Complex trusts are allowed to deduct distributions made to beneficiaries. All trusts that are not simple or grantor trusts are classified as complex trusts. For complex trusts, the trustee should determine if a distribution of the current year’s income makes sense and if it is allowed in the trust instrument.
A trust instrument may give the trustee discretion as to making distributions or not to the beneficiaries. If a distribution of income is made, the trust takes a distribution deduction. The income passes through to the beneficiary on a Schedule K-1.
The trust instrument of a complex trust can require an amount to be distributed to the beneficiary each year, even if that amount exceeds the trust’s income. The trust instrument can also give the trustee discretion to distribute or accumulate any fiduciary accounting income in excess of the stated amount. If the trust instrument allows for amounts paid to a charity those amounts are not considered a distribution deduction but rather a charitable deduction.
Trust income tax rates are very compressed and reach the top bracket very quickly, so many times it makes sense to pay out the trust income to the beneficiaries who are in a lower tax bracket and ultimately pay less income tax. Trusts are at the 37% rate at taxable income over $12,950. The additional net investment income tax rate of 3.8% kicks in at this $12,950 amount as well. Trusts reach the maximum tax rate at lower taxable income than individuals. The preferential rates for qualified dividends apply for trusts however the net investment income tax is an issue.
The good news with complex trusts is that if you don’t make a distribution by year-end, you have 65 days after the year-end to make the distribution and have it apply to the previous year. The amount is considered to have been paid on the last day of the immediately prior tax year. This is a very useful tool when looking at the potential taxable income for complex trusts. The trustee can designate some or all of the distributions made in the first 65 days of the tax year as covered by the 65-day election.
December is always the month to complete tax planning ideas for the year, but as noted here, in complex trusts there is a little more time to accomplish some goals.
Our Estate and Trust Team is available to assist you with any complex trust planning questions you may have.
This post was written by Pam Guschausky, a CPA and Shareholder in the Anderson ZurMuehlen Great Falls office.