home | nyu school of law of trusts... · web viewsimple trusts 1) calculate gross income (do not...

SIMPLE TRUSTS 1) CALCULATE GROSS INCOME (Do NOT include TEI in Gross Income) 2) CALCULATE TENTATIVE TAXABLE INCOME (TTI) A) FORMULA : Gross Income

(Personal Exemption) (Capital Loss) (Total Direct Expenses)

(Total Deductible Indirect Expenses) (All Other Deductions, Except DD)

TTI B) DEDUCTIBLE INDIRECT EXPENSES :

TEI In DNI Indirect Expense A x ——————— = Indirect Expense

Total DNI Allocated to TEI TEI (Indirect Expense Allocated to TEI) Net TEI

Indirect Expense A (Indirect Expense Allocated to TEI) Deductible Indirect Expense From Class A

TEI In DNI Indirect Expense B x ——————— = Indirect Expense


Indirect Expense A (Indirect Expense Allocated to TEI) Deductible Indirect Expense From Class B

Deductible Indirect Expense From Class A Deductible Indirect Expense From Class B Total Deductible Indirect Expenses

3) DISTRIBUTION DEDUCTION A) WHAT IS FAI? (Do NOT include Phantom Income from PA) B) WHAT IS DNI?

TTI + Personal Exemption

(Capital Gains) + Capital Losses+ Net TEI + Certain Types of Capital Gains (Extraordinary Dividends)

DNI C) IS FAI OR DNI LOWER?

I) IF FAI IS LOWER, FAI is Tentative DD II) IF DNI IS LOWER, DNI is Tentative DD

D) SUBTRACT NET TEI FROM TENTATIVE DD Tentative DD (Net TEI) Distribution Deduction

4) COMPUTE THE TRUST’S TAXABLE INCOME TTI (Distribution Deduction)Simple Trust’s Taxable Income

5) COMPUTE AMOUNT INCLUDED IN EACH BENEFICIARIES’ INCOME A) IF FAI IS LOWER THAN DNI

FAIRTBD(B) FAI x ————————

Total FAIRTBD B) IF DNI IS LOWER THAN FAI

FAIRTBD to This Beneficiary DNI x —————————————

Total FAIRTBD 6) DETERMINE CHARACTER OF INCLUSIONS A) MAKE A LIST OF ITEMS IN DNI

Class A ItemClass B Item Net TEI

B) ADJUST OTHER NON-TEI ITEMS OF DEDUCTION Class A Income (Class A Direct Expenses) (Deductible Indirect Expense From Class A) (See Step 2(B))Adjusted Class A Income

Class B Income (Class B Direct Expenses) *Deductible Indirect Expense from Class B) (See Step 2(B))Adjusted Class B Income

* ONLY Deduct if remaining deductible indirect expenses

C) DETERMINE TOTAL

Adjusted Class A Income Adjusted Class B Income Net TEI Total DNI

D) DETERMINE CHARACTER

Total Amount Included Class A Asset in DNI In Each Beneficiary’s x ————————— Gross Income Total DNI

Total Amount Included Class B Asset in DNI In Each Beneficiary’s x ————————— Gross Income Total DNI

COMPLEX TRUSTS 1) CALCULATE GROSS INCOME (Do NOT include TEI in Gross Income) 2) CALCULATE TENTATIVE TAXABLE INCOME (TTI) A) FORMULA : Gross Income

(Personal Exemption) (Capital Loss) (Total Direct Expenses)

(Total Deductible Indirect Expenses) (All Other Deductions, Except DD)

TTI B) DEDUCTIBLE INDIRECT EXPENSES :

TEI In DNI Indirect Expense A x ——————— = Indirect Expense


Indirect Expense A (Indirect Expense Allocated to TEI) Deductible Indirect Expense From Class A

TEI In DNI Indirect Expense B x ——————— = Indirect Expense


Indirect Expense A (Indirect Expense Allocated to TEI) Deductible Indirect Expense From Class B

Deductible Indirect Expense From Class A Deductible Indirect Expense From Class B Total Deductible Indirect Expenses

3) DISTRIBUTION DEDUCTION A) WHAT IS FAIRTBD + OAPCRTBD? (Do NOT include Phantom Income)

I) FAIRTBD? Class A Income (Class A Direct Expense)

Class B Income —> May be TEI (Class B Direct Expense)—> May be Indirect Costs to TEI

FAI x FAIRTBD Percentage

FAIRTBD II) OAPCRTBD? III) SUM? FAIRTBD

+ OAPCRTBD FAIRTBD + OAPCRTBD

B) WHAT IS DNI? TTI

+ Personal Exemption (Capital Gains)

+ Capital Losses+ Net TEI + Certain Types of Capital Gains (Extraordinary Dividends)

DNI C) IS FAI OR DNI LOWER?

I) IF FAIRTBD + OAPCRTBD IS LOWER, FAIRTBD + OAPCRTBD is Tent. DDII) IF DNI IS LOWER, DNI is Tentative DD

D) ADJUST FOR TEI Net TEI

Tentative DD x ———————— = Adjustment for TEI Total DNI

E) CALCULATE DISTRIBUTION DEDUCTION Tentative DD

(Adjustment for TEI) Distribution Deduction

4) COMPUTE TRUST’S TAXABLE INCOME TTI (Distribution Deduction)Complex Trust’s Taxable Income

5) COMPUTE AMOUNT INCLUDED IN EACH BENEFICIARIES’ INCOME A) TIER 1 BENEFICIARIES

I) IF FAIRTBD IS LOWER THAN DNI

FAIRTBD(B) FAIRTBD x —————————— = Tier 1

Total FAIRTBD Inclusion

II) IF DNI IS LOWER THAN FAIRTBD

FAIRTBD(B) DNI x ——————————— = Tier 1

Total FAIRTBD InclusionIII) CALCULATE REMAINING DNI

DNI (FAIRTBD) Remaining DNI

B) TIER 2 BENEFICIARIES I) IF OAPCRTBD IS LESS THAN REMAINING DNI

OAPCRTBD(B) OAPCRTBD x ————————— = Tier 2

Total OAPCRTBD Inclusion

II) IF REMAINING DNI IS LESS THAN OAPCTBD OAPCRTBD(B)

Remaining DNI x ————————— = Tier 2 Total OAPCRTBD Inclusion

C) DETERMINE TOTAL INCLUSIONS Beneficiary A:

T1 Inclusion T2 Inclusion Beneficiary A’s Total Inclusions

Beneficiary B: T1 Inclusion T2 Inclusion Beneficiary B’s Total Inclusions 6) DETERMINE CHARACTER OF INCLUSIONS A) MAKE A LIST OF ITEMS IN DNI

Class A ItemClass B Item Class C ItemNet TEI

B) ADJUST OTHER NON-TEI ITEMS OF DEDUCTION Class A Income (Class A Direct Expenses) (Deductible Indirect Expense From Class A) (See Step 2(B))Adjusted Class A Income

Class B Income (Class B Direct Expenses) *Deductible Indirect Expense from Class B) (See Step 2(B))Adjusted Class B Income

* ONLY Deduct if remaining deductible indirect expenses

C) DETERMINE TOTAL Adjusted Class A Income Adjusted Class B Income Net TEI Total DNI


Total Amount Included Adjusted Class A Asset in DNI In Each Beneficiary’s x —————————————— Gross Income Total DNI

Total Amount Included Adjusted Class B Asset in DNI In Each Beneficiary’s x —————————————— Gross Income Total DNI

COMMON RULES

OVERVIEW GENERALLY IRC 61(15): gross income includes income from a trust/estateIRC 102(a): Corpus (the tree) passes to B tax-free Gross income does NOT include gifts, bequests, or devises IRC 102(b)(1): Income (the fruit) passes to B subject to tax Gross income DOES include income from a trustIRC 102(b)(2): Income from a gift, bequest, devise is included in gross income, even if the gift is a gift of income STRUCTURE Subpart A: General Rules Subpart D: Excess Trust Distributions Subpart B: Simple Trusts Subpart E: Grantor Trusts Subpart C: Complex Trusts

COMPUTATION OF TAXABLE INCOME GENERALLY IRC 1(e): impose a tax on “taxable income” of every (1) estate, and (2) trust Rates: If Taxable Income Is | The Tax Is

$0 to $2,600 | $0 plus 10% on excess over $0 $2,601 to $9,450 | $260 plus 24% on excess over $2,600 $9,451 to $12,950 | $1,904 plus 35% on excess over $9,450 $12,951+ | $3,129 plus 37% on excess over $12,950

COMPUTATIONGeneral Rule: IRC 641(b): Compute “Taxable income” of trust/estate in the same manner as an individual Exceptions: Standard Deduction: IRC 63(c)(6): no standard deduction for trusts/estate Personal Exemption (PE): Estates: IRC 642(b)(1): PE is $600 Simple Trusts: IRC 642(b)(2)(B): PE is $300 Complex Trusts: MUST Distrib. All Income Currently: IRC 642(b)(2)(B): PE is $300 Need NOT Distrib. All Income Currently: IRC 642(b)(2)(A): PE is $100 Distribution Deductions: Simple Trust: IRC 651(a): Simple trusts get DD via one formula Complex Trusts: IRC 661(a): Complex trusts get DD via another formulaFinal Formula: Gross Income

(Personal Exemption) (All Deductions Except DD) Tentative Taxable Income (Distribution Deduction) Trust’s Taxable Income x Rates Taxable Income (Credits) Amount Subject to Tax

DIFFERENTIATE BETWEEN SIMPLE & COMPLEX TRUSTS Default: Complex trust status is the default IRC 661(a): unless Subpart B (simple trust) applies, use complex trust rules RR 1.661(a)-1: Same Estates: Subpart B never applies, so always treated like a complex trust Terminology: RR 1.651(a)-1: If IRC 651 applies call it a “simple trust”

If IRC 661 applies, call it a “complex trust” Analysis: 1) Is It a trust or estate? 2) If trust, is it a grantor trust under Subpart E? 3) If no, the trust is a complex trust under Subpart C unless: A) The trust requires ALL Income Be Distributed Annually;

PROF: Does NOT matter what T actually did, only matters what T was required to do

B) Nothing is paid, permanently set aside, used for year for charity; C) For the year, the trust can ONLY distribute current income PROF: Does NOT matter what T is required to do, only matters what T

actually did

FIDUCIARY ACCOUNTING INCOME (FAI) GENERALLY RR 1.651(a)-2: “Income Required to Be Distributed Currently” depends on what the trust’s terms and local law says IRC 643: For Subparts B, C, D, the term “income” without “taxable” “DNI,” “undistributed net,” or “gross” means the amount of income determined under the trust and local lawPhantom Income: if trust owns a PA interest, but no distribution for the year, allocate $0 to income and $0 to pricnpal

UNIFORM PRINCIPAL & INCOME ACT (UPIA) Fiduciary Duties: UPIA 103(1): in allocating income/expenses, T must admin the trust in accords with the trust Allocation Power: UPIA 503(b): Trustee can transfer a R amount of net cash receipts from a depreciable asset from income to principal UPIA 104(a): Trustee can adjust between income and principal to the extent that the he considers necessary if: 1) T invests/manages trust assets prudently; 2) Trust describes the amounts that may/must be distributed to B by referring to the trust’s income; and 3) T decides, after apply UPIA 103(a), that T is unable to comply with UPIA 103(b) (duty of impartiality) Allocation of Receipts & Expenses:

Income Principal Rental, Interest Income Proceeds from sale of asset Cash dividends Stock Dividends Casualty insurance proceeds Life Insurance Proceeds

Receipts 10% of liquidating assets 90% of liquidating Assets Bond interest payments (Base OID Income (If 0 coupon bond allthe interest payment received interest goes to princ. in last year) on the bond’s face value) Capital Gains

Eminent domain proceeds

50% of Trustee Commissions 50% of Trustee Commissions 50% of accounting, legal costs 50% of accounting, legal costs

Expenses (effecting income/remainders) (effecting income/remainder) Mortgage interest payments Mortgage principal payments Repairs Improvements Property Taxes Estate, Transfer Taxes

Environmental Costs

TermsFAIRTBD: Fiduciary Accounting Income Required to be Distributed CurrentlyOAPCRTBD: Sum properly paid, properly credited, or required to be distributed OFAIPC: Other FAI paid or credited for the year (other than to the annuitant)

SPECIFIC ALLOCATIONS SIMPLE TRUSTS IRC 652(b): use Normal Allocation rules money specified in IRC 652(a), unless the trust specifically allocates different classes of income to different Bs RR 1.652(b)-2(a): Apply the Normal Allocation rules unless either: 1) Trust specifically allocates different classes of income to different Bs; 2) Or, local law requires a different allocation RR 1.652(b)-2(a): If there’s a specific allocation, each B will be deemed to have received those items of income specifically allocated to him COMPLEX TRUSTS IRC 662(b): Same as IRC 652(b) (See above) Effect: Follow RR 1.652(b)-1 for specific allocations in complex trusts APPLICATION Economic Effect: RR 1.652(b)-2(b): ONLY respected if, in every year: 1) There’s an allocation in the trust 2) The specific allocation has an EE, independent of tax consequences A) Yes respected if requires a specific class of income go to a B B) NOT respected if the trust either:

A) Gives T discretion to decide which B gets a class of income; B) Or, specific class must be first be allocated to a specific B’s share

Test: Does the allocation determine the actual amount that the B receives? PROF: If respected, just go by the trust & ignore the Normal Character rules Analysis: 1) IS THERE A SPECIFIC ALLOCATION?

2) IF YES, DOES THE SPECIFIC ALLOCATION HAVE ECONOMIC EFFECT? A) DOES TRUST MANDATE A SPECIFIC CLASS OF INCOME BE ALLOCATED TO

B?I) IF YES, it is respected (CAN use to decide character) Ex: “1/2 of interest to B”

B) IF NO, DOES THE TRUST GIVE T DISCRETION TO ALLOCATE THE CLASSES OF INCOME TO CERTAIN BS?

I) IF YES, allocation is NOT respected C) IF NO, DOES THE TRUST MANDATE THAT A SPECIFIC CLASS OF INCOME IS FIRST ALLOCATED TO A B’S SHARE?

I) IF YES, allocation is NOT respected Ex: “All interest to A. B gets the lesser of $100 or income other than interest” PROF: If B is limited by specific pecuniary amount (here, B), no EE and NOT respected

3) IF YES ECONOMIC EFFECT, USE THE ALLOCATION TO DETERMINE THE CHARACTER OF THE TOTAL AMOUNT INCLUDED IN EACH B’S INCOME PROF: This may change the amount included in B’s income Ex: “all dividends to A or B, whichever is in the higher bracket, the rest of the income to the other” PROF: This WILL be respected (tax motivation is NOT bad)

Ex: “1/2 of interest to A, the balance of income to B.” $8,000 of dividends, $8,000 of interest. Character of amounts included in A’s and B’s income? 1) GROSS INCOME: $16,000 2) TTI: $15,700 3) DD: $16,000 A) FAI is $16,000

B) DNI is $16,000 4) TRUST’S TAXABLE INCOME: $0 5) AMOUNT INCLUDE IN EACH B’S INCOME? A: $4,000

B: $12,000 6) CHARACTER: A: $4,000 at Ordinary Rates B: $4,000 at Ordinary Rates

$8,000 at Dividend Rates Ex: “1/2 of dividends to A, the balance to ABC equally.” $12,000 of dividends, $15,000 of interest, $6,000 of CG. T sells land for $30,000 (no gain). State’s law says 10% of sale proceeds to income. Character of amounts included? 1) GROSS INCOME: $33,000 2) TTI: $32,700 3) DD: $27,000 A) FAI is $30,000

B) DNI is $27,000 4) TRUST’S TAXABLE INCOME: $5,700

TTI $32,700 (DD) ($27,000) Taxable Income $5,700

5) AMOUNT INCLUDED IN EACH B’S INCOME? A: $14,000 C: $8,000 B: $8,000

6) CHARACTER: A: $6,000 at Dividend Rates B/C: $0 at Dividend Rates $2,000 at Dividend Rates $2,000 at Dividend Rates

$5,000 at Interest Rates $5,000 at Interest Rates

$1,000 at State Rate (0%) $1,000 at State Rate (0%) $13,000 Subject to Tax $7,000 Subject to Tax

DISTRIBUTABLE NET INCOME (DNI) EASY EXAMPLES Ex: Testamentary trust. “All income to A annually, then principal to B.” In Y1, trustee gets $6,000 dividends, sells land for $30,000 but Jx’s underproductive property statute says 10% of gross sale proceeds go to income 1) Gross Income? $6,000 Dividends

$0 Sale proceeds $6,000 Gross Income

2) TTI? $6,000 Gross Income($300) Personal Exemption $5,700 TTI

3) DD? A) FAI $6,000 Dividends

$3,000 Land Underproductive Property Proceeds $9,000 FAI

B) DNI $5,700 TTI$300 Personal Exemption $6,000 DNI

4) Taxable Income? $5,700 TTI($6,000) Distribution Deduction $0 Taxable Income

Ex: Testamentary trust. “All income to A annually, then principal to B.” In Y1, trustee gets $3,000 dividends, $5,000 of CG 1) Gross Income? $3,000 Dividends

$5,000 CG $8,000 Gross Income

2) TTI? $8,000 Gross Income($300) Personal Exemption $7,700 TTI

3) DD? A) FAI $3,000 Dividends

$3,000 FAI

B) DNI $7,700 TTI$300 Personal Exemption ($5,000) Capital Gains $3,000 DNI

4) Taxable Income? $7,700 TTI($3,000) Distribution Deduction $4,700 Taxable Income

TAX EXEMPT INTEREST (TEI) GENERAL RULES Inclusion: IRC 643(a)(5): DNI is taxable income, plus TEI which IRC 103 appliesReduction: IRC 643(a)(5): Reduce the TEI included in DNI by amounts which would be deductible disbursements allocable to such interest but for IRC 265

SIMPLE TRUSTSIRC 651(b): If FAI exceeds DNI, DD is limited to DNI For DD purposes, DNI [or FAI] does NOT include TEI RR 1.651(b)-1: in computing the DD, FAI and DNI do NOT include TEI

Ex: Testamentary trust. “50% income to each A and B annually.” In Y1, $5,400 of TEI, $8,100 of rental income from a PA (phantom income) 1) CALCULATE GROSS INCOME $8,100 Rental Income

$8,100 Gross Income 2) CALCULATE TENTATIVE TAXABLE INCOME (TTI)

$8,100 Gross Income ($300) Personal Exemption $7,800 TTI

3) DISTRIBUTION DEDUCTION A) WHAT IS FAI? $5,400 Net TEI —> Phantom income NOT

$5,400 DNI included in FAI B) WHAT IS DNI?

$7,800 TTI $300 Personal Exemption $5,400 Net TEI $13,500 DNI

C) IS FAI OR DNI LOWER? I) IF FAI IS LOWER, FAI ($5,400) is Tentative DD

D) SUBTRACT NET TEI FROM TENTATIVE DD Tentative DD $5,400

(Net TEI) ($5,400) “Adjusted DNI or Adjusted FAIRTBD” —> DD $0 4) COMPUTE THE TRUST’S TAXABLE INCOME

$7,800 TTI ($0) DD $7,800 Trust’s Taxable Income

5) COMPUTE AMOUNT INCLUDED IN EACH BENEFICIARIES’ INCOME A) IF FAI IS LOWER THAN DNI

A: $2,700 $5,400 x ————— = $2,700

$5,400

B: $2,700 $5,400 x ————— = $2,700

$5,400 6) DETERMINE CHARACTER OF INCLUSIONS A) MAKE A LIST OF ITEMS IN DNI

$8,100 Rental Income (Phantom Income from PA) $5,400 TEI

B) ADJUST OTHER NON-TEI ITEMS OF DEDUCTION : N/A C) DETERMINE TOTAL

$8,100 Rental Income (Phantom Income from PA) $5,400 TEI $13,500 Total DNI

D) DETERMINE CHARACTER A: $8,100 Rental Income (Phantom) $1,620 @ $2,700 x ———————————————— = Ordinary Rates

$13,500 Total DNI

$5,400 TEI $2,700 x ———————————————— = $1,080 @

$13,500 Total DNI 0% Rates

B: $8,100 Rental Income (Phantom) $1,620 @ $2,700 x ———————————————— = Ordinary Rates

$13,500 Total DNI

$5,400 TEI $2,700 x ———————————————— = $1,080 @

$13,500 Total DNI 0% Rates

COMPLEX TRUSTS IRC 661(c): no deduction for any portion of the amount allowed as a DD which is consists of any item of DNI not included in gross income (TEI) RR 1.661(c)-1: SameEx: Testamentary trust. “50% of income annually to A. T can give principal to A.” $18k dividends, $10,800 TEI, $18k of CG. T gives $7,200 principal to A 1) CALCULATE GROSS INCOME $18,000 Dividends


2) CALCULATE TENTATIVE TAXABLE INCOME (TTI) A) FORMULA : $36,000 Gross Income

($100) Personal Exemption $35,900 TTI

B) DEDUCTIBLE INDIRECT EXPENSES : N/A 3) DISTRIBUTION DEDUCTION A) WHAT IS FAIRTBD + OAPCRTBD?

I) FAIRTBD? $18,000 Dividends $10,800 TEI $28,800 FAI

x 50% FAIRTBD Percentage $14,400 FAIRTBD

II) OAPCRTBD? $7,200 OAPCRTBD III) SUM? $14,400 FAIRTBD

$7,200 OAPCRTBD $21,600 FAIRTBD + OAPCRTBD

B) WHAT IS DNI? $35,900 TTI $100 Personal Exemption($18,000) CG $10,800 Net TEI $28,800 DNI

C) IS FAI OR DNI LOWER? I) IF FAIRTBD + OAPCRTBD IS LOWER, ($21,600) is Tentative DD

D) ADJUST FOR TEI $10,800$21,600 x —————— = $8,100 Adjustment

$28,800 for TEI E) CALCULATE DISTRIBUTION DEDUCTION $21,600 Tentative DD

($8,100) Adjustment for TEI $13,500 DD

4) COMPUTE TRUST’S TAXABLE INCOME $35,900 TTI ($13,500) DD $22,400 Taxable Income


I) IF FAIRTBD IS LOWER THAN DNI $14,400 $14,400$14,400 x ——————————— = T1 Inclusion

$14,400 Total FAIRTBD III) CALCULATE REMAINING DNI

$28,800 DNI ($14,400) (FAIRTBD) $14,400 Remaining DNI

B) TIER 2 BENEFICIARIES I) IF OAPCRTBD IS LESS THAN REMAINING DNI $7,200 $7,200

$7,200 x ——————————— = T2 Inclusion $7,200 Total OAPCRTBD

C) DETERMINE TOTAL INCLUSIONS Beneficiary A: $14,400 T1 Inclusion

$7,200 T2 Inclusion $21,600 Beneficiary A’s Total Inclusions

6) DETERMINE CHARACTER OF INCLUSIONS $18,000 Dividends A) MAKE A LIST OF ITEMS IN DNI $18,000 CG

$10,800 Net TEI $28,000 Total DNI

B) ADJUST OTHER NON-TEI ITEMS OF DEDUCTION : N/A C) DETERMINE TOTAL : (See Above) D) DETERMINE CHARACTER $18,000 Dividends $13,500 @

$21,600 x ————————— = Dividend Rates $28,800 Total DNI

$10,800 TEI $8,100 @ $21,600 x ————————— = 0% Rates

$28,800 Total DNI DEDUCTIONS STATUTORY DELEGATION Simple Trusts: IRC 652(b): items entering DNI allocated in accords with regs Complex Trusts: IRC 662(b): items entering DNI allocated in accords with reg

DIRECT EXPENSESDefinition: repairs to, taxes on, other expenses directly attributable to the maintenance of property General Rule: RR 1.652(b)-3(a): All deductions directly attributable to a class of income are allocated to that class of income

INDIRECT EXPENSESDefinition: Trustee commissions, rental of safe deposit boxes, state income taxes, state personal property taxes IF NO TAX-EXEMPT INCOME General Rule: RR 1.652(b)-3(b): Indirect costs can be allocated to ANY item of income included in DNI IF YES TAX-EXEMPT INCOME Allocation: RR 1.652(b)-3(b): some indirect costs must go to TEI in IRC 265Delegation: IRC 265(a)(1): No deduction for indirect cost IRC 212 gives to TEI General Rule: RR 1.212-1(i): Yes deduction for “R amounts paid” by T for O&N admin expenses, even if the trust/estate isn't engaged in T/B Exception: RR 1.212-1(i): No deduction for indirect cost allocated to TEI Application: RR 1.265-1(c): if indirect costs are allocable to both TEI and non-TEI income, “R proportion” [of costs] is given to each, determined in light of all facts and circumstances Reasonable Proportion: RR 1.652(b)-3(b): $10 dividend, $10 rents, & $10 TEI, but $3 of trustee commissions

Effect: $10 of trustee commissions allocated to TEI $20 allocated as trustee elects

Capital Gains: Revenue Ruling 77-355: CGs are NOT included in DNI in IRC 643(a)(3), so CG are NOT included in allocated indirect costs Ex: RR 1.652(b)-3(b): $10 dividend, $10 rents, & $10 TEI, a and $10 CGs, but $3 of trustee commissions

Effect: $10 of trustee commissions allocated to TEI $20 allocated as trustee elects Ex: Testamentary trust. “All income to A annually.” $10,000 of rent, $10,000 of TEI, but $5,000 of T commissions. What amountamount of deduction is allocated against TEI?

$10,000 TEI in DNI $5,000 x —————————— = $2,500 Indirect Expense

$20,000 Total DNI Allocated to TEI Ex: Testamentary trust. “All income to A annually.” $10,000 of rent, $10,000 of TEI, $20,000 of CG, but $5,000 of T commissions. What amount of deduction is allocated against TEI?

$10,000 TEI in DNI $5,000 x —————————— = $2,500 Indirect Expense

$20,000 Total DNI Allocated to TEI

TEI’s Effect on DNI: IRC 643(a)(5): in finding DNI, ONLY include TEI, reduced by indirect expenses allocated to TEI under IRC 265 Effect: RR 1.643(a)-5(a): include Net TEI in DNI

EXCESS EXPENSESDIRECT EXPENSES: RR 1.652(b)-3(d): if direct costs exceed a particular class of income, trustee can allocate excess costs against ANY other class of income Exception: RR 1.652(b)-3(d): Excess costs attributable to TEI can NOT be used to offset any other classes of income Planning Opportunity: Allocate excess expenses to high bracket income INDIRECT EXPENSES: RR 1.652(b)-3(b): if indirect costs exceed a particular class of income, trustee can allocate excess costs to ANY class of income Exception: RR 1.652(b)-3(d): Excess costs attributable to TEI can NOT be used to offset any other classes of income Planning Opportunity: Allocate excess expenses to high bracket income Ex: Trust has $10 rent, $10 dividends, $10 TEI, but $15 of direct rent costs Allocate $10 direct rent costs to rent Allocate $5 remaining rent costs as trustee elects Ex: Trust has $10 rent, $10 dividends, $10 TEI, but $15 of direct TEI costs

Allocate $10 direct TEI costs to TEI Do NOT allocate $5 remaining TEI

SIMPLE TRUSTS EXAMPLE Ex: Testamentary trust. “All income to A annually.” $45,000 of rent, $45,000 of TEI, $120,000 of CG, $30,000 of CL, but $18,000 of trustee commissions (All of which the will requires to be charged to principal) 1) CALCULATE GROSS INCOME $45,000 Rent

$120,000 CG $165,000 Gross Income


($300) (Personal Exemption) ($30,000) (Capital Loss) ($0) (Total Direct Expenses)

($9,000) (Total Deductible Indirect Expenses) (See Below) ($0) (All Other Deductions, Except DD) $125,700 TTI

B) DEDUCTIBLE INDIRECT EXPENSES : $45,000 TEI in DNI

$18,000 x ——————————— = $9,000 $90,000 Total DNI

$45,000 TEI $9,000 (Indirect Expense Allocated to TEI) $36,000 Net TEI

$18,000 Trustee Commissions ($9,000) (Indirect Expense Allocated to TEI) $9,000 Total Deductible Indirect Expense

3) DISTRIBUTION DEDUCTION A) WHAT IS FAI? $45,000 Rent

$45,000 TEI $90,000 FAI

B) WHAT IS DNI? $125,700 TTI $300 Personal Exemption ($120,000) CG$30,000 Capital Losses $36,000 Net TEI $72,000 DNI

C) IS FAI OR DNI LOWER? II) IF DNI IS LOWER, DNI ($72,000) is Tentative DD

D) SUBTRACT NET TEI FROM TENTATIVE DD $72,000 Tentative DD ($36,000) (Net TEI) $36,000 Distribution Deduction

4) COMPUTE THE TRUST’S TAXABLE INCOME $125,700 TTI ($36,000) (DD)

$89,700 Simple Trust’s Taxable Income 5) COMPUTE AMOUNT INCLUDED IN EACH BENEFICIARIES’ INCOME B) IF DNI IS LOWER THAN FAI

$90,000 FAITBD(A) $72,000 DNI x ———————————— = $72,000

$90,000 Total FAIRTBD 6) DETERMINE CHARACTER OF INCLUSIONS A) MAKE A LIST OF ITEMS IN DNI

$45,000 Rent $36,000 Net TEI

B) ADJUST OTHER NON-TEI ITEMS OF DEDUCTION $45,000 Rent ($0) Direct Rent Expenses ($9,000) (Deductible Indirect Expense From Class A) (See Step 2(B))$36,000 Adjusted Rent

C) DETERMINE TOTAL $36,000 Adjusted Rent Income $36,000 Net TEI $72,000 Total DNI

D) DETERMINE CHARACTER $36,000 Adjusted Rent in DNI

$72,000 x ————————————— = $36,000 @ Ordinary Rates $72,000 Total DNI

$36,000 Net TEI in DNI$72,000 x ———————————— = $36,000 @ 0% Rates

$72,000 Total DNI COMPLEX TRUST EXAMPLE Ex: Testamentary trust. “50% of income to A annually. Trustee can give principal to B.” $45,000 of rent, $45,000 of TEI, $9,000 of building maintenance, $9,000 of trustee commissions (50% is charged to income). T distributes $36,000 to B 1) CALCULATE GROSS INCOME $45,000 Rent

$45,000 Gross Income 2) CALCULATE TENTATIVE TAXABLE INCOME (TTI) A) FORMULA : $45,000 Gross Income

($100) Personal Exemption($0) Capital Loss($9,000) Total Direct Expense (Building Maintenance) ($4,500) Total Deductible Indirect Expenses (See Below)

($0) (All Other Deductions, Except DD) $31,400 TTI

B) DEDUCTIBLE INDIRECT EXPENSES :$45,000 TEI in DNI

$9,000 x ——————————— = $4,500 $90,000 Total DNI

$45,000 TEI $4,500 (Indirect Expense Allocated to TEI) $40,500 Net TEI

$9,000 Trustee Commissions ($4,500) (Indirect Expense Allocated to TEI) $4,500 Total Deductible Indirect Expense

3) DISTRIBUTION DEDUCTION A) WHAT IS FAIRTBD + OAPCRTBD?

I) FAIRTBD? $45,000 Rent ($9,000) Direct Expense (Building Maintenance) $45,000 TEI ($4,500) Indirect Costs Allocated to TEI $76,500 FAI x 50% FAIRTBD Percentage $38,250 FAIRTBD

II) OAPCRTBD? $36,000 OAPCRTBD

III) SUM? $38,250 FAIRTBD $36,000 OAPCRTBD

$74,250 FAIRTBD + OAPCRTBD B) WHAT IS DNI?

$31,400 TTI $100 Personal Exemption$40,500 Net TEI $72,000 DNI

C) IS FAI OR DNI LOWER? II) IF DNI IS LOWER, DNI ($72,000) is Tentative DD

D) ADJUST FOR TEI $40,500 Net TEI

$72,000 x ————————— = $40,500 Adjustment for TEI $72,000 Total DNI

E) CALCULATE DISTRIBUTION DEDUCTION $72,000 Tentative DD($40,500) (Adjustment for TEI) $31,500 Distribution Deduction

4) COMPUTE TRUST’S TAXABLE INCOME $31,400 TTI ($31,500) (DD)

$0 Complex Trust’s Taxable Income


I) IF FAIRTBD IS LOWER THAN DNI

$38,250 FAIRTBD(A) $38,250 x ——————————— = $38,250 Tier 1

$38,250 Total FAIRTBD Inclusion

III) CALCULATE REMAINING DNI $72,000 DNI

($38,250) FAIRTBD $33,750 Remaining DNI

B) TIER 2 BENEFICIARIES II) IF REMAINING DNI IS LESS THAN OAPCTBD

$36,000 OAPCRTBD(B) $33,750 x ———————————— = $33,750 Tier 2

$36,000 Total OAPCRTBD Inclusion C) DETERMINE TOTAL INCLUSIONS

Beneficiary A $38,250 T1 Inclusion $0 T2 Inclusion $38,250 Beneficiary A’s Total Inclusions

Beneficiary B $0 T1 Inclusion $33,750 T2 Inclusion $33,750 Beneficiary B’s Total Inclusions 6) DETERMINE CHARACTER OF INCLUSIONS A) MAKE A LIST OF ITEMS IN DNI

$45,000 Rent $40,500 Net TEI

B) ADJUST OTHER NON-TEI ITEMS OF DEDUCTION $45,000 Rental Income ($9,000) Direct Expense (Building Maintenance)($4,500) Total Deductible Indirect Expenses $31,500 Adjusted Rental Income

C) DETERMINE TOTAL $31,500 Adjusted Rent Income $40,500 Net TEI $72,000 Total DNI


A: $31,500 Adjusted Rent in DNI



$72,000 Total DNI

B: $31,500 Adjusted Rent in DNI



$72,000 Total DNI

CAPITAL GAINSGeneral Rule: IRC 643(a)(3): CGs are NOT included in DNIException: CGs ARE included in DNI if: 1) CG ARE NOT ALLOCATED TO PRINCIPAL; OR 2) CG ARE ALLOCATED TO PRINCIPAL, BUT THE CG ARE EITHER: A) PAID, CREDITED, OR REQUIRED TO BE DISTRIBUTED TO A B DURING THE YEAR; OREx: “Proceeds from sale of property must go to B” —> Yes included in DNIEx: Local law: “Underproductive asset proceed to income” —> Yes include in DNI Ex: T terminates the trust and pays the property to Bs —> Yes include in DNI Ex: Trust is SH of S Corp (has CG income, but no distrib.) —> NOT included in DNI RR 1.643(a)-3(b): except for [foreign trusts], CG IS included in DNI if: 1) ONE OF THE FOLLOWING IS MET: A) MANDATORY ALLOCATION

There’s a mandatory allocation of CG to income from either: i) The terms of the trust; or ii) Local Law

RR 1.643(a)-3(b)(1): Uni-Trust Election: CG allocation must be exercised consistently if state law has a defined unitrust amount RR 1.643(a)-3(e), Example 4: “All income to A for life. T can give principal to A. CG go to income.” $5,000 of dividend, $10,000 of CG CG is included in DNI bc the trust allocated CG to DNI Revenue Ruling 85-116: if a court holds that X is allocated to income, it is a mandatory allocation

B) DISCRETIONARY ALLOCATION There’s a discretionary allocation of CG to income by trustee, and allocation is: i) R and impartial; and pursuant to either

I) Local; or II) Trust’s terms (if not banned by local law)

2) AND, ONE OF THE FOLLOWING IS MET: A) CG IS ALLOCATED TO INCOME WITH UNI-TRUST ELECTION

RR 1.643(a)-3(b)(1): If income under state law is defined as a “unit trust amount,” & T’s power to give CG to income is discretionary Limit: Must treat it consistently and the amount can NOT be greater than the uni-trust amount minus the amount of DNI

B) DEEMING POWER RR 1.643(a)-3(b)(2): CG is allocated to principal but is consistently treated as part of a distribution to B Ex: “Income to A for life. T can give principal to A. T has power to deem discretionary distributions to be made from CG realized in the year.” In Y1, $5 dividends, $10 CG. T gives $10 CG to principal, $5 to A. T also distributes $12 to A from T’s discretionary power T didn’t use deeming power to deem discretionary distributions of principal as being paid from CG —> CG is NOT included in DNI But See Ex: Same facts, but T intends to follow a regular practice treating all discretionary distributions of principal as being paid first form net CG realized in that year. T shows this on trust’s first tax return, so that the CG is taxed to A T DID use deeming power to deem discretionary distributions of principal as being paid from CG —> CG IS included in DNI PROF: If you do it in first year, must do it the same in the future!

C) CG IS ALLOCATED TO PRINCIPAL & ACTUALLY DISTRIBUTED TO B RR 1.643(a)-3(b)(3): include CG in DNI when CG is allocated to corpus,

but is actually distributed to B Ex: “T must hold land for 10 years, then sell. All land proceeds to A”

Effect: Sales Proceeds — Basis = CG included in DNI Ex: “All income to A. When A is 35, trust terminates and all to A” Effect: All actually distributed to A, so CG included in DNI Ex: “income to A. 1/3 corpus to A at 40, the rest at 45.” At 40, res is worth $150 ($50 stock, $60 bonds, $30 cash). At 40, T sells stock, gets $45 of CG, makes $75 cash distribution to A. How much CG is in DNI? If Trust & Local Law Let T Decide How Much CG Is Distributed:

Min CG to A: $45 Ordinary Max CG to A: $45 CG $30 CG $30 Ordinary

If Trust & Local Law Do NOT Let T Decide How Much CG Is Distrib.: Max CG $45

Distribution $75 x —————————— = $45 CG Total Distribution $75 in DNI

D) CG IS ALLOCATED TO CORPUS, BUT USED TO DETERMINE THE DISTRIBUTION TO B

RR 1.643(a)-3(b)(3): Include CG in DNI when CG is allocated to corpus but used by T to determine the amount distributed to B Ex: T only makes distributions if T has CG —> Yes included in DNI Ex: T distributes corpus to A equal to CG —> Yes included in DNI Ex: T distributes res to A qual to 1/4 of CG —> 1/4 of CG included

SIMPLE TRUST RULESDISTRIBUTION DEDUCTION IRC 651(a): deduct from taxable income the amount of income that is required to be distributed currently IRC 651(b): DD is the lesser of: 1) Distributable Net Income (DNI); or

2) Fiduciary Accounting Income (FAI) WHAT’S INCLUDE IN BENEFICIARY’S GROSS INCOME? IRC 652(a):1) If FAI Is Less Than DNI:

Include FAIRTBD(B) in Beneficiary’s Gross Income Formula: FAIRTBD(B)

FAI x ——————— Total FAIRTBD

2) If DNI Is Less Than DNI: Include an amount that bears the same ratio to DNI as the FAIRTBD(B) bears to Total FAIRTBD Formula: FAIRTBD(B)

DNI x ——————— Total FAIRTBD

TIMING OF INCLUSIONSIRC 652(a): FAIRTBD(B) is include in B’s gross income in the year it’s required to be distributed, whether or not is has been distributedSteingold: IRS must respect a state court’s order on whether or not an item of income is required to be distributed It does NOT matter what the trust says, follow the court order! Ex: Testamentary trust: “All income to A” Issue: When does the income go to A? Annually? Can T accumulate? Solution: Steingold: If state law is silent, Trustee can go to the state court and get a ruling State court’s order is binding on when income must be distributed Issue: This is inconsistent & inexperienced judges get too much power Sprinkle Trusts: When a trustee must make a distribution of all income, but can “sprinkle” the income between A, B, and C RR 1.651(a)-2(b): It does NOT matter if the specific amount of income that a certain B gets isn’t specified in the trust RR 1.651(a)-2(b): If a T is required to distribute all income currently, but has discretion to “sprinkle” the income among a class of B’s, all income Is required to be distributed currently Ex: “Income to A, B, & C annually. T has discretion to decide what amounts of income each ABC getLate Distributions: RR 1.652(a)-1: Include FAIRTBD(B) in B’s gross income in the year it’s required to be distributed, whether or not is has been distributed Ex: Testamentary trust. “Income to A annually for life, then to B.” Trustee is incompetent and hasn’t made a distribution for 5 years. What happens? Trust gets a DD in Y1-Y5 B includes all the income he would’ve gotten in Y1-Y5 in his income Ex: Testamentary Trust. “Income to A, B, & C annually. T has discretion to determine what amounts of income ABC get.” $12,000 FAI in 2017. In June 2018, T distributes all $12,000 to C. When does C include the $12,000? RR 1.651(a)-2(b) says to include ALL $12,000 in C’s gross income in the year that it should’ve been distributed (2017!) Ex: “All income to kids.” At death, D’s kids are A & B. D has posthumous kid (C) in Y1. C sues for 1/3 of income. In Y5, state court rules that C gets 1/3 of income. Does C include his 1/3 share of income in Y1-Y5? Yes under Steingold and RR 1.651(a)-2(b) (C must amend his returns)

CHARACTER OF INCLUSIONS NORMAL ALLOCATIONS IRC 652(b): amount included in B’s gross income has the same character in the hands of the B as it did in the hands of the trust For this purpose, amounts consist of the same proportion of each class of items entering into DNI as the total of each class bears to total DNI Formula: 1) MAKE A LIST OF ITEMS IN DNI

2) ADJUST OTHER NON-TEI ITEMS OF DEDUCTION (See below) 3) DETERMINE TOTAL DNI (See below) 4) APPLY RATIO

Total Amount Included Class A Asset in DNI

In Each Beneficiary’s x ————————— Gross Income Total DNI

Total Amount Included Class B Asset in DNI In Each Beneficiary’s x ————————— Gross Income Total DNI

EXTRAORDINARY DIVIDENDSGeneral Rule: IRC 643(a): 1) If trust is a simple trust;

2) Then, include extraordinary dividends in DNI Exception: Extraordinary dividends are NOT included in DNI ONLY if: 1) Trust is a simple trust; 2) The trustee, acting in GF, distributed these dividends to the income B 3) And, such dividends are allocable to corpus under the trust/local law Ex: “Income to A for life. T can give principal to A.” T gets $2M from X Corp. T assumes that X Corp is liquidating and allocates all $2M to corpus. In fact, X Corp just gave a really big dividend that year. Is the $2M included in DNI? Meets all of the elements above, so do NOT include dividends in DNI Ex: “Income to A for life. T can give principal to A.” T gets XYZ Corp Stock Dividend from ABC Corp, as a dividend. T distributes $100 of principal to A. Is the stock dividend included in DNI? PROF: If trustee actually distributes the dividend, do NOT include in DNI

COMPLEX TRUST RULESDISTRIBUTION DEDUCTION IRC 661(a): deduct the income that’s required to be distributed currently IRC 651(b): DD is the lesser of: 1) DNI; or

2) FAIRTBD + OAPCRTBDFAIRTBD: amount of FAI for year that’s required to be distributed currently OAPCRTBD: Other amounts that are properly paid, credited, or required to be distributed during the taxable year Ex: Testamentary trust. “50% of income to A annually. Accumulate the rest. A can also get principal.” 48,000 of interest, $30,000 of CG, distributed $18,000 to A1) CALCULATE GROSS INCOME $48,000 Interest





I) FAIRTBD? $48,000 Interest $48,000 FAI x 50% FAIRTBD Percentage $24,000 FAIRTBD




$77,900 TTI $100 Personal Exemption($30,000) CG $48,000 DNI

C) IS FAI OR DNI LOWER? I) IF FAIRTBD + OAPCRTBD (FO) IS LOWER, FO ($42,000) is Tentative DD

4) COMPUTE TRUST’S TAXABLE INCOME $77,900 TTI ($42,000) (DD)

$35,900 Complex Trust’s Taxable Income Ex: Testamentary trust. “50% of income to A annually. Accumulate the rest. When A turns 40, 1/4 of principal to A.” In the year A turns 40, $24,000 of interest, $24,000 of rent, $60,000 of OID. Corpus value is $1.2M1) CALCULATE GROSS INCOME $24,000 Interest

$24,000 Rent$60,000 OID $108,000 Gross Income




I) FAIRTBD? $24,000 Interest $24,000 Rent $48,000 FAI x 50% FAIRTBD Percentage $24,000 FAIRTBD




$107,900 TTI $100 Personal Exemption

$108,000 DNI C) IS FAI OR DNI LOWER?

II) IF DNI IS LOWER, DNI ($108,000) is Tentative DD4) COMPUTE TRUST’S TAXABLE INCOME

$107,900 TTI ($108,000) (DD)

$0 Complex Trust’s Taxable Income EXCLUSION OF SPECIFIC GIFTS & SUMSIRC 663(a)(1): DD does NOT include any amounts that are property paid or credited as a gift/bequest of a specific sum of money/property, which is paid or credited all at once or in not more then 3 installmentsExclusion: Gifts of personal property/household items NOT subject to IRC 663(a) Effect: Beneficiary’s POV: B is NOT taxed on the specific gift

Trust’s POV: Trust IS taxed on the specific gift Elements: the following gifts/bequests are excluded from the DD: 1) GIFT IS NOT A GIFT OF PERSONAL PROPERTY OR HOUSEHOLD ITEMS Ex: “4 cars to A, but Car 1 in Y1, Car 2 in Y2, Car 3 in Y3, and Car 4 in Y4” Gift of personal property NOT subject to IRC 663(a) 2) GIFT IS OF A SPECIFIC SUM/PROPERTY & IS PROPERLY PAID GIFT UNDER TRUST’S TERMS OUTRIGHT GIFTS: yes a specific sum

Ex: D dies with $200 estate. D’s will made a $100 cash bequest to A A is NOT taxed on the $100 cash because it is a specific sum

Ex: D’s will: “Stock #103-110 of X Corp” —> Yes ascertainable Ex: D’s will: “Cash equal to DOD FMV of 8 share” —> Yes ascertainable Ex: D’s will: “All of D’s tangible property” —> Yes ascertainable

PROF: Use of “all my tangible property, and residue” has tax effects ANNUITIES: NOT a specific sum RESIDUARY ESTATE: NOT a specific sum bc admin costs are unknown

Ex: D dies with $200 estate. D’s will gave residuary estate ($100) to A A is taxed on the $100 bc it is NOT a specific sum

MARITAL CREDIT FORMULAS: NOT ascertainable at creation Ex: D’s will: “To my kids, the amx amount that D’s taxable estate for estate tax purposes can be increased without causing tax to be due. The rest to SS” —> NOT a specific sum

TRUSTEE DISCRETION: NOT ascertainable at creation if the property/money is dependent on trustee’s discretion Ex: D’s trust: “10 Share of X Corp when A is 40, but T has discretion to give to A before then” —> NOT ascertainable 3) THE GIFT IS “ASCERTAINABLE” AT DEATH OR AT CREATION OF TRUST GENERAL RULE: RR 1.663(a)-1(b): the amount must be ascertainable at either: A) IF WILL: At the D’s death B) IF INTER VIVOS TRUST: At of trust’s creation WILLS: Ex: D’s will: “1/3 of D’s residuary estate ” —> NOT ascertainable Ex: D’s will: “Cash of $200, but capped at 1/3 of the net value of D’s gross estate for estate tax purposes” —> Yes ascertainable But See Ex: D’s will: “Cash of $200, but capped at 1/3 of the net value of D’s gross estate (after admin expenses)” —> NOT ascertainable Ex: D’s will: “All tangible property outright to SS.” —> YES ascertainable But See Ex: D’s will: “Entire estate outright to SS.” —> NOT ascertainable TRUSTS: Ex: D’s trust: “1/3 of trust principal when A is 40 ” —> NOT ascertainable Ex: D’s trust: “$70 of trust principal when A is 40 ” —> YES ascertainable Ex: D’s trust: “$70 of principal when A is 40, but only if X happens ”

RR 1.663(1)-1(b)(4): YES ascertainable bc, just bc a specific bequest is subject to a condition, does NOT mean it is not a specific sum

4) GIFT IS PAID (UNDER THE TRUST’S TERMS) IN 3 OR LESS INSTALLMENTS; AND GENERAL RULE: IRC 663(a)(1): Must be paid within 3 installments NO TIME STATED: Gifts under D’s will that have no specified time of payment are considered to be paid in a single installment ALL PAID AT ONCE: Gifts payable at any one specified time is deemed to be a single installment Ex: “$20 to A in Y1, $20 in Y2, $20 in Y3” —> Yes 3 installments Ex: “$20 to A in Y1, $20 in Y2, $20 in Y3, $20 in Y4” —> NOT 3 installments Ex: “$60 cash to A.” T satisfies this bequest by giving $15 to A in Y1, $15 in Y2, $15 in Y3, and $15 in Y4 —> Yes 3 installments PROF: Specific gift in 1 installment & T, on his own, decided to break it up Ex: “$20, 8 Shares, D’s car, and my dog to A” —> Yes 3 installments Ex: “$20 to A. Also, TT giving $20 at 35, $20 at 45, & $10 when A marries” RR 1.663-1(c)(1): treat the trust and the outright gift separately $20 Outright: Yes 3 installments (doesn't impact gifts in trust)

Gifts in Trust: Yes 3 installments 5) THE GIFT IS NOT REQUIRED TO BE PAID FROM INCOME

GENERAL RULE: RR 1.663(a)-1(b)(2)(i): NOT a specific bequest if an amount can ONLY be paid or credited from income or accumulated income Ex: “Accumulate income for 10 years. Then, $20 to A in Y12-Y18 and $20 to B and C from income or principal. All the rest (residue) to C” $20 to A: IRC 663(a) does NOT apply bc only comes from income $20 to BC: IRC 663(a) DOES apply bc can come from income OR principal Residuary to C: IRC 663 does NOT apply bc from accumulated income WHAT’S INCLUDE IN BENEFICIARY’S GROSS INCOME? IRC 662(a): Include in a beneficiary’s income the sum of: (1) Tier 1 Distributions; and Amount of income required to be distributed currently to such B, whether distributed or not (2) Tier 2 Distributions All other amounts properly paid, credited, required to be distributed Ex: “25% of income to each A and B. Accumulate the rest. T can pay principal to A, B, or C.” $18,000 dividends, $19,000 CG, $12,000 principal to BOTH B and C1) CALCULATE GROSS INCOME $18,000 Dividends





I) FAIRTBD? $18,000 Dividends $18,000 FAI

x 50% FAIRTBD Percentage —> 25% to A$9,000 FAIRTBD 25% to B





C) IS FAI OR DNI LOWER? I) IF DNI IS LOWER, DNI ($18,000) is Tentative DD

4) COMPUTE TRUST’S TAXABLE INCOME $36,900 TTI ($18,000) DD $18,900 Taxable Income


I) IF FAIRTBD IS LOWER THAN DNI $4,500 FAIRTBD(A) $4,500 is A’s A: $9,000 x ——————————— = T1 Inclusion

$9,000 Total FAIRTBD

B: $4,500 FAIRTBD(B) $4,500 is B’s$9,000 x ——————————— = T1 Inclusion

$9,000 Total FAIRTBD III) CALCULATE REMAINING DNI


B) TIER 2 BENEFICIARIES II) IF REMAINING DNI IS LESS THAN OAPCRTBD B: $12,000 OAPCRTBD(B) $4,500 is B’s


C: $12,000 OAPCRTBD(C) $4,500 is C’s$9,000 x ——————————— = T2 Inclusion

$24,000 Total OAPCRTBD C) DETERMINE TOTAL INCLUSIONS

Beneficiary A: $4,500 T1 Inclusion $0 T2 Inclusion $4,500 Beneficiary A’s Total Inclusions

Beneficiary B: $4,500 T1 Inclusion

$4,500 T2 Inclusion $9,000 Beneficiary A’s Total Inclusions

Beneficiary C: $0 T1 Inclusion $4,500 T2 Inclusion $4,500 Beneficiary A’s Total Inclusions

6) DETERMINE CHARACTER OF INCLUSIONS: (See Below) PAID & CREDITED DEFINITIONIRC 661(a): DD for … or other amounts “properly paid or credited” IRC 662(a): Include in B’s income… amounts that are “properly paid or credited” BINDING PAYMENTS: If payment is irreversible/binding, it is properly paid/credited Ex: Testamentary trust. “T can make payments/distributions for A’s support.” In Y1, T writes a letter to A saying that T intends to give $10 to A, but asks A to sign the letter and return it. A does so, but $10 is not paid until Y2 Yes properly paid or credited But See Ex: Same facts, but T mere writes a sticky note reminding himself to pay A, but T never sent A any letter NOT properly paid or credit bc it was never actually paid IN-KIND PAYMENTS: Yes properly paid or credited Ex: A rents small apartment and T pays $10 monthly rent to landlord Yes properly paid or credited MERE USE OF PROPERTY: NOT properly paid Ex: T, himself, rents an apartment and allows A to live there NOT properly paid or credited bc mere use of property ≠ properly paid

CHARACTERIRC 662(b): Amounts have the same character in the hands of the beneficiary as they did in the hands of the trust, consisting of the same proportion of each class of income interest into DNI bears to total DNI

Ex: “33.33% of income to A and B each annually. T can give principal or corpus to C.” $18,000 dividends, $36,000 interest, $60,000 CG, $18,000 distributive share of PA income (Phantom Income). Trustee distributes $48,000 to C

1) CALCULATE GROSS INCOME $18,000 Dividends$36,000 Interest $60,000 CG$18,000 PA Income (Phantom Income) $132,000 Gross Income




I) FAIRTBD? $18,000 Dividends $36,000 Interest $54,000 FAI

x 66.6% FAIRTBD Percentage —> 33.3% to A$36,000 FAIRTBD 33.3% to B






4) COMPUTE TRUST’S TAXABLE INCOME $131,900 TTI ($72,000) DD $59,900 Taxable Income of Trust


I) IF FAIRTBD IS LOWER THAN DNI A: $18,000 FAIRTBD(A) $18,000 is A’s

$36,000 x ——————————— = T1 Inclusion $36,000 Total FAIRTBD

B: $18,000 FAIRTBD(B) $18,000 is B’s$36,000 x ——————————— = T1 Inclusion

$36,000 Total FAIRTBDIII) CALCULATE REMAINING DNI


B) TIER 2 BENEFICIARIES II) IF REMAINING DNI IS LESS THAN OAPCRTBD C: $48,000 OAPCRTBD(C) $36,000 is C’s



$0 T2 Inclusion $18,000 Beneficiary A’s Total Inclusions

Beneficiary B: $18,000 T1 Inclusion

$0 T2 Inclusion $18,000 Beneficiary B’s Total Inclusions

Beneficiary C: $0 T1 Inclusion

$36,000 T2 Inclusion $36,000 Beneficiary C’s Total Inclusions

6) DETERMINE CHARACTER OF INCLUSIONS A) MAKE A LIST OF ITEMS IN DNI —> CGs are NOT included in DNI!!!

$18,000 Dividends$36,000 Interest $18,000 Phantom PA Income $72,000 Total

B) ADJUST OTHER NON-TEI ITEMS OF DEDUCTION : N/A C) DETERMINE TOTAL : (See Above) D) DETERMINE CHARACTER

A: $18,000 Dividends in DNI

$18,000 x ————————————— = $4,500 @ Dividend Rates $72,000 Total DNI

$36,000 Interest in DNI $18,000 x ———————————— = $9,000 @ Ordinary Rates

$72,000 Total DNI

$36,000 PA Phantom in DNI $18,000 x ———————————— = $4,500 @ Ordinary Rates

$72,000 Total DNI

B: $18,000 Dividends in DNI



$72,000 Total DNI


$72,000 Total DNI

C: $18,000 Dividends in DNI



$72,000 Total DNI


$72,000 Total DNI

IMPACT OF FIDUCIARY POWERSADJUSTMENTS TO PRINCIPAL & INCOME Power to Adjust: UP&IA 104(a): Trustee can adjust between principal and income, to the extent the trustee considers necessary, as long as: 1) Trustee invests & manages trust assets as a prudent investor; 2) Trust describes the amount that may/may not be distributed to B by referring to the trust’s income; and 3) Trustee determines, after applying UP&IA 103(a), that the trustee is unable to comply with UP&IA 103(b) (duty of impartiality) Standard of Review: UP&IA 105(a): court can ONLY change trustee’s adjustment decision if it was an abuse of discretion Court can NOT call it an abuse of discretion merely bc the court would’ve exercised the power to adjust differently

UNITRUSTSConcept: Not in UP&IA, but state law may let trust/trustee elect into the “unitrust regime” where trustee merely says that X% each year is income Redefining Income: EPTL 11-2.4(a): unless trust says otherwise, “net income” from the trust means the “unitrust amount” Unitrust Amount: EPTL 11-1.4(b): “Unitrust Amount” is 4% of the net FMV of the assets held in the trust Election: EPTL 11-2.4(e): Unitrust amount ONLY applies if: 1) The trust says the unitrust amount applies; or 2) Before the last day of the 2nd year of trust’s creation, trustee, with consent/on behalf of all interested person, makes unitrust election Not Respected: RR 1.643(b)-1: If trusts fundamentally departs from “traditional” principals of income and principal, allocation is “generally” NOT respected Yes Respected: RR 1.643(b)-1: allocation between income & principal under local law are respected IF local law (NOT the trust) provides for a “R apportionment” between income & principal beneficiaries of total return of the trust for the year R Apportionment: RR 1.643(b)-1: Yes R apportionment if: 1) State law says income is a unitrust amount of 3-5% of FMV of assets 2) Adjustments to meet trustee’s duty of impartiality usually OK Effect: Income given to a B from a trustee using his “Power to Adjust” would likely be included in FAI and is considered a Tier 1 Inclusion

Ex: “All income to A annually. T can give principal to B.” $9,000 dividends, $9,000 of OID from Zero Coupon Bond. State has Power-to-Adjust law. T adjusts $9,000 of principal to income. T distributes $6,000 principal to B

1) CALCULATE GROSS INCOME $9,000 Dividends$9,000 OID $18,000 Gross Income




I) FAIRTBD? $9,000 Dividends $9,000 Power to Adjust Income—> Likely FAI $18,000 FAI

x 100% FAIRTBD Percentage $18,000 FAIRTBD




$17,700 TTI $300 Personal Exemption $18,000 DNI


4) COMPUTE TRUST’S TAXABLE INCOME $17,700 TTI ($18,000) DD $0 Taxable Income of Trust


I) IF FAIRTBD IS LOWER THAN DNI A: $18,000 FAIRTBD(A) $18,000 is A’s

$18,000 x ——————————— = T1 Inclusion $18,000 Total FAIRTBD

III) CALCULATE REMAINING DNI $18,000 DNI($18,000) (FAIRTBD) $0 Remaining DNI

B) TIER 2 BENEFICIARIES II) IF REMAINING DNI IS LESS THAN OAPCRTBD B: $6,000 OAPCRTBD(C) $0 is B’s

$0 x ——————————— = T2 Inclusion $6,000 Total OAPCRTBD

C) DETERMINE TOTAL INCLUSIONS Beneficiary A: $18,000 T1 Inclusion —> Power to Adjust

$0 T2 Inclusion Income is T1 Inclusion $18,000 Beneficiary A’s Total Inclusions

Beneficiary B: $0 T1 Inclusion $0 T2 Inclusion $0 Beneficiary B’s Total Inclusions

Ex: “All income to A annually. 25% of principal to B at 50.” State is NOT a UP&IA state, but D’s will says UP&IA controls adjustments. At 50, T makes adjustment for of income to principal. Trustee distributes to B What is the effect? Under RR 1.643(b)-1, NOT respected bc the trust (governing instrument), NOT local law, is telling trustee what to do (if respected, it’d be a simple trust) Effect: T’s conversion of principal into income is not respected, meaning that it is a complex trust when B turns 50 bc trustee distributed principal Means that B has phantom income

ANNUITIES GENERAL RULE: ONLY applies to complex trusts!!! DISTRIBUTION DEDUCTION: IRC 661(a): For complex trusts, DD is FAIRTBD (including amounts required to be distributed which may be paid out of income or corpus, to the extent such amount is paid out of income for the year) plus OAPCRTBD AMOUNT INCLUDED IN B’S INCOME: IRC 662(a)(1): include in B’s gross income sum of [Tier 1 Inclusions] (which includes amounts required to be paid from income or corpus, to the extent that such amount is paid out of income for the year)… Treatment: RR 1.662(a)-2(c): If an annuity is required to be paid in all events (whether from income or corpus), it qualifies as a [Tier 1 Inclusion] to the extent that there is income not paid or credited to other Bs for the year If an annuity (or part of an annuity) is deemed to be FAIRTD, it is treated in the same manner as a [Tier 1 Inclusion] FORMULA: 5) COMPUTE AMOUNT INCLUDED IN EACH BENEFICIARIES’ INCOME A) DETERMINE WHETHER ANNUITY IS A TIER 1 OR TIER 2 INCLUSION I) FAIRTBD IS NOW “ACTUAL FAIRTBD” II) CALCULATE OFAIPC

I) IF OA PCRTBD PAID FROM PRINCIPAL:OF AIPC IS $0

II) IF OA PCRTBD PAID FROM INCOME:OF AIPC IS OAPCRTBD

III) CALCULATE RESIDUAL FAI FAI(Actual FAIRTBD) (OFAIPC) Residual FAI

IV) IS THE ANNUITY PAYMENT OR RESIDUAL FAI LOWER? I) IF RESIDUAL FAI IS LOWER:

RESIDUAL FAI IS DEEMED FAIRTBD II) IF ANNUITY IS LOWER:

ANNUITY IS DEEMED FAIRTBD V) IS DEEMED FAIRTBD A T1 OR T2 INCLUSION?

I) IF OAPCRTBD IS PAID FROM PRINCIPAL:DEEMED FAIRTBD IS T1 INCLUSION

II) IF OAPCRTBD IS PAID FROM INCOME:DEEMED FAIRTBD IS T2 INCLUSION

B) CALCULATE OTHER TIER 1 INCLUSIONS I) IF FAIRTBD IS LOWER THAN DNI

FAIRTBD(B) FAIRTBD x —————————— = Tier 1

Total FAIRTBD Inclusion II) IF DNI IS LOWER THAN FAIRTBD

FAIRTBD(B) DNI x ——————————— = Tier 1

Total FAIRTBD Inclusion III) CALCULATE REMAINING DNI

I) IF DEEMED FAIRTBD IS T1 INCLUSION DNI

(FAIRTBD) (Deemed FAIRTBD) Remaining DNI

II) IF DEEMED FAIRTBD IS T2 INCLUSION DNI

(FAIRTBD) Remaining DNI

C) TIER 2 BENEFICIARIES I) IF OAPCRTBD IS LESS THAN REMAINING DNI

OAPCRTBD(B) OAPCRTBD x ————————— = Tier 2

Total OAPCRTBD Inclusion

II) IF REMAINING DNI IS LESS THAN OAPCTBD OAPCRTBD(B)

Remaining DNI x ————————— = Tier 2 Total OAPCRTBD Inclusion

C) DETERMINE TOTAL INCLUSIONS

Beneficiary A: T1 Inclusion T2 Inclusion Beneficiary A’s Total Inclusions

Beneficiary B: T1 Inclusion T2 Inclusion Beneficiary B’s Total Inclusions

Example: ANNUITY PAID FROM PRINCIPALEx: “50% of income to A annually. T must pay $27,000 to B (annuity). T has discretion (T may) distribute income or principal to C.” $90,000 FAI, $72,000 DNI. T distributes $45,000 principal to C. $27,000 is paid from principal 5) COMPUTE AMOUNT INCLUDED IN EACH BENEFICIARIES’ INCOME A) DETERMINE WHETHER ANNUITY IS A TIER 1 OR TIER 2 INCLUSIOPN I) FAIRTBD IS NOW “ACTUAL FAIRTBD” ($45,000) II) CALCULATE OFAIPC

I) IF OA PCRTBD PAID FROM PRINCIPAL: (Yes)OF AIPC IS $0

III) CALCULATE RESIDUAL FAI $90,000 FAI ($45,000) (Actual FAIRTBD) ($0) (OFAIPC) $45,000 Residual FAI

IV) IS THE ANNUITY PAYMENT OR RESIDUAL FAI LOWER? II) IF ANNUITY IS LOWER:

ANNUITY ($27,000) IS DEEMED FAIRTBD V) IS DEEMED FAIRTBD A T1 OR T2 INCLUSION?

I) IF OAPCRTBD IS PAID FROM PRINCIPAL:DEEMED FAIRTBD ($27,000) IS T1 INCLUSION


A: $45,000 FAIRTBD(B)

$45,000 x —————————— = $45,000 Tier 1 Inclusion $45,000 Total FAIRTBD

III) CALCULATE REMAINING DNI I) IF DEEMED FAIRTBD IS T1 INCLUSION

$72,000 DNI ($45,000) (FAIRTBD)

($27,000) (Deemed FAIRTBD) $0 Remaining DNI

C) TIER 2 BENEFICIARIES II) IF REMAINING DNI IS LESS THAN OAPCTBD

B: $0 OAPCRTBD(B) $0 x ———————————— = $0 Tier 2 Inclusion

$45,000 Total OAPCRTBD

C: $45,000 OAPCRTBD(B) $0 x ———————————— = $0 Tier 2 Inclusion




Beneficiary B: $27,000 T1 Inclusion $0 T2 Inclusion $0 Beneficiary B’s Total Inclusions

Beneficiary C: $0 T1 Inclusion $0 T2 Inclusion $0 Beneficiary B’s Total Inclusions

Example: ANNUITY PAID FROM INCOME Ex: “50% of income to A annually. T must pay $27,000 to B (annuity). T has discretion (T may) distribute income or principal to C.” $90,000 FAI, $72,000 DNI. T distributes $45,000 principal to C. $27,000 is paid from income 5) COMPUTE AMOUNT INCLUDED IN EACH BENEFICIARIES’ INCOME A) DETERMINE WHETHER ANNUITY IS A TIER 1 OR TIER 2 INCLUSIOPN I) FAIRTBD IS NOW “ACTUAL FAIRTBD” ($45,000) II) CALCULATE OFAIPC

II) IF OA PCRTBD PAID FROM INCOME: (Yes)OF AIPC IS OAPCRTBD ($45,000)

III) CALCULATE RESIDUAL FAI $90,000 FAI ($45,000) (Actual FAIRTBD) ($45,000) (OFAIPC) $0 Residual FAI

IV) IS THE ANNUITY PAYMENT OR RESIDUAL FAI LOWER? II) IF RESIDUAL FAI IS LOWER:

RESIDUAL FAI ($0) IS DEEMED FAIRTBD V) IS DEEMED FAIRTBD A T1 OR T2 INCLUSION?

II) IF OAPCRTBD IS PAID FROM INCOME:DEEMED FAIRTBD ($0) IS T2 INCLUSION


A: $45,000 FAIRTBD(B)

$45,000 x —————————— = $45,000 Tier 1 Inclusion $45,000 Total FAIRTBD

III) CALCULATE REMAINING DNI II) IF DEEMED FAIRTBD IS T2 INCLUSION


C) TIER 2 BENEFICIARIES II) IF REMAINING DNI IS LESS THAN OAPCTBD

B: $27,000 OAPCRTBD(B) $27,000 x ———————————— = $10,125 T2 Inclusion


C: $45,000 OAPCRTBD(B) $27,000 x ———————————— = $16,875 T2 Inclusion




Beneficiary B: $0 T1 Inclusion $10,125 T2 Inclusion $10,125 Beneficiary B’s Total Inclusions

Beneficiary C: $0 T1 Inclusion $16,875 T2 Inclusion $16,875 Beneficiary B’s Total Inclusions

65 DAY RULECONCEPT: Trustee can distribute $X within the first 65 days of Year 2, but have it treated as if it were distributed in Year 1 GENERAL RULE: IRC 663(b)(1): If, within the first 65 days of the trust’s taxable year, an amount is properly paid or credited, such amount is considered to be paid or credited on the last day of the previous yearELECTION: IRC 663(b)(2): 65 Day Rule ONLY applies if trustee elects RR 1.663(b)-2(a)(1): If a trust return is required to be filed in the year the election is made, trustee must make the election on the return Timing: Election must be no later than the time to file the return Irrevocable: election is irrevocable after the last day for making the election AMOUNT ALLOWED: RR 1.663(b)-1(a)(2)(i): amount of money that can be allocated from Year 2 to the previous year (Year 1) can NOT exceed: 1) The Greater Of: A) The Amount FAI in Year 1

B) The Amount of DNI in Year 1 2) Minus, Amounts Paid, Credited, Required to Be Distributed in Y1 (PCRTBD) FORMULA: 1) WHICH IS GREATER? A) FAI IN YEAR 1 B) DNI IN YEAR 1 2) ACTUAL AMOUNTS PAID, CREDITED, REQUIRED TO BE DISTRIBUTED (PCRTBD) IN YEAR 1?

FAIRTBD Actually Distributed in Year 1OAPCRTBD In Year 1 Actual Amounts PCRTBD

3) COMPUTE THE 65-DAY ELECTION MAXIMUM Greater of FAI In Year 1 or DNI In Year 1(Actual Amounts PCRTBD) 65-Day Election Maximum

4) COMPUTE REVISED AMOUNT INCLUDED IN BENEFICIARY’S INCOME IN YEAR 1 A) TIER 1 BENEFICIARIES

I) IF FAIRTBD IS LOWER THAN DNI FAIRTBD(B) FAIRTBD x —————————— = Tier 1

Total FAIRTBD Inclusion

II) IF DNI IS LOWER THAN FAIRTBD FAIRTBD(B)

DNI x ——————————— = Tier 1 Total FAIRTBD Inclusion

III) CALCULATE REMAINING DNI DNI

(FAIRTBD) Remaining DNI

B) TIER 2 BENEFICIARIES I) CALCULATE OAPCRTBD

OAPCRTBD in Year 1 65 Day-Election MaximumOAPCRTBD

II) IF OAPCRTBD IS LESS THAN REMAINING DNI OAPCRTBD(B) OAPCRTBD x ————————— = Tier 2

Total OAPCRTBD Inclusion III) IF REMAINING DNI IS LESS THAN OAPCTBD

OAPCRTBD(B) Remaining DNI x ————————— = Tier 2

Total OAPCRTBD Inclusion C) DETERMINE TOTAL INCLUSIONS :

Beneficiary A: T1 Inclusion T2 Inclusion Beneficiary A’s Total Inclusions

Beneficiary B: T1 Inclusion

T2 Inclusion Beneficiary B’s Total Inclusions

4) COMPUTE AMOUNT DEEMED DISTRIBUTED IN YEAR 2 Amount Actually Distributed in Year 2 (65 Day-Election Maximum) Deemed Distribution in Year 2

PLANNING OPPORTUNITIES: 1) IF DNI IS GREATER THAN FAI Likely causes more taxes for the B whom we elect to apply the 65 Day Rule to (See Example: DNI Greater Than FAI) 2) IF FAI IS GREATER THAN DNI Can effectively give tax distributions to higher-bracket beneficiaries by making the 65-Day Rule Election (See Example FAI Greater Than DNI)

Effect: Can shift tax distributions to high-bracket TPs by election

Example: DNI GREATER THAN FAI Ex: “50% of income to A annually. The balance to B in T’s discretion.” In Y1, trust has $5,400 of FAI and $13,500 of DNI. T distributes $4,500 to B on September 1 of Year 1. T distributes $7,200 to B in Year 2. T makes 65-Day election 1) WHICH IS GREATER? A) FAI IN YEAR 1 ($5,400) B) DNI IN YEAR 1 ($13,500)2) ACTUAL AMOUNTS PAID, CREDITED, REQUIRED TO BE DISTRIBUTED (PCRTBD) IN YEAR 1?

$2,700 FAIRTBD Actually Distributed in Year 1$4,500 OAPCRTBD In Year 1 $7,200 Actual Amounts PCRTBD

3) COMPUTE THE 65-DAY ELECTION MAXIMUM $13,500 Greater of FAI In Year 1 or DNI In Year 1($7,200) (Actual Amounts PCRTBD) $6,300 65-Day Election Maximum


I) IF FAIRTBD IS LOWER THAN DNI $2,700 FAIRTBD(B) $2,700 x —————————— = $2,700 Tier 1



($2,700) (FAIRTBD) $10,800 Remaining DNI


$4,500 OAPCRTBD in Year 1 $6,300 65 Day-Election Maximum $10,800 OAPCRTBD

II) IF OAPCRTBD IS LESS THAN REMAINING DNI $10,800 OAPCRTBD(B) $10,800 x ———————————— = $10,800 Tier 2



Beneficiary B: $0 T1 Inclusion $10,800 T2 Inclusion $10,800 Beneficiary B’s Total Inclusions

4) COMPUTE AMOUNT DEEMED DISTRIBUTED IN YEAR 2 $7,200 Amount Actually Distributed in Year 2 ($6,300) (65 Day-Election Maximum) $900 Deemed Distribution in Year 2

Example: FAI GREATER THAN DNI Ex: “50% of income to A annually. The balance to B in T’s discretion.” In Y1, trust has $13,500 of FAI and $5,400 of DNI. T distributes $4,500 to B on September 1 of Year 1. T distributes $7,200 to B in Year 2. T makes 65-Day election 1) WHICH IS GREATER? A) FAI IN YEAR 1 ($13,500) B) DNI IN YEAR 1 ($5,400)2) ACTUAL AMOUNTS PAID, CREDITED, REQUIRED TO BE DISTRIBUTED (PCRTBD) IN YEAR 1?

$6,750 FAIRTBD Actually Distributed in Year 1$4,500 OAPCRTBD In Year 1 $11,250 Actual Amounts PCRTBD

3) COMPUTE THE 65-DAY ELECTION MAXIMUM $13,500 Greater of FAI In Year 1 or DNI In Year 1($11,250) (Actual Amounts PCRTBD) $2,250 65-Day Election Maximum


II) IF DNI IS LOWER THAN FAIRTBD $6,750 FAIRTBD(B) $5,400 x —————————— = $5,400 Tier 1



($5,400) (FAIRTBD) $0 Remaining DNI


$4,500 OAPCRTBD in Year 1 $2,250 65 Day-Election Maximum $2,250 OAPCRTBD

III) IF REMAINING DNI IS LESS THAN OAPCRTBD $2,250 OAPCRTBD(B) $0 x ———————————— = $0 Tier 2



Beneficiary B: $0 T1 Inclusion $0 T2 Inclusion $0 Beneficiary B’s Total Inclusions

4) COMPUTE AMOUNT DEEMED DISTRIBUTED IN YEAR 2 $7,200 Amount Actually Distributed in Year 2 ($2,250) (65 Day-Election Maximum) $4,950 Deemed Distribution in Year 2

DEPRECIATION & DEPLETION GENERAL RULES Concept: deductions given directly to beneficiary instead of to the trust or estateDepreciation: IRC 167(a): R allowance for wear/tear for assets used in T/BDepletion: IRC 611(a): yes depletion for mines, O&G, timber

TRUSTSGeneral Rule: IRC 642(f): trust is allowed depreciation/depletion deduction ONLY to the extent not allowed to the beneficiaries under IRC 167(d) or IRC 611(b) Apportionment: IRC 167(d): Deduction is apportioned between income beneficiaries and the trust either: 1) In accords with the trust’s terms; or 2) If no trust provision, on the basis of trust “income” allocable to each IRC 643: Income does NOT mean FAI bc IRC 167 is NOT in Subpart B, C, D Effect: Use trust income to determine how much of a deduction the trust gets, and how much the beneficiaries getException: Depreciation Reserves: RR 1.167(h)-1(b): do NOT follow the above if the trust (or local law) requires or permits the trustee (or gives T discretion) to maintain a “reserve for depletion” (Depreciation Reserves) Effect: If Depletion Reserve, deduction is first allocated to trust to the extent that income is set aside for the Depreciation Reserve Excess: Extra deduction is apportioned between income Bs and the trust on the basis of trust income allocable to each Not Respected: allocation of Depreciation Reserves which gives B/trust more than his pro rata share of income is NOT respected (unless local law or trust require/permit T to do so) Ex: “All income to A annually, then to B.” Trust has $0 gross income, $0 FAI, ($9,000) deprecation, ($9,000) trustee commissions Effect: A gets $9,000 depreciation deduction bc it does NOT matter if there was FAI, it is based on the FAI that would be allocable Depreciation Reserves: UP&IA 503(b): trustee can transfer to principal a R amount of net cash receipts/income from a depreciable asset Exception: Trustee can NOT transfer any amount for depreciation: (1) Of that portion of property used by B as a residence or for personal use (2) Or, during the admin of D’s estate No Separate Fund: UP&IA 503(c): amounts transferred to principal need NOT be held in a separate fund

ESTATESGeneral Rule: IRC 642(f): estate allowed depreciation/depletion deduction ONLY to the extent not allowed to the beneficiaries under IRC 167(d) or IRC 611(b) Apportionment: Allocable deduction is apportioned between heirs on the basis of the income of the estate allocable to each RR 1.167(h)-1(c): Same

ESTATES FORMULA1) COMPUTE TOTAL COST RECOVERY DEDUCTION (TOTAL CRD) Concept: How much total depreciation or depletion is there? 2) COMPUTE EACH B’S SHARE OF FAI Concept: Amount of FAIRTBD distributed to each B 3) COMPUTE EACH B’S & THE ESTATE’S SHARE OF CRD A) SHARE OF TOTAL CRD Beneficiary A:

A’s Share of FAI Total CRD x ———————— = A’s Share of Total CRD

Total FAI Beneficiary B:

B’s Share of FAI Total CRD x ———————— = B’s Share of Total CRD

Total FAI Estate:

Estate’s Share of FAI

Total CRD x ————————— = Trust’s Share of Total CRD Total FAI

TRUSTS FORMULA1) COMPUTE TOTAL COST RECOVERY DEDUCTION (TOTAL CRD) Concept: How much total depreciation or depletion is there? 2) COMPUTE UNRESERVED FAI Concept: What is FAI before any depletion or depreciation is given? 3) COMPUTE RESERVED AMOUNT Concept: How much of Unreserved FAI is reserved for depreciation under the trust, local law, or trustee’s discretion? 4) COMPUTE REMAINING CRD

Total CRD(Reserve Amount) Remaining CRD

5) COMPUTE FAI AFTER RESERVES FOR DEPRECIATION FAI(Reserve Amount) FAI After Reserves for Deprecation

6) COMPUTE EACH B’S AND TRUST’S SHARE OF FAI Concept: Amount of FAIRTBD distributed to each B 7) COMPUTE EACH B’S SHARE OF TOTAL CRD A) SHARE OF TOTAL CRD Beneficiary A:

A’s Share of FAI Remaining CRD x ———————— = A’s Share of Total CRD

Total FAI Beneficiary B:

B’s Share of FAI Remaining CRD x ———————— = B’s Share of Total CRD

Total FAI Trust:

Trust’s Share of FAI Remaining CRD x ————————— = Trust’s Share of Total CRD

Total FAI

B) COMPARE TO EACH B’S PRO RATE SHARE OF TRUST INCOME I) COMPARISON: Share of Total CRD Pro Rata Share

Beneficiary A: Beneficiary B:

II) IF B’S SHARE OF TOTAL CRD IS LESS THAN B’S PRO RATA SHARE: ALLOCATION IS RESPECTED: allocate in proportion to how much FAI each B and the trust got III) IF B’S PRO RATA SHARE IS LESS THAN B’S SHARE OF TOTAL CRD: ALLOCATION MAYBE RESPECTED: ONLY respected if trust requires or permits T to keep a depreciation reserve

8) COMPUTE THE TRUST’S SHARE OF TOTAL CRD A) TRUST’S SHARE OF REMAINING CRD

Trust’s Share of FAI Remaining CRD x ———————— = Trust’s Share of Total CRD

Total FAI

B) TRUST’S SHARE OF TOTAL CRD

Reserve AmountTrust’s Share of Remaining CRD Trust’s Share of Total CRD

Example: YES DEPLETION RESERVEEx: “50% of income to A annually. T can give B the rest of the income in T’s discretion. T can give a R proportion of rental income to principal as a reserve.” $18,000 rent and trustee gives $9,000 of this to principal (Depletion reserve). T distributes $2,250 to B. $45,000 depreciation deduction1) COMPUTE TOTAL COST RECOVERY DEDUCTION (TOTAL CRD) ($45,000) 2) COMPUTE UNRESERVED FAI ($18,000)3) COMPUTE RESERVED AMOUNT ($9,000)4) COMPUTE REMAINING CRD

$45,000 Total CRD($9,000) (Reserve Amount) $36,000 Remaining CRD

5) COMPUTE FAI AFTER RESERVES FOR DEPRECIATION $18,000 FAI($9,000) (Reserve Amount) $9,000 FAI After Reserves for Deprecation

6) COMPUTE EACH B’S SHARE OF FAIBeneficiary A: $4,500 (A gets 50% of income) Beneficiary B: $2,250 (B gets 25% of income) Trust: $2,250 (Trust gets 25% of income)

7) COMPUTE EACH B’S SHARE OF TOTAL CRD A) SHARE OF TOTAL CRD Beneficiary A:

$4,500 A’s Share of FAI $36,000 x ——————————— = $18,000 A’s Share of

$9,000 Total FAI Total CRD Beneficiary B:

$2,250 B’s Share of FAI $36,000 x ——————————— = $9,000 B’s Share of

$9,000 Total FAI Total CRD


Beneficiary A: $18,000 < $4,500 Beneficiary B: $9,000 < $2,250

II) IF B’S SHARE OF TOTAL CRD IS LESS THAN B’S PRO RATA SHARE: ALLOCATION IS RESPECTED: allocate in proportion to how much FAI each B and the trust got


$2,250 Trust’s Share of FAI $36,000 x ———————————— = $9,000 Trust’s Share of

$9,000 Total FAI Remaining CRD

B) TRUST’S SHARE OF CRD

$9,000 Reserve Amount$9,000 Trust’s Share of Remaining CRD $18,000 Trust’s Share of Total CRD

Example: NO DEPLETION RESERVEEx: “50% of income to A annually. T can give B the rest of the income in T’s discretion. T can give a R proportion of rental income to principal as a reserve.” $18,000 rent and trustee gives $0 of this to principal (Depletion reserve). T distributes $2,250 to B. $45,000 depreciation deduction1) COMPUTE TOTAL COST RECOVERY DEDUCTION (TOTAL CRD) ($45,000) 2) COMPUTE UNRESERVED FAI ($18,000)3) COMPUTE RESERVED AMOUNT ($0)4) COMPUTE REMAINING CRD

$45,000 Total CRD($0) (Reserve Amount) $45,000 Remaining CRD

5) COMPUTE FAI AFTER RESERVES FOR DEPRECIATION $18,000 FAI($0) (Reserve Amount) $18,000 FAI After Reserves for Deprecation

6) COMPUTE EACH B’S SHARE OF FAIBeneficiary A: $9,000 (A gets 50% of income) Beneficiary B: $4,500 (B gets 25% of income) Trust: $4,500 (Trust gets 25% of income)







Beneficiary A: $22,500 < $9,000 Beneficiary B: $11,250 < $4,500






$0 Reserve Amount$11,250 Trust’s Share of Remaining CRD $11,250 Trust’s Share of Total CRD

Example: NO DEPLETION RESERVEEx: “T can distribute income/principal to A or B for 10 years. After 10 years, to A and B equally.” $36,000 rent, $18,000 depreciation. T distributes $18,000 to A out of income and $18,000 to B from principal

1) COMPUTE TOTAL COST RECOVERY DEDUCTION (TOTAL CRD) ($18,000) 2) COMPUTE UNRESERVED FAI ($36,000)3) COMPUTE RESERVED AMOUNT ($0)4) COMPUTE REMAINING CRD

$18,000 Total CRD($0) (Reserve Amount) $18,000 Remaining CRD

5) COMPUTE FAI AFTER RESERVES FOR DEPRECIATION $36,000 FAI($0) (Reserve Amount) $36,000 FAI After Reserves for Deprecation

6) COMPUTE EACH B’S SHARE OF FAIBeneficiary A: $18,000 (A gets 50% of income) Beneficiary B: $0 (B gets 0% of income) Trust: $18,000 (Trust gets 50% of income)




$0 B’s Share of FAI $18,000 x ——————————— = $0 B’s Share of



Beneficiary A: $9,000 < $18,000Beneficiary B: $9,000 < $2,250






$0 Reserve Amount$9,000 Trust’s Share of Remaining CRD $9,000 Trust’s Share of Total CRD

Example: NOT RESPECTED Ex: “All income to A annually for life, then to B. T can allocate depreciation as T deems fit.” $9,000 rent, but T transfers $4,500 of this to principal under UP&IA 503 (Depreciation reserves). Building has $9,000 of depreciation. T allocates all CRD to A. What is A’s share of total CRD?

1) COMPUTE TOTAL COST RECOVERY DEDUCTION (TOTAL CRD) ($9,000) 2) COMPUTE UNRESERVED FAI ($9,000)3) COMPUTE RESERVED AMOUNT ($4,500)4) COMPUTE REMAINING CRD

$9,000 Total CRD($4,500) (Reserve Amount) $4,500 Remaining CRD

5) COMPUTE FAI AFTER RESERVES FOR DEPRECIATION $9,000 FAI($4,500) (Reserve Amount) $4,500 FAI After Reserves for Deprecation

6) COMPUTE EACH B’S SHARE OF FAIBeneficiary A: $4,500 (A gets all the income)





Beneficiary A: $4,500 > $9,000 III) IF B’S PRO RATA SHARE IS LESS THAN B’S SHARE OF TOTAL CRD: ALLOCATION MAYBE RESPECTED: NOT respected bc trust doesn't give trustee to power to allocate all of the CRD to A

Example: ESTATEEx: D’s will gives all stock to A and all rental property to B. In Y1 of the estate, PR pays $3,000 of income form stocks to A and $3,000 of rental income to B. Estate has $12,000 of depreciation deductions from the rental property 1) COMPUTE TOTAL COST RECOVERY DEDUCTION (TOTAL CRD) ($12,000) 2) COMPUTE EACH B’S SHARE OF FAI

Beneficiary A: $3,000 (A gets 50% of income - Stock) Beneficiary B: $3,000 (B gets 50% of income - Rent) Estate: $0 (Estate gets 0% of income)

3) COMPUTE EACH B’S & THE ESTATE’S SHARE OF TOTAL CRD A) BENEFICIARIES SHARE OF TOTAL CRD Beneficiary A:





B) ESTATE’S SHARE OF TOTAL CRD

$0 Estate’s Share of FAI $12,000 x ———————————— = $0 Estate’s Share of


MISCELLANEOUS ITEMIZED DEDUCTIONSGENERALLY IRC 67(b): NOT a MID if it is: 1) Interest deduction under IRC 163

2) S&L Tax deduction under IRC 1643) Casualty losses under IRC 165(a)4) T/B losses5) Charitable deduction under IRC 170

IRC 67(e): the following are deductions for trusts and estates, without 2% AGI floor: 1) Deductions for costs incurred in connection with trust or estate

admin, which would NOT have been incurred if not in a trust3) Or, personal exemption under IRC 642(b)2) Or, distribution deductions IRC 651 and IRC 661

IRC 67(g): no MIDs can be deduction until 2025Notice 2018-61: IRC 67(g) does NOT apply to IRC 67(e), treat as ATL deductions CATEGORIES OF DEDUCTIONS 1) ATL DEDUCTIONS: Deductions Allowed in Computing AGI A) Deductions under IRC 162 (T/B expenses) B) IRC 642(b) deduction in lieu of personal exemption C) Distribution deduction under IRC 651 and IRC 661 D) Costs paid in connection with trust/estate admin which wouldn’t have been incurred if the property weren’t held in trust

O’Neill: not subject to 2% AGI floorMellon Bank: If expense is uncommon for an individual to incur, then yes deductible for trust/estate Ex: Costs of preparing Form 1041 (trust tax return) —> Yes deductible Ex: Costs to prepare a fiduciary accounting —> Yes deductible Ex: Costs to defend a suit on trust interpretation —> Yes deductible Ex: Condo fees for a trust-owned apartment —> NOT deductible Ex: Fees paid to trust’s investment advisor —> NOT deductible

2) BTL DEDUCTIONS: Deductions NOT Allowed in Computing AGI but NOT MIDs Medical expenses, interest, IRC 642(c) charitable distribution deduction 3) MID: All Other Deductions

COMMISSIONS & BUNDLED FEESGeneral Rule: RR 1.67-4(c): if trust pays a single (bundled) fee which contains deductible and non-deductible costs, then must allocate the cost between the deductible and non-deductible expenses Exception: RR 67-4(c)(2): if bundled fee is not computed on an hourly basis, ONLY the part of the fee attributable to investment advice is subject to 2% AGI floor Reasonable Allocation Method: RR 1.67-4(c): Any “R method” can be used to allocate a bundled fee between deductible and non-deductible costs Factors:1) Percentage of corpus value subject to investment advice

2) Whether a 3rd party advisor would charge comparable fees 3) Amount of T’s attention to trust is devoted to investment advice

DEFINITION OF TRUSTS & ESTATESWHAT IS A TRUST? General Rule: RR 301.7701-4(a): “trust” is arrangement via will or inter vivos declaration where T takes title, to protect it for Bs under chancery court rules Generally speaking, an arrangement is a trust if purpose is to vest T with the responsibility for protection of property for B’s who can't share in these duties and, thus, are NOT in a joint enterprise for profit for T/B Not Always A Trust: Sometimes, for Subchapter J purposes, an arrangement that is called a “trust” is not taxed as a trust, and vice versa Revenue Ruling 56-484: custodial account for a minor is taxed to the minor Revenue Ruling 75-61: a “power in trust” is taxed as a trust Revenue Ruling 76-486: a “pet trust” is taxed as a trust De Bonchamps: Holders of a life estate are taxed as T’s of a trust where they had FD’s to remaindermen that are “clothed with trust characteristics” Termination of Trusts: RR 1.641(b)-3(b): whether a trust has terminated depends on if the property has been distributed to Bs, rather than on the technicality of whether T has rendered a final account No Auto-Termination: Trusts do NOT auto terminate upon an event

Post-Termination: A R time is allowed after termination to perform remaining trust admin duties, R necessary to wind up trust affairs Unduly Postponed: Wind up can NOT be “unduly postponed” and, if corpus distribution is UnR delayed, trust is deemed to terminate after a R period for the T to finish trust’s admin WHAT IS AN ESTATE? Start Of An Estate: RR 1.443-1(a)(2): estate begins on DOD Planning Opportunity: inclusion of income received on DOD creates taxes in D’s final year of life, which can be deducted for estate tax purposes Termination of An Estate: RR 1.641(b)-3(a): Same as trusts SEPARATE SHARES RULE (SSR) COMPLEX TRUSTSIRC 663(c): Solely for DNI calculation, if a single trust has 2+ beneficiaries, then substantially separate and independent shares of different B’s in the trust must be treated as separate trusts Application: RR 1.663(c)-3(a): applicability depends on whether distributions are made in substantially the same manner as if separate trusts were created General Rule: RR 1.663-3(b): SSR does NOT apply to income or corpus distributions to Bs within a group or class Exception: RR 1.663-3(b): SSR DOES apply to such payments if payment of income or corpus of 1 B’s share can NOT affect the proportionate share of income or corpus that another B ESTATES IRC 663(c): Same, so that we treat substantially separate & independent shares of different Bs in an estate as having 2+ B’s as separate estates Ex: Fractional shares of residue (1/2) (1/3) —> SSR DOES apply Ex: Elective share of SS —> SSR DOES apply Ex: Pecuniary formula bequest in “reduce-to-zero” clause —> SSR DOES apply Ex: Income from specifically bequeathed property —> SSR DOES apply Ex: D dies with $540 cash, $90 of deferred comp that D gets in Y2 & Y3. D’s will says: “entire estate to A and B (kids).” D’s SS exercises elective share to get 1/3 of D’s estate. In Y2, D’s PR pays $120 to SS. In Y3, D’s PR pays $120 to SS. In Y4, PR distributes the rest of the estate to the kids No Separate Share Rule: Unfair to SS Year 2: SS’s POV: Deferred Comp: $90 (Taxable) —> $90_

Elective Share: $30 (NOT Taxable) —> $0 | $180 Year 3: SS’s POV: Deferred Comp: $90 (Taxable) —> $90 |Total

Elective Share: $30 (NOT Taxable) —> $0 | Tax Year 4: AB’s POV: 2/3 of Estate: $480 (NOT Taxable)—> $0 _| Yes Separate Share Rule: Year 2: SS’s POV: $120 (25% taxable) —> $30__________

AB’s POV: $0 —> $0 | $180 Year 3: SS’s POV: $120 (25% taxable) —> $30 | Total

AB’s POV: $0 —> $0 | Tax Year 4: AB’s POV: $480 (25% taxable) —> $120 ________|

Ex: “T must pay 50% of income to each A and B, but T can give principal to A or B from the entire corpus” SSR does NOT apply bc ability to “sprinkle” payment to one B affects what the other B gets (if T gives principal to A, less income to A & B next year) Ex: T creates separate share equal in value for each of D’s kids. “T must pay all income to ABC from the earned income on each’s share. T has discretion to give principal to ABC from each of their respective shares” SSR DOES apply bc what T gives A will not affect what B or C get Ex: Sprinkle trust. “T has discretion to sprinkle income/principal to ABC” SSR does NOT apply bc ability to sprinkle payment to A reduces what BC getALLOCATING DNIRR 1.663(c)-2(b)(1): the amount of DNI for any share under IRC 663(c) is computed as a separate trust/estate, based on the proportion of gross income/deduction that’s included/deducted from DNI Allocation: 1) GI that’s included in DNI AND FAI is allocated in accords with the

amount of FAI to which each share is entitled (RR 1.663-2(b)(2)) 2) Phantom income is allocated in same proportion as FAI (-2(b)(4)) 3) IRD, if not FAI, is allocated based on relative values of shares that could potentially be funded with IRS (RR 1.663(c)-2(b)(3)) 4) Deductions & losses that apply solely to one share are NOT

available to the other shares (RR 1.663(c)-2(b)(5))

TAXABLE YEARS Trusts: IRC 644(a): trusts are on calendar year taxable yearEstates: IRC 441: estates need NOT be on the calendar year taxable year Timing Issues: IRC 662(c): if B’s taxable year is different than the trust or estate’s taxable year, the amount of income included in B’s gross income is based on the

DNI and OAPCRTBD a B gets from the trust/estate during the trust/estate’s taxable eyar, ending within or with B’s taxable year Ex: D died in 2016. D’s estate elects a Jan 31, 2017 taxable year. Estate makes a distribution to B on February 15, 2017. B is calendar year TP Estate files it’s tax return in April 2018 (made distribution in its 2018 Year) B “gets” the income in B’s 2018 Year B reports the income in April 2019 (B got income during B’s 2018 Year)

IN-KIND DISTRIBUTIONS1) IS THERE MANDATORY GAIN OR LOSS RECOGNITION? A) MANDATORY RECOGNITION : Yes Sale or Exchange: Kenan Gain: Required distribution of assets to

satisfy a gift is a “sale or other disposition” for IRC 1001 purposes Sold for FMV: RR 1.651(a)-2(d): if distributes assets bc of requirement to distribute all income currently, treat as if trust sold the property for its FMV on the date of distribution Discretionary Distributions: do NOT trigger gain/loss recognition Gain/Loss Recognition: RR 1.661(a)-2(f): yes recognize gain/loss from an in-kind distribution if the distribution is in satisfaction of a right to receive a distribution of: i) Specific dollar amount;

Distribution of assets in lieu of cash is OK ii) Specific assets, other than that distributed Distribution of different assets OK if allowed under local law iii) Income in IRC 643(b) (unitrust income) if it is required to be distributed currently

Residuary Beneficiary: do NOT recognize gain/loss (not specific) Ex: PR distributes 10 shares of stock to ABCD, each of whom got 25% of the residuary estate

Gain is NOT recognized bc not a right to specific property Ex: T has discretion to give corpus to A. T gives 50 shares of Stock to A Gain is NOT recognized, T had discretion so it is NOT “mandatory” Ex: T must distribute $5 to A at 40. T gives 40 shares of Stock ($5 FMV)

Gain IS recognized bc mandatory distribution Ex: PR distributes 40 shares of Stock X to A, even though T was required to distribute 50 share of Stock Y to A. Same FMV Gain IS recognized bc mandatory even though different property

B) IF LOSS IS RECOGNIZED, IS IT DISALLOWED UNDER IRC 267 RELATED PARTY RULES? Trusts: IRC 267(b)(4): trust can NOT deduct loss from sales/exchangesEstates: IRC 267(b)(4): estate can NOT deduct loss from sale/exchange Exception: IRC 267(b)(13): Estates (NOT trusts) CAN deduct losses to meet a specific pecuniary bequest

C) DOES THE GAIN OR LOSS ENTER INTO DNI? 2) IF NOT MANDATORY, SHOULD THE T ELECT TO RECOGNIZE THE GAIN UNDER IRC 643(e)(3)? Election: IRC 643(e)(3)(B): if in-kind distribution is not mandatory, then TP can still elect to recognize gain or loss Irrevocability: Once an election is made, it is irrevocable Scope: Election must be made for ALL distributions in the year, and the full amount of gain must be recognized Loss: NEVER good idea to elect to recognize a loss (disallowed in IRC 267)3) IF IT IS A T2 DISTRIBUTION, WHAT IS THE AMOUNT DEEMED TO HAVE BEEN DISTRIBUTED? IRC 643(e)(2): the amount taken into account for FAIRTBD and OAPCRTBD is the lesser of: A) Basis of the property in B’s hands; or

B) The FMV of the property 4) WHAT IS THE B’S BASIS IN THE PROPERTY? IRC 643(e)(1): basis of the property received by B is the AB plus/minus any gain/loss recognized on distribution Formula: AB of Asset

Gain Recognized (Loss Recognized) AB of Asset in B’s Hands

Tacking: IRC 1223(2): tacking of holding periods IS allowed Ex: D’s will says: “Must give $5,000 to A.” PR meets this in Y3 with Stock X ($4,000 AB, $5,000 FMV). A sells Stock X in Y4 for $6,000

At Distribution: Trust’s POV: $1,000 Gain A’s POV: $5,000 AB

At Sale: A’s POV: $1,000 Gain

Ex: D’s will says: “Must give $5,000 to A.” PR meets this in Y3 with Stock X ($7,000 AB, $5,000 FMV). A sells Stock X in Y4 for $6,000

At Distribution: Trust’s POV: $2,000 Loss (See IRC 267(b)(13)) A’s POV: $5,000 AB

At Sale: A’s POV: $1,000 Gain

Ex: D’s trust says: “Must give $5,000 to A.” PR meets this in Y3 with Stock X ($7,000 AB, $5,000 FMV). A sells Stock X in Y4 for $6,000

At Distribution: Trust’s POV: $0 Loss (See IRC 267(b)) A’s POV: $7,000 AB

At Sale: A’s POV: $0 Gain

home | nyu school of law of trusts... · web viewsimple trusts 1) calculate gross income (do not...

Documents