Estates, Trusts, & K-1's

just as a follwup from a couple of the bene's points of view - A - since no distributions were made, then no income would be reported anyway B - since if a cap loss was incurred in the Trust, but not reported / passed thru via issuing a K-1 - it's just unfortunate for each bene on their tax-loss, but not a big deal.

There's speculation here, but no one asking about the terms of the trust.

The trust documents spell out when/how the assets are to be distributed. Anything else is guessing from us.

Our irrevocable trust dishes out realized gains (with K-1) each year to my 13 yr old, but no principal until college.

My MIL's revocable trust will dish out a small percent each year (after she passes) to each of her two daughters, and on their death, to my daughter.

It's all about the details.

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Agree completely. Don't know that much about taxing trusts, but I believe that for estates, if the will mandates immediate distribution (e.g. income from property to be distributed), then that income is taxable to the beneficiaries, regardless of whether it is actually distributed. Just another example of where the details matter.

When talking about a will, as opposed to a trust, there is essentially no such thing thing as an immediate distribution. All distributions are subject to estate administration.

Even with a trust, a particular asset can't be legitimately distributed until all creditors are assured of being paid.

___ Stu

I know there's a choice (in how it's written) and retained earnings inside a trust get taxed at high rates for low numbers, i.e. the marginal rates are far steeper than for the normal brackets. 35% kicks in after $2937.00 (not typo, under $3K).

Respectfully, I don't see how I can get a K-1 telling me to claim taxable income with no receipt of that income. Someone smarter than I am would need to comment. (Imagine a $100K K-1. You'd owe $28-35K depending. Now imagine not getting any money from the trust. Doesn't feel right)

The sticky part of this ongoing 6yr old situation, is the "family" issues... Dad died 6 years ago - Estate - Trust Mom died 4 years ago - Estate - Trust

The Trustee is one of the family, and basically controls what is being said or filed. She is also a CPA for the Estates and the Trust. So, all info is basically in her control.

Can't recall exactly all the checklist items for filing the Dad & Mom Estate Returns, along with any Trust returns.

The rest of the family can ask for status, and the rumbling of the K-1, but she can just say nothing...

The Trust currently holds these assets :

- proceeds from the sale of Mom's house

- a couple rental condos (mortgage underwater)

- a couple bank accounts

No distributions have been made, with the thought being.... to hold cash for any expenses or potential mortgage payoff.

SO - there you have it - We can fight with the family member Trustee to get the info - and have her walk and never speak to anyone again - or gently walk on the family egg shells until this finally gets resolved some year....

That was kinda our point - I guess it's a flip between the Trust reporting it's gain/loss, vs then distributing to the bene's via a K-1

And therein lies the rub.

Certain types of entities don't pay tax directly instead the income is divided up and passed through to the owners on a K-1. Other types of entities, trusts and decedent's estates can CHOOSE whether to pay the tax directly or to pass the income through to the beneficiaires. Generally the trustee will make this decision based on the net income and tax brackets of the trust and the beneficairies.

Once net income for a trust hits a certain level the trust will pay tax at the HIGHEST individual rate. That income level is relatively low, I think around $11K. So passing the income through to the beneficiaries can result in the trust paying less in tax, thus preserving more of the corpus for the beneficiary. It's also possible that the trust document calls for the income to be passed through to the beneficiaries, leaving the trustee with no choice.

BTW, when we're talking about trusts the correct terminology is Distributable Net Income.

The same thing happens with S Corporations, Partnerships and Limited Liability Companies - they pay no tax directly. Instead they pass the income and other separately reportable items through to the owners who then pay the tax directly. Almost every year we get a client with a complaint like yours "I got this K-1 that I'm supposed to pay on but I didn't get any money." And our response is always the same - you own, or are a beneficiary of, an entity that pays no tax. Its up to YOU to put that income on your return and pay the tax.

Think of it like reinvested dividends or capital gain distributions from other investments. If your ABC stock throws off $100K in dividends BUT reinvests those dividends you pay the tax. You may even argue that you didn't get the money, but really you did. Its treated as if you got the $100K and immediately used it to buy more ABC stock.

For capital gain distributions it works like this - you and I are the ONLY owners of XYZ mutual fund. At some point I want out and tell my broker to sell my shares in XYZ and give me my money. To do this the fund manager must sell some of the funds holdings to generate enough cash to buy me out. This creates a capital gain distribution that gets shared among the owners based on their ownership percentages. While you did NOTHING you still get to pay tax on your share of the capital gains generated internally by the fund manager when he sold enough to cash me out.

Hope this helps, Gene E. Utterback, EA, RFC, ABA

Gene, I understand that Trusts can have unique rules for what/how/why on the distributions. I understand the trustee can have the trust pay the tax on gains or pass to the beneficiaries. I'm new to the possibility of a trust having term which gives the beneficiaries no distribution, but does issue K-1 for the tax due. When I issue a K-1, it distributes the gains and it's for the beneficiary to pay at her rate. What's suggested here is the K-1 is a tax bill with no distribution. I got that right?

Actually the highest rate kicks in for estates and trusts at $7500. That bracket creep can be deadly!

___ Stu

That's the way it is with partnerships and S-corporations. I thought trusts could only take a deduction and pass the income on to beneficiaries to the extent they may actual distributions. I have not researched this issue, though.

___ Stu

Gene, I understand that Trusts can have unique rules for what/how/why on the distributions. I understand the trustee can have the trust pay the tax on gains or pass to the beneficiaries. I'm new to the possibility of a trust having term which gives the beneficiaries no distribution, but does issue K-1 for the tax due. When I issue a K-1, it distributes the gains and it's for the beneficiary to pay at her rate. What's suggested here is the K-1 is a tax bill with no distribution. I got that right?

I know partnerships can do that. But my understanding is that for a trust to deduct income, that income must be required to be distributed under the trust document. See for example §§651 and 661.

___ Stu