CFP

Income Taxation Of Trusts And Estates - Trust Income

Trust Income  

Trust Accounting Income
Trust Accounting Income refers to all of the dividends, interest, ordinary gain, real estate income, royalty income and any other income that is generated by the trust for a given tax year.

The importance of distinguishing accounting income from the corpus or principal of the trust again lies in the unique difference between simple and complex trusts. Simple trusts are required to pay out all of the accounting income to the beneficiary of the trust. Complex trusts are much more flexible in that they can pay out dividends and principal to the beneficiaries, or just let the accounting income accumulate within the trust.

Charitable donations (complex trusts only) can be deductible if they are paid specifically from the current year's gross accounting income.

Trust Taxable Income
Trust or estate taxable income will be treated as taxable income to either the beneficiary or the trust itself, but not taxable to both. Because the trust is allowed an "income distribution deduction" for income paid to a beneficiary, the beneficiary would be responsible for paying the tax if the trust distributes the income.

Income Distribution Deduction Is the Lesser of:

  • Distributable Net Income (DNI) less tax-exempt interest
OR

  • Distributions less tax-exempt income included in distribution
If the estate administrator or trustee elects not to pay out the income of the trust, then the legal representative of the trust is responsible for including the income on the trust's income tax return.

Distributable Net Income
Distributable net income (DNI) is the maximum allowable income that can be paid from a trust in a given year per the terms of the trust, regardless if a will or other document might specify a larger share "entitlement" to the beneficiary.

For Example:
Suppose that John's will specifies that Julie (his wife) and Debby (his daughter) were to receive $10,000 and $5,000, respectively, from the income of his estate trust each year. If the trust only had $12,000 of distributable net income for the year, then each beneficiary will only receive a pro-rata share of their amount.

Julie would receive $8,000 [($10,000 / $15,000) x $12,000]

Debby would receive $4,000 [($5,000 / $15,000) x $12,000]

*Beneficiaries entitled to receive current distributable income, generally must include in the gross income the entire amount due to them. However, if the DNI is less than the entitlement, then each beneficiary is only taxed on the actual amount received from the DNI, not their full entitlement amount.


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