estate planning & administration newsletter | …...estate planning and administration section...

Bonus Issue

A Fiduciary Income Tax Primer

Philip N. Jones Duffy Kekel LLP, Portland, OR

Contents

1. Introduction ............................................................................. 1 2. Entities not Taxed as Trusts ................................................... 3 3. Tax Rates .................................................................................. 3 4. Simple vs. Complex Trusts; Credit Shelter Trusts .............. 4 5. Filing Thresholds .................................................................... 5 6. Estimated Taxes....................................................................... 5 7. The Decedent’s Final Tax Year and the First Tax Year of an Estate or Trust ..................................... 6 8. Formerly-Revocable Trust Election to Use a Fiscal Year ... 8 9. The Final Tax Year ................................................................. 9 10. Fiduciary Accounting Income .............................................. 10 11. Partnerships and S Corporations ........................................ 11 12. Distributable Net Income (DNI) .......................................... 12 13. Capital Gains and Losses ..................................................... 13 14. Exemptions ............................................................................. 14 15. Calculating Taxable Income; Deductions ........................... 14 16. The Net Investment Income Tax .......................................... 16 17. The Election to Take Deductions on the Fiduciary Income Tax Return ............................................................... 17 18. The Distribution Deduction ................................................. 19 19. Tax-Exempt Income .............................................................. 2020. SpecificBequests ................................................................... 20 21. In-Kind Distributions ........................................................... 21 22. Charitable Deduction ............................................................ 22 23. The Sixty-Five Day Rule....................................................... 2324. TiersofDistributionsandBeneficiaries ............................. 24 25. Income in Respect of a Decedent (IRD); Deductions in Respect of a Decedent (DRD) ...................... 25 26. Retirement Accounts ............................................................. 26 27. Separate Share Rule .............................................................. 2828. BasisStep-up ......................................................................... 28 29. State Fiduciary Income Taxes .............................................. 29 30. Revocable Trusts and Grantor Trusts................................. 30 Selected Additional Research Materials...................................... 31 Appendices:

Appendix A: Miscellaneous Itemized Deductions of Trusts and Estates ...................................................................... 32AppendixB:RetirementPlanDistributionsAfterDeath ..... 33

BonusIssueofthe Oregon Estate Planning

and AdministrationSection Newsletter

Volume XXXI, No. 4 October 2014

Published by theEstate Planningand AdministrationSection of theOregon State Bar

Estate Planning and Administration Section Bonus Issue | October 2014

1. Introduction Thepurposeofthispaperistosummarizethebasicelementsofthefiduciaryincometaxforthebenefit

ofprofessionals(particularlyattorneysandtrustofficers)whoadministertrustsandestatesorwhoadvisefiduciaries.Thoseprofessionalsandtheirclientswillregularlymakeadministrativedecisionsthatwillimpactthefiduciaryincometaxationoftrustsandestates,andthosedecisionswillalsoimpacttheindividualincometaxationofbeneficiaries(includingthetaxationoftruststhatarebeneficiariesofestates,orarebeneficiariesofothertrusts).Becauseadministrativedecisionshaveasignificantimpactonincometaxconsequences,attorneysandtrustofficerswhoadministertrustsandestatesshouldfamiliarizethemselveswiththebasicsoffiduciaryincometaxation.Evenifanaccountantexperiencedwiththefiduciaryincometaxispartoftheprofessionalteamadvisinganestateortrust,attorneysandtrustofficersshouldbeconversantonthesubjectoffiduciaryincometaxation,ifonlytospotissuesthatneedtobediscussedwiththeaccountant.

Thispaperisdevotedprimarilytothefederalfiduciaryincometax,butdiscussionofOregonlawandtheOregonfiduciaryincometaxisalsoincluded.

Thefiduciaryincometaxisimposedontheincomeofalltrustsandestates,tobereportedbyeachtrustorestateonaForm1041federalfiduciaryincometaxreturn(andonaForm41Oregonfiduciaryincometaxreturn).Insomecases,theincometaxwillactuallybepaidbythetrustorestate,butinmanycasestheincomewillbetaxedtothebeneficiaries(oreventothegrantor),andthetrustorestatewillescapetaxonthatsameincome.TheincomeallocabletothebeneficiariesappearsononeormoreSchedulesK-1(oneforeachbeneficiary)attachedtotheForm1041.Ingeneral,theincomeofatrustorestatewillbetaxedonlyonce,eithertothetrustorestate,ortothebeneficiaries,ortothegrantor.Butbeneaththatgeneralrulelieamyriadofotherrulesandexceptionstothoserules.

Nearlyeveryestateandtrustpresentsfiduciaryincometaxissuesthatmustbedealtwithbytheattorneys,accountants,andtrustofficersadministeringthoseestatesandtrusts.Evenanuncomplicatedestateinvolvingonlyaresidence,aninvestmentaccount,andaretirementaccountwillpresentmanyfiduciaryincometaxissues.

ThefiduciaryincometaxisgovernedbySubchapterJofSubtitleAoftheInternalRevenueCode(InternalRevenueCode§§641-692)andtheregulationspromulgatedthereunder.ThenumberofCodesectionsthatgovernfiduciaryincometaxesarerelativelyfew,buttheyprovideanelegantframeworkthatefficientlyallocatestrustandestateincomeamongthetrust,theestate,thebeneficiaries,and/orthegrantor.Inaddition,muchoftherestoftheInternalRevenueCodeappliestotrustsandestates,becausetrustsandestatesaredefinedaspersonsunder§7701(a)(1),becausetaxpayersaredefinedaspersonssubjecttotaxunder§7701(a)(14),andbecausetrustsandestatesaretaxedinthesamemannerasindividuals,withcertainexceptions.§641(b).

ThegeneralstatutesofSubchapterJappearin§§641-646.Thestatutesapplicabletosimpletrustsappearin§§651-652.Thestatutesapplicabletoestatesandcomplextrustsappearin§§661-664.(Thedistinctionbetweensimpletrustsandcomplextrustsisdiscussedbelow.)Thestatutesapplicabletograntortrustsappearin§§671-679.

A caution to the reader:Althoughthegeneralrulesgoverningthefiduciaryincometaxarerelativelysimple,themanynuancesandexceptionscanbeverycomplex;manyofthegeneralrulesstatedinthisshortpaperaresubjecttoexceptionsthatarenotdiscussedinthispaper.Inaddition,changestothelawmayhaveoccurredafterthispaperwaspublished.ReferencestoInternalRevenueCodesections,alongwithregulationsandcases,areincludedinthispaper;pleasereviewthoseCodesections,theapplicableregulations,andthecaselawwhenapplyingthegeneralrulestoyourparticularsituation,inordertomakecertainthatyouarecorrectlyapplyingthemanyexceptionsandthecurrentlaw.OtherCodesections,regulations,andcasesmaybeapplicablethatarenotcitedinthisbriefsummary.Selectedadditionalresearchmaterialsarelistedattheendofthispaper.Theauthorwouldappreciatehearingfromreaderswhohavecorrections,suggestions,orupdatestooffer.

Afiduciarymusttakecaretoensurethatallofthetaxobligationsoftheestateortrustaresatisfied.Ifafiduciaryweretodistributeassetsofatrustorestatewithoutcompletelysatisfyingthoseobligations,thentwoformsofliabilityarecreated.First,thefiduciarywillbecomepersonallyliableforthosetaxobligations,totheextentassetsweredistributedbythefiduciary.Second,thebeneficiarieswillbeliableforthosetaxobligationstotheextentthebeneficiariesreceivedassets.§6901(a).Theformerisknownasfiduciaryliability,whilethelatterisknownastransfereeliability.Ingeneral,thesetwotypesofliabilityarecreatedbystatelaw,butenforcedbyfederalprocedurallaw;§6901(a)ismerelyafederalproceduralstatute.Sawyer v. Commissioner,T.C.Memo2011-298;Julia R. Swords Trust v. Commissioner;142T.C.No.19___(2014).Insomesituations,statelawmightevengovernthecalculationofinterestonthetransfereetaxliability.Schussel v. Commissioner,___F.3d


___,114AFTR2d¶2014-5038(2ndCir.2014).AnadditionalyearistackedontothenormalstatuteoflimitationsiftheIRSfindsitnecessarytoenforcefiduciaryliabilityortransfereeliability.§6901(c);see also Reg.§1.641(b)-2;31U.S.C.§3713(b);United States v. Coppola,85F.3d1015,1020(2dCir.1996).Theobligationforanestateortrusttopaytaxesincludestheobligationtopaythetaxliabilitiesofthedecedent.United States v. Shriner,113AFTR2d¶2014-616(DCMd.2014).

Manyofthewordsandphrasesusedinthispaperaretermsofart,definedintheInternalRevenueCode,theregulations,orelsewhere.Wheneverpossible,thoseexacttermswillbeemployed.Forpurposesofclarity,practitionersshouldbecomeaccustomedtousingthatsameterminology.

2. Entities not Taxed as Trusts Thefiduciaryincometaxdoesnotapplytograntortrusts,whichincluderevocablelivingtrusts

(whilethegrantorisalive)andcertainothertruststhatarespecificallydesignedtobetaxedtothegrantor.(Abriefsummaryofgrantortrustsappearsattheendofthispaper.)Similarly,assetsheldincustodianshipsforminorsarenottaxedastrusts;incomegeneratedbyacustodianshipistaxeddirectlytotheminor.Anastasio v. Commissioner,67T.C.814(1977),affirmed without opinion,573F.2d1287(2ndCir.1977).Forthesamereason,conservatorshipsarenottaxedastrusts.§7701(a)(6);§6012(b)(2).

3. Tax Rates Practitionersdealingwithtrusts,estates,andbeneficiariesmustkeepinmindonefundamental

principle:trustsandestatesareusuallytaxedatmuchhigherincometaxratesthanaremostindividuals.In2014,individualsreachthehighesttaxbracket(39.6%)at$406,750oftaxableincome($457,600formarriedcouplesfilingjointly).§1(a),(c).Buttrustsandestatesreachthehighesttaxbracketatonly$12,150oftaxableincome.§1(e).Thosefigureswillbeadjustedforinflationinfutureyears.SeeRev.Proc.2013-35,2013I.R.B.537.(Thepurposeofthosecompressedbracketsistopreventtaxpayersfromusingtrustsasincometaxreductiondevices.)Forthatreason,fiduciarieshaveastrongincentivetomakecertainthattheirtrustorestatehasverylittletaxableincome,orpossiblynotaxableincome.Themostcommontechniquesforminimizingtheincomeofatrustorestatecanbesummarizedasfollows,andarediscussedindetailinotherpartsofthispaper:

a. Maximizingtheuseandtimingofdeductionsforadministrationexpenses.Thisisusuallydonebypayingsuchexpensesbeforetheendofthefiscalyear,andbyelectingtotakethosedeductionsonthefiduciaryincometaxreturn,andnotontheestatetaxreturn.(Insomecases,thereverseisbetter,asisdiscussedbelow.)Ifdoneproperly,thetaxableincomeofthetrustorestatecanbereducedtoasmallamount,orpossiblytozero.(Inanestate,someadministrationexpenses,suchasattorneyfeesandpersonalrepresentative’sfees,requirepriorcourtapproval;planahead.)Thesevariousdeductionsarediscussedbelow,asistheelectionwhethertotakethedeductionsforincometaxpurposesorestatetaxpurposes.

b. Maximizingtheuseandtimingofthedistributiondeductionbymakingdistributionstobeneficiaries.§651;§661.Ifdoneproperly,thetaxableincomeofthetrustorestatecanbereducedtoasmallamount,orpossiblytozero,andtheincomewillthenbetaxedtothebeneficiariesattheirlowertaxrates.§652;§662.(Inanestate,distributionsrequirepriorcourtapproval;planahead.)Thedistributiondeductionisdiscussedingreaterdetailbelow.

c. Closinganestateonorbeforetheendofthefiscalyear,orterminatingatrustonorbeforetheendofitsfiscalyear.Ifthisisaccomplished,thenalloftheincome,gains,deductions,andothertaxattributesofthetrustorestateforthattaxyearwillflowouttothebeneficiariestobetaxedatthebeneficiaries’rates,notatthehigherratesofthetrustorestate.§662;§643(a)(3);Reg.§1.643(a)-3(d).Inmanycases,theestateortrustcanbecommencedandclosedwithinthesametaxyear,sothatyearbecomesboththefirsttaxyearandthefinaltaxyear.Inmanycases,thatwilloftenbethesimplestsolution.(Inanestate,finaldistributionsrequirepriorcourtapproval;planahead.)Thefinalyearisdiscussedingreaterdetailbelow.

Manyyearsago,trustsweretaxedinlowerbracketsthanindividuals.Becausesometaxpayerswereabletominimizetaxationbyaccumulatingincomeintrustsanddistributingthatincomeinsubsequentyears,Congressenactedwhatareknownasthethrowbackrulestoincreasethetaxationofsuchdistributions.§§665-667.Althoughthosestatutesarestillonthebooks,theyhavelittleimpactduetosubsequentchangesinthetaxratesapplicabletotrustsandestates.Inaddition,1997amendmentstothethrowbackrulesnowmakethemprimarilyapplicabletoforeigntrusts.


4. Simple vs. Complex Trusts; Credit Shelter Trusts Trustsaregenerallydividedintotwotypesforpurposesofthefiduciaryincometax:

• Asimpletrustisonethatisrequiredtodistributeallofitsincomeonacurrentbasis,anditmaynotpayorpermanentlysetasidefundsforcharitablepurposes.§651(a).Ifduringanyparticulartaxyearasimpletrustdistributesprincipal,itwillbetreatedasacomplextrustforthattaxyear.§651(a)(2);Reg.§1.651(a)-3(b).Ifitdoesnotdistributeanyprincipalinthefollowingyear,itwillregainitsstatusasasimpletrust.Reg.§1.651(a)-3(b).Similarly,anin-kinddistributioncausesasimpletrusttobereclassifiedasacomplextrust.Rev.Rul.67-74,1967-1C.B.194.Seethediscussionofin-kinddistributions,below.Becausedistributionsofprincipalcauseatrusttobetaxedasacomplextrust,alltrustsarecomplextrustsintheirfinalyear.

• Acomplextrustisanytrustthatisnotasimpletrust.§661.Thusacomplextrustmayaccumulateincome,maydistributecorpus,andmaymakecharitablecontributions.Ifatrustqualifiesasasimpletrustunder§651and§652,thenitwillbegovernedbythosesectionsandnotby§661.Forexample,ifatrustispermittedtodistributeprincipal,butinaparticularyearitdistributesonlyincome,itwillbetaxedasasimpletrust.Reg.§1.661(a)-1.ThustheCodeestablishesaprioritythattrustsbeclassifiedassimpletrustsifpossible.

TheInternalRevenueCodedoesnotusethetermssimpleandcomplex,buttheregulationsadoptthatterminology.Reg.§1.651(a)-1.

Anestateisneitherasimpletrustnoracomplextrust,butitistaxedinthesamemannerasacomplextrust.§661;§662;Reg.§1.661(a)-1.

Wheredoesacreditsheltertrustfitintothisscheme?Isitasimpletrustoracomplextrust?Orisitagrantortrust?(Seethediscussionofgrantortrusts,below.)Atypicalcreditsheltertrusthasthefollowingcharacteristics:

a. Itwascreatedbythewillorrevocabletrustofthefirstspousetodie.b. Thesurvivingspouseisthetrustee.c. Thesurvivingspouseisentitledtoreceiveallofthenetincomeofthetrustfortherestofherlife.d. Thesurvivingspousemayreceivediscretionarydistributionsofprincipalunderanascertainable

standardthatpermitsdistributionsofprincipalforherhealth,education,maintenance,andsupportinordertomaintainherstandardofliving.ThisisknownasaHEMSstandard.

e. Afterthedeathofthesurvivingspouse,theremainderofthetrustpassestothechildrenofthecouple.

Suchatrustisasimpletrust,exceptforthoseyearsinwhichprincipalisdistributed,inwhicheventitwouldbeacomplextrustforthatyear.§651(a)(2);Reg.§1.651(a)-3(b).Asasimpletrust,itisrequiredtofileaseparateincometaxreturn(Form1041),whichwouldreporttheordinaryincomeaspassingouttothesurvivingspouseandtaxabletothesurvivingspouse,regardlessofwhetherthatordinaryincomeisactuallydistributedornot.§652(a).Theresultwouldbethesameifitwereclassifiedasacomplextrust;ifitisrequiredtodistributeordinaryincome,thatrequiredamountwillbetaxedtothesurvivingspouseregardlessofwhetheritisactuallydistributed.§662(a)(1).

Butcoulditbeclassifiedasagrantortrust,thuseliminatingtheneedforthesurvivingspousetofileaseparateincometaxreturnforthecreditsheltertrustcreatedbyherlatehusband?Couldn’tthesurvivingspousesimplyreporttheincome(andcapitalgains)onherindividualincometaxreturn(Form1040)?Thegrantortruststatutesincludewithinthedefinitionofagrantortrustanytrustsubjecttothepowerofapersontovesttheincome ortheprincipalinthatperson.§678(a)(1).Thusatypicalcreditsheltertrustmightappeartobeagrantortrust.

Isitaregular(simpleorcomplex)trust,orisitagrantortrust?Thequestionismuchdebated.Clearly,thesurvivingspouseistaxedontheordinaryincome,and§678(a)(1)statesthatsuchatrustisagrantortrust.Butwhoistaxedonthecapitalgains?Somepractitionersbelievethatatrustcanbeagrantortrustastoincome,whilenotbeingagrantortrustastoprincipal,and§678(a)itselfdoesstatethatapersonshallbetreatedasthegrantorifthatpersonholdsapowerover“anyportionofatrust”withrespecttowhichthepersonholdsapowertowithdrawincomeorprincipal.(Emphasisadded.)

TheNinthCircuit,sittingen banc,hasheldthatacreditsheltertrustisnotagrantortrust.InUnited States v. DeBonchamps,278F.2d127(9thCir.1960),theNinthCircuitheldthatasurvivingspousewhohadthe


righttowithdrawincome,butwhoserighttowithdrawprincipalwaslimitedbyastandard,wouldbetaxableontheincome,butnotonthecapitalgains,eventhoughthestandardwasaratherlooseone.InDeBonchamps,therightswerecreatedbyadeedthatgrantedtothesurvivingspouseanincomeinterest,alongwiththerighttowithdrawprincipalunderastandard,withtheremainderpassingtoaremainderman.Althoughatrustwasnotexpresslycreated,thecourtheldthatthesituationwouldbetaxedasifitwereatrust,thegrantortruststatuteswouldnotapply,andthecapitalgainswouldbetaxedtothetrust,nottothesurvivingspouse.Seealso,Blattmachr,Gans,andLo,A Beneficiary as Trust Owner: Decoding Section 678,ACTECJournal,Vol.35,No.2,Fall2009,whichreachedtheconclusionthattherighttowithdrawincome,combinedwiththerighttowithdrawprincipalunderanascertainablestandard,didnottriggergrantortruststatusunder§678(a)(1).

Thusthesafestanswerseemstobethatatypicalcreditsheltertrustisnotagrantortrust,anditshouldobtainitsownEIN(employeridentificationnumber)andfileaseparatereturn,inwhichcasethesurvivingspousewillbetaxedontheordinaryincomethroughtheissuanceofaK-1,andthetrustwillbetaxedonthecapitalgains.Thisalsomeansthatapersonalresidenceheldinacreditsheltertrustisnoteligibleforthecapitalgainsexclusiononpersonalresidencesprovidedby§121.PLR200104005;PLR199912026;Reg.§1.121-1(c)(3).Seethediscussionofcapitalgainsandlosses,below.

(Onarelatednote,§1014(e)deniesastepped-upbasisforpropertyacquiredfromadecedentwhohadacquiredthepropertyfromthebeneficiarywithintheone-yearperiodpriortothedecedent’sdeath.Itisanopenquestionwhetherthedenialofthebasisstep-upappliesnotonlytothebeneficiary,butalsotoatrustforthebenefitofthebeneficiary.ThusifWifeconveysappreciatedpropertytoHusband,andHusbanddieswithinoneyearandthenbequeathsthepropertytoacreditsheltertrustforthebenefitofWife(ortoaQTIPtrustforthebenefitofWife),whetherthetrustreceivesastepped-upbasisisuncertain.Siegel,I.R.C. Section 1014(e) and Gifted Property Reconveyed in Trust,27AkronTaxJ.33(2012).Regulationsunder§1014(e)havenotyetbeenpromulgated.)

5. Filing ThresholdsAnestatemustfileaForm1041ifithasgrossincomeof$600ormore,orhasanonresidentalien

beneficiary.Reg.§1.6012-3(a)(1)(i).AtrustmustfileaForm1041ifithasanytaxableincomefortheyear,grossincomeof$600ormore,or

abeneficiarywhoisanonresidentalien.Reg.§1.6012-3(a)(1)(ii).Forpurposesofdeterminingwhetheratrustorestatehasgrossincomeinexcessof$600,grossincome

doesnotnecessarilyincludegrossproceedsfromthesaleofacapitalasset.Instead,grossincomeincludesanamountequaltogrossproceedsminusbasis.Reg.§1.61-6(a).

6. Estimated Taxes Estatesandtrustsarerequiredtopayquarterlyestimatedfederalfiduciaryincometaxesinamanner

similartoindividuals.§6654(l)(1).(ThestateofOregondoesnotrequireestimatedfiduciaryincometaxes.)ThequarterlyinstallmentsforcalendaryeartrustsandestatesaredueonApril15,June15,September15,andJanuary15.

Estatesneednotpayestimatedtaxesfortaxyearsendingbeforethesecondanniversaryofthedateofdeath.§6654(l)(2).Trustsareobligatedtopaysuchestimatedtaxes,butnotifthetrusthasmadea§645electiontouseafiscalyearaspartofthedecedent’sestate.Reg.§1.645-1(e)(4).Seethediscussionofatrust’selectiontouseafiscalyear,below.

Norareestimatedtaxesdueiftheprecedingtaxyearwasatwelve-monthyearandhadnotaxliability.§6654(e)(2).Form1041specificallyaskswhethertheestatehasbeenopenformorethantwoyears,andifso,anexplanationisrequested.

Estimatedtaxesarenotrequiredunlesstheestateortrustisexpectedtooweatleast$1,000intax,§6654(e)(1),orthewithholdingsandcreditsareexpectedtobethelesserofninetypercentofthecurrentyear’staxor100%oftheprioryear’stax,assumingtheprioryearwasatwelve-monthyear.§6654(d)(1).Iftheadjustedgrossincomeismorethan$150,000,thenthe100%requirementbecomes110%.§6654(d)(1)(C)(i).

Atrust(oranestateinitsfinalyear)ispermittedtoelecttotreatitsestimatedtaxpaymentsasifthepaymentshadbeenmadebythebeneficiaries.§643(g)(1)(A).Theelectionmustbemadewithinsixty-fivedaysfollowingtheendofthetaxableyear,andalateelectionisnotvalid.§643(g)(2).TheelectionismadebyfilingaForm1041-T.Asaresultofthiselection,theestimatedtaxpaymentsoftheestateortrustareallocatedto


thebeneficiariestoreducethetaxliabilityofthebeneficiaries.Theestimatedtaxpaymentsareallocatedtothebeneficiariesasofthelastdayofthetaxyearofthetrust,andaretreatedasifthebeneficiarieshadpaidthoseestimatedtaxesonJanuary15ofthefollowingyear.§643(g)(1)(C)(ii).BecausetheestimatedpaymentsaredeemedtohavebeenpaidonJanuary15ofthefollowingyear,the§643(g)electionisoflittleassistancetobeneficiarieswhoshouldhavemadeestimatedpaymentsinearlierquarters.(Thetrusteemightconsideradvisingthebeneficiariesthatsuchanelectiondoesnotretroactivelycureanyproblemsofbeneficiarieswhoareunder-estimatedforpriorquarters.)Theallocationistreatedasasecondtierdistributiontothebeneficiaries,andthusitisshownonForm1041ScheduleBasan“otheramountpaid.”(Seethediscussionoftiersbelow.)TheScheduleK-1providedtoeachbeneficiarywillreflecttheallocation.

Theallocationsofestimatedtaxtomultiplebeneficiariesneednotbeequal;theForm1041-Tallowsunequalallocations.Theelectionappliestoestimatedtaxesonly;itdoesnotapplytotaxwithholdings.§643(g)(1)(A).

7. The Decedent’s Final Tax Year and the First Tax Year of an Estate or Trust Likealltaxpayers,trustsandestatesarerequiredtoadoptataxableyear.Withsomeexceptions(seethe

followingsection),trustsarerequiredtouseacalendaryear,§644(a),whileestatesarepermittedtouseeitherafiscalyearoracalendaryear.§441(e).

Thetaxableyearofadecedentendsonthedateofdeath,andhisexecutorortrusteeisobligatedtofileafinalpersonalincometaxreturn(Form1040)fortheshortyearbeginningonJanuary1andendingonthedateofdeath.Reg.§1.443-1(a)(2).ThatreturnisnotdueuntilApril15ofthefollowingyear,regardlessofwhenduringtheyearthedecedentdied.Reg.§1.6072-1(b).Subjecttosomeexceptions,thesurvivingspouseispermittedtofileajointreturnforthattaxyear.Thatjointreturnwillreportthesurvivingspouse’sincomefortheentireyear,andthedecedent’sincomefortheshortyearduringwhichhewasalive.§6013(a)(3);Reg.§1.6013-1(d).TheallocationoftheincometaxliabilitybetweenthedecedentandthesurvivingspouseisdeterminedunderReg.§20.2053-6(f).

Afinalreturnforthedecedentisnotrequiredtobefiledifthedecedent’sincomewasunderthefilingthresholdfortheyearofdeath.Thefilingthresholdvariesfromyeartoyear,andisbasedonthedecedent’sage,thestandarddeduction,thepersonalexemption,andthefilingstatusofthedecedent.§6012(a).See alsoReg.§1.443-1.

Thedecedent’sfinalindividualincometaxreturnisusuallysignedbyeitherthepersonalrepresentative(ortrustee)or,inthecaseofajointreturn,bythesurvivingspouse(whosignsassurvivingspouseifafiduciaryhasnotbeenappointed).Section6012(b)(1)authorizesthedecedent’sfinalreturntobesignedby“hisexecutor,administrator,orotherpersonchargedwiththepropertyofsuchdecedent.”SeealsotheinstructionstoForm1040,§7701(a)(6),andCCA201334040.Thefiduciaryincometaxreturnissignedbythepersonalrepresentativeortrustee.Iftwofiduciariesareservingasco-fiduciaries,thenonlyoneneedstosignthefiduciaryincometaxreturn.SeetheinstructionstoForm1041.(Incontrast,iftwoormorefiduciariesareserving,allneedtosigntheForm706estatetaxreturn,Reg.§20.6018-2,althoughtheinstructionstotheForm706statethatonlyoneneedstosign.Seealso§2203regardingthesigningofestatetaxreturns.)

Ifthedecedent’sfinalindividualincometaxreturnshowsarefunddue,thefilingofajointreturnbythesurvivingspouseissufficienttoclaimtherefund.Ifthesurvivingspouseisacourt-appointedfiduciary,acopyofthecourtappointmentshouldbeattachedtotheForm1040.OtherfilersneedtoattachaForm1310tothereturn.SeetheinstructionstoForm1040.

Adecedent’sestate(ortrust)isnotrequiredtomakeestimatedpaymentsonthedecedent’sindividual(Form1040)taxliabilityafterthedateofdeath.PLR9102010(10/10/90).However,asurvivingspousemayneedtocontinuetomakeestimatedpayments.

Thepersonalrepresentative(orthetrusteeofaformerly-revocabletrust)shouldfileaForm56(NoticeConcerningFiduciaryRelationship)withtheIRStoensurethatthefiduciarywillreceiveanynoticesconcerningthedecedent’staxliability.Ifanincometaxrefundisowingtothedecedent,afederalForm1310shouldbefiledwiththereturn,and/oranOregonForm243shouldbefiled.Undersomecircumstances,afiduciarycanasktobereleasedforcertainincometaxliabilities,orcanrequestapromptassessmentofsuchliabilities.Foradiscussionofreleasesandrequestsforpromptassessment,seeMitchell,Tax Procedure Issues for Estates and Trusts,OregonStateBarEstatePlanningandAdministrationSectionNewsletter,Vol.XXVII,No.3,July2010.

Ifthedecedent’sassetswereheldinarevocabletrust,thesuccessortrusteewillusuallyobtainanEIN(employeridentificationnumber)forthenow-irrevocabletrustandthenproceedtoadministerthetrustand


eventuallydistributetheassetstothebeneficiaries.However,insomecasesdistributingtrustassetsimmediatelyfollowingaterminatingevent(suchasthedeathofthedecedent)isasimpleandadvantageousalternative.Thus,whenarevocabletrustcallsforterminationofthetrustuponthedeathofthetrustor,thesuccessortrusteehastwochoices.First,thesuccessortrusteemaycontinuethetrustasanewtrustwithitsownEIN,whichwillthencarryoutthevariousadministrativetasksandfilefiduciaryincometaxreturnsfortheperiodofadministration.Suchatrustisoftendescribedasanadministrativetrust,eventhoughitmightcontinueinexistenceforayearortwoormore.Second,inthealternative,thesuccessortrusteemightdecidetoforgotheadministrativetrustandsimplydistributetheassetsofthetrusttothebeneficiariesinapromptfashion,withoutobtaininganEINorfilingfiduciaryincometaxreturns.Ifthatsecondalternativeischosen,thenthesuccessortrusteewillsupplyappropriateincometaxinformationtothebeneficiaries,andthebeneficiarieswilleachreporttheirshareoftheincomeearnedafterthedateofdeath,alongwiththeirshareofthedeductions.Reg.§1.641(b)-3(d).Thissecondalternativemightbeappropriateifthepost-mortemadministrationofthetrustisverystraight-forward,suchasisthecasewithasmalltrustthathasnoneedtofilefederalorOregonestatetaxreturns.

Thefirsttaxyearofadecedent’sestate(orformerly-revocabletrust)beginsonthedayafterthedeathofthedecedent,regardlessofthetimeofdaythatdeathtookplace,andregardlessofwhenthepersonalrepresentativeisappointed.However,transactionscarriedoutafterthemomentofdeatharelikelytobeviewedastransactionsoftheestate,notthedecedent.Thispointisnotentirelyclear.Somepractitionersbelievethattransactionsthattakeplaceonthedateofdeath,butafterthemomentofdeath,arestillincludedinthedecedent’sfinaltaxyear,andarenotincludedinthefirsttaxyearoftheestate.Theybasethatopiniononthefollowinglanguageof§691(a)(1):(a) InclusioninGrossIncome.

(1) GeneralRule.--Theamountofallitemsofgrossincomeinrespectofadecedentwhicharenotproperly includable in respect of the taxable period in which falls the date of his death or a prior period...shallbeincludedinthegrossincomeforthetaxableyearwhenreceived,of[theestate].(Emphasisadded.)

Thetaxyearoftheestateendsonthelastdayofamonthselectedbytheexecutor,aslongasthefirsttaxyeardoesnotexceedtwelvemonths.§441(e).Asaresult,thefirsttaxyearofanestateisalmostalwaysashortyear,unlessthedecedentdiedonthelastdayofamonth.Ifthedecedentdiedinthemiddleofamonth,thenthefirsttaxyearcouldbeasshortastwoweeks,oraslongaselevenandahalfmonths.Forexample,ifadecedentdiedonMay10,2013,thefirsttaxyearoftheestatecouldendasearlyasMay31,2013,oraslateasApril30,2014,butthefirsttaxyearcouldnotpossiblyextendbeyondApril30,2014.

Theselectionofanendingmonthforthefiscalyearismadebyfilinganinitialfiduciaryincometaxreturnfortheperiodendingonthelastdayofthatmonth.Reg.§1.441-1(c)(1).Theelectionmaybemadeonalate-filedreturn.Reg.§1.441-1(c)(1).Thefilingofanextensionrequest,orthefilingofaFormSS-4(applicationforEIN),orthepaymentofestimatedtaxes,doesnotconstitutethemakingofanelectiontouseafiscalyear,nordoesitconstitutetheselectionofanendingmonth,eventhoughtheFormSS-4asksfortheendingmonthofthefiscalyear.

Theselectionofafiscalyearhasimportanttaximplicationsforthebeneficiariesofatrustorestate,inadditiontothetaximplicationsforthetrustorestateitself.IfatrustorestatemakesadistributionofDNItoabeneficiary(orincomeisdeemedtobetaxabletothebeneficiaryunder§652(a)or§662(a)(1)),thenthebeneficiarywillbetaxedonthatdistributioninthetaxyearofthebeneficiaryinwhichthetaxyearoftheestateortrustends.§662(c);Reg.§1.662(c)-1.Insomecases,itmaybedesirabletoselectafirstfiscalyearthatisaslongaspossible,inordertodefertaxation.Selectingalongfiscalyearalsoincreasesthepossibilityofcompletingtheadministrationoftheestateortrustwithinoneyear,sothatthefirstfiscalyearisalsothefinalyear,thusallowingalloftheincome(ortheexcessdeductions)tobecarriedouttothebeneficiaries,withnochancethatanyoftheincomewillbetaxedatthehigherincometaxratesofthetrustorestate.§662;§643(a)(3);Reg.§1.643(a)-3(d).Seethediscussionofthefinaltaxyear,below.

Theselectionofafiscalyearcanbeusedtopreventatrustfromearningsufficientincomeinthefirsttaxyeartoputthetrustorestateinthehighestincometaxbracket.Ifneedbe,thetrusteeorpersonalrepresentativecanmonitortheincomeasitisreceived,andthenterminatethetaxyearbeforetheamountisreachedthatwouldplacetheestateortrustinthehighestbracket.

Theselectionofafiscalyearcanalsohelpsolvethefollowingrelatedproblem.Assumethatanestatehasexperiencedasignificanttaxableevent,suchasthewithdrawalofsignificantfundsfromanIRA.Iftheestatehasalsoexperiencedsignificantexpensesandneedstomakecertainthatthoseexpensesareincurred


inthesametaxyearasthetaxableevent,theselectionofafiscalyearcanhelpachievethatgoal.Orperhapstheestatehasexperiencedasignificanttaxableeventthatoccurredwithinthefirsttwelvemonthsoftheestateadministration,butthatfirsttwelve-monthperiodhasnowended,andtheestatefailedtodistributethatincometothebeneficiaries.Theseproblemscanoftenbeaddressedbyselectingayear-endthatcausestheestatetohaveaveryshortfirstyear(say,afirstfiscalyearofonlythreeorfourmonths),followedbyafulltwelve-monthsecondyear.Thatdecisioncanbemadeatanytimepriortothefilingofthefirstfiduciaryincometaxreturn,anditcanbemadeeventhoughitcausesthereturnfortheshortfirstyeartobeoverdue,sincetheelectionofafiscalyearcanbemadeonalate-filedreturn.Thistechniquecannotbeusedifthetaxissuesoccurinaformerly-revocabletrustthathaselectedunder§645tousethefiscalyearoftheestate(discussedinthefollowingsection),sincethe§645electioncannotbemadeonalate-filedreturn.§645(c).

Forexample,assumethatadecedentdiedinFebruary,2013.ThelongestpossiblefirstfiscalyearoftheestatewouldendonJanuary31,2014,andthepersonalrepresentativemadeatentativedecisiontousethatyearendforthefiscalyear.TheestatewithdrewallofthefundsinalargeIRAaccountinOctober2013,butnosignificantexpenseswereincurredin2013,norwereanydistributionsmade.InApril2014,thepersonalrepresentativerealizedthatusingafiscalyearendofJanuary31,2014,wouldresultinasignificanttaxdueatthehighestrates,becauseofthelackofdeductibleexpensesandthelackofdeductibledistributions.WhatcanthepersonalrepresentativedoinApril2014toremedythissituation?RatherthanuseayearendofJanuary31,thepersonalrepresentativecoulddecidetouseayearendofSeptember30.AlthoughtheincometaxreturnforayearendingSeptember30wasdueonJanuary15,thepersonalrepresentativecouldneverthelessfilealatereturnandmaketheelectiontouseSeptember30astheyearend(payingparticularlycloseattentiontoanyapplicableinterestandpenalties.)ThepersonalrepresentativewouldthenhaveuntilSeptember30,2014,tomitigatethelargetaxableeventthatoccurredinOctober2013.Thatmitigationcouldtaketheformof(a)payingdeductibleexpenses,(b)makingdistributionsthatcarryoutincometothebeneficiaries,or(c)closingtheestateinordertocarrytheincomeouttothebeneficiariesinthefinaltaxyear.

Ifthebeneficiaryhasthesameyear-endasthetrustorestate,distributionstothebeneficiarywillcausethebeneficiarytobetaxedonthetrustorestateincomeinthesameyearthatthetrustorestatereceivedtheincome.§652(c).Ifthebeneficiaryisonadifferenttaxyear,thebeneficiarywillbetaxedinhisorhertaxyearinwhichthetrustorestatetaxyearends.§652(c).Thisisadeferralopportunity:IfthetrustorestatetaxyearendsonJanuary31,2013,theincomeearnedduringmostof2012willnotbetaxabletothebeneficiaryuntil2013,andthetaxwillnotbepayablebythebeneficiaryuntilApril15,2014(subject,ofcourse,totheneedforthebeneficiarytomakeestimatedtaxpaymentsofhisindividualtaxliability).

Ifadecedent’swillcreatesatestamentarytrust,thefirsttaxyearofthetestamentarytrustdoesnotbeginonthedateofdeath,becausethetrusttypicallyacquiresnoassetsonthatdate.Instead,thefirsttaxyearofatestamentarytrustbeginswhenthetrustfirstacquiresassets,whichisusuallyonthedatethattheprobateestatedistributesitsassetstothetestamentarytrust.United States v. Britten,161F.2d921(3rdCir.1947);Maresca Trust v. Commissioner,T.C.Memo1983-501.Ifapartialdistributionismadetothetrustfromtheestatepriortotheterminationoftheestate,thenthetrustwillhavebeencreatedonthatearlierdateofthepartialdistribution.

Anannualfiduciaryincometaxreturnisduewithinthreeandahalfmonthsfollowingtheendofeachtaxableyear.§6072(a).Thefederalformis1041;theOregonformis41.ThusanestateortrustwithataxyearendingonDecember31willfileitsannualfiduciaryincometaxreturnonorbeforeApril15,whileanestatewithataxyearendingJune30willfileitsannualfiduciaryincometaxreturnbyOctober15.

Anautomaticextensionofthetimewithinwhichtofile a return for a trust or for an estate can be obtainedbyfilingaForm7004onorbeforetheduedateofthereturn.See§6081;Reg.§1.6081-6(a).(Form8736isnolongerused.)Unlikeextensionsforindividualreturnsthatareforsixmonths,theautomaticextensionforafiduciaryreturnisforonlyfivemonths.Extensionsoftimetopaythetaxarenotauthorized.Reg.§1.6081-6(c).Furtherextensionstofilebeyondtheoriginalfive-monthextensionarenotauthorized.Reg.§1.6081-6(a).Theextensionofthetimetofileareturnforatrustorestatedoesnotextendthetimeforthebeneficiariestofiletheirreturnsortopaytheirtax.Reg.§1.6081-6(d).Asaresult,afiduciarywhoextendsthetimeforfilingafiduciaryincometaxreturnshouldadvisethebeneficiariestoobtaintheirownextensionsoftimetofiletheirindividualreturns,andshouldadvisethemtopayanestimatedtaxatthetimethatthebeneficiariesextendtheirownreturns.


8. Formerly-Revocable Trust Election to Use a Fiscal Year Althoughtrustsaregenerallyrequiredtouseacalendartaxyear,§644(a),aformerly-revocableliving

trustmayelecttouseafiscalyearfollowingthedeathofthegrantor.§645.ThiselectionismadebyfilingaForm8855,inwhichtherevocablelivingtrust(whichisnowneitherrevocablenorliving)electstobetaxedasifitwerepartofthedecedent’sestate.Theformisnormallyfiledwiththefirstfiduciaryincometaxreturnfiledfortheestate.Itisduebytheduedateofthereturn,ortheextendedduedate;theelectioncannotbemadeonalatereturn.§645(c).The§645electionisirrevocable.§645(c).Theelectionisavailableregardlessofwhetheraprobateestateisactuallybeingadministeredforthedecedent,butanEIN(employeridentificationnumber)mustneverthelessbeobtainedfortheestate,andtheestatewillfiletheForm1041underthatEIN.ThetrustwillalsoobtainanEIN,butthetrustwillnotfileareturn;theEINofthetrustwillbelistedonPartIIIoftheForm8855,andthetrustwillbetreatedasaseparateshareoftheestateforpurposesoftheseparatesharerule.Reg.§1.663(c)-4(a).(Thetrustitselfmightconsistoftwoormoreseparateshares;seebelowforadiscussionoftheseparatesharerule.)Ifaprobateestateisbeingadministered,thenboththeestateandthetrustwillreporttheirincomeonthesameForm1041,whichwillbetheincometaxreturnoftheestate.

Theelectiontobetreatedaspartofthedecedent’sestatemaynotbecontinuedindefinitely.Ifafederalestatetaxreturnisnotfiled,theelectionmayremaininplaceforuptotwoyearsfollowingthedateofdeath.§645(b)(2)(A).Ifafederalestatetaxreturnisfiled,theelectionmayremaininplaceuntilsixmonthsaftertheestatetaxliabilityisfinallydetermined.§645(b)(2)(B).Thefilingofastateestatetaxreturnisnotrelevantforthepurposeofthisrule.

Aftertheperiodduringwhichafiscalyearispermittedhasexpired,thetrustwillthenberequiredtofileashort-yearreturnendingDecember31,andsubsequentreturnswillbefull-yearreturnsendingDecember31.Reg.§1.645-1(h)(4)(ii).Attheendofthe§645electionperiod,thetrustisdeemedtohavedistributeditsassetsandallofitstaxattributestoanewtrustinadistributiontowhich§661and§662apply.Reg.§1.645-1(h)(2).ThetrusteemayneedtoobtainanewEINforthetrust,dependingonwhetheranestateexists.SeeReg.§1.645-1(h)(3);Reg.§301.6109-1(a)(4).

Theelectiontobetreatedaspartofthedecedent’sestate,andtousethefiscalyearoftheestate,alsotriggersseveralotherfiduciaryincometaxbenefitsthatestatesareallowed,comparedtotrusts.Thosebenefitsincludefewerobligationstopayestimatedtaxes,useofthecharitableset-asidededuction,useoftheexemptionapplicabletoestates,andfewerrestrictionsonholdingScorporationstock,amongothers.Thosebenefitsarediscussedseparatelyunderthosetopics.

9. The Final Tax Year Specialrulesapplytothefinaltaxyearofalltrustsandestates.Theprimarypurposeofmostofthese

specialrulesistoshiftallofthetaxliabilityforthefinalyeartothebeneficiaries.Asaresult,alltrustsandallestatespaynoincometaxesforincomereceived(orgainsrealized)intheirfinalyear,buttheyneverthelessmustfileafinalreturn.Thereasonwhynotaxisdue:theCodeisdesignedtopermittrustsandestatestodistributealloftheirassetstotheirbeneficiariesattheendoftheirfinalyear,withoutanyneedtoholdbackareservetopayincometaxes.Alloftheincome,capitalgains,anddeductionsarereportedonthefinalreturn,butthenadistributiondeductionisallowedforalloftheincomeandcapitalgains(unlikeanon-finalyear),andthenalloftheincome,deductions,andgainsarecarriedouttothebeneficiaries.§662;§643(a)(3);Reg.§1.643(a)-3(d).

Thisisaveryimportantrule,andsoitbearsrepeating:trustsandestatespaynotaxesintheirfinalyear;alloftheirincome,gains,deductionsandothertaxattributesflowouttothebeneficiariesinthefinalyear;andthebeneficiariespaytheresultingtaxorobtainthebenefitofanyexcessdeductions.§662(b).AlthoughtheCodedoesnotexpresslystatethatthefinalyearinvolvesnotaxliabilityforanestateortrust,thatistheneteffectof§§662and643.

Forthatreason,simpletrustsarenolongerclassifiedassimpletrustsintheirfinalyear;theyareclassifiedascomplextrusts.Themechanismthatforcesthatclassificationis§661(a)(2)andthelastsentenceof§651(a).Reg.§1.651(a)-3(a).

Anyexcessdeductionsinthefinalyearflowouttothebeneficiariestobeusedbythebeneficiariesontheirindividualtaxreturns,subjecttotworestrictions.§642(h).Excessdeductionsaredefinedastheamountbywhichdeductionsexceedgrossincomeinthefinalyear.§642(h);Reg.§1.642(h)-2(a).Forpurposesofcalculatingtheexcessdeductions,thepersonalexemptionandthecharitabledeductionaredisregarded.§642(h)(2).Ineffect,thecharitabledeductioninthefinalyeariswasted.O’Bryan v. Commissioner,75T.C.304(1980).Thedistributiondeductionisalsodisregarded.§643(a)(1).


Although§642(h)providesthatexcessdeductionsinthefinalyearflowouttothebeneficiariestobeusedbythebeneficiariesontheirindividualtaxreturns,tworestrictionsapply.Becauseofthosetworestrictions,somebeneficiarieswillnotbeabletousetheexcessdeductions.Thoserestrictionsstemfromthefactthatexcessdeductionsareconsideredtobemiscellaneousitemizeddeductionsontheindividualincometaxreturnsofthebeneficiaries.§67(b).Miscellaneousitemizeddeductionscanbeusedbyabeneficiary(1)onlyifthebeneficiaryitemizeshisdeductions,and(2)eventhenthedeductionscanbeutilizedbythebeneficiaryonlytotheextentthathismiscellaneousitemizeddeductionsexceedtwopercentofthebeneficiary’sadjustedgrossincome.§67(a);§642(h);Reg.§1.642(h)-2(a);Rev.Rul.59-392,1959-2C.B.163.Thoseexcessdeductionscannotbecarriedforwardorbackwardbyabeneficiarytoasubsequentyearoraprioryear;theymaybeused,ifatall,inthebeneficiary’syearinwhichthetrust’sfinalyearortheestate’sfinalyearended.Reg.§1.642(h)-2(a).Ifthetrustorestatepassesoutanetoperatinglosscarryoveroranetcapitalloss,thebeneficiariesmaycontinuetocarryoverthelosses.Reg.§1.642(h)(1).

Atrustdoesnotenditsexistencesimplybecausethegoverningdocumentstatesthatthetrustterminatesuponthehappeningofaparticularevent.Instead,thetrustcontinuesinexistenceuntilithasdistributedall(oralmostall)ofitsassets.Reg.§1.641(b)-3(b);Reg.§1.641(b)-3(c)(1);Dominion Trust Co. of Tenn. v. United States,786F.Supp.1321(M.D.Tenn.1991)affirmed7F.3d233(6thCir.1993;unpublishedopinion);Herbert v. Commissioner,25T.C.807(1956),acq.1956-2C.B.6;Rev.Rul.55-287,1955-1C.B.130.Forexample,ifatrustdocumentstatesthatthetrustterminatesuponthedeathofthelifeincomebeneficiary,andthedocumentthenrequiresthatthetrustdistributeallofitsassetstoaremainderman,thetrustdoesnotactuallyterminateonthatdateofdeath.Similarly,arevocablelivingtrustmightprovidethatitterminatesonthedeathofthetrustor,butthetrustusuallycontinuesinexistenceforthepurposesofpayingdebts,resolvingclaims,filingthedecedent’sfinalincometaxreturn,filinganestatetaxreturn,filingincometaxreturnsforthetrust,resolvinganestatetaxaudit,liquidatingassets,formulatingaplanofdistribution,obtainingreleases,etc.Notallofthosetasksarerequiredofeverytrust,butnearlyalltrustshavetaskstocompletebeforetheassetscanbedistributedtotheultimatebeneficiaries.InDominion Trust,thecompletionofthosetaskstookmorethanthreeyears.InLowery v. Evonuk,95Or.App.98(1989),thecourtheldthatatrusteehadnotadministeredatrustwithinareasonableperiodoftimewhenthepost-mortemadministrationofthetrusttookmorethantwenty-onemonths.Ofcourse,whatconstitutesareasonabletimedependsofthefactsandcircumstancesofeachcase;twenty-onemonthsmightbetooshortforalarge,complextrust.Evenifacourtordersatrusttobeterminated,thetrustdoesnotterminateuntilithasaccomplishedthetasksnecessarytoeffectuateafulldistributionofitsassets.Richards v. Campbell,21AFTR2d1122,68-1USTC¶9288(N.D.Tex.1968).However,ORS130.730requiresthatatrusteeproceedexpeditiouslytodistributetrustpropertyfollowingaterminatingevent,andthusatrusteehasanobligationtocompletethosetaskswithreasonablepromptness.See alsoReg.§1.641(b)-3(a).

Althoughatrustterminatesfortaxpurposeswhenithasdisposedofallofitsassets,thetrustmayretainareserveforcontingenciesandstillbetreatedashavingbeenterminated.Reg.§1.641(b)-3(a),(b).

Ifthefinaltaxyearconcludesinthemiddleofacalendaryear,someaccountantsarereluctanttofileafinalreturnuntilthefollowingtaxseason,whennewtaxformsbecomeavailable,andnewtaxreturnpreparationsoftwarebecomesavailable.Forexample,ifanestatefullydistributesitsassetsandclosesinMarchof2014,thefinalForm1041isdueJuly15,2014,andthereturnissupposedtobefiledusing2014taxforms,but2014forms(and2014taxreturnpreparationsoftware)won’tbecomeavailableuntilJanuaryof2015.Filingthatreturnduringthesubsequenttaxseasoninearly2015usuallycausesnoharm(eventhoughitistechnicallylate),butsomefiduciariesprefertofilethefinalreturnsooner,inordertofullyandfinallysatisfytheiralloftheirduties.Thesolution:theIRSusuallywillacceptthatfinal2014returnfiledon2013formsifthe“2013”intheupper-rightcorneroftheformsiscrossedoutand“2014”iswritteninbolddigitsabovethestruck-out“2013.”Fortaxreturnpreparerswhoarerequiredtofilealloftheirreturnselectronically,aspecial“opt-out”Form8948canbeattachedtothereturnandwillpermitthepreparertofilesuchareturninpaperform.

10. Fiduciary Accounting Income Fiduciaryaccountingincomeisessentiallytheincomeofatrustorestatedefinedbythewillortrust,

andbylocallaw.§643(b).Ingeneral,theIRSwillnothonordefinitionsofincomecontainedinatrustdocumentthatfundamentallyvaryfromstatelaw.Reg.§1.643(b)-1.Inmoststates,theprincipalsourceofthatlawistheUniformPrincipalandIncomeAct,whichhasbeenenactedinOregonaschapter129oftheOregonRevisedStatutes.Becausefiduciaryaccountingincomeisbasedonstatelaw,itisusuallyexpressedasadollaramountnetofexpenses.TheUniformPrincipalandIncomeActreferstoitasnetincome.ORS129.205(8).


ThefiduciaryincometaxprovisionsoftheInternalRevenueCoderefertofiduciaryaccountingincomewheneverthewordincomeisnotprecededbythewordsgross,taxable,distributablenet,orundistributednet.§643(b).

Atrustorestateispermittedtocomputeitstaxableincomeunderthecashmethod,theaccrualmethod,orotherpermissiblemethods.§446(c).See also§641(b);§7701(a)(1),(14).Onceamethodhasbeenadopted,however,themethodcannotbechangedwithoutthepermissionoftheIRS.§446(e).

Theprimarypurposeforthetermfiduciaryaccountingincomeistodistinguishbetweenprincipal(includingcapitalgains)andincome,particularlysincemanytrustscallforthedistributionofincometoonebeneficiary,followedbyadistributionofprincipal(includingcapitalgains)toadifferentbeneficiary,suchasaremainderman.ButfiduciaryaccountingincomealsohasimportantusesindeterminingDNIandthedistributiondeduction,asnotedbelow.

ThedefinitionoffiduciaryaccountingincomecausesspecialproblemswhenatrustorestateholdsaninterestinanScorporationorapartnership.Theincomeofsuchentitiesisgenerallytaxedtotheshareholders/partners,regardlessofwhethertheincomeisactuallydistributedtothem.Iftheentityearnsincome,butdoesnotdistributeit,thentheK-1sissuedtotheshareholders/partnerswillshowincometaxabletotheshareholders/partners,buttheshareholder/partnerswillhavereceivednocashwithwhichtopaythetaxonthattaxableincome.Suchincomeunaccompaniedbycashisknownasphantomincome.Buttheproblemisevenmorecomplicatediftheshareholder/partnerisatrustorestate.UndertheUniformPrincipalandIncomeActenactedinmoststates,incomeisgenerallylimitedtoamountsreceivedincash.See, e.g.,ORS129.300(2).Itemsthatdonotqualifyasincomearedeemedtobeprincipal.ORS129.300(3)(a).Amountsactuallydistributedbytheentitywillbetreatedasincome,andwillbeincludedinDNI.Butamountsnotactuallydistributedbytheentityarenotincludedinfiduciaryaccountingincome,noraretheyincludedinDNI.Yettheyaretaxabletothetrustorestate.Andthetrustorestateisnotabletodistributesuchincometothebeneficiariesandcauseittobetaxedtothebeneficiaries,because§§651(a)and661(a)allowdistributiondeductionsonlyforincomeactuallydistributedorrequiredtobedistributed,anditisnotpossibleforthefiduciarytodistributeincomewhichthefiduciaryhasnotactuallyreceived.Yetforincometaxpurposes,thefiduciaryisdeemedtobetaxedonthatincome,andthebeneficiarywillnotbetaxedonthatincome.SeethenextsectionforafurtherdiscussionofpartnershipandScorporationinterestsheldinanestateortrust.

11. Partnerships and S Corporations S corporations pose special problems in estate and trust administration after an S corporation

shareholderhasdied.OnlycertainkindsoftrustsareeligibletobeshareholdersinScorporations,andsomeofthosetrustsareeligibleonlyforbriefperiodsfollowingthedeathofashareholder.ThetypesoftrustseligibletoholdScorporationstockincludegrantortrusts,revocabletrustswithintwoyearsfollowingthedeathoftheshareholder,testamentarytrustswithintwoyearsofthereceiptofScorporationstock,estatesduringareasonableperiodofadministration,QualifiedSubchapterSTrusts(QSSTs),andElectingSmallBusinessTrusts(ESBTs).See§1361.Formoredetailonthissubject,seeHeathandSchnell,Estate Planning with S Corporation Stock,OregonStateBarEstatePlanningandAdministrationSectionNewsletter,Vol.XXVII,No.3,July2010.Atrustmaybetreatedasanestateforpurposesoftheserulesifthetrusthasmadea§645electiontouseafiscalyearaspartofthedecedent’sestate.Reg.§1.645-1(e)(3)(i).Seethediscussionofatrust’selectiontouseafiscalyear,above.

IfadecedentownedaninterestinapartnershiporanLLC,thepartnershiporLLCmaymakeanelectionunder§754toadjustthebasisofpartnershipassetswithrespecttothetransfereepartneronly(thepersontakingtheinterestasaresultofthedeathofthepartner).Thisadjustmentismadepursuantto§743(b).Theamountofthe§743(b)adjustmentisequaltothedifferencebetweenthetransferee’sinitialbasisinhispartnershipinterest(fairmarketvalueasofthedateofdeath)andhisproportionateshareoftheadjustedbasisofpartnershipproperty.Theadjustmentcanbeapositiveoranegativeadjustment.Oncetheelectionismade,the§743(b)adjustmentappliestoalltransfersofpartnershipinterestsbysaleorexchangeoruponthedeathofapartneruntiltheelectionisformallyrevoked.Theelectionmustbefiledwithatimelypartnershipreturnforthetaxableyearduringwhichthetransferoccurs.Reg.§1.754-1(b).Inthecaseofdeath,thiswouldbethereturnfortheyearofdeath.Section743(b)basisadjustmentsaremandatoryifthepartnershiphasasubstantialbuilt-inlossimmediatelyafterthetransferofapartnershipinterest.Asubstantialbuilt-inlossexistswheretheadjustedbasisofallpartnershippropertyexceedsitsfairmarketvaluebyatleast$250,000.Reg.§1.754-1(d)(1).

Assumingtheadjustmentispositive,thebenefitoftheelectionisthatthetransfereeisallowedanincreaseinhisorherbasisinthepartnershipassets.Thisinturnreducesthetransferee’sshareofcapital


gainrealizedonthesaleofanyoftheassets.A§743(b)basisadjustmenthasnoeffectonthepartnership›scomputationofanyitemunder§703,nordoesitimpactthetransferee›scapitalaccount.

Thedisadvantagesoftheelectiontoadjustthebasisofpartnershipassetsinclude:a. Theelectionisessentiallyirrevocable(exceptwithIRSconsent).b. Ifthetransferee’sbasisinpartnershipassetsexceedshisorherbasisinhisorherpartnership

interest,the§743(b)adjustmentwoulddecreasehisorherbasisinpartnershipassets.c. Itappliestobothtransfersofpartnershipinterestsanddistributionsofpartnershipassets.Thiscould

resultinfuturedecreasesinbasisdependinguponsubsequentevents.d. Theelectionaddsaccountingandrecordkeepingcomplexityforthepartnership.e. Ifa§743(b)electionisnotmade,thegainthatcouldhavebeenavoidedbythebasisincreasewill

berecognized.However,sincethisgainincreasesthepartner’sbasisinhispartnershipinterest,uponasaleofhispartnershipinterestthepartnerwouldhaveanoffsettingrecoveryoftheamountearlierrecognized.

12. Distributable Net Income (DNI) Theconceptofdistributablenetincomeiscentraltounderstandingthefiduciaryincometax.DNIis

essentiallythetaxableincomeoftheestateortrust,includingbothtaxableincomeandtax-exemptincome.§643(a).Sinceitisbasedontaxableincome,DNIiscalculatedafterreducingtheincomebydeductibleadministrationexpenses,suchasattorneyfees,executorfees,andotherexpenses,butDNIisnotreducedbydistributionstobeneficiaries,orbythepersonalexemptionofthetrustorestate.Whenincludingtax-exemptincomeinDNI,theincomeisreducedbyexpensesthatarenon-deductiblebyreasonofhavingbeenallocatedtothetax-exemptincome.§643(a)(5).Seetax-exemptincome,below.

TheprimaryfunctionoftheDNIcalculationistoserveasalimitonhowmuchofadistributiontobeneficiariesmaybedeductedunderthedistributiondeduction.§651(b);§661(a).ThatfactexplainswhyDNIiscalculatedwithouttakingintoaccountthedistributiondeduction.Seethediscussionofthedistributiondeduction,below.

DNIdoesnotincludemostcapitalgains,exceptinthefinalyear.§643(a)(3);Reg.§1.643(a)-3(d).Seethediscussionofthefinalyear,above.TheexclusionofcapitalgainsfromDNIexplainswhycapitalgainsaresubtractedfromadjustedtotalincomeonScheduleBofForm1041inordertocalculateDNI.ThefactthatDNIdoesnotincludecapitalgains(exceptinthefinalyear)explainswhymostcapitalgainsaretaxedtothetrustorestate,andnottothebeneficiaries,exceptinthefinalyear.§643(a)(3).

BecauseDNIisbasedontaxableincome,charitabledeductionshavealreadybeenremovedfromDNI,andnofurtheradjustmenttoDNIisneededwithrespecttocharitabledeductions.Thisrulepreventsnon-charitablebeneficiariesfrombeingtaxedonincomedistributedtocharityorsetasideforcharitablepurposes,withoneexception:tier1beneficiariesreceivenobenefitfromacharitabledistributionofincome.§662(a)(1).Ineffect,tier1beneficiarieshaveprioritytobetaxedontheincomeofatrustorestate,andcharitabledistributionsofincomearetreatedasalowerpriority,butahigherprioritythantier2distributions.Seethediscussionsofthecharitabledeductionandthetiersystem,bothbelow.

ThecalculationofDNIismadewithoutsubtractingthe§691(c)deductionforestatetaxespaidonincomeinrespectofadecedent.Reg.§1.691(c)-2(a)(2).Seeincomeinrespectofadecedent,below.

Asnotedbelow,thefiduciarymayelecttodeductsomeexpensesonanestatetaxreturnunder§642(g),inwhichcasethoseparticularexpensesmaynotbedeductedonthefiduciaryincometaxreturn,andinthateventsuchexpenseswillnotreduceDNI.Normayexpensesdeductedontheestatetaxreturnalsobeusedtoreducecapitalgainsonafiduciaryincometaxreturn.§642(g).


13. Capital Gains and Losses Ingeneral,capitalgainsandlossesaretaxedtotrustsandestatesinmuchthesamefashionastheyare

taxedtoindividuals.Thegeneralrule,subjecttomanyexceptions,isthatineachyearlong-termgainsarenettedagainstlong-termlosses,andshort-termgainsarenettedagainstshort-termlosses.Thenthelong-termnetgain/lossisnettedagainsttheshort-termnetgain/loss.Iftheresultisagain,itistaxedtothetrustorestateat20%,or15%iftaxableincomeislessthan$12,150.§1(h).Iftheresultisaloss,itcanbededucteduptotheamountof$3,000inthatyear,andtheexcesscanbecarriedoverintofutureyearsindefinitelyuntilithasbeenconsumedinthosefutureyears.§1212(b).See also§1.643(a)-3(d).

Trustsandestatesreachthehighestcapitalgainratesatamuchlowerthresholdthandoindividuals.Anindividualsinglepersondoesnotreachthemaximum20%rateunlesstaxableincomeisabove$400,000in2013,andjoint-filingmarriedtaxpayersdonotreachthemaximum20%rateunlesstaxableincomeisabove$450,000in2013.§1(h).In2014,thosenumbersincreaseto$406,750and$457,600,andinfutureyearsthosenumberswillcontinuetobeadjustedforinflation.SeeRev.Proc.2013-35.

Assetsacquiredfromadecedentanddisposedofwithinoneyearafterthedeathareautomaticallydeemedtohavebeenheldbytherecipientformorethanoneyear,eveniftherecipientdisposesoftheassetshortlyafterthedeathofthedecedent.§1223(9).Asaresult,anygainrealizedisdeemedtobelong-term.Thisruleappliesnotonlytoestates,butalsotorevocabletruststhatbecameirrevocableuponthedeathofthedecedent.§1014(b).Infact,thisruleappliestoanyassetwherethebasisisdeterminedby§1014(basisofpropertyacquiredfromadecedent).§1223(9).Seethediscussionofbasisstep-up,below.

Ingeneral,capitalgainsandlossesdonotpassouttothebeneficiaries;thetrustorestatepaystheincometaxonthenetgains,andthenetlossesaredeductiblebythetrustorestatesubjecttothelimitationsdescribedabove.ThatresultisbroughtaboutbythefactthatsuchgainsandlossesarenotincludedinDNI.§643(a)(3).Thatresultisbasedinpartonstatelaw,whichtypicallyallocatescapitalgainstoprincipal.ORS129.310.However,inthefinalyearofatrustorestate,allofthetaxattributesofthattaxyearpassouttothebeneficiariesaspartofDNI,sothatanycapitalgainsrealizedinthatfinalyearwillbereportedbythetrustorestateonthefiduciaryincometaxreturn,butthenthegainswillbecarriedouttothebeneficiariesontheirK-1s,aswillthelosses.§662;§643(a)(3);Reg.§1.643(a)-3(d).Seethediscussionofthefinalyear,above.

Undersomecircumstances,capitalgainsareincludedinDNIinanon-finalyearofatrustorestate,andthusthoseexceptionsallowcapitalgainstobepassedouttothebeneficiaries.Thoseexceptionsaredescribedin§643(a)(3)andReg.§1.643(a)-3:

a. Gainsthatareallocatedtofiduciaryaccountingincome,understatelawandthegoverninginstrument,orpursuanttotheexerciseofthefiduciary’sdiscretionifauthorizedbystatelaw,orauthorizedbythegoverninginstrumentifnotprohibitedbystatelaw.

b. Gainsthatareallocatedtoprincipal,butareactuallypaid,credited,orrequiredtobedistributedtoanybeneficiaryduringthetaxableyear.

c. Gainsthatarepaidorpermanentlysetasideforcharitablepurposesunder§642(c).Theregulationsunder§643clarifythatcapitalgainscanbeincludedinDNIifthegainsareallocated

toincomebystatelawandunderthegoverninginstrument;orareconsistentlytreatedbythefiduciaryonthebooks,records,andtaxreturnsofthetrustorestateaspartofadistributiontoabeneficiary;orareallocatedtoprincipalbutactuallydistributedtoabeneficiary,ortreatedbythefiduciaryasrequiredtobedistributedtoabeneficiary.Reg.§1.643(a)-3.CapitalgainsarealsoincludedinDNIifpaidorpermanentlysetasideforcharitablepurposes.Reg.§1.643(a)-3(c).

Theregulationsunder§643providefourteenexamplestoillustratehow§643(a)(3)operatestoallowcapitalgainstobepassedouttobeneficiaries.Thoseexamplesdemonstratethatthesecondexceptiondescribedabovecanbeusedonlyifthegoverninginstrumentorstatelawpermitssuchdistributions.Reg.§1.643(a)-3(e).

Inmanymodestestates,capitalgainsarerelativelyfewandsmall,particularlysincetheassetswillhavereceivedastepped-upbasisforincometaxpurposes.Inarelativelysmallestate,oftentheonlysignificantcapitaltransactionisthesaleofthedecedent’spersonalresidence.Let’sassumethatthehouseissoldontheopenmarketafewmonthsafterthedateofdeath,throughtheservicesofaprofessionalrealestatebroker.Thatsaleusuallydeterminesthefairmarketvalueoftheresidence,anditisnotunreasonabletousethatsalepriceasthefairmarketvalueontheestatetaxreturnandasthepost-mortemincometaxbasisoftheresidence.Buthowarethebroker’scommission,thetitleinsurancepremium,andrelatedclosingcostshandledfortaxpurposes?Asnotedbelowinthediscussionofdeductions,theexpensesofsalearenotusuallydeductibleagainstordinary


incomeforfiduciaryincometaxpurposes.Instead,thoseexpensesareoffsetsagainstthesellingpricetoreducegainortoincreaseloss.§642(g).Butbecausethesalepriceisalsothebasis,offsettingthoseclosingcostswillproduceacapitalloss.Thatlosscanbeoffsetagainstcapitalgains,andifthelossesexceedthegains(asnotedabove),theexcesscanbedeductedupto$3,000peryearagainstordinaryincome.Ifthesaletakesplaceinthefinalyearoftheestate(andmodestestatesoftenhaveonlyonetaxyear,whichisboththefirsttaxyearandalsothefinaltaxyear),thenthelossflowsouttothebeneficiaries,whocanusethelosstooffsettheirowncapitalgains,andanynetlossofeachbeneficiarycanbedeductedagainstordinaryincomebyeachbeneficiaryupto$3,000peryearunder§1211(b).§1.642(h)-1(c).(TheIRSoncetookthepositionthatalossonthepostmortemsaleofapersonalresidencecouldnotbedeductedunlesstheestatehadrentedouttheresidence,SCA1998-012,butapparentlytheIRSnolongertakesthatposition.SeeIRSPublication559.)

Unlessitisagrantortrust,atrustisnoteligibleforthecapitalgainexclusiononthesaleofapersonalresidenceprovidedby§121.PLR200104005;PLR199912026;Reg.§1.121-1(c)(3).Ifthetrustisdeemedtobepartiallyagrantortrust,thenthegrantormayexcludethatportionofthegain.PLR200104005.

Occasionallyanundividedhalfinterestinapersonalresidenceisplacedinacreditsheltertrust,whiletheotherhalfinterestcontinuestobeownedbythesurvivingspouse.Underthepriorversionof§121,theownerofapartialinterestcouldexcludethatowner’sportionofthegain.Rev.Rul.67-234,1967-2C.B.78;Rev.Rul.67-235,1967-2C.B.79.Presumablythatresultisstillavailableunderthecurrentversionof§121.

Forpurposesofdeterminingwhetheratrustorestatehasgrossincomeinexcessofthe$600filingthreshold,grossincomedoesnotnecessarilyincludegrossproceedsfromthesaleofacapitalasset.Instead,grossincomeincludesanamountequaltogrossproceedsminusbasis.Reg.§1.61-6(a).

14. Exemptions Under§642(b),anestateisallowedapersonalexemptionof$600,asimpletrustisallowedapersonal

exemptionof$300,andacomplextrustisallowedapersonalexemptionof$100.Theseexemptionsarenotavailableinthefinalyearofatrustorestatebecausethetrustorestatepaysnotaxesinthefinalyearandtheexemptionmaynotbepassedouttothebeneficiariesasanexcessdeduction.§642(h)(2).

Atrustisallowedtousethelarger$600exemptionofanestateifthetrusthasmadea§645electiontouseafiscalyearaspartofthedecedent’sestate.Reg.§1.645-1(e)(2)(ii)(A).Seethediscussionofatrust’selectiontouseafiscalyear,above.

15. Calculating Taxable Income; Deductions Estatesandtrustsaregenerallytaxedinthesamemannerasindividuals,withseveralexceptions.

§641(b).Calculatingthetaxableincomeofanestateortrustinvolvesseveralsteps.Themostimportantstepsare:a. Determinegrossincome.Grossincomegenerallydoesnotincludetheproceedsoflifeinsurance

receivedduetothedeathofthedecedent.§101(a)(1).Also,grossincomedoesnotincludetax-exemptincome.§103.Inthefollowingdiscussionofdeductions,deductionsrelatingtotax-exemptincomemustbeallocatedinfullorinparttotheexemptincome,andtheportionsoallocatedmaynotbededucted.§265.Forexample,atrustee’sfeeforinvestmentmanagementmustbeallocatedbetweentaxableinvestmentsandtax-exemptinvestments.

b. Deducttheabove-the-linedeductions.Thesearedeductionsdefinedby§62asdeductionsfromgrossincometodetermineadjustedgrossincome(AGI).Theyareknownasabove-the-linedeductionsbecausetheyaredeductedfromgrossincome,notfromadjustedgrossincome.Theseareprimarilydeductionsincurredincarryingonatradeorbusiness,includingordinaryandnecessarybusinessexpensesunder§162,businessinterestunder§163,businesstaxesunder§164,businesslossesunder§165,anddepreciationofbusinessassetsunder§167,168,and642(e).Ifthebusinessgeneratesanetoperatingloss,theNOLmaybecarriedbacktwoyearsandthenmaybecarriedforwarduptotwentyyears.§642(d);§172(b).

c. Theresultwouldnormallybeadjustedgrossincomeasitisdefinedby§62ifitwerecalculatedforanindividualtaxpayer,but§67(e)makesseveralsignificantchangestothecalculationofadjustedgrossincomeifitisbeingcalculatedforatrustorestate.Section67(e),whichestablishesatestknownasthe2%floor,requiresthatfourdeductionsthatwouldnormallybebelow-the-linedeductionsfromadjustedgrossincomemust,inthecaseoftrustsandestates,besubtractedinordertocalculateadjustedgrossincome.Thosefourdeductionsare(1)administrationexpensesthat“wouldnothavebeenincurredifthepropertywerenotheldinsuchtrustorestate,”(2)thepersonal


exemptionunder§642(b),(3)thedistributiondeductionforsimpletrustsunder§651,and(4)thedistributiondeductionforcomplextrustsunder§661.Notethat§67(e)doesnotactuallypermitthosefourdeductionstobetakenabove-the-line;itmerelyprovidesthattheyshouldbesubtractedwhencalculatingadjustedgrossincome“[f]orpurposesofthissection.”Inotherwords,thosefourdeductionswillbesubtractedforpurposesofdeterminingAGI,butonlyforpurposesofdeterminingthe2%floor,whichisappliedlaterinthetaxcalculation(seebelow).Thosedeductionsthataresubtractedfromgrossincomeforpurposesofthiscalculationofadjustedgrossincomewillbedeductedbelowforpurposesofcalculatingadjustedtotalincomeandeventuallytaxableincome,butinthisstepthecalculationsimplytakesaminordetourtocalculatethespecialdefinitionofadjustedgrossincomeforpurposesofestatesandtrusts.Becauseadjustedgrossincomeislaterusedtodeterminethe2%flooronsomeofthosedeductions,andbecausethosedeductionsareusedtocalculateadjustedgrossincomeandtaxableincome,asimultaneous(circular)calculationisoftenrequired.

d. Theresultisadjustedgrossincome,asitisspeciallydefinedby§67(e) for trusts and estates for purposesofcalculatingthe2%floor(discussedbelow).However,becauseofthecircularnatureofthecalculation,thetermadjustedgrossincomeisnotactuallyusedinthecalculationofthetax;itisusedonlytocalculatethe2%floor.Forexample,theForm1041doesnotactuallyusethetermadjustedgrossincomeontheformitself,althoughthetermisusedintheinstructionstocalculatethe2%floor.Theinstructionsgiveanexampleofhowtomanuallyperformthecircularcalculation.Mostpractitioners,however,usecommercialtaxreturnsoftware,whicheliminatestheneedforthemanualcalculation.Thecircularcalculationisnotrequiredineverycase;forexample,sometrustshavenomiscellaneousitemizeddeductionsthataresubjecttothe2%floor.Inanotherexample,sometrustsdistributelessthanDNI,andtheirdistributiondeductionisthereforelessthanDNI,andthusthedistributionisnotlimitedbyDNI.Inthatsituation,theimpactthatAGIhasonDNIdoesnotaffectthedistributiondeduction.

e. Deductthebelow-the-linedeductions.Thesearedefinedby§63(d)(1)asdeductionsotherthantheabove-the-linedeductions.Theyarereferredtoasbelow-the-linedeductionsbecausetheyaredeductionsthatarenormally(inthecaseofindividuals)deductedfromadjustedgrossincome,notdeductionstakentodetermineadjustedgrossincome.Inthecaseofanestateortrust,however,adjustedgrossincomeisgivenaspecialdefinition(seeabove)thatinsomecasesresultsinacircularcalculation.Forthatreason,thesebelow-the-linedeductionsarenotactuallydeductedfromadjustedgrossincome.Instead,theyaremerelydeductedasthenextstepafterdeductingtheabove-the-linedeductions.Thesebelow-the-linedeductionsincludeitemizeddeductionsandasubsetofitemizeddeductionsknownasmiscellaneousitemizeddeductions.§63(d)(1).Theitemizeddeductionsincludeexpensesrelatingtopropertyorinvestmentsheldfortheproductionofincome,includingordinaryandnecessaryexpensesunder§212fortheproductionofincome,includingadministrationexpenses.Reg.§1.212-1(i).Administrationexpensesgenerallyincludepersonalrepresentative’sfees,trustee’sfees,attorney’sfees,andaccountant’sfeesunder§212;interestunder§163;stateandlocaltaxesunder§164;lossesunder§165;baddebtsunder§166;depreciationunder§§167,168and642(e);andtaxadviceandtaxpreparationcostsunder§212(3).Miscellaneousitemizeddeductionsaredefinedby§67(b)asnotincludinginterestunder§163,stateandlocaltaxesunder§164,thecharitabledeductionunder§642(c),andestatetaxesunder§691(c).Thusmiscellaneousitemizeddeductionsaredefinedby§67(b)toincludemostitemizeddeductions,andthosemiscellaneousitemizeddeductionsaresubjecttoarestrictionknownasthe2%floor.Thustheonlybelow-the-lineitemizeddeductionsthatarenotsubjecttothe2%floorareinterestunder§163,stateandlocaltaxesunder§164,thecharitabledeductionunder§642(c),andestatetaxesunder§691(c).Thedeductionofmiscellaneousitemizeddeductions,andtherestrictionsonthosedeductions,aredescribedinthefollowingstep.Inthisparticularstep,however,wearemerelydeductingtheitemizeddeductionsthatarenotconsideredtobemiscellaneousitemizeddeductions,whicharedeductedbelow.Expensesincurredinsellingpropertyaregenerallynotdeductibleasadministrativeexpenses,butareoffsetsagainstthesellingpricetoreducegainortoincreaseloss.§642(g).However,ifanassetmustbesoldinordertopaytaxes,topayclaims,ortosatisfypecuniarybequests,thentheexpensesofsalebecomedeductible.Estate of Jenner v. Commissioner,577F.2d1100(7thCir.1978);Estate of Joslyn v. Commissioner,566F.2d677(9thCir.1977).Asalefortheconvenienceofthebeneficiariessothattheywillnotendupowningtheassetastenantsincommonwouldnotfallintothatexception.


f. Deductmiscellaneousitemizeddeductions.Pursuantto§67(e),estatesandtrustsarepermittedtodeductmiscellaneousitemizeddeductions,butonlytotheextentthatthemiscellaneousitemizeddeductions“wouldnothavebeenincurredifthepropertywerenotheld”inatrustorestate.§67(e)(1).Ifadeductionfailsthattest,thenthatdeductionmaybedeductedonlytotheextentthatthetotalmiscellaneousitemizeddeductionsexceed2%oftheadjustedgrossincomeofthetrustorestate(asAGIisspeciallydefinedforpurposesofestatesandtrusts).§67(a).TheSupremeCourthasinterpretedthatstatuteasexemptingfromthe2%floorsuchmiscellaneousitemizeddeductionsthatanindividualwouldhavebeenunlikelytoincur.Knight v. Commissioner,552U.S.181,128S.Ct.782,101AFTR2d2008-544(2008);Jones,Supreme Court Rules - Negatively - on Deductibility of Trust Investment Advisor Fees,JournalofTaxation,February2008,Vol.108No.2;Jones,Final Regulations on Trust Administration Expenses – No Surprises,JournalofTaxation,July2014,Vol.121No.1.AttachedtothispaperasAppendixAisatabledescribinghowmiscellaneousitemizeddeductions are affected by the Knightopinionandthefinalregulationsthatwerepublishedfollowingthe Knightopinion.Ingeneral,thoseregulationsallowfulldeductibility(notsubjecttothe2%floor)ofadministrationexpensesthat“wouldnothavebeenincurredifthepropertywerenotheldin[an]estateortrust.”Reg.§1.67-4(a).ThoseregulationsareeffectivefortaxyearsbeginningafterDecember31,2014.Afterthemiscellaneousitemizeddeductionsaredividedintotheonesthatare100%deductibleandthosethataredeductibleonlytotheextenttheyexceed2%ofadjustedgrossincome,thosedeductions(aftertheapplicationofthe2%floor)arereferredtointheForm1041instructionsasadjustedmiscellaneousitemizeddeductions(AMID).

g. Aftertheabovedeductionsaretaken,theresultisreferredtobyForm1041asadjustedtotalincome,althoughtheCodeitselfdoesnotusethatterm.Occasionallythisamountiscalledthetentativetaxableincome,buttheprecisedefinitionofthattermiselusive.

h. Deductthedistributiondeductionunder§651or§661,theestatetaxdeductionunder§691(c),andthepersonalexemptionunder§642(b).Notethattwoofthesedeductionsweretakenintoaccountaboveincalculatingadjustedgrossincomeforpurposesofthe2%floorof§67(a),buttheywerenotactuallydeductedatthatstage,whichisanotherreasonwhythecalculationofthetaxofanestateortrustisoftencircular.

i. Theresultistaxableincome.§63.Ifthetaxableincomeisanegative,theexcessdeductionswillflowouttothebeneficiaries,butonlythedeductionsincurredinthefinalyearofthetrustorestate.§642(h).Innon-finalyears,theonlynegativesthatmaybecarriedovertothenexttaxyeararecapitallosscarryoversandbusinessnetoperatinglosses.§642(h).

j. Applythetaxratetabletothetaxableincome.§641(a);§1(e).Sometrustsmightbesubjecttothealternativeminimumtax(AMT)under§455.SeeScheduleIofForm1041.The2014AMTexemptionamountforestatesandtrustsisonly$23,500,muchlowerthantheexemptionamountformarriedcouples($82,100)orsingleindividuals($52,800).§55(d)(1).AndtheAMTexemptionforestatesandtrustsphasesoutatmuchlowerlevelsaswell.§55(d)(3).SeeRev.Proc.2013-35.Inaddition,miscellaneousitemizeddeductionsarenotdeductibleforpurposesofcalculatingthealternativeminimumtax,eveniftheyexceedthe2%floor;taxesarealsonotdeductible.§56(b)(1)(A).Sometrustsandestateswillalsoberequiredtopayanadditionaltaxonnetinvestmentincome;seethefollowingsection.

16. The Net Investment Income Tax ThenetinvestmentincometaxbecameeffectiveonJanuary1,2013.§1411.Itimposesa3.8%taxonthe

netinvestmentincomeofindividuals,trusts,andestates.ThetaxisreportedonForm8960attachedtotheForm1041.Asinthecaseofthemaximumincometaxrate,thethresholdforapplyingthistaxismuchlowerfortrustsandestatesthanforindividuals.Whileindividualsaresubjecttothistaxiftheiradjustedgrossincomeexceeds$200,000($250,000formarriedcouplesfilingjointly),the2014thresholdlevelfortrustsandestatesis$12,150ofundistributednetinvestmentincome.§1411(a),(b).Thethresholdforestatesandtrustsisinflation-adjustedannually,butthethresholdforcouplesandindividualsisnotadjusted.§1411(a),(b).SeeRev.Proc.2013-35.

Thetaxisimposedonthreetypesofincomedescribedin§1411(c):a. Interest,dividends,annuities,rents,royalties,andcertainotherpassiveincome.


b. Tradeorbusinessincome(“coveredbusinessincome”)derivedfromtradinginfinancialinstrumentsorcommodities,passiveactivityincomeunder§469,andincomegeneratedbyinvestingworkingcapital.

c. Netgainfromthedispositionofproperty,withsomeexclusions.Thisincludesmostcapitalgains,with someexceptions.

TheU.S.TaxCourthasheldthatatrustwillbedeemedtohavemateriallyparticipatedinrealestatebusinessactivitiesunder§469(c)(7),andthustherealestatebusinesswillnotbedeemedtobeapassiveactivityunder§469,ifthetrusteespersonallyperformedsufficientservicestomeettheexceptiondescribedin§469(c)(7).Aragona v. Commissioner,142T.C.No.9___(3/27/14).Thatexceptionpermitsarealestatebusinesstonotbeapassiveactivityifmorethanhalfofthepersonalservicesperformedbythetaxpayerintradesorbusinesseswereperformedinrealestateactivitiesinwhichthetaxpayermateriallyparticipated,andthetaxpayerperformedmorethan750hoursinitsmaterialparticipationinrealestatebusinesses.InAragona,thetrusteeswereindividualswhoactivelyworkedintherealestatebusinessofthetrustastrustees,andsomeofthetrusteeswerealsoemployeesofarealestateLLCthatwaswholly-ownedbythetrust.Thecourtheldthattheiractivitiesastrusteesandasemployeescouldbeaggregatedtodeterminewhetherthetrustmateriallyparticipatedintherealestatebusiness,becauseunderlocaltrustlawtrusteeswhooperateatrustbusinessthroughacorporationcontrolledbythetrustcontinuetohavethesamefiduciaryresponsibilitiesthattrusteeshave.(Oregonlawissimilar.ORS130.655(7).)Thatdecisionhasimportantimplicationsfortheapplicationofthenetinvestmentincometaxtotrusts,because§1411(c)exemptstaxpayerswhomateriallyparticipateinatradeorbusinessunderthestandardsof§469.However,theTaxCourtinAragona limited its holding to the facts and arguments of thatcase(theargumentsadvancedbytheIRSinthatcaseweresomewhatnarrow),andthecourtspecificallydeclinedtoexpressanopinionwhetheratrustcouldmateriallyparticipatethroughemployeeswhowerenottrustees.

Althoughtheimpositionofthemaximumincometaxratesonthetaxableincomeoftrustsandestatesinexcessof$12,150hasinrecentyearsgivenfiduciariesastrongincentivetodistributeincometobeneficiaries(whowilloftenbeinlowerincometaxbrackets),theimpositionofthisnewinvestmentincometaxwillgivefiduciariesanevenstrongerincentivetodistributeincome,becausetrustsandestatesdonotpaythisnewtaxonincomethatisdistributedtothebeneficiaries,andthebeneficiariesmightnotbesubjecttothetaxiftheiradjustedgrossincomeisbelowthethresholdlevelforindividuals,whichismuchhigherthanthethresholdlevelfortrusts,asdiscussedabove.Inthealternative,thefiduciarycouldminimizeinvestmentsthatproduceinvestmentincome,andmaximizeinvestmentsthatproducetax-exemptincomeorproducelittledividendincomebutoffergreaterfuturegrowthpotential.Ofcourse,thefiduciarywouldneedtoconsidertheinvestmentobjectivesofthetrustandoftheindividualbeneficiaries.

17. The Election to Take Deductions on the Fiduciary Income Tax Return Decedents’estatesarepermittedtomakeanelectiontodeducttheiradministrationexpenseseitheron

thefiduciaryincometaxreturn(Form1041)fortheyearinwhichtheexpenseisincurred,orontheestatetaxreturn(Form706)forthedecedent.§642(g);§2053(a)(2).Thechoiceisoftenmadebycomparingthemarginalestatetaxrate(combinedfederalandstate)withthemarginalincometaxrate(combinedfederalandstate).Iftheestatetaxrateishigherthantheincometaxrate,thenclaimingthedeductionsontheestatetaxreturnsisusuallymostbeneficial.Iftheincometaxmarginalrateishigherthantheestatetaxmarginalrate,thenclaimingthedeductionsonthefiduciaryincometaxreturnsisusuallymostbeneficial.Ifnoestatetaxreturns(federalorstate)arebeingfiledbecausetheestateisbelowtheestatetaxfilingthresholds(ornotaxisduebecauseofthemaritaldeduction),thentakingthedeductionsontheestatetaxreturnsmightappeartobepointless,butdeductingthoseexpensesontheestatetaxreturnmightneverthelesshavethebeneficialeffectofincreasingthesizeofthecreditsheltertrust,andthatbenefitshouldbeweighedagainstthepossiblebenefitofdeductingthoseexpensesonthefiduciaryincometaxreturn,asisdiscussedbelow.Theestatetaxfilingthresholds(federalandstate)arebasedonthesizeofthegrossestate,notthesizeofthetaxableestate,sothedeductionsdonotaffectwhetherestatetaxreturnsarerequiredtobefiled,butthetakingofdeductionsontheestatetaxreturnsmighteitherreducetheestatetaxdueoreliminatetheestatetaxdue.

Whencalculatingbequestsunderformulaclausesthatcalculatetheamountstobeusedtofundacreditshelter(bypass)trust,ortofundamaritaltrust,ortofundanoutrightmaritalbequest,the§642(g)electioncanaltertheamountstobeplacedinthosepartsoftheestate.Ingeneral,electingtotaketheadministrationexpensedeductionsontheincometaxreturnscausesaportionoftheestate(equaltotheadministrationexpenses)tobe


exposedtotheestatetax,becausethosedeductionsarenotbeingdeductedontheestatetaxreturns.Formulaclausesintax-planningwillsandtrustsareusuallydesignedtoreducetheestatetaxtozerothroughtheuseoftwotools:theunifiedcreditandthemaritaldeduction.Sincetheadministrationexpensedeductionwillnotbeavailableontheestatetaxreturnsiftheelectionismadetotakethosedeductionsontheincometaxreturns,thenoneofthosetwotoolsmustbeusedtoshelterthatamountfromtax,orataxwillresult.Obviously,thoseexpensesdonotqualifyforthemaritaldeduction.Asaresult,aportionoftheunifiedcreditmustthenbeusedtoshelterfromestatetaxtheportionoftheestatethatwasusedtopaythoseexpenses.Thecreditsheltertrustwillthenbereducedbythatamount;theformulaclausesusedinmostwillsandtrustswillrequirethatresult.Forafullerdiscussionofthissubject,seeJones,Calculating Bequests Under Formula Clauses,OregonStateBarEstatePlanningandAdministrationSectionNewsletter,Vol.XXVI,No.4,October2009.

ItshouldalsobenotedthatIRSregulationsdivideadministrationexpensesintotwotypes.Thesearetheinfamous HubertregulationsthatweredevelopedaftertheSupremeCourtdecidedCommissioner v. Estate of Hubert,520U.S.93(1997).TheholdinginHubertisnowofmerelyacademicinterest,becausetheregulationstakeanentirelydifferentapproachthantheSupremeCourtopinion.Theregulationsdivideadministrationexpensesintomanagementexpensesandtransmissionexpenses.Managementexpensesareincurredtomaintainestateassets;theyincludeinvestmentadvisoryfees.Transmissionexpensesincludethecostsofmarshalingestateassets,payingdebtsandtaxes,anddistributingtheassets;theyincludefiduciaryfeesandattorneyfees.Reg.§20.2056(b)-4(d)(1).Managementexpensespaidfromthemaritalsharewillreducethemaritaldeductiononlyifthoseexpensesaredeductedontheestatetaxreturn.Transmissionexpensespaidfromthemaritalsharewillalwaysreducethemaritaldeduction.Reg.§20.2056(b)-4(d)(2)(3).

Anotherfactortoconsideriswhethertakingtheadministrationexpensedeductionsontheincometaxreturnwillactuallycauseareductionintax.Iftheestatedoesnothavesufficientincometoabsorbthedeductions,thenexcessdeductionswillresult,andthoseexcessdeductionswilloftenbewasted(andwillalwaysbewastedinanon-finalyear).Ifthoseexcessdeductionsareincurredinthefinalyearoftheestateortrust,theexcessdeductionscanbepassedouttothebeneficiaries,§642(h),butinsomecasesthebeneficiarieswillnotbeabletousethoseexcessdeductions,becauseexcessdeductionsareclassifiedasmiscellaneousitemizeddeductionsinthehandsofthebeneficiaries,eventhoughnotallofthosedeductionswereclassifiedasmiscellaneousitemizeddeductionsontheincometaxreturnoftheestateortrust.Reg.§1.642(h)-2(a).Thoseexcessdeductionscanbeusedbythebeneficiariesonlyifthebeneficiariesitemizetheirdeductions,andeventhenthedeductionscanbeutilizedbythebeneficiariesonlytotheextentthatthedeductionsexceedtwopercentofthebeneficiary’sadjustedgrossincome.§67(a);Reg.§1.642(h)-2(a).

The§642(g)electionismadebyfilingastatement,induplicate,withthefiduciaryincometaxreturntotheeffectthatthedeductionshavenotbeenallowedasdeductionsontheestatetaxreturn,andtherighttoclaimthemontheestatetaxreturnisbeingwaived.Reg.§1.642(g)-1.Iftheelectionisnotmade,andthedeductionsareclaimedontheestatetaxreturn,nostatementisneeded.Estate of Keitel v. Commissioner,T.C.Memo1990-416(1990).

Thiselectionneednotbemadeonablanketbasis.Itcanbemadeforsomedeductionsandnotothers,oritcanbemadeforpartsofsomedeductionsandnototherparts.Reg.§1.642(g)-2.

Funeralexpensesarenotsubjecttothiselection.Theymaybedeductedonlyontheestatetaxreturn,andnotonthefiduciaryincometaxreturn.§2053(a)(1).Thefiduciaryincometaxstatutescontainnoprovisionfordeductingfuneralexpenses.Estate of Yetter v. Commissioner,35T.C.737(1961).

Similarly,claimsagainsttheestatecanbedeductedonlyontheestatetaxreturn,notonthefiduciaryincometaxreturn.§2053(a)(3).Thesameruleappliestoincometaxesandgifttaxesowingasofthedateofdeath,evenifthosetaxeshavenotyetbeencalculatedasofthedateofdeath.Reg.§20.2053-6.

Similarly,themedicalexpensesofthedecedentpaidbytheestatearenotdeductibleonafiduciaryincometaxreturn.Reg.§1.642(g)-2.Theymaybedeductedeitheronthefinalindividualincometaxreturnofthedecedent(evenifpaidafterhisdeath,buttheymustbepaidwithinoneyearofhisdeath)oronthedecedent’sestatetaxreturn.§213(c);Reg.§1.642(g)-2;§2053.A7.5%ofadjustedgrossincomefloorappliestomedicalexpensesdeductedonthedecedent’sfinalincometaxreturn,butthatlimitationdoesnotapplytotheestatetaxreturn.§213.

The§642(g)electiondoesnotapplytodeductionsinrespectofadecedent,whichshouldbedeductedonboththefiduciaryincometaxreturnandontheestatetaxreturn.Reg.§1.642(g)-2.Seeincomeinrespectofadecedent,below.


Thesame§642(g)electionisavailableforpurposesoftheOregonfiduciaryincometax.OAR150-316.272;150-118.010.

18. The Distribution Deduction Asageneralrule,atrustorestatethathasDNIwillpayincometaxonthatDNIifthetrustorestate

retainsthatincome,butdistributionstobeneficiariesinthesametaxyearwillusuallycausethatDNItobecarriedouttothebeneficiariesreceivingthosedistributions.§662(a).

TheDNIofasimpletrustwillbetaxedtothebeneficiariesregardlessofwhetheritisdistributed.§652(a).Similarly,ifacomplextrustisrequiredtodistributeincome,thatrequiredamountwillbetaxedtothebeneficiariesregardlessofwhetheritisdistributed.§662(a)(1).

IftheDNIiscarriedouttothebeneficiaries,thenthebeneficiarieswillbetaxedonthatDNI,andthetrustorestatewillnotbetaxed.Thustheincomewillbetaxedonlyonce.TheexactmechanismusedbytheCodetocarryoutthatsingletaxationisthedistributiondeduction:amountsdistributedtobeneficiariesaredeductiblebythetrustorestate,uptotheamountofDNI.§651(b);§661(b).(Oneexception:AdistributionofaspecificbequestdoesnotcarryoutDNItotherecipientbeneficiary.§663(a)(1).Asaresult,thetrustorestatewillnotbeentitledtoadistributiondeductionunder§661,norwillthebeneficiarybetaxedunder§662.Seethediscussionofspecificbequestsbelow.)

Forexample,ifacomplextrusthas$40,000ofDNIforthetaxyear2014,butthetrustdistributes$25,000toitsbeneficiaries,thenthetrustwillbetaxedonthe$15,000ofDNIretainedbythetrust,andthebeneficiarieswillbetaxedonthe$25,000ofDNIdistributedtothem.Ifthatsametrustweretodistribute$60,000tothebeneficiariesinthattaxyear,thenthetrustwouldbeabletodeductonly$40,000oftheamountdistributed,andthebeneficiarieswouldbetaxedononly$40,000oftheamountdistributed.Theother$20,000ofdistributionstothebeneficiarieswouldnotbedeductiblebythetrust(sinceitexceedsDNI),norwouldthebeneficiariesbetaxedonthatother$20,000.Instead,that$20,000wouldbetreatedasadistributionofprincipal,whichisnottaxabletothebeneficiariesnordeductiblebythetrust.§661(a);§662(a)(2).

DNIincludestax-exemptincome,butthedistributiondeductionislimitedtothetaxableportionofDNI.§§651(b);661(c).Seethediscussionoftax-exemptincome,below.

Simpletrustsdeducttheincometheyarerequiredbythetermsofthetrusttodistribute,regardlessofwhetherthatincomeisactuallydistributed.§652(a).Estatesandcomplextrustsdeductboththeincomethatisrequiredtobedistributedandotheramountsthatare“properlypaidorcreditedorrequiredtobedistributed.”§661(a)(2).Bothdeductions,however,arelimitedtotheamountofDNI.§651(b);§661(a).Andbothdeductionscauseincometobetaxedtothebeneficiary.§652(a);§662(a).

Charitabledistributionsarenotincludedinthedistributiondeduction.§661(b);§663(a)(2);Reg.§1.663(a)-2.Instead,theyaredeductibleunder§642(c),andtheymaynotbedeductedthroughthedistributiondeduction.Reg.§1.663-(a)-2.However,charitabledistributionsoutofincome,whicharedeductibleunder§642(c),reduceDNI,sothatthenon-charitablebeneficiarieswillnotbetaxedontheincomedistributedtocharity.§661(b);§663(a)(2).However,thatruledoesnotapplytotier1beneficiaries,whowillstillbetaxedontheincomerequiredtobedistributedeachyear,regardlessofanycharitabledistribution.§662(a)(1).Seethediscussionofthecharitablededuction,below,andthediscussionofthetiersystem,alsobelow.

Ifatrustisrequiredbythetermsofthetrusttomaintainaresidencefortheuseofabeneficiary,theamountsspentbythetrusttomaintaintheresidencearenotconsideredtohavebeendistributedtothebeneficiary,arenotdeductibleasadistribution,andarenottaxedtothebeneficiary.Instead,theincomeusedtopaythoseexpensesistaxedtothetrust.Commissioner v. Plant,76F.2d8(2ndCir.1935);PLR8341005.Whendraftingsuchatrust,thebetterpractice(fortaxpurposes)mightbetorequiredistributionstothebeneficiary,andthenthetrustshouldrequirethebeneficiarytopaythemaintenanceexpenses,inordertoavoidthehighincometaxratesoftrusts.


19. Tax-Exempt Income Theincomecarriedouttothebeneficiariestakeswithittheincometaxattributesthattheincomehad

inthetrustorestate.§652(b);§662(b).Forexample,tax-exemptmunicipalbondinterestearnedbyanestateortrustandcarriedouttothebeneficiariesisreportedbythebeneficiariesastax-exemptincome.Similarly,interestdistributedtothebeneficiariesretainsitscharacterasinterest,dividendsretaintheircharacterasdividends,etc.ThebeneficiariesaredeemedtohavereceivedeachofthoseitemsinthesamepercentageaseachofthoseitemsbearstothetotalDNI,unlessthetrustinstrumentallocatesthedifferenttypesofincomeinadifferentmanner.§652(b);§662(b).

DNIincludestax-exemptincome,butgrossincomedoesnot.§103;§643(a)(5).However,thedistributiondeductiondoesnotincludetax-exemptincomedistributedtothebeneficiaries.§651(b);§661(c).Andasnotedabove,§652(b)and§662(b)requirethattheincomeallocabletothebeneficiarieswillbedeemedtoincludethesameproportionofthetaxattributesaswasreceivedbytheestateortrust.Theneteffectoftheserulescanbeillustratedbythefollowingexamples.Assumeatrusthas$50,000ofordinarytaxableincomeand$20,000oftax-exemptincome,forafiduciaryaccountingincomeof$70,000,agrossincomeof$50,000andaDNIof$70,000.Ifthattrustdistributes$100,000toitsbeneficiaries,thetrustwillhave$50,000ofgrossincome,whichisthenreducedbya$50,000distributiondeduction.Thebeneficiarieswillthenbetaxedon$50,000ofordinaryincome,buttheywillnotbetaxedonthe$20,000oftax-exemptincometheyreceived.Thesameresultwouldhavetakenplaceifthetrusthaddistributedonly$70,000.Ifthetrustdistributesonly$60,000,DNIwillstillbe$70,000,butthedistributiondeductionwillbereducedto$42,857,or85.7%ofitslevelinthepreviousexample(60,000/70,000=.857).Inthatevent,thebeneficiarieswillbedeemedtohavereceived$42,857oftaxableincomeand$17,143oftax-exemptincome,foratotaltaxableandexemptincomeof$60,000.Thetrustwillthenbetaxedontheother$7,143ofordinaryincome,andwillbedeemedtohaveretained$2,857oftax-exemptincome.Theneteffectoftheserulesisthatifthetrusteeofthisparticulartrustwishestodistributeallofthetaxableincometothebeneficiariesandobtainthebenefitofadistributiondeductionforallofthatdistributedtaxableincome,thenthetrusteemustdistributeallofthetaxableincomeandalloftheexemptincome.§652(b);§662(b).

Keepinmindthatdeductionsrelatingtotax-exemptincomemustbeallocatedinwholeorinparttotheexemptincome,andtheportionsoallocatedmaynotbededucted.§265.Forexample,atrustee’sfeeforinvestmentmanagementmustbeallocatedbetweenthetaxableinvestmentsandthetax-exemptinvestments.

20. SpecificBequestsSpecificbequestsincludetwotypesofbequests:apecuniarybequestofaspecificamountofmoney,

andaspecificbequestofaparticularitemofproperty.Abequestof$1,000isaspecificbequestbecauseitisapecuniarybequest.Abequestof100sharesofGeneralMotorsstockisalsoaspecificbequest,butitisnotapecuniarybequest.

DistributionsofspecificbequestsdonotcarryoutDNItotherecipientbeneficiary.§663(a)(1).Asaresult,thetrustorestatewillnotbeentitledtoadistributiondeductionunder§661,norwillthebeneficiarybetaxedunder§662.Thelogicbehindthisruleisthatsuchdistributionsareinthenatureofprincipal,notincome.§102.

Aspecificbequestisdefinedas“agiftorbequestofaspecificsumofmoneyorofspecificproperty.”§663(a)(1).Soabequestof$1,000orof100sharesofGeneralMotorsstockisclearlyaspecificbequest.Theamountofmoneyortheidentityofthespecificpropertymustbeascertainableunderthewillasofthedateofdeath,orascertainableunderthetermsofanintervivostrustasofthedateofinceptionofthetrust.Reg.§1.663(a)-1(b).Abequestofanamountofmoneytobecalculatedbythefiduciary(orofpropertytobeselectedbythefiduciary)equaltoastatedfractionorpercentageoftheestateisnotconsideredtobeaspecificbequest.Reg.§1.663(a)-1(b);Rev.Rul.60-87,1960-1C.B.286.SeePLR200210002.Thereissomedebateoverwhetherapecuniaryformula(asopposedtoafractionalshareformulaorapercentageshareformula)isaspecificbequest,buttheconsensusseemstobethatapecuniaryformulabequestisnotaspecificbequest,andthusitdoescarryoutDNI.

Severalexceptionsapplytothisgeneralrulethatspecificbequestsdonotcarryoutincome.ThefollowingdistributionswillcarryoutDNI:

a. Ifthegoverningdocumentrequirestheamounttobepaidfromincome.§663(a)(1).b. Ifthebequestisaresiduarybequest.Reg.§1.663(a)-1(b)(2)(iii).


c. Ifthebequestisrequiredbythegoverningdocumenttobepaidinthreeormoreinstallments.§663(a)(1).

Afteradistributionismadepursuanttoaspecificbequest,thebasisofthedistributedpropertyinthehandsofthebeneficiarywillbedeterminedundereither§1014(propertyacquiredfromadecedent,ifthebequestwasinawill,inaformerly-revocabletrust,orinatestamentarytrust)or§1015(propertyacquiredbygift,iftheassetwasacquiredbythetrustthroughanintervivosgift),andthebeneficiarywillreceivethesamebasisasthetrustorestatehadinthepropertyimmediatelybeforethedistribution.

21. In-Kind Distributions Anin-kinddistribution(adistributionofassetsotherthancash)raisesseveralquestions:

a. Doesthein-kinddistributioncarryoutDNItotherecipient?Ifthedistributionismadepursuanttoaspecificbequest(abequestofaparticularitemofproperty,suchas100sharesofstockinGeneralMotors),thenthedistributiondoesnotcarryoutDNI.§663(a)(1).Similarly,ifatrustdistributessecuritiesinsatisfactionofapecuniarybequest(suchasabequestof$1,000),thenthedistributiondoesnotcarryoutDNItotherecipientbeneficiary.§663(a)(1).Inbothsituations,thetrustorestatewillnotbeentitledtoadistributiondeduction.§663(a)(1).Butinothersituations,suchasadistributionofpropertyin-kindtosatisfyaresiduarybequest,thedistributionwillcarryoutDNItothebeneficiary.§662.

b. Willtheestateortrustrecognizegainorlossasaresultofthein-kinddistribution?Thegeneralruleisthattheestateortrustdoesnotrecognizegainorlossonanin-kinddistribution,unlessthe distribution is being made in satisfaction of an obligation to pay money or an obligation todistributepropertyotherthanthepropertydistributedinkind.Reg.§1.661(a)-2;Kenan v. Commissioner,114F.2d217(2ndCir.1940).Thusgainorlosswillberecognizedifassetsaredistributedin-kindtosatisfyapecuniarybequest.Rev.Rul.66-207,1966-2C.B.243.(Thatruleapplieseveniftheestateisinsufficienttofullyfundthepecuniarybequestandthebequestineffectbecomesaresiduarybequest.Rev.Rul.66-207.)Gainorlossisalsorecognizedwhenanassetisdistributedin-kindtoacreditorinsatisfactionofadebtintheformofaspecificdollaramount.First Trust & Deposit Co. v. United States,58F.Supp.162(N.D.N.Y.1944).Gainorlossisalsorecognizedifthetrustorestatewasobligatedorpermittedtomakeanincomedistributiontothebeneficiary(orthetrustorestatewasobligatedtodistributeapecuniaryamount,orwasobligatedtodistributespecificpropertyotherthanthatdistributed),butthetrustorestatechoseinsteadtodistributein-kindassetsequalinvaluetotherequireddistribution.Reg.§1.661(a)-2(f);Rev.Rul.67-74,1967-1C.B.194;Suisman v. Eaton,15F.Supp.113,36-2USTC¶9443,aff’d83F.2d1019(2ndCir.1936),cert. denied299U.S.573(1936).Forexample,ifawillrequiresa$100,000cashbequesttoabeneficiary,andratherthandistributingcashtothebeneficiarytheestatedistributesmarketablesecuritieswithacurrentvalueof$100,000andabasisof$60,000,theestatewillrecognizeagainof$40,000.Thustheresultisthesameasiftheestatehadsoldthesecuritiesandthendistributedthecashtothebeneficiary.Thesamegainwouldberecognizedifthetrustdistributedappreciatedsecuritiestoabeneficiaryinlieuofdistributingincome.Thesamegainwouldberecognizedifthetrustdistributedappreciatedsecuritiestoacreditorinsatisfactionofaclaim.Ifthetrustdistributedsecuritiesthathaddecreasedinvalue,thenalosswillberecognized.Inmostcases,however,anyresultinglosswillbedisallowedundertherelated-partyrulesof§267,whichappliestobothtrustsandestates.

c. Ifnogainorlossisrequiredtoberecognizedonanin-kinddistribution,maythefiduciaryneverthelesselecttorecognizegainorloss?Yes,thefiduciarymayelectunder§643(e)(3)torecognizegainorlossonanin-kinddistribution.Iftheelectionismade,thenthetrustorestatewillbedeemedtohavesoldtheassetatitsthenfairmarketvalue,andthebeneficiarywillreceivetheassetwithabasisequaltothatfairmarketvalue.Iftheelectionisnotmade,thebeneficiary’sbasiswillbethebasisoftheassetinthehandsofthefiduciary,andthatbasiswillbe used to calculate both the distribution deduction and the amount includable in the income of thebeneficiary.§643(e).Thiselectiondoesnotapplytoin-kinddistributionsmadeinsatisfactionofpecuniarybequestsorin-kinddistributionsmadeinsatisfactionofspecificbequeststhataremadeinlessthanthreeinstallments.§643(e)(4);§663(a)(1).Theelectionappliestoalleligiblein-kinddistributionsmadeduringtheyear,notjustselectedin-kinddistributions;thefiduciarycannotpickandchoose.§643(e)(3)(B).Thisisacomplexsubjectthatwarrantscareful


considerationbythefiduciary.Thefiduciarywillneedtoweighthepossiblerecognitionofgainbytheestateortrust,theavailabilityofadistributiondeduction,theincometaxconsequencestothebeneficiary,andtheresultingbasisinthehandsofthebeneficiary.Forexample,thetrustorestatemighthavelossesordeductionsthatcanbeusedtooffsetthegainresultingfromtheelection.Iftheestateortrustdoesnothavesuchlossesordeductions,thenoftentimesitisbesttonotmaketheelection,andthebeneficiarywillreceivetheassetwithalowercarry-overbasis.Ifthebeneficiarysubsequentlydieswiththeassetinhispossession,thegainwillbeforgivenduetothestepped-upbasisruleof§1014(a).

d. Ifthein-kinddistributioncarriesoutDNI,whatisthevalueofthein-kinddistributionforpurposesofcalculatingthedistributiondeduction?Ifgainorlossisrecognizedonthedistribution(duetoa§643electionorfortheotherreasonsdescribedabove),thenthedistributiondeductionwillincludethefairmarketvalueoftheasset.Ifnogainorlossisrecognized,thenthedistributiondeductionwillincludeonlytheadjustedbasisoftheasset,theamounttaxabletothebeneficiarywillbethatsameamount,andthebasisoftheassetinthehandsofthebeneficiarywillbethesame.§643(e).

e. Whatistheincometaxbasisoftheassetinthehandsofabeneficiary?Thegeneralruleisthatthebeneficiarywillreceivethesamebasisthattheassethadinthehandsoftheestateortrust,exceptthatthebasiswillbeincreasedbyanygainrecognizedbytheestateortrustanddecreasedbyanylossrecognizedbytheestateortrust.Inotherwords,ifgainorlosswasrecognizedbytheestateortrustonthedistributionoftheasset,thenthebasisoftheassetinthehandsofthebeneficiarywillbethefairmarketvalueoftheassetonthedateofdistribution.Rev.Rul.67-74,1967-1C.B.194;§1012.Ifnogainorlosswasrecognizedbytheestateortrustonthedistributionoftheasset,thenthebasisoftheassetinthehandsofthebeneficiarywillbetheincometaxbasisoftheassetinthehandsofthefiduciaryimmediatelybeforethedistribution.§§1014and1015.

f. Canasimpletrustmakeanin-kinddistribution?No,anin-kinddistributioncausesasimpletrusttobereclassifiedasacomplextrust.Rev.Rul.67-74,1967-1C.B.194.

Foradiscussionoftheincometaxconsequencesoffundingthevarioussharesofatax-planningwillortrust,includingthefundingofpecuniarymaritalbequestsandfractional-sharemaritalbequests,seechapter17of Administering Trusts in Oregon(OregonStateBar,2007),particularly§§17.100through17.117.

22. Charitable DeductionEstatesandcomplextrusts(butnotsimpletrusts)maydeductcharitablecontributionsofgrossincome

thatarepaidorpermanentlysetaside.§642(c).Thisdeductiondoesnotapplytosimpletrusts,becauseasimpletrustwillbereclassifiedasacomplextrustinanyyearinwhichitmakescharitablecontributions,regardlessofwhetherthosecontributionsarefromincomeorprincipal.§651(a);Reg.§1.651(a)-3(a).

The charitable contribution deduction for estates and trusts is more generous than the charitable deductionavailableforindividuals,infourrespects:

a. Trusts and estates may deduct charitable contributions in any amount of income up to the total amountofgrossincome(includingcapitalgains),andarenotlimitedtoaceilingof50%ofadjustedgrossincome.§642(c)(1);Rev.Rul.78-24,1978-1C.B.196.

b. An estate or trust may elect to deduct a charitable contribution made in one year as if it had been paidintheprioryear.§642(c)(1).

c. Atrustorestatemaydeductacontributiontoaforeigncharity.§642(c)(1).d. Estates(butnotmosttrusts)mayalsodeductthoseportionsofnetincomethatarepermanently

setasideforcharitablepurposes,eventhoughthatincomehasnotyetbeendistributedtocharity.§642(c)(2).However,atrustmaytakeadvantageofthisset-asidedeductionifthetrusthasmadea§645electiontouseafiscalyearaspartofthedecedent’sestate.Reg.§1.645-1(e)(2)(iv),(e)(3)(i).Seethediscussionofatrust’selectiontouseafiscalyear,above.

Theabilitytoelecttotreatcharitablecontributionsasifmadeintheprioryearcanhavesignificantadvantagesinthefinalyearofatrustorestate,whenthetrustorestateisprohibitedfrompassingoutcharitabledeductionsasexcessdeductions.§642(h)(2).Inthatsituation,thefiduciarymayelecttotreatthecharitablecontributionsmadeinthefinalyearasifmadeintheprioryear,thusallowingadeductionintheprioryear.


Tobedeductible,thecontributionmustbemadepursuanttothetermsofthegoverninginstrument(thewillortrust).Thegoverninginstrumentneednotrequirethecontribution;itneedonlypermitit.§642(c).

Specialsubstantiationrequirementsapplytocharitabledeductionsinexcessof$250.Ingeneral,theestateortrustmustobtain(priortothefilingdateofthereturn)awrittenacknowledgmentfromthecharitabledonee,confirmingthedonationreceived,theamountofthedonation,adescriptionofanypropertyreceived,whetheranygoodsorserviceswereprovidedbythedonee,andadescriptionofanysuchgoodsorservices.Property(otherthancashorpublicly-tradedsecurities)withavalueof$5,000ormorerequiresanappraisal.§170(f)(8);Reg.§1.170A-13(f).

The amount deducted must be a portion of gross income (including capital gains and income in respect ofadecedent,butnotincludingtax-exemptincome),notprincipal.§642(c);Reg.§1.642(c)(3);Crestar Bank v. Commissioner,47F.Supp.2d.670(E.D.Va.1999);Rev.Rul.2003-123,2003-50I.R.B.1200.Distributionsofprincipal,suchasasimplecharitablebequest,willusuallyqualifyforanestatetaxcharitablecontribution,butnotafiduciaryincometaxdeduction.§2055;§642(c).Forthosereasons,charitablecontributionsneedtobetracedtotheirsourceaseitherdistributionsofincomeordistributionsofprincipal.Mott v. United States,462F.2d512(Ct.Cl.1972);Riggs National Bank v. United States,352F.2d812(Ct.Cl.1965).(Thisisoneofthefewexamplesofadistributionfromatrustoranestatethatneedstobetracedtothesourceofthedistribution.)

Asnotedabove,acharitabledeductionisnoteligibletobepassedouttothebeneficiariesasanexcessdeductioninthefinalyearofthetrustorestate.§642(h)(2);O’Bryan v. Commissioner,75T.C.304(1980).

Seethediscussionofthedistributiondeduction,above,regardingtheinterplaybetweenthedistributiondeductionandthecharitablededuction.

23. The Sixty-Five Day Rule Asageneralrule,incomeretainedbyanestateoracomplextrustistaxedtotheestateortrust,and

incomedistributedtothebeneficiariesduringthetaxableyearistaxedtothebeneficiaries.§662(a).Thusadistributionofcurrentincomecarriesthatincomeouttothebeneficiaries,tobetaxedtothebeneficiaries,andnottaxedtothetrustorestate.Ifincomeisretainedbyanestateoracomplextrust,butdistributedinalateryear,thatlaterdistributionhasnoincometaxsignificance;itistreatedasifitwereadistributionofincomethatwasalreadytaxedtothetrustorestateintheprioryear.(Seebelowforadifferentruleforsimpletrusts.)Ineffect,itistreatedasifitwereadistributionofprincipal.§663(a)(3).(However,ifinthatlateryearthetrustorestatehasundistributedDNI,thenadistributionofprincipalwillcarryoutthatundistributedDNI,sincethedistributionrulesdonotrequireanytracingofadistributiontodeterminewhetheritcamefromincomeorprincipal.Seethetierrules,discussedbelow.)

However,§663(b)permitsasignificantexceptiontothatrule:Ifanamountisdistributedwithinsixty-fivedaysfollowingtheendofthetaxyear,andifa§663(b)electionismadebycheckingaboxontheForm1041,thenthedistributionwillbetreatedasifmadeonthelastdayofthatprecedingtaxyear.Forexample,ifacalendaryeartrustearnsincomein2013,andadistributionofthatamountismadewithinthefirstsixty-fivedaysof2014,andthe§663(b)electionismade,thenthedistributioncanbedeductedonthetrust’s2013return,andthatamountwillthenbetaxedtothebeneficiariesontheir2013returns.

Thepurposeofthiselectionistopermitatrustorestatetocalculateitstaxableincomeinthefirstsixty-fivedaysofthefollowingtaxyear,afterthetrustorestatehasreceiveditsForms1099andothertaxinformationfortheyear.Thetrustorestatecanthendistributetheexactamountnecessarytocarrythatincomeouttothebeneficiaries.Withoutthiselection,manyfiduciarieswouldneedtomakeanestimateofthetrustorestateincome,andthendistributethatestimatedamounttothebeneficiariespriortoDecember31inordertocarrytheincomeouttothebeneficiaries.

Although§663(b)distributionsmustbemadewithinthesixty-fivedayperiod,theelectionisnotmadeuntiltheForm1041isfiled,eitherontimeorunderanextension.Theelectioncannotbemadeonalatereturn.Reg.§1.663(b)-2(a).Oncemade,itisirrevocableafterthelastdayprescribedformakingit,butitmayberevokedupuntilthatdate.Reg.§1.663(b)-2(a).TheelectionismadebycheckingaboxontheForm1041.Theelectionappliesonlytothatparticulartaxyear;itdoesnotaffectsubsequentorprevioustaxyears.Reg.§1.663(b)-1(a)(2).Thus,ifdesired,theelectionneedstobemadeeachandeveryyear.

Forcalendar-yeartrusts,thedeadlineformakingthe§663(b)distributionsinmostyearsisMarch6.Inleapyears,itisMarch5.


Thesixty-fivedayruleappliesonlytoestatesandcomplextrusts.Simpletrusts,whicharerequiredtodistributealloftheirincomeintheyearinwhichitisearned,arealwaystreatedasifthatincomeweredistributedcurrently,regardlessofwhethertheincomeisactuallydistributed.§652(a).Asaresult,makinga§663(b)electionforasimpletrustwouldhavenoeffect.

Thesixty-fivedayruleappliesonlytodistributiondeductions.Itdoesnotapplytootherdeductions,suchasadministrationexpenses.§663(b).Ifadeductionforadministrationexpensesisneededforaparticularyear,thoseexpensesmustactuallybepaidbeforetheendoftheyear,andnotwithinthefirstsixty-fivedaysofthefollowingyear.

The§663(b)electionneednotapplytoalldistributionsmadewithinthefirstsixty-fivedaysofthefollowingyear;somedistributionsmaybedesignatedfortheelection,whileotherdistributionsnotsodesignatedwillnotbeaffectedbytheelection.Reg.§1.663(b)-1(a),(2)(a).

Query:Cana§663(b)electionbeusedtoterminateatrustorestate?Inotherwords,mayafiduciarydistributealloftheassetsofatrustoranestatewithinthefirst65daysofataxyearandthentreatthetrustorestateashavingterminatedinthepreviousyear,suchthatthepreviousyearisdeemedtobethefinalyearofthetrustorestate?Theanswerisno.Section663(b)(1)statesthatthedistributionmustbemadewithinthefirst65days“ofanytaxableyear,”andiftheeffectistoterminatethetrustorestate,thenthedistributionwillnothavebeenmadewithinataxableyear.Inaddition,Reg.§1.663(b)-1(a)(2)limitstheelectiontodistributionsofincome,notprincipal.

24. TiersofDistributionsandBeneficiaries Whentheincomeofatrustorestateistaxedtothebeneficiaries,itistaxedonatiersystem.Neitherthe

Codenortheregulationsutilizethewordtier,butthatisthecommonparlance. Thefirsttierconsistsoftheincomethatisrequiredtobedistributedonacurrentbasis,regardlessof

whetheritisactuallydistributed.§662(a)(1). Thesecondtierconsistsofotheramountsthatmaybedistributed,butarenotrequiredtobedistributed

aspartofthefirsttier.§662(a)(2).Forexample,thesecondtierincludesdiscretionarydistributionsofincome,distributionsofprincipal,anddistributionsofincomeaccumulatedfromprioryears.Broadhead Trust v. Commissioner,T.C.Memo1972-196.

Inthecaseofboththefirstandsecondtiers,theamountthatistaxabletothebeneficiariesislimitedtotheamountofDNIfortheyear,andinparticularislimitedtothetaxableportionofDNI.§651(b);§661(c).IftheamountoffirsttierincomeislessthanDNI,andnosecondtierdistributionismade,thenthedistributiondeductionwillbelimitedtotheamountofthefirsttierincome.IftheamountoffirsttierincomeexceedsDNI,thedeductionwillbelimitedtotheamountofDNI.Inthatlattercase,eachbeneficiarywillbedeemedtohavereceived(andwillbetaxedon)aportionoftheDNIbasedonthatbeneficiary’srighttoreceivetier1income.Forexample,ifincomeisrequiredtobedistributed75%toBeneficiaryAand25%toBeneficiaryB,then75%oftheDNIwillbeallocatedtoBeneficiaryAand25%willbeallocatedtoBeneficiaryB.§662(a)(1).

BeneficiarieswillbedeemedtohavereceivedsecondtierincomeonlyifDNIexceedsthefirsttierdistributions.§662(a)(2).Thepurposeofthisruleistogiveprioritytothetaxationoffirsttierincome,andtogiveprioritytothetaxationoffirsttierbeneficiaries.Oneofthebenefitsofthisruleistoeliminatetheneedtotraceaparticulardistributiontoitssourceinordertodeterminewhetherthedistributionconsistedofincomeorprincipal.Forexample,assumeBeneficiaryAisentitledtoreceive$10,000ofcurrentincomeannually,andBeneficiaryBmayreceivediscretionarydistributionsofincomeorprincipal.IfDNIis$12,000,andeachbeneficiaryreceives$10,000,thenBeneficiaryAwillbetaxedon$10,000oftier1incomeandBeneficiaryBwillbetaxedon$2,000oftier2income.Theother$8,000receivedbyBeneficiaryBisdeemedtobeadistributionofprincipal,whichisnottaxabletoBeneficiaryB.

Thetiersystemappliesnotonlytotypesofincome,butalsototypesofbeneficiaries.Tier1beneficiariesaretherecipientsofmandatorycurrentincomedistributions,whiletier2beneficiariesmayreceiveotherdistributions.Thebeneficiariesaretaxedonaprioritysystem:DNIisallocatedtotier1beneficiariesfirst,andDNIisallocatedtotier2beneficiariesonlytotheextentthattheDNIisnotallocatedtotier1beneficiaries.Reg.§1.662(a)-3(c).AfteralloftheDNIhasbeenallocated,anydistributionsinexcessofDNIaretreatedasdistributionsofprincipal.Insomecases,abeneficiarymightbebothatier1beneficiaryandatier2beneficiary.

IfthetotalamountdistributedislessthanDNI,thenthetiersystembecomesirrelevant;everyamountreceivedbyabeneficiarycarriesoutDNIandistaxabletothebeneficiary,andtheportionofDNInotdistributed


istaxedtotheestateortrust,becausethedistributiondeductionwillbelimitedtotheamountdistributed.§661(a).

Simpletrustshaveonlyonetierofdistributions;alldistributionsaredeemedtobetier1distributions,andallbeneficiariesaredeemedtobetier1beneficiaries.

25. Income in Respect of a Decedent (IRD); Deductions in Respect of a Decedent (DRD) Incomeinrespectofadecedent(alsoknownasIRD)isincomethatwasearnedbythedecedent,or

accruedtothebenefitofthedecedent,duringhislifetime,butitwasnotactuallyreceivedbythedecedentduringhislifetime.§691.Examplesusuallyinclude:

a. Wagesearnedduringlife,butnotpaiduntilafterdeath.b. Otherformsofdeferredcompensationnotpaiduntilafterdeath.c. Interestaccruedduringlife,butnotreceiveduntilafterdeath.d. AssetsheldinanIndividualRetirementAccount(butnotaRothIRA)asofthedateofdeath.e. Assetsheldinotherqualifiedretirementaccountsasofthedateofdeath.f. Gainsorlossesfromassetssoldduringlife,butnotreceiveduntilafterdeath.

ThegrossincomeofatrustoranestateincludesanyIRDreceivedbythetrustorestate,tobereportedastaxableincomeinthetaxyearinwhichitisreceived.§691(a)(1).IRDdoesnotreceiveastepped-upbasisonthedateofdeath.§1014(c).

Asaresult,oneofthedutiesofafiduciaryistocarefullymanage(orpostpone)thereceiptofIRD.Ifanestatereceivesapaycheckresultingfrompre-deathworkperformedbythedecedent,theestatehasnochoicebuttoincludethatIRDingrossincome.Butiftheestateisthebeneficiaryofaretirementaccount(whichisusually100%IRD),theestatehassomeflexibilityregardingwhentowithdrawthatIRD,andthustheestatehassomeflexibilitytodecidewhenthatIRDwillbetaxed.

Section691alsopermitsanestateortrusttotakecertaindeductionsthataccruedduringthedecedent’slifetime,butcouldnotbeclaimedonthedecedent’sindividualincometaxreturns.§691(b).Thesedeductionsareknownasdeductionsinrespectofadecedent(DRD).Forexample,businessexpenses,interest,ortaxesthatwereincurredoraccruedduringthelifeofthedecedent,butwerenotpaidduringhislifetime,wouldbeconsideredtobedeductionsinrespectofadecedent,ifpaidbytheestate.

NotonlyisIRDincludedingrossincomeforincometaxpurposes,itisalsoincludedinthegrossestateforestatetaxpurposes.IfanestateisrequiredtoincludeIRDinitsgrossincomeforaparticularyear,thenitisentitledinthatyeartodeductthefederalestatetaxattributabletothatIRD.§691(c).ThisdeductionappliesonlytothatpartoftheIRDthatwasnotdistributedorwasnotrequiredtobedistributedtothebeneficiariesduringthatyear.§691(c)(1)(B).Ifthatrestrictionapplies,thenthebeneficiariesaretaxedontheIRDthattheyreceived,andtheymaytakethe§691(c)deduction.Reg.§1.691(c)-1.Butthe§691(c)deductionisavailabletothebeneficiaryonlyifthebeneficiaryitemizeshisorherdeductions,sincethedeductionisnotlistedin§62.Rev.Rul.78-203,1978-1C.B.199.However,thedeductionisnotconsideredtobeamiscellaneousitemizeddeduction.§67(b)(7).

ThedeductionislimitedtothefederalestatetaxpaidonitemsofIRD;nodeductionisallowedforstateestatetaxesorstateinheritancetaxes.§691(c)(2)(a).IftheitemofIRDisnottaxableinOregonforpurposesoftheOregonincometax,thenORS316.680(2)(c)deniesanOregonincometaxdeductionunder§691(c)forthefederalestatetaxpaidwithrespecttothatitem.

SeethefollowingsectionforadiscussionoftheIRDaspectsofretirementaccounts.InstallmentsaleproceedsareanothercommonexampleofIRD.Whenataxpayerreceivesapaymenton

aninstallmentsaleofanasset,thepaymentisnormallyreportedbytherecipientasthereceiptofthreeelements:(1)interest,whichistaxableasordinaryincome,(2)theportionofprincipalthatrepresentsgain,whichisoftentaxableascapitalgain,and(3)theportionofprincipalthatrepresentsareturnofbasis,whichisnottaxable.§453;§453A;§453B.Therelativeportionsofprincipalthatrepresentgainandreturnofbasisareusuallycalculatedbyapplyingthesameratiothatthepurchasepricebearstothegainandthebasis.

Whenaninstallmentobligationisacquiredfromadecedentseller(asopposedtoaninstallmentobligationcreatedbyanestatewhentheestatesellsanasset),theportionofeachpaymentthatrepresentsgainistreatedasIRD.§691(a)(4);Reg.§1.691(a)-5.AswithotheritemsofIRD,nostep-upinbasistakesplaceonthedeathofthedecedent.§1014(c).


Thuspaymentsreceivedbytheestateorbeneficiaryonaninstallmentobligationwillcontinuetobereportedbytheestateorbeneficiaryinthesamemannerthatthepaymentswerebeingreportedbythedecedent.Reg.§1.691(a)-5.Thusthegainisnotacceleratedonthedeathofthedecedentoronthetransferoftheobligationtoabeneficiarywhoisentitledtoreceiveitunderthewillortrust.Instead,theestateorbeneficiarywillcontinuetoreportthegainovertime,asthepaymentsarereceived.Reg.§1.691(a)-5.Seebelowforadifferentruleifthebeneficiaryisalsotheobligor.

Iftheestateorthebeneficiarysellstheinstallmentobligationortransferstheobligationtoanon-beneficiary,thesellermustrecognizegainasIRD,usingthefairmarketvalueoftheobligationandthedecedent’sbasisinthesoldasset,adjustedtoreflecttheportionsofbasisthatwerepreviouslyreceivedbythedecedentorbyhisestate.§691(a)(2).ThereceiptofbasisisnotconsideredtobeanitemofIRD.§691(a)(4).

Ifadecedentbequeathsaninstallmentobligationtothepersonwhoisobligatedtopaytheinstallmentpayments,thentheestaterealizesagainequaltotheamountofgainthathadnotyetbeenreportedbythedecedent.§691(a)(5).Thegainismeasuredbythedifferencebetweenthefairmarketvalueoftheobligationandthedecedent’sremainingbasisintheobligation.§691(a)(5).Thatsameresulttakesplaceifthedecedentdischargesthedebtatthedeathofthedecedent.§691(a)(5).Ifthedecedentdischargesthedebtatdeath,andthedecedentandtheobligorarerelated,thenthevalueoftheobligationwillnotbelessthanitsfacevalue.§691(a)(5)(B).Inthecaseofsuchadischargeorbequestofthedebttotheobligor,theestatemustrecognizethegainnolaterthantheconclusionoftheestateadministration,unlesssomeactofcancellationoccurspriortothattime.PLR8806048;S.Rep.No.96-1000,27(1980-2C.B.494,508;1980WL356610).However,aresiduarybequestthatincludestheinstallmentobligationdoesnotautomaticallytransfertheobligationtotheobligor;instead,thetransfertakesplaceinthetaxyearduringwhichtheobligationisactuallytransferredtotheobligor.PLR8806048.Thatresultiscorrectevenifstatelawprovidesthattheassetsoftheestatevestimmediatelyinthebeneficiaries,subjectonlytotheadministrationoftheestate.PLR8806048.(Oregonlawsoprovides.ORS114.215(1)(a).)Ifthecancellationtakesplaceatdeath,thecancellationistobetreatedasifthetransferhadbeenmadebytheestateofthedecedent.S.Rep.No.96-1000,27(1980-2C.B.494,508;1980WL356610).Presumably,thattransferwillbedeemedtohavetakenplaceinthefirsttaxyearoftheestate.TheSenateReportgoesontostate,“However,iftheobligationwereheldbyapersonotherthanthedecedent,suchasatrust,thecancellationwillbetreatedasatransferimmediatelyafterthedecedent’sdeathbythatperson.”

26. Retirement AccountsThelargestandmostcommonly-encounteredformsofincomeinrespectofadecedent(IRD)are

retirementaccounts.Retirementaccounts(exceptRothIRAs)arealmostalwaysmadeupofIRD,whichistaxableincome

toanestate,trust,orbeneficiarywhowithdrawsassetsfromaretirementaccount.Inotherwords,neitheraretirementaccountnortheassetsinaretirementaccountreceiveastepped-upbasisonthedeathoftheowneroftheretirementaccount.§1014(c).Fundswithdrawnfromtheretirementaccountareconsideredtobeordinaryincome(withsomeexceptions),tobereportedonanincometaxreturnoftherecipientintheyearofwithdrawal.

Thatfactmakesretirementaccountsverydangeroustodealwith,sinceaninadvertentwithdrawal(oraninadvertentclosingoftheaccount)cantriggeraverylargeincometaxliability.Proceedwithcaution.

BecauseoftheIRDnatureofretirementaccounts,suchassetsmakeidealcandidatesforcharitabledispositions.Ifapersonholdsbothregular(after-tax)investmentsandpre-taxretirementaccounts,andthatpersondesirestoleavesomeofhisassetstohisfamilyandotherassetstoacharity,thecharityshouldbedesignatedasthebeneficiaryoftheretirementaccounts,becausethecharityistax-exemptandwillnotberequiredtopayincometaxwhentheretirementassetsarewithdrawnfromtheretirementaccount.Incontrast,iftheretirementaccountwerelefttofamilymembers,thefamilymemberswouldberequiredtopayincometaxontheirwithdrawalsfromtheretirementaccount.

Thetaxationofretirementaccountsdependsprimarilyonwhothebeneficiaryis:• FamilyMembers.Inmostcases,thedesignatedbeneficiariesoftheretirementaccountwillbefamily

members(suchaschildrenofthedecedent)orthesurvivingspouse.Inthosesituations,theattorneyrepresentingthepersonalrepresentativeorrepresentingthetrusteewilloftenbecalledonbyfamilymemberstogiveadviceonhowtohandletheretirementaccount.Ifthefiduciaryisnotalsothebeneficiary,maintainanawarenessofwhoyourclientis,andwatchforconflictsofinterest.


• TheEstateoraTrust.Insomecases,thebeneficiaryoftheretirementaccountistheestateortrust,andnotanindividualfamilymember.Ifso,theattorneywillneedtocarefullyadvisethefiduciaryabouthowtheactionsofthefiduciarywillaffectthetimingofthetaxationoftheaccount.

• NoBeneficiaryNamed.Insomeinstances,thedecedentmayhaveneglectedtonameabeneficiaryforaretirementaccount.Inthoseinstances,theretirementplandocumentmustbereviewedinordertodeterminetheidentityofthedefaultbeneficiary.Often,thedefaultbeneficiarywillbetheestateofthedecedent.

Typically,thesurvivingspouseisthedesignatedbeneficiaryofmostretirementaccounts,includingIRAs.Ifthespouseisthebeneficiary,thespousecanusuallyrolltheaccountoverintoherownnamewithouttriggeringincometax.§408(d)(3)(C).Theincometaxwillthenbepostponeduntilthespousemakeswithdrawals.

IftheestateisthebeneficiaryofanIRA,thefiduciarymustexerciseextremecare.Iftheestateisthebeneficiary,thefiduciaryshouldcarefullyconsidermethodsthatmightbeusedtopostponethetaxationofthataccount,keepinginmindthatawithdrawalfromtheaccountisataxableevent,buttheassignmentoftheaccountintactistypicallynotataxableevent.Iftheaccountisasmallone,thenperhapsthesimplestanswerwouldbetowithdrawalloftheassetsandpaythetax.Butiftheaccountisalargeone,thefiduciaryshouldconsiderassigningtheaccounttothebeneficiariesintheformofoneormoreinheritedIRAaccounts,withoutmakinganyactualwithdrawalsfromtheIRA.Ifthedecedenthadthreechildren,forexample,theaccountcantypicallybedividedintothreeseparateinheritedIRAs,oneforeachofthethreechildren.Thethreechildrencouldtheneachdecidewheneachofthemwouldliketowithdrawfundsfromtheirrespectiveseparateaccounts,andthuseachofthemcancontrolwhentheywilleachbetaxedonthewithdrawals.Thisisparticularlyhelpfulifthebeneficiariesareindifferentcircumstances:Onebeneficiarymightnotneedtheincome,andmightwishtopostponewithdrawalsandtaxationforaslongaspossible,whileanotherbeneficiarymightbeinneedofincomeandmightbewillingtomakeawithdrawalandpaytaximmediately.

Beforetakingactionwithrespecttoaretirementaccount,considereverypossiblealternativeinordertominimize(i.e.,postpone)theexposuretoincometaxation.Typically,thealternativesincludethefollowing(inthisdiscussion,areferencetoabeneficiarymeansthebeneficiaryoftheretirementaccount,notthebeneficiaryofanestateortrust):

a. Havethebeneficiarywithdrawalloftheassetsfromtheretirementaccount,whichisataxableeventforthebeneficiary.Thisisusuallynotthebestchoice,unlesstheaccountissmallandthetaxconsequencesminor.

b. Ifthebeneficiaryisthesurvivingspouse,shecanrolltheaccountintoanIRAinherownname.Notethatthisdoesnotinvolveawithdrawal;theassetsstaywithinanIRA.Taxationwillnottakeplaceuntilthespouse,asthebeneficiaryoftherolloverIRA,makesawithdrawalfromtherolloveraccount.Thisrolloveroptionisoftenthebestchoiceforaspousebeneficiary.

c. Ifthespouseisnotthebeneficiary(thebeneficiariesarethechildrenofthedecedentorarenon-relatives),thebeneficiariescannotdoarollover,buttheycandosomethingsimilar:theycanconverttheaccountintooneormoreinheritedIRAs.Notethatthisdoesnotinvolveawithdrawal;theassetsstaywithintheinheritedIRAsandarenottaxeduntilwithdrawnfromoneoftheinheritedIRAs.

d. Ifthebeneficiaryistheestateoratrust,theestateortrustmaywishtocontinuetomaintaintheaccountasaninheritedIRAforthebenefitoftheestateortrust,butthatwouldrequirekeepingtheestateortrustopen.Inmostcases,theestateortrustwillprefertoconverttheaccountintooneormoreinheritedIRAsforthebenefitofthebeneficiariesoftheestateortrust.

Keepinmindthatsomeretirementplans,orsomeplancustodians,willnotpermitaretirementaccounttobedividedintoseparateinheritedaccountsforeachbeneficiary;contacttheplancustodian/administratorandreviewtheplandocumenttodeterminewhatispermitted.

Theprimarypurposeofthetechniquesdescribedaboveistopermitthebeneficiarytopostponewithdrawalsforthelongestperiodoftimepermittedbythetaxlaws,althoughthebeneficiaryisalsofreetomakewithdrawalsonamoreacceleratedbasis,ifthatiswhatthebeneficiarydesires.Thelengthofthatpossibledeferralperioddependsonseveralfactors.AttachedtothispaperasAppendixBisasummaryofthosetimeperiods,entitled“RetirementPlanDistributionsAfterDeath.”Exceptionsmayapplytothegeneralrules.Seealso,Duffy,Beneficiary Designation: More Prominent Considerations in Today’s Estate Tax World,OregonStateBarEstatePlanningandAdministrationSectionNewsletter,Vol.XXX,No.3,July2013.


27. Separate Share Rule Ifmultipletrustsareestablishedfortherespectivebenefitofmultiplebeneficiaries,theneachofthose

trustswillbetreatedfortaxpurposesasaseparateanddifferenttrust,eachcalculatingitsownincomeanddeductionsandeachfilingitsownincometaxreturn.Butifasingletrust(oranestate)isdesignedtobenefitmultiplebeneficiariesandthetermsofthetrustorwillpreventdistributionstoonebeneficiaryfromaffectingtheinterestsoftheotherbeneficiaries,then§663(c)requirestheapplicationoftheseparatesharerule.Reg.§1.663(c)-3.Theseparateshareruleisstatedverysimplyin§663(c),withnearlyallofthedetailprovidedinregulations.Reg.§1.663(c).

Iftheseparateshareruleapplies,thentheresultisthateachseparateshareofthetrustorestatewillcalculateitsownDNI,separateandapartfromtheothersharesofthetrustorestate.§663(c).Theruledoesnotapplyforanyotherpurpose.

Thisruleismandatory;itisnotelective.Reg.§1.663(c)-1(d).Itdoesnotrequireorpermitthecreationofseparatetrusts,nordoesitrequireorpermitthefilingofseparatetaxreturns.Reg.§1.663(c)-1(b).Instead,theseparateshareruleoperateswithinasingletrusttoensurethatthetaxattributesofoneseparateshareheldforthebenefitofonebeneficiarydonotaffectthetaxationofanyothershareheldforthebenefitofanyotherbeneficiary.Asaresultoftheseparatesharerule,ifitisapplicable,abeneficiarywillnotbetaxedonincomedistributedto,oraccumulatedforthebenefitof,anotherbeneficiary.Reg.§1.663(c)-1.

Aseparateshareisdefinedasthatportionofatrustthatisadministeredasifitwereaseparatetrust.Reg.§1.663(c)-3.Forexample,ifatrustcreatedforthebenefitofthreebeneficiariesrequiresthatdistributionstoeachbeneficiarymaybemadeonlyfromtherespectiveshareofthatparticularbeneficiary,thentheseparatesharerulewillapply.Itdoesnotapplyifthetrustdocumentactuallyrequiresthecreationandadministrationofaseparatetrustforeachbeneficiary.Anditdoesnotapplytotrustswherethetrusteehasthepowertosprinkledistributionsofincomeorprincipalfromtheentiretrustamongthevariousbeneficiaries,becausedistributionstoonebeneficiarywillaffecttheinterestsoftheotherbeneficiaries.Reg.§1.663(c)-3(b).Aspecificbequestthatispaidinthreeorfewerinstallmentsisnotconsideredtobeaseparateshare,becauseitdoesnotcarryoutDNI.§663(a)(1);Reg.§1.663(c)-4.Theseparateshareruleneverappliestoasimpletrust,becauseitsapplicationisunnecessary;theDNIofanyseparatesharescontainedwithinasimpletrustwillbeallocatedtoeachseparateshareinanyevent.

ThemechanismusedtoachievethegoaloftheseparateshareruleisthecalculationofseparateDNIandaseparatedistributiondeductionforeachseparateshare.Reg.§1.663(c)-2(b).Oncethoseseparatedistributiondeductionsarecalculatedpershare,theyarethenaddedtogethertocreateonedistributiondeductionfortheentiretrust.Thatonecombineddistributiondeductionisthensubtractedfromtheadjustedtotalincomeofthetrusttodeterminetaxableincome,andthenthetrustfilesasingleincometaxreturnforalloftheshares.Theseparateshareruledoesnotresultinseparatetruststhatfileseparatereturns.

Theseparatesharerulecanapplytobothestatesandtrusts.§663(c). In2013,theOregonlegislatureenactedanewtruststatute,providingthatifatrustcallsforthecreation

ofseparatesharesforthebenefitofseparatebeneficiaries,theneachofthoseseparateshareswillbedeemedtobeaseparatetrustforthesolebenefitofitsbeneficiaries,andthetrust(orportionofthetrust)fromwhichthosenewtrustswerecreatedwillbedeemedtohaveterminatedtotheextentofthenewtrusts.ORS130.232(SB592,OregonLaws2013ch.529,§24).Query:Asaresultofthisnewlegislation,willtheseparateshareruleof§663(c)rarelyapplyinOregon?ThisnewstatuteappearstorequireseparatetrustsunderthesameconditionsthattheseparatesharerulewouldtreattheoriginaltrustasonetrustwithseparatesharesthatcalculatetheirownDNIanddistributiondeduction.Ifso,theninOregonsuchtrustswillbetreatedasseparatetrusts,andnotseparateshares,andtheseparatesharerulewillnotapply.Underthisnewstatute,itisdifficulttoimaginethetermsofanOregontrustthatwouldbecomesubjecttotheseparatesharerule.(ORS130.232isunderconsiderationforrevisionatthe2015sessionofthelegislature;checkthecurrentstatusofthatstatute.)

28. BasisStep-upTheincometaxbasisofpropertyacquiredbyanestatefromadecedentisitsfairmarketvalueonthe

dateofdeath,§1014(a),oritsalternatevalueonthealternatevaluationdateifelectedunder§2032,oritsspecialusevalueifelectedunder§2032A.Thisisknownasthebasisstep-up,althoughintimesofdecliningvaluesitbecomesabasisstep-down.§1014(a).

Thebasisstep-upgenerallyappliestoallassetsincludedinthegrossestatebyreasonofanyCodesection,notjustassetsheldintheindividualnameofthedecedent.Reg.§1.1014-1(a).Oneexception:Incomeinrespectofadecedent(IRD)doesnotreceiveabasisstep-up.SeethediscussionofIRD,above.


Incontrast,thebasisofpropertyacquiredbygiftorbyanintervivostransferintoanirrevocabletrustremainsthesamebasisthatthepropertyhadinthehandsofthedonorortransferor.§1015.Thisisknownascarry-overbasis.

Asaresult,thebasisofassetsheldbyanestate,atestamentarytrust,orapost-mortemrevocabletrustisthedateofdeathvalue,orthealternatevaluationdatevalueifelectedunder§2032,orthespecialusevalueifelectedunder§2032A.Thesameruleappliestootherformsoftransfersatdeath.Butintervivostransfersdonotreceiveanewbasis,unlessforsomereasonthetransferbecameincludedinthegrossestateofthedecedentforestatetaxpurposes.§1014(b).

Thisisaveryimportantpointbecauseinmostsituationsatrust,estate,orbeneficiaryreceivingadecedent’spropertythatappreciatedsignificantlyduringthedecedent’slifetimecansellthatassetafterdeathwithlittleornocapitalgainrealizationorrecognition.(Seethediscussionofcapitalgainsandlosses,above.)Anddepreciableassetstransferredatdeathreceiveanewincometaxbasisthattheestate,trust,orbeneficiarymaybegindepreciatingalloveragain.However,thenewincometaxbasisofdepreciableassetstransferredatdeathmustbereducedbyanydepreciationtakenbythetaxpayer(notthedecedent)duringthelifeofthedecedent.§1014(b)(9);Reg.§1.1014-6(a)(1);Rev.Rul.58-130,1958-1C.B.121.

29. State Fiduciary Income Taxes Somestatesimposetheirownfiduciaryincometaxes,inadditiontothefederalfiduciaryincometax,but

therulesvarywidelyfromstatetostateregardingwhenastateconsidersaparticulartrusttobesubjecttoitsstatefiduciaryincometax.TherulesapplicabletoCalifornia,Oregon,andWashingtonare:

California -TheCaliforniafiduciaryincometaxappliestotruststhathaveaCaliforniaresidenttrusteeoraCaliforniaresidentnon-contingentbeneficiary.(IfonlyoneofseveraltrusteesisaCaliforniaresident,thenonlyaproportionatefractionoftheincomeistaxed.ThesameruleappliesifonlyoneofseveralbeneficiariesisaCaliforniaresident.)ThetaxalsoappliestoestatesifthedecedentwasaresidentofCalifornia.Incomedistributedtothebeneficiariesisgenerallynottaxedtotheestateortrust;itistaxedtothebeneficiaries,asinthefederalsystem.IfthebeneficiaryisanonresidentofCalifornia,thebeneficiarywillnotbetaxedbythestateofCaliforniaunlesstheincomeisCalifornia-sourceincome.Theinitial(lowest)incometaxrateis1%onthefirst$7,582oftaxableincome;themaximumrateis13.3%onincomeinexcessof$1million.Cal.Rev.andTax.Code§§17041,17043,17742.ForafullerdiscussionoftheCaliforniafiduciaryincometax,seeKinyon,Marois,andJohnson,California Income Taxation of Trusts and Estates,ACTECLawJournal,Vol.39,No.1&2,69(Spring/Fall2013).SeealsoCaliforniaForm541anditsinstructions.

Oregon -TheOregonfiduciaryincometaxappliestobothresidentOregontrustsandnonresidenttrusts,butindifferentways.AtrustisdeemedtobearesidenttrustifthetrusthasoneOregontrusteeorco-trustee,ortheadministrationofthetrustiscarriedoninOregon.ORS316.282(1)(d);OAR150-316.282(3),(5)ex.3.Administrationisdefinedasfiduciarydecision-making,notincidentalexecutionofdecisionsmadebyothers.ORS316.282(3);OAR150-316.282(5).AresidenttrustisatrustwitharesidentfiduciaryoriftheadministrationisbeingcarriedoninOregon,evenifthetrusteeisacorporatetrusteewithheadquarterselsewhere.ORS316.282(1)(d);OAR150-316.282(5).Nonresidenttrustsaredefinedastrustsotherthanresidenttrusts.ORS316.302.TheOregonfiduciaryincometaxalsoappliestoanestateifthefiduciarywasappointedbyanOregoncourtortheadministrationoftheestateiscarriedoninOregon.ORS316.282(1)(b);OAR150-316.282(2).Aprincipalprobateandanancillaryprobateintwodifferentstatesareconsideredtobeoneestate,butiftheprincipaladministrationtakesplaceinOregon,alloftheincomeofbothestateswillbetaxedinOregon.Iftheprincipaladministrationtakesplaceinanotherstate,thentheestatewillbetaxedasanon-residentestate.OAR150-316.282(2).ThecalculationoftheOregonfiduciaryincometaxonresidenttrustsandestatesismadeinmuchthesamemannerastheOregonindividualincometax,withsomeexceptions.ORS316.272;OAR150-316.282(6).Similarly,OregontaxestheOregon-sourceincomeofnonresidenttrustsandnonresidentestatesasifthetrustorestatewereanonresidentindividual.ORS316.307(3);316.312;OAR150-316.307.Thetaxableincomeofanestateortrustisbasedonfederaltaxableincome,butanOregonfiduciaryadjustmentismade.ORS316.282;316.287.Theinitial(lowest)rateoftheOregonfiduciaryincometaxis5%onthefirst$3,250oftaxableincome;themaximumrateis9.9%onincomeinexcessof$125,000.ORS316.037;316.282;OAR150-316.282(3),(4).Undersomecircumstances,Oregongrantsacreditforfiduciaryincometaxespaidtootherstates.ORS316.082(residents);ORS316.131and316.292(nonresidents).Anonresidentbeneficiaryofatrustorestate(residentornonresident)istaxedinthesamemannerasifthebeneficiaryhadreceivedtheincomedirectly,andnotthroughatrustoranestate.OAR150-316.282(7).Asaresult,anonresidentbeneficiaryofaresidentOregontrustwillbetaxedinOregoniftheincomeresultedfromtheownershipordispositionoftangibleproperty(real


orpersonal)inOregon,orfromtheoperationofatradeorbusinessinOregon.ORS316.127;OAR150-316.127-(D).

Washington –Washingtonhasnotenactedafiduciaryincometax. Inotherwesternstates,fiduciaryincometaxeshavebeenadoptedinIdaho(maximumrate7.4%)

Arizona(maximumrate4.54%)andHawaii(maximumrate8.25%).FiduciaryincometaxeshavenotbeenadoptedinAlaskaorNevada.

30. Revocable Trusts and Grantor TrustsAdetaileddiscussionofgrantortrusts(includingrevocabletrusts)isbeyondthescopeofthispaper,but

hereisabriefsummaryofthebasicelementsofrevocabletrustsandgrantortrusts. Agrantortrustisessentiallyatrustthataperson(usuallythegrantorortrustor,butnotalways)has

sufficientcontrolover,suchthatsomeaspectsofthetrustaretaxedtothatperson.Themostcommonexampleisatrustthatistreatedasagrantortrustforincometaxpurposesbecausethegrantorhasretainedcertainpowersthatmaketheincomeofthetrusttaxabletothatpersonforincometaxpurposes.Othertrustsgrantthetrustorsuchpowersthatthetrustbecomespartofthetrustor’sgrossestateforestatetaxpurposes,butthetermgrantortrustisusuallyusedprimarilyintheincometaxcontext.(Seetheabovediscussionofcreditsheltertrustsforadiscussionofwhetheratypicalcreditsheltertrustisagrantortrust.)

Grantortruststypicallyfallintotwoprimarycategories: First,arevocablelivingtrustisagrantortrustforpurposesofboththeincometax(duringthegrantor’s

life)andtheestatetax(atthegrantor’sdeath).Itisprimarilyaprobate-avoidancetool,andthetrustorofarevocablelivingtrustisnotintendingtoachieveanyparticularincometaxadvantagesorestatetaxadvantages,althoughrevocablelivingtrustsoftencreatepost-mortemtruststhathaveestatetaxadvantagesforthesurvivingspouseofthetrustor.Severalalternativemethodsareavailableforreportingtheincomeofarevocablelivingtrust.Themostcommonly-usedmethodisforthegrantortofileanindividualincometaxreturn,usingthegrantor’ssocialsecuritynumber;thatreturnwillreportalloftheincomeandcapitalgainsreceivedbythetrustorbythegrantor.Reg.§1.671-4(b)(2)(i)(A).Thesameistrueforahusbandandwifewhohaveajointrevocabletrustandfileajointreturn.Reg.§1.671-4(b)(8).Inbothcases,nofurtherreportingisneeded,butifthegrantorisnotthetrusteethencertainspecifiedinformationmustbesuppliedtothegrantorbythetrustee.Reg.§1.671-4(b)(2)(ii).SeeReg.§1.671-4foralternativereportingmethods.

Second,othergrantortrustsareoftencreatedthataredesignedtobegrantortrustsforincometaxpurposes,butnotforestatetaxpurposes.(Thesetrustsaresometimesreferredtoasintentionallydefectivegrantortrusts,orIDGTs.)Thesetrustsaredesignedtooffercertainincometaxadvantagesduringthelifeofthetrustor,buttheassetsalsoavoidestatetaxonthedeathofthetrustor.Forexample,atrustormightcreateagrantortrustduringhislifetime,andthensellanappreciatedassettothattrust.Theincomegeneratedbythetrustmightbepayabletothetrustor’schildren,andonthegrantor’sdeaththeprincipalofthetrustwouldbedistributedtohischildrenorbeheldinfurthertrustforthebenefitofhischildren.Butbecausethetrustisagrantortrustforincometaxpurposes,thesaleoftheappreciatedassetisnotataxableevent,becausethetrustorhasineffectsoldtheassettohimself.Insomecases,theassetisnotsoldtothetrust,butinsteadisgiftedtothetrust,andacompletedtaxablegiftwillhavetakenplace,becausethechildrenreceivedavestedinterestinthetrust.Followingthesaleorgift,anyincomeearnedbytheassetinthehandsofthetrustistaxedtothetrustor,becausethetrustcontainscertainprovisionsthattriggerthegrantortrustprovisionsoftheCode,suchas§§673through677.However,theincomeearnedbythetrustisnotpayabletothetrustor,eventhoughthetrustoristaxedonthatincomeforincometaxpurposes.Suchatrusttypicallycontainsnoprovisionsthatwouldtriggerestatetaxonthedeathofthetrustor.Inparticular,thetrustcontainsnoprovisionsthatwouldtriggerthestringsectionsoftheestatetaxstatutes.(Sections2036through2038arecolloquiallyknownasthestringsections,becausetheywillresultininclusioninthegrossestateofthedonororgrantorifthelifetimetransfersweremadewithcertainstringsattached,suchasretentionofanincomeinterest,retentionofarighttorevoke,etc.)Thusatrustorcanreducehistaxableestatebytransferringassetstoagrantortrust,andthenfurtherreducehisestatebypayingtheincometaxontheincomegeneratedbythegrantortrust,allthewhileexcludingthetransferredassets(andtheincomegeneratedbythosetransferredassets)fromhisgrossestateforestatetaxpurposes.Thepaymentoftheincometaxesbythegrantorisnotconsideredtobeagifttothetrustortoitsbeneficiaries.

Toinvokegrantortruststatuswithouttriggeringestatetaxonthedeathofthetrustor,thegrantortrustmustbecarefullydesignedtotriggertheincometaxgrantortruststatuteswithouttriggeringtheestatetaxstatutes.Toavoidthelatter,thetrustmustnotgivethetrustortherighttoreceivetheincomeofthetrust,orthe


righttoamend,alter,orrevokethetrust.§§2036through2038.Totriggerthegrantorincometaxprovisions,thetrustoristypicallygiventhepowertoborrowtrustassetswithoutadequatesecurityoradequateinterest,orthetrustorisgiventhepowertoreacquiretrustassetsandreplacethemwithpropertyofequivalentvalue.§675(2);§675(4)(C).

Theincome,includingcapitalgains,earnedbyanirrevocablelifeinsurancetrustistaxabletothegrantorbecause§677(a)(3)providesthatiftrustassetsmaybeappliedtothepaymentofpremiumsonthelifeofthetrustor,orhisspouse,thenthetrustwillbetreatedasagrantortrustforincometaxpurposes.

Selected Additional Research MaterialsAcker,Income Taxation of Trusts and Estates,Portfolio852-3d,BloombergBureauofNationalAffairs:

TaxManagementEstates,GiftsandTrustsPortfolios(2010).Acker,Income in Respect of a Decedent,Portfolio862-3d,BloombergBureauofNationalAffairs:Tax

ManagementEstates,GiftsandTrustsPortfolios(2010).ZaritskyandLane,Federal Income Taxation of Estates and Trusts,WarrenGorham,andLamont(3ded.

2003).Federal Income Taxes of Decedents, Estates and Trusts,CCHTaxSpotlightSeries(23ded.2007).Choate,Life and Death Planning for Retirement Benefits,AtaxplanPublications(7thed.2011).KantorandMiller,eds.,Administering Trusts in Oregon,OregonStateBar,2007.

Appendices

AppendixA:MiscellaneousItemizedDeductionsofTrustsandEstates AppendixB:RetirementPlanDistributionsAfterDeath

Oregon Estate Planning and Administration Section Newsletter

EditorialBoard

Questions,Comments,Suggestions AboutThisNewsletter?

Contact:SherylS.McConnell,Editor-in-Chief(503)857-6860•[email protected]

DisclaimerThe articles and notes in the Oregon State Bar Estate Planning and Administration Section Newsletter may contain analysis and opinions that do not necessarily reflect the analysis and opinions of the Newsletter Editor-in-Chief, the Editorial Board, the Estate Planning Section Board or the membership of the Estate Planning Section. It is the responsibility of each practitioner to perform their own research and analysis and to reach their own opinions.

JaniceHattonPhilipN.JonesSarahS.Keane

JohnD.SorlieTimothyR.StraderVanessaUsui


Appendix AMiscellaneous Itemized Deductions of Trusts and Estates on Form 1041under§67(e),Knight v. Commissioner,andReg.§1.67-4(TD9664;5/8/14)

Type of Deduction Fully Deductible Deductible Subject to 2% FloorTrustee Fees andInvestmentManagementFees

Fees attributable to estate or trust administration,includingspecializedbalancingoftrustbeneficiaryinterests,allocation of income and principal among beneficiaries,distributionofassetstobeneficiaries,pursuitofunusualfiduciaryinvestmentobjectives,andspecializedfeesapplicableonlytotrustsandestates.

Feesattributabletoinvestmentmanagementorbalancinginvestmentsbetweencurrentbeneficiariesandremaindermen.Unitarytrusteefees that compensate for both trust administrationandinvestmentmanagement must be unbundled or allocatedbetweentrustadministrationandinvestmentmanagement,beginningwithtaxyearsstartingafter5/9/14.

Attorney Fees Mostattorneyfeesarefullydeductible,because most are not commonly incurred by individuals.

Feesnotuniquetotrustsandestates,suchasattorneyfeesexpendedindefenseofclaims.

WillandTrustContests

All. None.

Courtfees Mostcourtfees,includingmostprobatecourtfeesandlegalpublicationcosts.

Feesincurreddefendingagainstclaims.

Fiduciary Accountings and Bond Premiums

All,includingcertifiedcopiesofthedeathcertificate.

None.

Appraisal Fees Fully deductible if obtained to determine estatetaxes,GSTtaxes,gifttaxes,ortodeterminedistributions.

Appraisals obtained for insurance purposes.

StateandLocalTaxes All(notaMiscellaneousItemizedDeduction).§67(b)(2).

None.

RealEstateManagement

None,unlessthetrustorestateisengagedinrealestatebusiness.§62.Businessexpensesarenotitemizeddeductions.§62(a)(1).

Realestatemanagementfees,insurance,propertyrepairsandmaintenance,condoassociationfees,utilities.

EstateandGSTTaxReturnPreparation

All. None.

GiftTaxReturnPreparation

None. All.

IncomeTaxReturnPreparation

Fiduciaryincometaxreturns.Decedent’sfinalincometaxreturn.

Allotherincometaxreturns.Returnsfor sole proprietorships and retirement plansmaybedeductedunder§162.

ThissummarywaspreparedbyPhilipN.JonesofDuffyKekelLLP.10/10/14.Reviewthestatutes,courtopinion,andregulationsforapplicationtoparticularsituations.Theregulationsbecamefinalon5/9/14.


AppendixBRetirement Plan Distributions After Death

Status of Account DeathBeforeAge70.5 Death After Age 70.5IndividualDesignatedBeneficiarynamed

Beneficiarymaywithdrawoverthebeneficiary’ssinglelifeexpectancytable.

Beneficiarymaywithdrawoverthebeneficiary’ssinglelifeexpectancytable.

NoDesignatedBeneficiarynamed

Beneficiarymustcompletewithdrawalswithinfiveyears (by the end of the year containingthefifthanniversaryofthedeath).

Beneficiarymaywithdrawoverthedecedent’sremaininglifeexpectancy.

SurvivingSpousenamedasbeneficiary

SurvivingspousemayrolltheaccountoverintoanIRAinthesurvivingspouse’sname.Spousemaythendeferwithdrawalsuntilage70.5,andmaythenuseherownlifeexpectancytable.

SurvivingspousemayrolltheaccountoverintoanIRAinthesurvivingspouse’sname.Spousemaythendeferwithdrawalsuntilage70.5,andmaythenuseherownlifeexpectancytable.

Estateisnamedasbeneficiary EstatecannotqualifyasaDesignatedBeneficiary.SeeNoDesignatedBeneficiarynamed,above.

EstatecannotqualifyasaDesignatedBeneficiary.SeeNoDesignatedBeneficiarynamed,above.

TrustisnamedasbeneficiaryandqualifiesasaDesignatedBeneficiary

Withdrawalsmaybemadeoverthelifeexpectancyoftheoldestbeneficiary.

Withdrawalsmaybemadeoverthelifeexpectancyoftheoldestbeneficiary.

MaritalTrustnamedasbeneficiary,anddoesnotqualifyasaDesignatedBeneficiary

Survivingspousemustcompletewithdrawalswithinfiveyears (by the end of the year containingthefifthanniversaryofthedeath).

Survivingspousemustbeginwithdrawalsbytheendoftheyearfollowingdeath,andmaythereafterfollowthedecedent’slifeexpectancy.

Account(butnotwithdrawalsfromtheaccount)isusedtofundapecuniarybequestfromanestate or trust

IRScontendsthatIRDincomeis realized immediately by the estateortrustunder§691(a)(2).SeeCCA2006-44020.Thisconclusionisprobablyincorrect.

IRScontendsthatIRDincomeisrealized immediately by the estate ortrustunder§691(a)(2).SeeCCA2006-44020.Thisconclusionisprobablyincorrect.

DecedenthadnotyettakenanRMDfortheyearofdeath

Notapplicable.NoRMDsrequired.

BeneficiarymusttimelywithdrawtheRMD.

CompiledbyPhilipN.JonesandPeterJ.Duffy,ofDuffyKekelLLP.Someexceptionsapply.10/13/14.SeealsoOSBEstatePlanningandAdministrationSectionNewsletter,July2013.

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