Tax Planning: Income and Taxation of Trusts and Estates (Module 9)

A trust is a domestic trust if what?

- A U.S. court is able to exercise primary supervision over the administration of the trust (court test) and - One or more U.S. persons have the authority to control all substantial decisions of the trust (control tests).

The fiduciary (or one of the joint fiduciaries) must file Form 1041 for a taxable domestic trust that has what qualities?

- Any taxable income for the tax year, - Gross income of $600 or more (regardless of taxable income), or - A beneficiary who is a non-resident alien.

Mr. Pierce is considering transferring $5,000,000 to a revocable trust or $5,000,000 to an irrevocable trust for his own benefit. Which of the following would be true? 1. If income is distributed from the irrevocable trust to him, it will be taxed as DNI. 2. If income is accumulated in the irrevocable trust, the income is taxed at trust tax rates, not personal tax rates. 3. If income is accumulated in the irrevocable trust, the income will be taxed to Mr. Pierce. 4. The income from the revocable trust will be taxed to Mr. Pierce.

1,3,4 Because the trust was established to benefit its grantor (Mr. Pierce), it is classified as a grantor trust for income tax purposes. The Internal Revenue Code deems this trust to be "tainted" because the trust does not pay tax on its own income. Grantor trust income will be taxed to the grantor. The income distributed is at the discretion of the grantor without the consent of an adverse party.

Which of the following statements concerning a simple trust is incorrect? a. Beneficiaries are never taxed on distributed income. b. The trust is treated as a separate tax entity. c. Accumulation of trust income is not allowed. d. A simple trust can never make distributions of principal or have a charitable beneficiary.

A A simple trust generally must obtain a federal ID number because it must file a tax return. All trust income must be distributed. The trust is treated as a tax entity only subject to a $300 personal exemption. Principal may not be distributed, and no charitable gifts can be made.

Distributable net income (DNI) is a concept that has not been developed for which of the following purposes? a. It advises beneficiaries of the amount of income the trust has earned. b. It establishes the character of the amount taxable to the beneficiaries. c. It limits the deduction a trust may receive for amounts distributed to beneficiaries. d. It limits the amount of distributions that may be taxable to the beneficiaries.

A DNI accounts for the income to the beneficiary.

Jack and Brenda are a married couple living in a community property states. They decide to transfer their community property to a GRAT. Jack passes away during the term of the GRAT. Where is his value of the community interest allocated? Why? a. included in Jack's estate b. Left in the GRAT c. Included in Branda's estate

A If husband and wife transfer community property to a GRAT or GRUT, each may reserve the right to the payment for the trust term as to his or her respective community interest. If either dies during the term, the value of his or her community interest in the trust would be included in his or her taxable estate, either in whole or in part

Mrs. Bell, a grandmother, transferred $1.5 million to an irrevocable trust seventeen years ago. She died this year. Under what circumstance will this trust not be part of her gross estate? a. She received income from the trust for 15 years. Now the income goes to her children. b. She had the power to specify whether income should be accumulated or disbursed annually. c. She received income from the trust for life. After death it will go to her children. d. She had the power to specify the amount of income and the beneficiary of the trust each year.

A Mrs. Bell's right to income had expired (or lapsed), and she has no beneficial enjoyment at death. Answers A and B are subject to beneficial enjoyment exposure (tainted trust rules). Under Answer C, she had a right to income. She retained that income interest at death.

A client should never establish an irrevocable trust that is tainted for both income and estate tax purposes? Why? a. Correct b. Maybe c. Always d. Incorrect, there are usually exceptions

A Tainting an irrevocable trust for both income tax and estate tax serves no purpose. The grantor might as well kept the assets in his or her name. The trust would also cost attorney and accounting fees.

Mr. Lowe (single taxpayer) died this year. He has a $9,000 carryforward capital loss from the prior year. How will his carryforward loss be treated? a. $3,000 can be deducted on the estate's 1041 tax return. b. $9,000 can be deducted in full on the final estate tax return (1041). c. $3,000 can be deducted on the estate's 1041 tax return; the remaining loss is carried forward to next year. d. No capital loss deduction can be claimed after death.

A The loss can be used in the year of death. However, any unused carryforward losses are lost after the year of death.

What type of trusts will protect an individual from a will contest, public scrutiny, or an election against the will if the grantor survives the trust term?

A GRAT, GRUT, or QPRT will protect assets from a will contest, public scrutiny, or an election against the will if the grantor survives the trust term.

Grantor Trusts

A grantor trust is a trust in which the grantor has retained such control of the trust that the IRS taxes the grantor on the trust income as if the trust did not exist. A form of grantor trust that has tax benefits (gift and estate tax) is the grantor retained trust. In this form of trust, the grantor is essentially making a current gift of the right to trust assets to the remainder person at a specified date in the future. Until the grantor's interest expires, such a trust is income taxable to the grantor.

Qualified Personal Residence Trust (QPRT)

A special form of a GRIT in which the grantor transfers his home to the QPRT and receives "use" of the personal residence as the annuity. The remainder interest of the trust passes to a non-charitable beneficiary.

Grantor Retained Income Trust (GRIT)

An irrevocable trust in which the grantor retains an income interest in the trust for the term of the trust. Thus, the grantor will donate property to the trust and the income from the asset will be distributed to the grantor during the term of the trust. At the end of the trust term, the remaining property is distributed to the beneficiary (remainderman)

Grantor Retained Unitrust (GRUT)

An irrevocable trust that annually pays a fixed percentage of the value of its assets (as revalued on an annual basis) to the grantor or (settlor) for some defined term, and pays the remainder interest of the trust to a non-charitable beneficiary.

Grantor Retained Annuity Trust (GRAT)

An irrevocable trust that pays a fixed annuity to the grantor (settlor) for some defined term, and pays the remainder interest of the trust to a non-charitable beneficiary.

For calendar year estates and trusts, Form 1041 and Schedule K-1 must be filed on or before ______________ for the prior year.

April 15, 20xx

Mr. O'Toole as part of his divorce instrument establishes a trust to provide support for his minor children. The income generated by the trust will be taxed to which of the following? a. The trust b. Mr. O'Toole c. Mr. O'Toole's children d. Mrs. O'Toole as child support payments

B If the trust income is used to satisfy a grantor's legal support obligation, the trust income will be taxed to the grantor.

Mr. Mark Thomas dies owning a business MT, Inc. After Mark dies, the personal representative manages MT, Inc. and she incurs business expenses. Is the estate entitled to take a deduction for those expenses? a. No, only the beneficiaries can deduct the expenses. b. No, only complex accumulating trusts can take expenses. c. Yes, as long as they are normal business expenses. d. Yes, but up to a limit of $600.

C An estate is entitled to take as a deduction any ordinary and necessary business expense.

A grandfather creates a trust to benefit his grandson. He transfers a million dollars into the trust. The trust pays the grandson income for eleven years, and then the trust corpus is returned to the grandfather's wife (the grandson's grandmother). This arrangement is which of the following? a. A remainder interest b. A reverse gift c. A reversionary interest d. A gift of corpus to the grandson

C Any power or interest held by the spouse is treated as if that interest was held by the grantor. Therefore, it will be treated as if it will revert to the grantor. Because of that revisionary interest, the trust income will be taxable to the grantor.

An estate is entitled to an income tax exemption amount of which of the following? a. $300 b. $4,050 c. $600 d. $100

C Estates receive an income tax exemption of $600.

Which of the following is a complex trust? a. A trust that must distribute income b. A revocable trust c. A trust that may distribute income d. A trust that is required to distribute all of its income

C The key word is "may." A complex trust may accumulate income, or the trustee has the discretion to accumulate income. A complex trust must be irrevocable.

Lance creates an irrevocable life insurance trust that will pay income to his ex-wife for life and then to his children. Lance transfers a $1,000,000 term policy and $100,000 of high yield bonds to the trust. The income from the bonds will be used to pay the premiums on the policy, and all remaining income will be paid to family members. Which of the following is correct? a. During Lance's lifetime, income from the trust will be taxable at the trust rates. b. During Lance's lifetime, the income of the trust will be split with the amount paid for insurance premiums taxable to the trust and the amount paid to the family members taxable to Lance. c. During Lance's lifetime, the income of the trust will be taxable to Lance.

C This grantor trust is tainted by a combination of trust income used to pay premium, beneficial enjoyment and support. Per the question only a portion of the trust income is being used to pay the premiums on the policy. The remainder is being paid out to family members and will be taxable to them (DNI principle).

Mrs. P establishes an irrevocable trust for her son. She transfers $500,000 to the trust. The trust principal is placed with a money manager generating 6% taxable income. The trust applied for a whole life policy on her life. The trust will own and be the beneficiary of the policy. The premium of the whole life policy is $13,000 per year. The trust will pay the premium. The remaining income will accumulate in the trust. How will the income be taxed? a. $30,000 as taxable income the trust. b. $13,000 as a taxable gift to Mrs. P and $17,000 as taxable income to the trust. c. $13,000 as taxable income to Mrs. P and $17,000 as taxable income to the trust. d. $30,000 as taxable income to Mrs. P.

C This is a tainted irrevocable trust. Only the life insurance premium is taxable to Mrs. P (the grantor). The remaining income is taxable to the trust.

A simple trust... a. must distribute all income. b. may not distribute income. c. cannot make charitable contributions. d. may distribute corpus.

C This is going to be very picky. The reference is the textbook trust accounting income (TAI). The document must require all TAI income be distributed (not income) to be a simple trust. It should say TAI income be distributed, not all income. If the trust could make a distribution that would qualify for a charitable deduction, then the trust cannot be classified as a simple trust, even if no charitable distributions are actually made.

Which of the following statements best describes distributable net income (DNI)? A. An estimate of the actual benefit available to the income beneficiaries of an estate or trust and is the maximum amount that can be taxed to beneficiaries. B. A tax imposed on the transfer of the taxable estate of every decedent who is a citizen or resident of the United States. C. A trust's or estate's share of all taxable income that was received during the tax year. D. The income and expense items that are used to determine the amount the income beneficiaries of an estate or trust are entitled to receive from the trust or estate each year.

Correct Answer: A. An estimate of the actual benefit available to the income beneficiaries of an estate or trust and is the maximum amount that can be taxed to beneficiaries. Explanation: Distributable Net Income is an estimate of the actual benefit available to the income beneficiaries of an estate or trust and is the maximum amount that can be taxed to beneficiaries. Distributions in excess of DNI are generally treated as tax-free distributions of principal.

A GRAT, GRUT, or QPRT is an excellent "estate freezing" device with respect to post-transfer appreciation. Why? A. True B. False

Correct Answer: A. True Explanation: 100% of post-gift appreciation in a property's value escapes estate, gift, and generation-skipping transfer tax. This makes a GRAT, GRUT, or QPRT an excellent "estate freezing" device with respect to post-transfer appreciation.

This type of trust is a useful technique when a client wants to purchase certain tangible assets, such as a work of art, then retain the right to display it in his or her own home and have it pass to a specified person immediately and without probate at death. A. grantor retained income trust (GRIT) B. grantor retained annuity trust (GRAT) C. grantor retained unitrust (GRUT) D. qualified personal residence trust (QPRT)

Correct Answer: A. grantor retained income trust (GRIT) Explanation: A grantor retained income trust (GRIT) is a useful technique when a client wants to purchase certain tangible assets, such as a work of art, then retain the right to display it in his or her own home and have it pass to a specified person immediately and without probate at death. (However, if the grantor is unable to establish the value of the retained interest, the gift of the transferred remainder will equal 100% of the value of the transferred property).

An estate has chosen a June 30, 2019 taxable year-end. If Ed Doyle, an heir of an estate, received a distribution of income from the estate in December, 2018, what year must he report the income on his individual tax return? A. 2018 B. Half in 2018; half in 2019 C. 2019 D. Prorated over the tax year of the estate

Correct Answer: C. 2019 Explanation: Distributions from an estate are deemed made on the last day of the estate's tax year. In this case, Ed reports the income for 2019, even though the distribution occurred in calendar year 2018.

Jack has a calendar year trust. When must he file his Form 1041 for 2019? A. December 31, 2019 B. January 1, 2020 C. April 1, 2020 D. April 15, 2020

Correct Answer: D. April 15, 2020 Explanation: For calendar year estates and trusts, Form 1041 and Schedule K-1 must be filed on or before April 15, 2020 for 2019.

A trust may qualify as a simple trust if it complies with which of the following? 1. The trust instrument requires that all income must be distributed currently. 2. The trust instrument does not provide that any amounts are to be paid, permanently set aside, or used for charitable purposes. 3. The trust does not distribute amounts allocated to the corpus of the trust. 4. The trust does distribute amounts allocated to the corpus of the trust.

Correct Answers: 1, 2, 3 Explanation: To qualify as a simple trust, the trust instrument must require that all income be distributed currently, does not provide that any amounts are to be paid, permanently set aside, or used for charitable purposes, and does not distribute amounts allocated to the corpus of the trust.

A fiduciary must file Form 1041 for a domestic trust taxable under Section 641 if it meets which of the following requirements? 1. Any taxable income for the tax year 2. Gross income of $1,000 or more (regardless of taxable income) 3. A beneficiary who is a nonresident alien 4. Gross income of $600 or more (regardless of taxable income) 5. Taxable income of $600 or more

Correct Answers: 1, 3, 4 Explanation: A fiduciary must file Form 1041 for a domestic trust taxable under Section 641 that has: any taxable income for the tax year, gross income of $600 or more (regardless of taxable income), or a beneficiary who is a nonresident alien.

Which of the following are examples of trust accounting income? 1. Stock dividends 2. Interest on notes, loans and mortgages 3. Interest on U.S. Treasury bills, notes, and bonds 4. Capital gains

Correct Answers: A., B. and C. Explanation: Trust accounting income does not include capital gains, which are allocated to principal. The other income items are all ordinary income items and allocated to income.

Which type of trust does not have to use a calendar year to file tax returns? a. Testamentary trust b. Irrevocable c. Revocable living trust d. Charitable trust

D All trusts (except 501(a) or charitable) must use a calendar year. Trusts (other than trusts exempt from tax under Code Section 501) and wholly charitable trusts must adopt a calendar tax year.

Mr. Rich wants to establish an irrevocable trust to benefit his daughter. He wants to deposit $1,000,000 into the trust with income accumulating until she is age 40 (10 years from now). He has spoken with one aggressive manager who feels he can generate 6% taxable income and a 6% growth rate. But another manager who is being considered is suggesting low risk municipal bonds yielding 4%. What do you suggest the client do if most of his personal investments are with the aggressive manager? a. Only give the aggressive manager $200,000 to control trust taxation and the remainder to the municipal bond manager. b. Split the money between the aggressive manager and the municipal bond manager to get more equity into the trust than either Answer A or B alone. c. Hire the municipal bond manager to get more equity in the trust. d. Hire the aggressive manager to get more equity in the trust.

D Although the 6% would produce a substantial income taxed at 37%, the other 6% is deferred (growth). $60,000 of income is far above the 37% trust threshold of $12,500. This net of tax income plus 6% growth would be substantially better than the other choices.

Sara Jane set up a revocable living trust. She placed all her income producing assets in the trust. How will the income be treated for tax purposes? a. Deferred until distribution to the ultimate (remainder) beneficiaries b. Accumulated in the trust c. Taxed at trust income tax rules d. Conduit to her

D The trust is tax-neutral (conduit).

When must fiscal year estates and trusts file their taxes?

For fiscal year estates and trusts, Form 1041 must be filed by the 15th day of the 4th month following the close of that tax year. If the due date falls on a Saturday, Sunday, or legal holiday, filing must occur on the next business day. For example, an estate that has a tax year that ends on June 30, 20XX, must file Form 1041 by October 15, 20XX.

Evidence should be obtained of the value of the assets placed in the ____ or ____. It is recommended that one or more qualified appraisers value the property shortly before it is placed into trust.

GRAT or GRUT

What type of trusts can serve as an alternative to (or be used in conjunction with) a recapitalization or other freezing technique that has the added advantages of gift tax leverage and possible estate tax savings. Such uses are beyond the scope of this course?

GRAT, GRUT, QPRT

What type of trusts are is a useful technique when a client wants to purchase certain tangible assets such as a work of art, retain the right to display it in his or her own home, and have it pass to a specified person immediately and without probate at death?

GRIT (However, if the grantor is unable to establish the value of the retained interest through comparable rentals, the gift of the transferred remainder will equal 100% of the value of the transferred property).

Wealthy widows or widowers, divorced individuals, or other unmarried persons can benefit from what types of trusts?

Grantor Retained Annuity Trust (GRAT), Grantor Retained Unitrust (GRUT), or Qualified Personal Residence Trust (QPRT) is particularly useful when a client is single and has a substantial estate upon which federal estate taxes are certain to be paid. Wealthy widows or widowers, divorced individuals, or other unmarried persons can use such a trust as a transfer tax savings device since they do not get a marital deduction.

Main difference between taxable trust income and trust accounting income?

Taxable trust income is not the same as trust accounting income. Taxable trust income, as distinguished from trust accounting income, includes income allocated to principal, such as capital gain.

Are taxable trusts and estates allowed to do fiscal and/or calendar year?

Taxable trusts just calendar Estates either

What trusts are best for individuals with income-producing property is located in more than one state and unification and probate savings are desired?

The GRAT, GRUT, or QPRT would serve to transfer ownership in a manner that would avoid the need to open probates in the state where the property is located but in which the deceased person is not a resident. Such probates are called ancillary administrations and can be expensive. By having the property in a trust, it passes automatically on death and there is no need for a probate for that property. The same result can be obtained by using a simpler form of trust as well.

A reversionary interest

The remnant of an estate that the grantor holds after granting a life estate to another person.

Tony creates an irrevocable life insurance trust. Tony transfers $500,000 of high yield bonds to the trust. The income from the bonds will be used to pay the premiums on a policy on his life owned by the trust. Which of the following is correct? a. During Tony's lifetime, the income of the trust will be taxable to Tony. b. During Tony's lifetime, income from the trust will be taxable at the trust rates.

a Grantor trust rules apply. Trust income is, or may be, used to pay premiums on life insurance on the life of either the grantor or the grantor's spouse. This funded irrevocable life insurance trust (ILIT) is a classic example of a grantor trust.

A married couple with an estate in excess of the couple's combined unified credit equivalent can benefit from what types of trusts?

can use a GRAT, GRUT, or QPRT to eliminate or reduce taxes on the death of the second spouse who dies. The larger and more rapidly appreciating these estates are, the more effective such a trust would be.

When there is a _______ probability that the client will outlive the trust term that is needed to obtain a low present value gift to the remainder person, then it is a good time to use a grantor trust

high

Grantor Retained Trust

is an irrevocable trust into which the grantor places assets and retains an interest for a fixed number of years. The principal, at the end of the specified period of years, will pass to a non-charitable beneficiary, such as a child or grandchild of the grantor. The benefit of these retained interest trusts is that they have or will have a high value which can be transferred using a low valuation method which limits the amount of gift or estate tax payable on these gifts.

Complex Trusts

is any trust that does not qualify as a simple trust. It is allowed to accumulate income, has a charitable beneficiary, or distributes principal.

Distributable Net Income (DNI)

is used to allocate taxable income of a trust or estate between the trust or estate and the beneficiaries. Distributable Net Income is an estimate of the actual benefit available to the income beneficiaries and is the maximum amount that can be taxed to beneficiaries. Distributions in excess of DNI are generally treated as tax-free distributions of principal.

Items of income and expense that are allocated to ___________ are not used in calculating accounting income

principal

Simple Trusts

requires that all income must be distributed currently, does not provide that any amounts are to be paid, permanently set aside, or used for charitable purposes, and does not distribute amounts allocated to the corpus of the trust.