65-Day Rule — 2015

March 6

Fiduciaries of estates and complex trusts have the option to treat certain distributions as having occurred last year. An election can be made with respect to distributions made within 65 days after the end of a tax year. The 65th day of 2015 is Friday, March 6.

Fiduciaries are allowed a deduction for amounts actually paid. During this 65-day period, a fiduciary can compute its fiduciary accounting income and distributable net income and compare these amounts to distributions already made during the year. If necessary, additional distributions can be made to balance the allocation of income between the fiduciary and beneficiary.

The election can be made on all or part of the additional distributions made. Therefore, a fiduciary can over distribute what might be necessary to pass out 2014 income to a beneficiary, but elect a smaller amount when the income tax return is prepared. Any amount distributed but not treated as 2014 distributions will naturally be 2015 distributions.

These distributions are then treated as having been made on the last day of 2014.

Remember that fiduciaries pay the highest tax rate (i.e. 39.6%) on all taxable income over $12,150 in 2014, and only have a personal exemption of either $100 (for complex trusts) or $600 (for estates). It may be advisable to make distributions to beneficiaries in a lower tax bracket for overall tax savings.

Example: A complex trust earned interest and ordinary dividends during 2014 of $20,000, and paid investment advisory fees of $2,000. If no distribution is made from the trust, the trust will pay federal income tax of $5,486. If the trustee makes a distribution to an income beneficiary in the 25% tax bracket, then she would have additional income tax of $4,500. The net tax savings is $986.

Net Investment Income Tax

In addition, fiduciaries must pay the Net Investment Income (NII) tax (at a rate of 3.8%) on the lesser of investment income or AGI over $12,150 (in 2014). Married individuals (who file jointly) must pay the NII tax only if their AGI exceeds $250,000.

While taxes are not always the driving force behind trust administration decisions, they should always be considered.

Reporting: The Form 1041 does not require any kind of formal declaration of the amount of distributions paid in 2014 and treated as paid in 2014. (However, be sure to keep good records so that the amount is not reported again as a 2015 distribution.) There is a check box on the bottom of page 2 of the Form 1041 which must be checked when a §663(b) election has been made.

Timing: A §663(b) election must be made on a timely filed return (including extensions). The election becomes irrevocable once the due date of the return has passed [Reg. §1.663(b)-2.1]


Simple trusts are not required to consider actual distributions when determining the trust’s Income Distribution Deduction, as all accounting income is required to be distributed. If some amount of accounting income has not been distributed during a calendar year, then it should be distributed as soon as administratively possible, without regard to a hard 65-day limit.

Citation: IRC §663(b)

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Final Misc. Itemized Deduction Regulations

The IRS has issued, effective today, final regulations for trusts and estates to follow on the proper treatment of expenses subject to the 2% floor for miscellaneous itemized deductions.

Background

Individuals and fiduciaries must reduce certain expenses, and not deduct the full amount, under IRC §67(a). These expenses include tax preparations fees, professional dues, home office expenses, and investment costs. IRC §67(e) says that expenses incurred by a trust are not limited if they “would not have been incurred if the property were not held in such trust or estate”. There has been must discussion about what expenses “would not have been incurred”.

The issue was litigated and reached the US Supreme Court who said (in 2008) that investment advisory fees incurred by trusts ARE subject to the 2%-floor limitation. Around that time, the IRS released temporary regulations regarding the deduction of certain expenses by trusts and estates. Those regulations are final and effective as of last Friday (May 9, 2014).

Regulations

The final regulations confirm that trusts and estates must subject expenses to the 2%-floor limitation any miscellaneous itemized deduction which “commonly or customarily would be incurred by a hypothetical individual holding the same property” [see Reg. §1.67-4(a)].

The regulation’s next section elaborates on the meaning of “commonly” and “customarily”. It discusses costs considered “ownership costs” (which are generally subject to limitation since an individual would incur the same costs); “tax preparation fees” (which EXCLUDE from limitation the cost of estate tax returns, all fiduciary income tax returns, and a decedent’s final Form 1040); “investment advisory fees” (which are generally subject to limitation, except for advice specifically identifiably as not likely to be incurred by an individual); and “appraisal fees” (which exclude from limitation the costs associated with appraisal’s for an estate’s or trust’s income tax return, or a GST tax return).

Other costs which are fiduciary in nature are not subject to the limitation; these include probate court fees and costs; fiduciary bond premiums, and other costs listed in the regulation. Not mentioned, but not subject to limitation, are trustees fees.

Bundled Fees

Finally, the regulation addresses the problem of bundled fees. If a trust or estate pays a single fee for services which are subject to limitation and services which are not subject to limitation, then the single fee must be separated and the appropriate part made subject to the limitation. The regulation permits any reasonable method of allocation to divide the single fee.

Application

The final regulation apply to tax years beginning on or after May 9, 2014. Previously issued (temporary) regulations have been removed. IRS Notices issued in 2008, 2010 and 2011 have been superseded by these final regulations.


See: TD 9664

65-Day Rule — 2014

March 6

For an updated article about the 65-Day Rule in 2015, click here.


Fiduciaries of estates and complex trusts have the option to treat certain distributions as having occurred last year. An election can be made with respect to distributions made within 65 days after the end of a tax year. The 65th day of 2014 is Thursday, March 6.

Fiduciaries are allowed a deduction for amounts actually paid. During this 65-day period, a fiduciary can compute its fiduciary accounting income and distributable net income and compare these amounts to distributions already made during the year. If necessary, additional distributions can be made to balance the allocation of income between the fiduciary and beneficiary.

The election can be made on all or part of the additional distributions made. Therefore, a fiduciary can over distribute what might be necessary to pass out 2013 income to a beneficiary, but elect a smaller amount when the income tax return is prepared. Any amount distributed but not treated as 2013 distributions will naturally be 2014 distributions.

These distributions are then treated as having been made on the last day of 2013.

Remember that fiduciaries pay the highest tax rate (i.e. 39.6%) on all taxable income over $11,950 in 2013, and only have a personal exemption of either $100 (for complex trusts) or $600 (for estates). It may be advisable to make distributions to beneficiaries in a lower tax bracket for overall tax savings.

Example: A complex trust earned interest and ordinary dividends during 2013 of $20,000, and paid investment advisory fees of $2,000. If no distribution is made from the trust, the trust will pay federal income tax of $5,486. If the trustee makes a distribution to an income beneficiary in the 25% tax bracket, then she would have additional income tax of $4,500. The net tax savings is $986.

New in 2013: Net Investment Income Tax

In addition, fiduciaries must pay the Net Investment Income (NII) tax (at a rate of 3.8%) on the lesser of investment income or AGI over $11,950 (in 2013). Married individuals must pay the NII tax only if their AGI exceeds $250,000.

While taxes are not always the driving force behind trust administration decisions, they should always be considered.

Reporting: The Form 1041 does not require any kind of formal declaration of the amount of distributions paid in 2014 and treated as paid in 2013. (However, be sure to keep good records so that the amount is not reported again as a 2014 distribution.) There is a check box on the bottom of page 2 of the Form 1041 which must be checked when a §663(b) election has been made.

Timing: A §663(b) election must be made on a timely filed return (including extensions). The election becomes irrevocable once the due date of the return has passed [Reg. §1.663(b)-2.1]


Simple trusts are not required to consider actual distributions when determining the trust’s Income Distribution Deduction, as all accounting income is required to be distributed. If some amount of accounting income has not been distributed during a calendar year, then it should be distributed as soon as administratively possible, without regard to a hard 65-day limit.

Citation: IRC §663(b)

Will New York Soon Have a Gift Tax?

Governor Cuomo’s recent budget proposal for New York incorporated some tax proposals made by two separate blue-ribbon panel.

A recent post by John D. Dadakis (a Partner at Holland & Knight in New York), explores the Governor’s proposal.

New York Gift Tax Changes Imminent? | Estate Planning content from WealthManagement.com

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It seems reasonable to think that Governor Cuomo would not have made any proposals in his budget which he didn’t think that a reasonable chance of becoming legislation. Time will tell, but not too much time since New York’s budget is due April 1, 2014. New York has had 3 years running of on-time budgets; expect the trend to continue.

65-Day Rule — 2013

March 6

For an updated article about the 65-Day Rule in 2015, click here.

For an updated article about the 65-Day Rule in 2014, click here.


Fiduciaries of estates and complex trusts have the ability to treat certain distributions as having occurred last year. An election can be made with respect to distributions made within 65 days after the end of a tax year. The 65th day of 2013 is Wednesday, March 6.

Fiduciaries are allowed a deduction for amounts actually paid. During this 65-day period, a fiduciary can compute its fiduciary accounting income and distributable net income and compare these amounts to distributions already made during the year. If necessary, additional distributions can be made to balance the allocation of income between the fiduciary and beneficiary.

The election can be made on all or part of distributions made. Therefore, a fiduciary can over distribute what might be necessary to pass out 2012 income to a beneficiary, but elect a smaller amount when the income tax return is prepared. Any amount distributed but not treated as 2012 distributions will naturally be 2013 distributions.

The distributions are then treated as having been made on the last day of 2012.

Remember that fiduciaries pay the highest tax rate (i.e. 35%) on all taxable income over $11,650 in 2012, and only have personal exemption between $100 (for complex trusts) or $600 (for estates). It may be advisable to make distributions to beneficiaries in a lower tax bracket for overall tax savings.

Example: A complex trust earned interest and dividends during 2012 of $20,000, and paid investment advisory fees of $2,000. If no distribution is made from the trust, the trust will pay federal income tax of $5,374. If the trustee makes a distribution to an income beneficiary in the 25% tax bracket, then she would have additional income tax of $4,500. The net tax savings is $874.

While taxes are not always the driving force behind trust administration decisions, they should always be considered.

Reporting: The Form 1041 do not require any kind of formal declaration of the amount of distributions paid in 2013 and treated as paid in 2012. (However, be sure to keep good records so that the amount is not reported again as a 2013 distribution.) There is a check box on the bottom of page 2 of the Form 1041 which must be checked when a §663(b) election has been made.

Timing: a §663(b) election must be made on a timely filed return (including extensions). The election becomes irrevocable once the due date of the return has passed [Reg. §1.663(b)-2.1]


Simple trusts are not required to consider actual distributions when determining the trust’s Income Distribution Deduction, as all accounting income is required to be distributed. If some amount of accounting income has not been distributed during a calendar year, then it should be distributed as soon as administratively possible, without regard to a hard 65-day limit.

Citation: IRC §663(b)

Coming soon: new Medicare Tax on Net Investment Income for Estates and Trusts

Income tax
Income tax (Photo credit: Alan Cleaver)

As part of the Healthcare and Education Act signed into law in 2010, an additional Medicare tax was added to the Internal Revenue Code (see §1411). The tax is a flat 3.8% assessed on “net investment income”. The tax applies to US individuals as well as estates and trusts (other than charitable trusts).

Until 2013, Medicare tax has been assessed only on earned income: wages earned by employees (paid half each by the employee and the employer) and self-employment income; the rated had been 2.9%. The new Medicare tax will be imposed on unearned income of high-income individuals, estates and trusts.

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Here is a table comparing how §1411 impacts the two types of taxpayers:

Individuals Estates & Trusts
IRC Section §1411(a)(1) §1411(a)(2)
Tax Rate 3.8% 3.8%
Medicare Tax Base: lesser of
(i) Net Investment Income Net Investment Income (defined below) Undistributed Net Investment Income (see comments below)
(ii) Excess of Modified AGI Adjusted Income (as defined in §67(e))
over Threshold amount:- $250,000 for MFJ or surviving spouse;- $200,000 for single taxpayers of HOH;- $125,000 for MFS. Threshold amount:- the highest tax bracket in §1(e) – currently $11,650

Net investment income is defined as the following types of income:

(a)    gross income from interest, dividends, annuities, royalties and rents [§1411(c)(1)(A)(i)];

(b)   net gains (e.g. capital gains) excluding gains from trade or business property (e.g. §1231 gains) [§1411(c)(1)(A)(iii)];

(c)    trade or business income from a passive activity [§1411(c)(2)(A)]; and,

(d)   trade or business income of trading in financial instruments or commodities (see §475(e)(2)) [§1411(c)(2)(B)].

From these income items above, a deduction is allowed for expenses properly allocated to the income. In addition, net investment income does not include distributions from retirement plans [§1411(c)(5)], nor any income already subject to self-employment tax [§1411(c)(6)].

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Note that the threshold floor for estates and trusts is extremely small compared to the floor for single or married taxpayers. To the extent that a trust incurs and retains net investment income, it will be subject to this additional Medicare tax.

With adequate planning and proper use of the 65-day rule, a trustee can work to balance the income tax burden and the Medicare tax burden between a trust and the trust’s beneficiaries.

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For estates and trusts, §1411(a)(2)(A) refers to “undistributed net investment income”, but does not define this term.  It seems logical to assume that the same Income Distribution Deduction (IDD) concept that reduces an estate or trust’s taxable income would apply here and reduce an estate or trust’s net investment income. One must assume that in general, simple trusts and complex trusts making adequate distributions will pass-through all of their undistributed net investment income.

As with other aspects of trust accounting and the tax consequences, we may see unintended results from the application of the IDD rules. For example, IDD is limited to the lesser of DNI and Accounting Income. If a trust invests only in a partnership which reports taxable interest and dividends, but does not report any distributions, there may not be any accounting income, and therefore no distribution of the net investment income.