Income Tax Considerations for Trusts & Estates: Avoiding the New Income Taxes

Transcription

1 Income Tax Considerations for Trusts & Estates: Avoiding the New Income Taxes By Robert S. Barnett CPA, JD, MS (TAXATION) CAPELL BARNETT MATALON & SCHOENFELD LLP ATTORNEYS AT LAW (516)

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3 INCOME TAX RATES RATE TAXABLE INCOME NOT OVER Married Filing Separately Individual Head of Household Married Filing Jointly 10% $8,925 $8,925 $12,750 $17,850 15% $36,250 $36,250 $48,600 $72,500 25% $73,200 $87,850 $125,450 $146,500 28% $111,525 $183,250 $203,150 $223,050 33% $199,175 $398,350 $398,350 $398,350 35% $225,000 $400,000 $425,000 $450, % Over $225,000 Over $400,000 Over $425,000 Over $450,000 3

4 ESTATE & TRUST INCOME TAX RATES Income Tax & Capital Gain: 39.6% and 20% rates apply when trust taxable income over $11,950 Medicare: 3.8% surtax on lesser of (i) undistributed net investment income; or (ii) excess of AGI over $11,950 = 43.4% income tax rate or 23.8% capital gain tax rate 2013 ESTATE & TRUST INCOME TAX RATES Taxable Income Income Tax Rate Capital Gain Rate Not over $2,450 15% 0% $2,450 - $5,700 25% 15% $5,700 - $8,750 28% 15% $8,750 - $11,950 33% 15% Over $11, % (+ 3.8% surtax) 20% (+ 3.8% surtax) 4

5 1411 MEDICARE SURTAX: TRUSTS/ESTATES 3.8% surtax on the lesser of: Undistributed net investment income OR Excess, if any, of AGI (as defined in 67(e)) over Dollar amount which the highest tax bracket in section 1(e) begins ( $11,950) 5

6 NET INVESTMENT INCOME Gross income from interest, dividends, annuities, royalties, and rents, other than from an ordinary trade or business; Gross income from passive activity or trade/business involving trading in financial instruments/commodities; and Net gain from disposition of property, other than property held in trade or business Includes gain from passive activity or trade/business involving trading in financial instruments/commodities Less allocable deductions 6

7 MEDICARE SURTAX THRESHOLD AMOUNTS Married, filing separately $125,000 Married, filing jointly $250,000 Individuals $200,000 Estates & Trusts $11,950 7

8 PLANNING OPPORTUNITY Potential significant savings if shift income tax burden from trust to beneficiary Avoid condensed trust income tax brackets Utilize Beneficiary s tax bracket Avoid 3.8% Medicare surtax 8

9 REDUCE TAX BURDEN: Beneficiary-Level Taxation Include capital gain in Distributable Net Income Treas. Reg (a)-3 In Kind Distribution IRC 643(e)(3) 65 Day election IRC 663(b) 9

10 DISTRIBUTABLE NET INCOME Governs allocation of trust taxable income between trust and beneficiaries Limits trust s distribution deduction Limits beneficiary-level taxation, even if a greater amount is distributed Determines character and amount of distribution 10

11 CALCULATING DNI TAXABLE INCOME, modified as follows: No deduction for distribution No deduction for personal exemptions Generally exclude capital gains Generally exclude capital losses Simple trusts: Exclude extraordinary dividends and taxable stock dividends allocated to corpus and not distributed Include tax-exempt interest paid on state and local bonds, reduced by allocable disbursements 11

12 DNI EXAMPLE 1 Complex Trust; income distribution required Interest $7,500 Dividend $14,500 Capital Gains $5,000 Admin Expenses $5,000 Distributions $27,000 12

13 DNI EXAMPLE 1 (cont.) Total Income 27,000 Expenses -5,000 Distribution Deduction* -17,000 Exemption -300 Taxable Income 4,700 * Limited to DNI 13

14 DNI & NII 3.8% surtax imposed on undistributed net investment income (NII) Reduce trust taxes: Distribute NII 14

15 WHAT IS INCLUDED IN NII, BUT NOT IN DNI? ANSWER: CAPITAL GAIN 15

16 CAPITAL GAINS Allocated to principal Generally excluded from DNI Taxed to trust (capital gain rate + NII) Treas. Reg (a)-3: Capital gain included in DNI if fiduciary utilizes one of two prerequisites and one of three methods Result: Beneficiary-level taxation 16

17 TWO PREREQUISITES Inclusion is pursuant to: (1) Governing instrument and local law; OR (2) Reasonable and impartial exercise of discretion by the fiduciary (in accordance with a power granted to the fiduciary by local law or by governing instrument if not prohibited by local law) 17

18 THREE METHODS (1) Allocated to income (unitrust exception); (2) Allocated to corpus but treated consistently by the fiduciary on the trust s books, records, and tax returns as part of a distribution; or (3) Allocated to corpus, but actually distributed or utilized by the fiduciary in determining the amount that is distributed or required to be distributed 18

19 GOVERNING INSTRUMENT Allocation according to trust terms? Discretion and power to: Distribute trust principal Allocate receipts and disbursements between income and principal Include capital gains in income If silent, must rely on local law 19

20 IRC 643(e) IN KIND DISTRIBUTION B reports capital gain on sale of appreciated property received from trust/estate B s basis: lesser of carry-over or FMV Avoids trust-level taxation Does not apply to specific bequests Governing instrument should expressly grant discretion to distribute in kind Avoid IRC 643(e)(3) election 20

21 65 DAY ELECTION IRC 663(b) Distributions paid/credited within first 65 days of any taxable year of estate or trust treated as paid on last day of previous year Cannot exceed: 1) Entity's accounting income for year of election or 2) DNI MUST ELECT (P. 2, Other information, Line 6) Election irrevocable once period for filing return expires (including extensions) 21