2009/2010 estate/trust tax question(s)

Clarify: It was Mary's mother who was your grandfather's younger sister, and Mary created her own trust separate from the trust of her mother. Is that right? Or was Mary your grandfather's sister? It doesn't make a lot of difference from a legal standpoint, but it does to understand what's going on.

You have to distinguish between two separate taxes. First is income tax. Trust income is taxed in the year it was received. If the trust is for someone who is still alive, the person who set up the trust is taxed on the income. If that person has died, and trust income was distributed to beneficiaries, the beneficiaries are taxed. And if it was not distributed, the trust generally pays the tax.

In addition to that is the estate tax. That tax is paid for the year the person died. It is similar to property tax, being imposed on the net value of the person's total estate. Beneficiaries do not pay income tax on gifts or inheritances except to the extent they receive taxable income that was not paid by either an estate or a trust.

If the person died in 2009, there is an exemption in the estate tax for the first $3,500,000. So if the total value of the estate (including the death benefit from any life insurance) is less than that, there is no estate tax. If the person died in 2010, there is no estate tax.

There is also the issue of the basis of property inherited, but let's leave that for another post.

His estate gets to take them. Others here who actually do tax returns will be able to give you a more complete answer.

I answer questions like this over the phone all the time.

You were right to recommend that they get professional help, though I would have suggested they retain a tax pro with experience in trusts and let the tax pro retain the attorney. Sadly, in my experience most tax pros know better who the good attorneys are than the other way round. With that said -

There is NO WAY to know from what you've posted - or should post - on this forum what the tax implications are. Local law and the trust document will make that determination. Let me give you one small example that happens a lot here in Maryland.

Let's say that the trust has an investment account that throws off:

1 - Interest income 2 - dividend income 3 - capital gain distributions 4 - gains from the sale of an investment (used to exchange one investment for another).

Let's also say that the trust document says that ALL INCOME will be distributed to the beneficiary.

Now, let's look at what we have! First - interest and dividends are income as defined by Maryland law, so those dollars must be distributed to the beneficiary.

However, capital gains - both CG distributions AND gains from the sale of an invesment ARE NOT INCOME under the Maryland statute. Instead they are conversions of capital - the trading of one piece of corpus for another. So they do NOT automatically get disbursed to the beneficiary.

However, if the trust document defines capital gain distributions as income then it can be disbursed.

What about the sale of the investment? If its sold at a gain it is still NOT income, even though it is taxable - at least not for distribution purposes UNLESS the document specifically says that it can be treated as income. AND does that definition attach to the basis or the basis and the gain, what about if its sold at a loss.

Let me be clear here - let's assume that an investment with a basis of $100 is sold for $110. There are several ways this can be treated -

1 - the conversion of one asset for another - taxable but not distributable; 2 - the conversion of one asset for another - taxable and distributable; 3 - the conversion of one asset for antoher - taxable with only the gain being distributable

And I haven't even touched on "taxable to whom". Does the trust or estate pay the tax or is the income distributed to the beneficiaries and taxed to them. And don't confuse Distributable Net Income for tax purposes, which shifts the tax burden out of the trust/estate and onto the beneficiaries, with a distribution of actual money. It is entirely possible for a beneficiary to get money that the trust has to pay taxes on OR to pay taxes on income they don't get.

And when the trust has to pay taxes does it pay taxes out of distributable income or does it liquidate other assets to pay those taxes?

And I haven't touched on what happens when an asset is sold at a loss!

I know its confusing - that is why there is NO SUBSTITUTE for good planning. Its also why it costs so much. There is a lot to consider and much of it means trying to out-guess what might happen one day in the future.

The first thing you have to do is to READ the trust document, see what it says about what is income and what is considered corpus. Make notes about what it DOESN'T say, then read your state's estate and trust laws to see how it resolved ambigous or unclear issues left unaddressed by the document. ONLY then will you have an idea of what your situation is.

I can tell you this -

When a trust pays tax, it gets taxed at the HIGHEST individual rate once taxable income hits a very low number - about $9K I think. So whenever possible I like to have the trust distribute the taxable income to the beneficiaries - most of them will not be in the highest bracket and a LOT of tax money can be saved. BUT we can't do that if the trust document won't allow it.

You do need professional help. I'd suggest you go to

- the National Association of Enrolled Agents (tax specialists by definition) and start calling around to find one who does trust and estate work, schedule a meeting and get some feedback specific to your situation. You can also make an appointment with the attorney you've retained to see what they are doing.

Whoever you use, do your best to get them to explain to you what has to happen and why.

Good luck, Gene E. Utterback, EA, RFC, ABA

Mary is my grandfather's younger sister. My grandfather's and Mary's mother left Mary as the trustee since she was always "the smart one" or something like that (my grandfather was a truck driver and now only drives to play lotto, heh).

Mary, my great aunt or great-great aunt (i don't know the proper term), was both the trustee of her mother's trust AND she, Mary, had a trust created with her own assets when she passed (with her son, Joseph named the beneficiary).

So if Joseph receives $X in 2010 as a distribution from his mother's trust, he has to claim it when he does his taxes next year as 2010 income. I was definitely confused about whether the death tax was involved, but I now think I understand that situation.

I am understanding you to say that anything not distributed ends up as a tax liability for the trust. Yes? So does the trust have to pay 2009 taxes for anything not distributed last december? And then it has to pay again in 2010 for anything not distributed?

Ok, wait, so if Joseph receives $X that was not taxed before, then he has to pay. But would income Mary received have been taxed? It would, right? Or are you mentioning this because anything Mary had as part of her mother's trust might not have ever been taxed?

Great.

Adjusting the "basis" for inflation and whatnot? I agree, let's ignore that for now.

His estate? He's still alive! What did I misunderstand?

Well Stu, you're awesome. You must not be in NJ, because everyone here has a stick up their ass about helping over the phone.

Much appreciated.

Very good start, I should take up that angle next week. Thanks.

I didn't realize trust instruments could be so varied or have such implications. I don't actually have any of the paperwork, I've just been trying to field calls from others in my family pushing me to "get involved" and ... yeah, not a great situation.

...Geez.

So there is no requirement to distribute everything in the trust? Is the difference between all and some the difference between simple and complex trust types?

I've got you on the "can not compute" ... I'll keep this stuff in mind and I'll try to sift through what I've got.

Because sometimes a distribution is mandatory, and other times it's not, right?

Hahaha, something like this would have been my next question. How do they pay? Etc...

Ok, you got me. Expect a follow-up post if I can't find someone to help me after I've read it better.

Do you mean income for the trust? Like what it gains that isn't a capital gain? I don't think they have any assets providing income, I think it's just stock.

Actually, speaking of stock, is the stock valued at the time it's distributed? Like a hundred shares of general electric bought for ... whatever it cost in the late 60's ... what does Joseph pay on *on his own behalf* if he receives, say, 50 shares, and what does the trust pay if it retains the other 50? In a simple situation, if the trust does not redefine capital gains as income, then the trust pays at its own rate for capital gains and Joseph pays his own capital gains tax?

I'm going to get somebody on the horn, but thank you for your help so far and thank you again if you can field the above.

Thank you very much, Gene!

Her relationship to you is she is your great-aunt (sometimes called grand-aunt).

I really don't like that statement. Technically, an estate has NO medical deduction. The deduction that is allowed is for UNPAID LIABILITIES, but only if the decedent did NOT also claim the same amount as a medical expense paid up to the one year anniversary of his/her death. There is no rollover of deductions or carry-forwards from a decedent to his estate. There is permitted a distribution of certain excess deductions and carry-forwards from the estate to the beneficiaries (IRC 642(h)).

why not go back to the attorney who created the trust?

It's not when Joseph receives trust income, it's when the trust receives it. If the trust receives it in 2010 and distributes to Joseph the same year, then the trust can deduct it and Joseph claims the income for income tax purposes.

It pays income tax just as any person would - on income earned during that particular year. So if it earned income in 2009 and paid income tax for 2009, it doesn't pay tax on the same money in

2010. Again, there is no income tax on assets held, only in income received.

Assets held (aside from income received) may be subject to estate tax in the year the trustor (the person who sets up the trust) dies. But as the movie title says, you only die once, and only pay estate tax once.

Anything earned before death should have been taxed to the person, so it's not normally taxed to the estate or to the trust. The reason I'm mentioning it is that money retained in qualified plans, such as an IRA, are not normally taxed during one's lifetime. When the person dies those funds are subject to both income tax AND estate tax.

As I like to say, 99% of the lawyers out there are the ones who give the rest of us a bad name. My guess is that if you look hard enough you can find a lawyer with heart, even in NJ - I found one in Brooklyn for a client a while ago.

Thanks for the clarification. I knew it was more complicated than what I was saying.

Good. I agree with Gene that a good tax pro is the best person to start with on this. The attorney, if at all, will come later.

One of the beauties of trusts is that there is tremendous flexibility in them. It also often means more complexity down the line, though.

There are many types of trusts. But all trusts can be categorized as simple, complex or grantor trusts. A grantor trust is normally taxed to the person who sets up the trust, and the trust is ignored for tax purposes.

Whether income is required to be distributed depends on the terms of the trust. If all income is required to be distributed (so that the trust is left with no taxable income) it is probably a simple trust. Any other trust that is not a grantor trust will be a complex trust.

Oh, that would be too easy, so no. One reason the trust would be taxed would be if it receives taxable income in one year and distributes it to a beneficiary the following year.

That's determined by the trustee - just as any person decides how to pay his own taxes. The rub with trusts is that bracket creep is steep - meaning that trust income goes into higher brackets more quickly then an individual's income. So often the tax will be higher if the trust doesn't distribute income and pass on its tax liability.

Years ago I got a phone call from an IRS attorney concerning a trust written by the firm I worked for. The attorney said, in effect, "That trust document is so long and complicated it's giving me a headache. Tell me how much of the estate will be allocated to each trust and I'll take your word for it."

you sure earned your fee on that one!