may deduct an annual maximum of by 7c3sP4v

VIEWS: 4 PAGES: 9

									        Chapter 15


                                                                                     INCOME TAXATION
                                                                                          OF ESTATES
                                                                                          AND TRUSTS
                              SOLUTIONS TO PROBLEM MATERIALS

DISCUSSION QUESTIONS

15-1    To describe a fiduciary as a conduit of income implies that income earned and accounted for by the
        fiduciary “flows through” the fiduciary and is taxed to the beneficiaries of the fiduciary rather than the
        fiduciary itself. Under this conduit principle, the character of the income is not changed as it flows
        through the fiduciary. A fiduciary functions as an income conduit only to the extent cash or property
        distributions are made to the beneficiaries. (See p. 15-12 and §§ 651, 652, 661, and 662.)

15-2    Trusts are useful in situations in which it is desirable or necessary to separate the legal ownership and
        control of property from the beneficial enjoyment of the property. Such situations could occur when
        the beneficial enjoyment of property is to be given to a number of individuals (as opposed to one
        individual), a minor, or an incompetent or incapacitated individual. (See p. 15-2.)

15-3    A trust cannot exist unless there is a separation of legal ownership and beneficial ownership. No such
        separation exists if the trustee and sole beneficiary are the same person. (See p. 15-2.)

15-4    If the income beneficiaries and remaindermen of a trust are different individuals, the grantor may want
        both types of beneficiaries to bear a portion of the cost of the trust administration. (See p. 15-3.)

15-5    Congressional tolerance may be due to the fact that estates, unlike trusts, are not intentionally created
        and that an estate usually exists as a separate taxable entity for a very short period of time. (See
        p. 15-1.)

15-6    The concept of fiduciary income as defined by the trust instrument or applicable state law may differ
        from the concept of fiduciary taxable income as defined in the Internal Revenue Code. Therefore, a
        distribution of 100 percent of fiduciary income may not represent a distribution of 100 percent of
        taxable income. [See pp. 15-2 and 15-3 and § 643(b).]

15-7    Administrative expenses (or any portion thereof) may be claimed as a § 2053 deduction from the gross
        estate or a § 212 expense for fiduciary income tax purposes. No double deduction is allowed. [See
        p. 15-7 and § 642(g).]

15-8    Per rules governing individual taxation, a fiduciary may deduct an annual maximum of $3,000 of net
        capital loss; and excess capital loss is carried forward [See p. 15-9 and § 641(b).]

15-9    Operating losses of a fiduciary do not “flow through” to be deducted by beneficiaries; rather, they are
        subject to carryback or carryforward at the fiduciary level. [See p. 15-9 and § 642(d).]

15-10   From the point of view of the fiduciary, the taxable portion of DNI is the maximum amount deductible
        for distributions to beneficiaries. For beneficiaries, the taxable portion of DNI represents the maximum
        amount of fiduciary income for which they may be taxed. [See pp. 15-12 through 15-14 and §§ 651(b),
        652(a), 661(c), and 662(a).]
2       Income Taxation of Estates and Trusts

15-11   When a beneficiary receives a distribution from a fiduciary, the distribution is considered nontaxable
        to the same extent, or in the same proportion, that the fiduciary DNI is nontaxable. [See Example 12,
        p. 15-14, and §§ 652(b) and 662(b).]

15-12   Unlike charitable contributions made by individual taxpayers, charitable contributions made from
        fiduciary gross income are deductible without limitation. Also, a fiduciary may elect to deduct a
        charitable contribution in the year paid or in the preceding taxable year. [See p. 15-8 and § 642(c)(1).]

15-13   Such property distribution may represent a distribution of estate taxable income, unless it is a specific
        property bequest. [See Example 9, pp. 15-12 and 15-13, and § 663(a)(1).]

15-14   In the year of termination, all trusts distribute trust corpus to the appropriate beneficiaries. A trust that
        distributes corpus, by statutory definition, is a complex trust. [See p. 15-15 and § 651(a), last sentence.]

15-15   Such a cash reserve economically replaces the decline in value of depreciable trust corpus. Thus, the
        ultimate recipient of the trust corpus is protected against the economic decline or deterioration of his
        property during the existence of the trust. (See p. 15-3.)

15-16   When a beneficiary receives a distribution from a fiduciary exceeding DNI, the distribution may
        represent corpus or previously accumulated fiduciary income. Such amounts are nontaxable.

15-17   Fiduciaries may want to avoid accumulating income since it may be taxed at very high rates. Because
        DNI may not be known until after the close of the year, a trustee may not know the amount of the
        current distributions needed to avoid accumulation. Under the 65 day rule, this problem can be avoided
        since it allows the fiduciary to treat distributions after the year end as made in the prior year. (See p.
        15-27.)

PROBLEMS

15-18                     Dividend income                              $38,000
                          Tax-exempt interest                           18,900
                          Taxable interest                              12,400
                                                                       $69,300
                          Less:
                             60% of $5,000 trustee fee                  (3,000)
                          Fiduciary accounting income                  $66,300

        Each beneficiary will receive one-third of $66,300 for a distribution of $22,100. (See Example 1 and
        pp. 15-2 and 15-3.)

15-19   a.   There is no income to M because he receives the stock as a specific bequest. [See § 663(a)(1).]
             The trust must recognize a capital gain of $4,000. M’s basis in the stock is $11,000. [See Example
             11, p. 15-13, and Reg. § 1.661(a)-2(f)(1).]
        b.   $7,000 of trust income (basis of the distributed shares) is taxable income to M. Trust T will
             recognize no gain on the distribution and will use the $7,000 basis of the stock as its deduction for
             distributions to beneficiaries. M will have a $7,000 basis in the 100 shares. [See Example 10,
             p. 15-13, and § 643(e)(1) and (2).]
        c.   $11,000 of trust income (FMV of the distributed shares) is taxable income to M. Trust T will
             recognize a $4,000 gain on the distribution and will use $11,000 as its deduction for distributions
             to beneficiaries. M will have an $11,000 basis in the 100 shares. [See Example 10, p. 15-13, and
             § 643(e)(1) and (3).]
                                                               Solutions to Problem Materials                        3
15-20   a.   Per Reg. § 1.167(h)-1(b), allowable depreciation is allocated to the trustee to the extent the
             governing trust instrument or local law requires a reserve for depreciation. Therefore, all $2,000 is
             allocated to the trust and none to the beneficiaries.
        b.   The above-cited regulation specifies that to the extent allowable depreciation exceeds the amount
             of any required reserve, such excess is allocated on the basis of trust income allocable to trustee
             and beneficiaries.

                          Allowable depreciation                            $7,000
                          Allocated based on trust reserve                  (3,000)
                          Allocated to 100% income
                             beneficiaries                                  $4,000

        (See Example 5 and p. 15-8.)

15-21                     Rents $62,000
                          Dividends                                                           12,000
                          Capital loss ($7,000 but limited to $3,000)                         (3,000)
                                                                                             $71,000
                          Less:
                             Rent expense ($70,000 but limited to rent income)              (62,000)
                             Trustee fee                                                     (4,000)
                             Exemption (complex trust)                                         (100)
                          Trust taxable income                                               $ 4,900

             The $8,000 excess of rent expense over rent income is a passive activity loss that may not be
             deducted against the trust’s dividend income. This passive activity loss will be carried forward by
             the trust. (See p. 15-9 and § 469.)

15-22   a.   The $19,900 legal and accounting fees and the $6,100 executor’s fee may be deducted either on
             the estate tax return (Form 706) or on the estate income tax return (Form 1041) but not both. The
             executor may allocate a portion of the expenses to each return in order to maximize the tax benefit
             of the deduction. In the case of Decedent L, the marginal income tax rate on $60,000 of income is
             31 percent, whereas the marginal estate tax rate on a $1,700,000 taxable estate is 45 percent.
             Therefore, the entire $26,000 of expenses should be deducted on the estate tax return. The $4,800
             funeral expenses may only be deducted on the estate tax return (Form 706). [See p. 15-7 and
             § 642(g).]
        b.   In this case, L’s taxable estate is zero because of the unlimited marital deduction of § 2056.
             Therefore, the executor should deduct all the administrative expenses on the estate’s income tax
             return. [See p. 15-7 and § 642(g).]

15-23   a.    $4,000   func{ [$10,000~ distribution~ ×~{$20,000~ taxable~ DNI}
              over{$50,000~ DNI} ]}
              (See Example 12, p. 15-14.)

        b.   $4,000. [See Example 12, p. 15-14, and Reg. § 1.661(c)-1.] Note that whatever amount is
             deducted by the trust is taxable to the beneficiaries.
4       Income Taxation of Estates and Trusts


15-24   a.    $6,000  func{ [$10,000~ charitable~ donation~ ×~{$60,000~ taxable~trust ~
              income} over{$100,000~ trust~ income} ]}

        [See Example 4, p. 15-8, and Reg. § 1.642(c)-3(b)(1).]


        b.    $3,000  func{ [$55,000~ trustee~fee~ ×~{$60,000~ taxable~trust ~ income}
              over{$100,000~ trust~ income} ]}

        [See Example 3, p. 15-6, and Reg. § 1.652(b)-3(b).]


        c.   $6,500 rent expense (all allocable to taxable rent). [See p. 15-6 and Reg. § 1.652(b)-3(a).]

15-25   a.                Taxable interest                                        $25,000
                          Rents 11,000
                                                                                  $36,000
                          Less:
                             Rent expense                                          (2,400)
                             Deductible trustee fee*                                 (900)
                                                                                  $32,700
                                               Solutions to Problem Materials            5
func{ $1,000~fee~ ×~{$36,000~ taxable~trust ~gross~ income} over{$40,000~ trust~gross~
income} }
6   Income Taxation of Estates and Trusts

                      Plus:
                         Net nontaxable interest
                         ($4,000  $100 trustee fee allocable
                         to nontaxable trust income)                            3,900
                      DNI                                                     $36,600

    [See Example 13, pp. 15-14 and 15-15, and § 643(a).]

    b.                Taxable interest                                        $25,000
                      Rents 11,000
                      LTCG (taxable even though not distributable)              9,000
                                                                              $45,000
                      Less:
                         Rent expense                                          (2,400)
                         Deductible trustee fee                                  (900)
                         Deduction for distribution to
                            beneficiaries (taxable DNI)                      (32,700)
                         Exemption (simple trust)                               (300)
                         Trust taxable income                                $ 8,700

    (See Example 13 and pp. 15-14 and 15-15.)

    c.   $1,560 (at 2001 tax rates). Because the entire $8,700 of taxable income represents LTCG, the
         trust’s 2001 tax liability equals 10% of the first $1,800 of taxable income, $180, plus 20% of the
         remaining $6,900 of income ($8,700  $1,800) or $1,380.
                                                               Solutions to Problem Materials                7
15-26   a.               Taxable dividends                                       $10,000
                         Rents                              30,000
                                                                                 $40,000
                         Less:
                            Rent expense                                          (7,500)
                            Deductible trustee fee*                               (4,000)
                         Taxable DNI                                             $28,500

func{*$5,000~ fee ~~ ×~~{$40,000~ taxable~ trust~ gross~ income} over
{$50,000~ trust~ gross~ income}}


                         Plus:
                            Net nontaxable interest
                               ($10,000  $1,000 trustee fee allocable
                               to trust nontaxable income)                         9,000
                         DNI                                                     $37,500

        [See Example 13, pp. 15-13 and 15-14, and § 643(a).]

        b.               Dividends                                               $10,000
                         Rents                              30,000
                         LTCG                                                     15,000
                                                                                 $55,000
                         Less:
                            Deductible trustee fee                               (4,000)
                            Rent expense                                         (7,500)
                            Deduction for distribution to
                               beneficiaries                                    (22,800) *
                            Exemption (complex trust)                              (100)
                            Trust taxable income                                 $20,600

func{*$30,000~ distributions ~ ×~{$28,500~ taxable~ DNI} over{$37,500~ DNI}}


        (See Example 16 and p. 15-16.)

        c.   Beneficiary C:func{$20,000`` distribution ``×``{$28,500``taxable``DNI} over
{$37,500`` DNI}`=` $15,200`` taxable`` income}.


            Beneficiary D:        func{$10,000`` distribution ``×``{$28,500``taxable``DNI} over {$37,500``
DNI}``=`` $7,600`` taxable`` income}.

        (See Example 16 and p. 15-16.)
8       Income Taxation of Estates and Trusts

15-27   a.   Because total current distributions of $70,000 are less than DNI, each beneficiary is required to
             report the amount of the distribution representing taxable DNI in his or her gross income.
             Therefore, E must report $60,000 of taxable DNI and G must report $10,000 of taxable DNI. The
             trust’s deduction for distribution to beneficiaries is $70,000. (See Example 15, p. 15-16.)
        b.   The required first-tier distribution to E is $42,500, 50 percent of the trust accounting income of
             $85,000. The additional $37,500 distributed to E and the $40,000 distributed to G are
             discretionary second-tier distributions. The first $42,500 of DNI is allocated to the first-tier
             distribution. The remaining $42,500 of DNI is allocated proportionately to the second-tier
             distributions as follows:

func {STACK {{$37,500~ E’s~ second-tier~ distribution} over {$77,500~ total~ second-tier~
distributions}~×~ $42,500~ =~ $20,565#~#~#
{$40,500~ G’s~ second-tier~ distribution} over {$77,500~ total~ second-tier~
distributions}~×~ $42,500~ =~ $21,935}}



             Therefore, E must report taxable DNI of $63,065 ($42,500 + $20,565), and G must report taxable
             DNI of $21,935. The trust’s deduction for distributions to beneficiaries is $85,000. [See Examples
             15, 16 and 17, p. 15-16, and § 662(a)(1) and (2).]

15-28   Beneficiary S: First-tier distribution of $60,000 is taxable to the extent of

func{{$75,000~ taxable~ DNI} over {$100,000~ DNI}~×~ $60,000~ =~ $45,000}


        Beneficiary T and U: Second-tier distributions are taxable to the extent of remaining taxable DNI:

                      DNI$100,000
                      First-tier distribution    (60,000)
                      Remaining DNI             $ 40,000       × 75% = $30,000          Taxable DNI allocable
                                                                                        to second-tier distributions

        T:     func{{$40,000~ distribution} over {$70,000` total` second-tier`
distributions}~×~ $30,000 ~=~ $17,143 ~taxable` \to` beneficiary` T}.

        U:     func{{$30,000~ distribution} over {$70,000` total` second-tier` distributions}~×~ $30,000
~= ~$12,857 ~taxable` \to` beneficiary` U}.

        [See Example 17, p. 15-17, and § 662(a).]

15-29   The beneficiaries pay tax on taxable DNI of $33,000. The balance represents previously taxed income
        and (since the repeal of the throwback rules) is not subject to tax.
                                                              Solutions to Problem Materials                       9
15-30   a.   Because the uncollected $14,500 income that K earned before his death could not be included in
             his final cash basis individual income tax return, it must be classified as income in respect of a
             decedent and taxed to K’s estate when it is received. The $1,600 debt to K’s attorney is a personal
             debt that would not have resulted in a business deduction when paid by K. Therefore, the payment
             of the debt by K’s executor does not result in a deduction in respect of a decedent. (See pp. 15-10
             and 15-11 and § 691.)
        b.   If K had been an accrual basis taxpayer, the $14,500 earned income would have been properly
             reported on K’s final income tax return even though the receivable was not collected prior to K’s
             death. The subsequent receipt of $14,500 cash by the executor would have no income tax
             consequence. (See pp. 15-10 and 15-11 and § 691.)

15-31   a.   Because Z is a cash basis taxpayer and did not receive an interest payment prior to her death, no
             amount of capital gain or interest income is includible on her final income tax return. [See
             pp. 15-10 and 15-11 and § 691(a).]
        b.   The amount of $18,000 interest income, accrued as of the date of Z’s death, represents income in
             respect of a decedent (IRD) and is taxable to the estate under § 691(a). The remainder of the
             interest ($1,700) was earned by the estate and is taxable under the general rule of § 61.
             The receipt of the $20,000 principal payment triggers recognition of $15,000 of capital gain under
             § 453(c).

func{{$150,000~ gross ~profit~ on ~sales ~of ~land} Over {$200,000 ~contract ~price} ~ = ~
75%~ gross ~profit~ percentage}


                    Principal payment                  $20,000
                    Gross profit percentage               75%
                    Capital gain                       $15,000

             The $15,000 capital gain is taxed to the estate as IRD. [See pp. 15-10 and 15-11 and
             Reg. § 1.691(a)-5.]
        c.   IRD collected by the estate totals $33,000. The total IRD included in Z’s taxable estate is
             $168,000 ($18,000 accrued interest plus $150,000 deferred capital gain on the installment sale).

func{{$33,000} over {$168,000} ~×~ $10,000~estate~ tax~ attributable~ \to ~total~ IRD~
=~ $1,964}

             Therefore, the estate may deduct $1,964 under § 691(c). [See Example 8, p. 15-10 and Reg.
             § 1.691(c)-1.]


TAX RETURN PROBLEM

A completed 2000 Form 1041, Schedule D, and Schedule K-1 for BTJ Problem (15-32) are contained in the
Instructor’s Guide for 2002.


RESEARCH PROBLEM

The solution to the Research Problem (15-33) is contained in the Instructor’s Guide for 2002.

								
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