Trust Tax Planning: Deducting Distributions Made After Year-End

If you are the trustee, executor, or even a beneficiary of a trust or estate required to file a fiduciary income tax return, time is running out on a potential 2013 election that could prove to be very beneficial in reducing fiduciary income tax.

Race to the Top

The tax rate for trust and estate fiduciary tax returns reaches the top tax bracket of 39.6 percent faster than any other type of entity. For 2013 fiduciary returns, it takes just $11,950 of taxable income to reach the 39.6 percent top tax bracket.

While that fact alone is reason enough to enlist some tax planning, starting in 2013, the 3.8 percent tax on net investment income (NII) will provide some extra incentive for reducing income taxable at the fiduciary level.

There is Still Time

You may be thinking that it's too late because 2013 deduction opportunities closed on December 31, 2013.Usually, that would be correct, except that trustees and executors of certain trusts and estates have the ability to make an election, made pursuant to Internal Revenue Code Section 663(b), to treat a beneficiary distribution made during the first 65 days of the year following the election year as being made in the election year (663(b) election). For a calendar year fiduciary return, that date is March 6, 2014.

An example of the election benefit: For 2013, before considering any additional tax planning, Trust X has taxable income of $40,000, all of which is subject to the 3.8 percent net investment income tax. Beneficiary Y, a single person, and sole beneficiary of Trust X, would report personal taxable income of $130,000. The trustee of X decides to distribute $36,000 to Beneficiary Y within 65 days after December 31, 2013, makes a 663(b) election in the 2013 fiduciary income tax return, and deducts the 2014 distribution in the 2013 return. What are the U.S. tax savings as a result of the 663(b) election?

Without the 663(b) election, Trust X would pay the U.S. $15,264 in tax (regular $14,198 and $1,066 in 3.8 percent NII tax), Beneficiary Y would pay the U.S. tax of $29,693, a combined total of $44,957. With the 663(b) election, Trust X would pay the U.S. $755 and Beneficiary Y would pay the U.S. $39,773, a combined total of $40,528. The 663(b) election results in an overall permanent tax savings of $4,429.

Be Careful with Beneficiary Distributions

While income tax savings for trusts and estates are important, these entities are established for wealth preservation and various other financial purposes, including protection of the assets and earnings of a spendthrift beneficiary. Therefore, trustees and executors should consider tax savings opportunities, such as the 663(b) election, but proceed with caution where beneficiary distributions are involved, consider where the cash is moving and follow the governing document.

If a 663(b) election for 2013 sounds attractive for your situation, remember the 65 day rule for a calendar year fiduciary return ends March 6, 2014. As they say, time is of the essence for this transaction. And remember, just because the 2014 distribution is made within the 65 day period, there is no requirement that the 663(b) election be made and the distribution deducted on the 2013 return, but if the distribution is not made within the 65 day period, the 663(b) election will not be available.

Contact your Eide Bailly service provider for additional information.