INCOME TAX OF ESTATES AND TRUSTS
PROFESSOR DENNIS CALFEE
SPRING 2013
INTRODUCTION
Estate
· Personal Representative (PR) // administrator has to gather assets && pay creditors
· WHO? 733.302: ANY person who is sui juris && is a resident of FL @ the time of death of the person whose estate is to be administered is qualified to act as PR in FL
o 733.304: A person who is NOT domiciled in FL CANNOT qualify as PR UNLESS: related by lineal consanguinity (or spouse of such)
· WHEN? Born on Date of Death
· HOW MUCH? 733.617: commission payable from the estate assets based on compensable value of estate, which is the inventory value of the probate estate assets and the income earned during administration
o 3% for 1st $1M, 2.5$ for $1M-$5M, 2% for $5M-$10M
o More for extraordinary services
Trust
· HOW? 736.0401: A trust may be created by: (1) transfer of property to another person as trustee during the settlor's lifetime or by will or other disposition taking effect on settlor's death; (2) declaration by the owner of the property that the owner holds identifiable property as trustee; OR (3) exercise of power of appt in favor of trustee
o 736.0402: other requirements (capacity, intent, definite beneficiary, trustee has duties, no merger)
o 736.0602: Unless the terms of a trust provide that that trust is irrevocable, the settlor may amend.
· NEVER truly revocable bc of judicial//nonjudicial modifications
· HOW LONG? 360 years in FL
· 1411: Imposition of tax– In the case of E//T, there is 3.8% tax of lesser of–
o (a)(2)(A): the undistributed net investment income of such taxable year OR
o (a) (2)(B): the excess of–
· (i): the AGI over
· (ii): dollar amount at which the highest tax bracket in 1(e) begins for such taxable year
o (c): “Net Investment income” means the excess of–
· (A): the sum of: (i) GI from interest, dividends, annuities, royalties, and rents +++ (ii) other GI derived from a trade//business +++ (iii) net gain attributable to disposition of NOT t/b prop
· Over (B): the deductions properly allocable to such GI or net gain
PROBLEM 1: PRINCIPAL && INCOME
Principal- the original amount invested, separate from earnings; the corpus of an estate or trust
(FLUPIA) property held in trust for distribution to remainder beneficiary when trust terminates
Income- (FLUPIA) money or property that a fiduciary receives as current return from a principal asset
(Code) amount of income of the estate or trust for the taxable year determined under the terms
of the instrument or applicable law
Fiduciary accounting income- income pot && principal pot
Principal Items ((DEFAULT))
Income Items
· 738.501(2)- Stock///proceeds from sale of stock
· 738.501(1)- Bonds, bills
· 738.502- Rental property
· 738.702(1)- 1/2 trustee commissions
· 738.702(1)- 1/2 judicial proceedings, acctings
· 738.703/738.403- Depreciation ((reas amount of net cash receipts from income))
· 738.502- Security deposit
· 738.504- Proceeds from life insurance policy
· 738.501(2)- Proceeds from sale of capital asset
· 738.607- Derivatives//options
· 738.702(f)- Estate, inheritance, && other transfer taxes
· 738.502(h)- Extraordinary repairs for capital improvements
· Casualty loss
· 738.401(2)-Dividends
· 738.503(3)- Value of bonds in excess of price
· 738.502- Rents, fees
· 738.701(1)- 1/2 trustee commissions
· 738.701(2)- 1/2 judicial proceedings, accts
· Taxes
· 738.503(1)- Interest
· 738.701(3)- Ordinary expenses incurred in connection with admin, mgmt, preservation of trust property
· Fiduciary uses PRINCIPAL to pay debts, expenses, and taxes of estate.
· In most states, the governing instrument can OVERRIDE local principal and income law AS LONG AS trust provisions don't depart fundamentally from traditional principles.
· Fiduciary discretion to allocate btw principal && income ALWAYS affects FAI, but sometimes affects DNI
· 30-yr $100K Treasury Bond with 6%. This bond would throw off $6K of taxable interest/year && if I was in 40% bracket– $2,400 in tax && $3,600 in hot little land. Yield is 3.6%.
o Bottom Line: Income is the same for a tax-exempt bond @ 3.6% && a $100K taxable bond @ 6%.
Approach:
1. READ THE INSTRUMENT, then look to FL Uniform Principal && Income Act
2. 738.103(1)(a)- Look to instrument
3. 738.103(1)(b)- Look to discretionary clauses
4. 738.103(1)(c)- Look to FLUPIA
5. 738.103(1)(d)- Default: PRINCIPAL because trustee will get a fee on it
Q1: Assuming the trust instrument does NOT contain a provision regarding the allocation of receipts to income or principal, or for charging trust expenses against either, what amount should be allocated to INCOME and what amount should be allocated to PRINCIPAL? How much money is the trustee required to give to the child?
RECEIPTS
Principal
Income
Authority
IBM stock
$350K (FMV)
738.102 –> 738.501(1)
Residential rental property
$400K (FMV)
738.501(1)
Corporate bond
$55K (FMV)
738.501(1)
IBM dividend
$500
738.401(2)
Proceeds from sale of IBM stock
$400K
738.501(2)
Interest from corporate bond
$1500
738.401(3) // 738.302(2) // 738.301(1)
Rents from residential property
$12K
738.502
Treasury bill proceeds at maturity
$9900
$1oo
738.503(3)
Treasury bond interest
$5K
738.503(1)
$1,214,900
$19,100
EXPENDITURES AND CHARGES
Authority
Trustee's commissions
738.701(1) 738.702(1)(a)
Depreciation on the rental property
$0 (assume)
$0 (assume)
738.703 // 738.403
Treasury bill purchase
Treasury bond purchase
Sales tax rental receipts
738.701(3)
Real property taxes on rental property
738.701(3)
Maintenance expense rental property
738.701(3)
TOTAL:
$972,500
$10,800 to child
Q2: Assuming the trust instrument provides that trustee commissions are to be allocated to INCOME and that a reserve for depreciation is to be established, what amount should be distributed to child?
· Reserve for depreciation –> Allocate the depreciation to PRINCIPAL. This makes sense: principal is the rese
y rel'ship ((Notice Form 56))
· WHEN? 6012(a)(4): Every trust having for the taxable year ANY taxable income OR having gross income $600+ //6012(a)(3): Every estates the gross income of which for the taxable year is $600+
o 644(a): The taxable year of any trust shall be the CALENDAR YEAR.
o 645: Certain revocable trusts treated as part of estate
o 443: short periods if change in accounting period OR tp is not in existence for entire taxable year
· HOW? 1(e): $11,950 (39.6%) –> trying to force distributions bc don't want trusts as wealth accumulators
How should we tax estates && trusts? Options:
1. Ignore entities, just tax beneficiaries, BUT might be taxing the wrong individual.
2. Ignore entities, just tax distributions, BUT that would hurt the tax base.
3. Tax TWICE: to entity && to beneficiaries, BUT that would be unfair.
4. Ignore beneficiaries, just tax entities, BUT this would overcome progressive tax structure.
5. As income comes into entity, if it's retained: TO TRUST // if it's distributed: TO BENEFICIARY.
3 Basic Rules Concerning Deductions:
1. The fiduciary MUST allocate deductions directly attributable to an item of income entering into DNI to THAT item of income
2. Deductions NOT directly attributable to a particular item of income are floating deductions –> fiduciary can allocate it however AS LONG AS fiduciary allocates appropriate portion of tax-exempt interest to tax-exempt interest.
· $Deduction XX (($Tax-exempt DNI // $Total DNI)) = $Tax-exempt portion of deduction
3. If a deduction is directly attributable to a class of income EXCEEDS that income, the excess is generally a floating deduction. If the deduction is attributable to tax-exempt interest, it CANNOT operate to reduce ANY item of income. The fiduciary need NOT allocate to tax-exempt interest ANY portion of an excess deductible expense directly attributable to a class of taxable income.
Deductions Generally Within Fiduciary's Discretion:
o Fiduciary commissions
o Safety deposit box rental
o State and city income taxes
o Personal property taxes
o Attorneys' fees && litigation expenses
Capital Gains are taxed to trust in PRINCIPAL– we don't force capital gains out bc LTCG are taxed @ flat rate whether it's in hands of beneficiaries OR entity.
651(a) sets forth 3 requirements:
1. The terms of the trust MUST require distribution of ALL of the trust's income currently
o “Currently” refers to taxable year && actual distribution is irrelevant
2. The terms of the trust MUST “NOT provide that any amounts are to be paid, permanently set aside, or used for the purposes specified in 642(c).”
