOPIC 62: INCOME TAXATION OF TRUSTS AND ESTATES
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1 General issues A Filing requirements (1) A trustee must le Form 1041 if the trust is not tax-exempt and if (a) The trust has any taxable income for the year, (b) The trust has gross income of $600 or more, or (c) Any bene ciary is a nonresident alien (2) The executor or administrator must le Form 1041 for a domestic estate that has (a) Gross income of $600 or more, or (b) Any bene ciary who is a nonresident alien (3) Trusts and estates are required to le a tax return in each calendar year that it has taxable income Trusts and estates use Form 1041 to report income and distributions Taxable income distributed to bene ciaries is passed through on a Schedule K-1 The trust pays tax on undistributed income B Deadlines For calendar-year estates and trusts, le Form 1041 and Schedule K-1 on or before April 15 For scal-year estates and trusts, le by the 15th day of the fourth month following the close of the tax year An automatic extension of three months is available C Choice of taxable year (1) Trusts must use a calendar year unless they are tax-exempt, charitable, or grantor trusts Estates can use either a calendar or scal year (2) The time allowed for selection of a calendar year for an estate cannot extend beyond 12 months after the decedent s death D Tax treatment of distributions to bene ciaries (1) The bene ciary, not the trust or decedent s estate, pays income tax on his or her distributive share of income Schedule K-1 (Form 1041) is used to notify bene ciaries of amounts to be included on their income tax returns The distributed income maintains the same form it had in the trust or estate Income is taxed to the trust or estate if it is retained (2) The composition of distributable net income (DNI) (discussed later) determines the type of income distributed and taxed to bene ciaries If 75 percent of DNI is taxable income and 25 percent is tax-exempt interest, then 75 percent of DNI allocated to bene ciaries is taxable income and 25 percent is tax-exempt (3) Schedule K-1 reports the amounts taxable to bene ciaries E Rate structure Trusts and estates compute their tax under a separate, unfavorable tax rate schedule that has ve brackets and quickly reaches the top marginal rate 2 Grantor trusts A trust grantor or another person with signi cant control over a trust and its property may be taxed on its income as the owner of the trust A grantor trust is not treated as a separate trust for tax purposes, and income from the trust is taxed to the grantor 3 Simple trusts A These trusts are required to distribute all of their trust accounting income to bene ciaries They have a standard deduction of zero and are allowed deductions similar to those of individuals, except that the personal exemption amount is only $300 B No distributions are allowed for charitable purposes 4 Complex trusts A trust that does not meet the de nition of a simple trust is a complex trust Such trusts can accumulate income, make charitable contributions, and distribute principal to
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200 - Income Tax Planning bene ciaries They have a standard deduction of zero and are allowed the same deductions as simple trusts, except that the personal exemption amount is only $100 5 Trust income A Trust accounting income This income includes interest, dividends, rents, royalties, and other items Capital gains may also be included in the income of the trust if allowed by state law Accounting income does not include DNI B Trust taxable income (1) The taxable income of a trust is calculated in the same manner as that of an individual unless indicated otherwise A trust s taxable income equals accounting income less any deduction, which is limited to DNI (2) Interest that is tax-exempt to an individual is also tax-exempt to a trust Capital gain and capital loss rules that apply to individuals also apply to estates and trusts The rules that apply to reporting ordinary gains and losses for an individual also apply to trusts and estates (3) Trusts and estates are subject to the passive activity loss rules and the at-risk rules If an owner of rental property actively participates in the management of the rental property, he or she can offset against other income up to $25,000 of net losses The offset is phased out when modi ed AGI exceeds $100,000 and eliminated at $150,000 A trust is not allowed to use the offset An estate is allowed to use the offset for taxable years ending within two years of the decedent s death (4) The rules for individual taxpayers claiming a deduction generally carry over to estates and trusts C Distributable net income (DNI) (1) The trust or estate receives a deduction based on the taxable income distributed to the bene ciaries during the year The deductible amount is computed on Schedule B, Form 1041 The income distribution deduction allowed by estates and trusts for funds distributed to bene ciaries is limited to DNI (2) Any type of income that includes DNI determines the taxability of the distribution, not the type of property received as distribution (3) Any amount distributed that is greater than the DNI is considered undistributed net income (UNI) or corpus This excess amount receives no current deduction If distributions are less than DNI, only the amount distributed can be deducted 6 Estate income tax A Estate income tax is calculated as follows: Step 1 Step 2 Step 3 Step 4 Determine adjusted total income Determine DNI Subtract DNI from adjusted total income The amount remaining is subject to tax at the estate or trust level
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B In calculating taxable income, an estate may use a personal exemption of $600 If a trust (simple) must distribute all of its trust accounting income immediately, it is allowed a $300 exemption All other trusts (complex) are allowed a $100 exemption
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