Federal Fiduciary Income Tax Workshop

FEDERAL FIDUCIARY INCOME
TAX WORKSHOP
Royse Law Firm, P.C.
www.rroyselaw.com
149 COMMONWEALTH DRIVE, SUITE 1001
MENLO PARK, CA 94025
650.813.9700

ROYSE LAW FIRM, P.C. – FACULTY
C. David Spence Michael L. Zosky
Jennifer Han Fiona Xu Allison Kroeker

INCOME TAXATION OF ESTATES
Basic Concepts and Issues
www.rroyselaw.com
650.813.9700
C. DAVID SPENCE, ESQ. AND MICHAEL L. ZOSKY, ESQ.
ROYSE LAW FIRM, PC
d s p e n c e @ r roys e l aw. co m a n d m zo s k y @ r roys e law. co m

• A person having legal duty to act primarily for
another’s benefit
• Duties include:
– Loyalty
– Prudence
– Impartiality
– Diligence
– Account
– Others Duties
WHAT IS A FIDUCIARY?

• Examples of Fiduciaries:
–Executor or Administrator of an Estate
–Trustee of a Trust
–Conservator of an Estate
–Certain other Persons Required by Agreement
or by Law to act for and on behalf of other(s)
• Spouse?
• Agent?
• Partner?
WHAT IS A FIDUCIARY?

• Statute of Wills
(enacted 1540)
• Codified the private right
to devise property by
Will
• Established early Will
requirements
–Signature and date
–2 witnesses
WHAT IS AN ESTATE?

CALIFORNIA ESTATE ADMINISTRATION
• 1500+ Pages of Rules
• Minimum Administration
Period (in most California
counties) of 8 months
• More realistic expected
time period is 12-18
months if no 706 filing
requirement

INCOME DURING ADMINISTRATION
• Report and pay tax on income realized during
period of administration

• Based on Centuries Old English Common
Law
• Lord Blackstone’s
Commentaries
from 1765 liken a
trust to a division
of components of
ownership like…
WHAT IS A TRUST?

• Division of Ownership
Characteristics
• Division of:
–Control over Disposition
–Title
–Benefit
A BUNDLE OF STICKS?

• Generally, a Written Instrument Governs
(except when state law pre-empts it):
– Agreement
– Declaration
– Deed
• Three Parties:
– Settlor, Trustor, Grantor
– Trustee
– Beneficiary
MODERN TRUSTS

• Begins on Date of Death of Individual Taxpayer
• Ends on Date of Final Distribution of the Estate (sec
641(a)(3))
• Tax Computed in the Same Manner as an Individual—
Except…[for a lot of exceptions]
• One Level of Taxation—either at Estate Level or
Beneficiary Level, not Both!
ESTATES UNDER THE IRC
From Death to Final Distribution

• Cash or accrual method of accounting
• Election made on the first fiduciary income
tax return
• Does not have to be the same method of
accounting used by the decedent
Accounting Method
Cash OR Accrual

• The first taxable year begins the day of the decedent’s
death
• Ends on the last day of a month not more than 12
months after the commencement date of the tax year
– A short first and/or final tax year of the estate are
permitted
• The estate may use a fiscal year – If fiscal year not
elected, assumption of calendar year
– Practice Note: An entry on Form SS-4 indicating the
closing month of an accounting year is not a fiscal
year election
Taxable Years

• Not required unless estate is open more than
two years after decedent’s date of death
– A short fiscal year counts as one tax year
• Once obligated to make estimated tax payments,
estate may become liable for penalties imposed
on underestimations of estimated tax
– 90%/100% Safe Harbor Rule
Estimated Tax Payments

• Special rule when AGI exceeds $150,000
– Required percentage of the preceding year’s tax that
must now be paid in a tax year to satisfy the safe
harbor provisions is 110%
• Final tax year, estimated tax payments may be
allocated to the beneficiaries per an election by
the executor (Form 1041-T)
Estimated Tax Payments (Cont.)

• Domestic estate must file Form 1041 if it has:
– Gross income in excess of $600.00 for the taxable
year; or
– A beneficiary who is a non-resident alien
• Foreign estates file Form 1040NR
Federal Filing Requirements

• Due date = fifteenth day of the fourth month
following the close of the tax year
– Generally, April 15 – for Calendar year
• Automatic 5 ½ month extension of time to file
Form 1041 (Form 7004)
Federal Filing Requirements (Cont.)

• Practice Note: Consider California Filing
Requirements

• Long-term capital gains and qualified dividends =
15%
– 20% if taxable income exceeds $12,500
• 3.8% net investment income tax (“NIIT”) on net
investment income applies if estate has
undistributed net income in excess of $12,500
• AMT applies
Federal Income Tax Rates (2017)
Marginal Rate Income of Estate or Trust
15% 0-$2,550
25% $2,551-6,000
28% $6,001-9,150
33% $9,151-12,500
39.6% Over $12,500

We will now take a 15 minute break!
BREAK

INCOME TAXATION OF TRUSTS
Basic Concepts and Issues
MICHAEL L. ZOSKY, ESQ.
ROYSE LAW FIRM, PC
mzosky@rroyselaw.com
www.rroyselaw.com
650.813.9700

• Settlor/Trustor/Grantor
• Beneficiary
• Trustee
Parties to a Trust
TRUSTEE
BENEFICIARYSETTLOR
Revocable Trust

• Commencement
– Trusts
– Grantor Trusts
– Separate Trusts (separate tax payers)
• Duration
– Termination –
• As specified in the trust
• When there are no longer any assets of the trust
– Trusts holding S corporation stock
Commencement and Duration

• Trusts are taxed under Subchapter J of the Code
• Trusts may be classified generally as either
simple trusts, complex trusts, or grantor trusts
– A trust may be deemed a simple trust one year and a complex
trust in another year
General

• S corporation eligible trusts:
– Electing Small Business Trust (“ESBT”) (1361(e))
• Multiple beneficiaries
– Qualified Subchapter S Trust (“QSST”) (1361(d))
• One beneficiary
– Grantor trusts
General

• General requirements in trust instrument:
– 651-652
– All income is to be distributed
currently;
– No accumulation of trust
income;
– The trust does not permit amounts to be paid,
permanently set aside, or used for charitable
purposes; and
– No trust principal is distributed in the current year
• Annual exemption of $300.00
Simple Trusts

• General requirements in trust instrument:
– 661-663
– Discretionary income distributions, including
discretion to accumulate;
– The trustee distributes principal, either pursuant to a
discretionary power or a mandatory directive; and
– May have charitable beneficiaries
• Annual exemption of $100.00
Complex Trusts

• 671-679
• Grantor trusts
– Revocable (living) Trusts
– Certain retained rights/interests also cause grantor
trust status
• Grantor must report all trust income on his or
her own Form 1040
• May need separate tax ID number and may need
to file informational Form 1041
Grantor Trusts

• There are two alternative methods without a Form
1041:
– The trustee may furnish the grantor’s tax information to
each payor of income, and provide the grantor with a
statement identifying each payor and showing
income/deductions and credits.
– The trustee may furnish the trust’s tax information to
each payor. The trustee then file Form 1099s with the IRS
showing the trust as the payor and the grantor as the
recipient. Trustee provides the grantor with a statement
identifying each payor and showing income/deductions
and credits.
• Both methods require Trustee must then advise
grantor to report items on individual Form 1040
Grantor Trusts (Cont.)

• Importance of Grantor Trusts in 2017 Income Tax
Planning
– Estate, Gift and Income Tax Planning
*Not all CLATs

• 671: Basic Grantor Trust Rules
• 672: Definitions and Rules
• 673: Reversionary Interests
• 674: Power to Control Beneficial Enjoyment
• 675: Administrative Powers
• 676: Power to Revoke
• 677: Income for Benefit of Grantor
• 678: Person Other Than Grantor Treated as
Substantial Owner
• 679: Foreign Trusts having one or more U.S.
Beneficiaries

• In general, calendar year
• Limited exceptions:
– Trusts exempt from taxation under Code Section
501(a)/charitable trusts
– Charitable trusts described in Code Section
4947(a)(1)/split-interest trusts
– Revocable trusts making Section 645 election – fiscal
year of estate
Taxable Years

• General rules require a trust to file a declaration
and make estimated tax payments if the trust is
expected to owe $1,000.00 or more in tax
liability
• Penalties
– Same safe harbors as estates
Estimated Tax Payments

• Form 1041 must be filed for a trust if it has:
– Any taxable income for the tax year;
– Gross income of $600.00 or more, regardless of taxable
income; or
– A non-resident alien beneficiary
• Due 15th day of the 4th month following the end of
the trust’s taxable year
– Generally April 15 for Calendar year
• Eligible for automatic 5 ½ month extension to file
• Practice Note: Consider California Filing
Requirements

• Tax Years Beginning in 2017:
• Long-term capital gains and qualified dividends -
15%
– 20% if taxable income exceeds $12,500
• NIIT applies
• Consider State Income Taxation
Federal Income Tax Rates (2017)
If Taxable Income is: The Tax Is:
Not over $2,550 15% of taxable income
Over $2,550 but not over $6,000 $382.50 plus 25% of the excess over $2,550
Over $6,000 but not over $9,150 $1,245.00 plus 28% of the excess over $6,000
Over $9,150 but not over $12,500 $2,127 plus 33% of the excess over $9,150
Over $12,500 $3,232.50 plus 39.6% of the excess over $12,500

• What is Income?
• What is Principal?
• In California:
Uniform Principal and
Income Act
Foundational Components

• Trust Accounting Income
– This is income as determined under state trust law
• I.e. Per the Agreement or State Probate Code
• May or may not comport with GAAP
• It is NOT a taxable income concept
• It is NOT the same as state taxable income
• Used to determine the appropriate allocation between principal and
income
• E.g., used to determine the amount of cash distributed when the trust
requires “income” to be distributed
Hint:
Whenever Subchapter J of the IRC uses the term “income”
without a modifier, it is referring to Trust Accounting
Income.

– Examples of differences between TAI and Taxable
Income:
• Tax Exempt Income
• Depreciation/Depletion Reserves
• Investment management Fees and other deductions
limited by tax law which may not be so limited for FAI
purposes
• Charitable Contributions
• CAPITAL GAINS

–Capital Gains:
• Gains on Sale of Principle Assets—historically
allocable to Principal
– Duty of Impartiality required balancing investments for
“income” (e.g. bonds) with investments for
“remainder” (non-dividend paying, growth
investments)
– Trust instrument always could define “income”
differently from state law

– Capital Gains:
• Modern Portfolio Theory has Necessitated Changes
Made by UPIA
– Allowing “Reallocation” of capital gains from principal to
income
– This may occur even if the trust instrument does not
specifically allow it
• Thus, the tax preparer should consult with the
attorney for the trustee if there are any ambiguities
about what constitutes income in any particular year
– “Reallocation” policy is not necessarily consistent year-to-
year

– Capital Gains:
• Modern Portfolio Theory has Necessitated Changes Made
by UPIA
– Allowing “Reallocation” of capital gains from principal to income
» This may occur even if the trust instrument does not
specifically allow it
– Unitrust distributions may also be used as an income proxy under
UPIA
» This is a specific percentage of principal regardless of receipts
during the period
• Thus, the tax preparer should consult with the attorney for
the trustee if there are any ambiguities about what
constitutes TAI in any particular year
– “Reallocation” policy is not necessarily consistent year-to-year

Time For an Accountant Joke…

• Trust Accounting Principal
–Property Contributed by the Settlor
–Income From Prior Years Which Was Not
Required to be Distributed, and Which was not
in fact Distributed
–Sometimes others, e.g.:
• Realized Gains from Sale of Assets
• Stock Dividends
• Insurance Proceeds
• IRD (discussed later)

• Distributable Net Income (DNI)
–This is a tax-only concept
–Think of it as applying tax concepts to
trust accounting income
–DNI is used to avoid Double Taxation

• Tax Calculation:
–Gross Income “pours
in” the bucket
–DNI is “distributed”
out
–The net increase is
Taxable Income

–Determines the Maximum Income
Distribution Deduction for the Year
–Determines the Maximum Amount of
Income Taxable to the Beneficiaries for
the Year
–DNI is used to determine the Character of
Income Distributed to Beneficiaries

• Taxable Income + Tax Exempt Income, Less:
–Allocable Expenses, modified to exclude:
• Deductions for distributions
• Annual personal exemption
• Cap gains allocable to corpus (and not
required to be distributed)
• Charitable distributions
• Capital Losses (except as used to arrive at net
capital gains)

⁼ Taxable Income + Tax Exempt Income, Less:
– Allocable Expenses, modified to exclude the
following:
• Deductions for distributions
• Annual personal exemption
• Cap gains allocable to corpus (and not required to
be distributed)
• Charitable distributions
• Capital Losses (except as used to arrive at net
capital gains)

• Distributable Net
Income (DNI)
Discussion
Examples:
–Specific Bequests of
Property
–Specific Bequests of
Cash (not more than
3 installments)

• Distributable Net
Income (DNI)
Discussion Examples:
–Reallocation of
Principal to Income
under state law:
–“Safe Harbor”:
allocations between
3%-5% deemed
reasonable
Reg. 1.643(b)-1

We will now take a one hour lunch break!
LUNCH

INCOME REPORTABLE BY FIDUCIARIES
FIONA XU, ESQ.
ROYSE LAW FIRM, PC
fxu@rroyselaw.com
www.rroyselaw.com
650.813.9700

What income should be Taxed
Section 61: Except as otherwise provided in this subtitle, gross income
means all income from whatever source derived, including: interests,
dividends, rents, royalties, gross income derived from businesses, the
distributive share of a partnership’s gross income.
Section 102(a): Gross income does not include the value of property
acquired by gift, bequest, devise, or inheritance.
Section 102(b): Subsection (a) shall not exclude from gross income—
(1) the income from any property referred to in subsection (a); or
(2) where the gift, bequest, devise, or inheritance is of income from
property, the amount of such income.
Any amount included in the gross income of a beneficiary under
subchapter J shall be treated for purposes of paragraph (2) as a gift,
bequest, devise, or inheritance of income from property.

What income should be Taxed
Section 641: The tax imposed by section 1(e) shall apply to the taxable
income of estates or of any kind of property held in trust, including:
For Estates,
 “income received by estates of deceased persons during the period of
administration or settlement of the estate,”
 “income accumulated or held for future distribution under the terms of the
will,” and
 “income which, in the discretion of the fiduciary, may be either distributed
to the beneficiaries or accumulated.”
For Trusts,
 “income which is to be distributed currently by the fiduciary to the
beneficiaries,”
 “income which, in the discretion of the fiduciary, may be either distributed
to the beneficiaries or accumulated,” and
 “income accumulated in trust for the benefit of unborn or unascertained
persons or persons with contingent interests, and income accumulated or
held for future distribution under the terms of the … trust.”

Fiduciary Accounting Income
• Presumption of Receipt as Principal. Section 16335(a)(4)
• Right of Independent Trustee To Make Adjustments. Section 16336
• Distribution from business entities, cash is income (unless it is part of
a partial or full liquidation), while other assets distributed are
principal. Section 16350
• All rents are income (unless a business). Section 16356
• Bond Premiums and Discounts. Interests are income, while amounts
received on sale or redemption are Principal (other than those
bought at a discount and maturing within a year). Section 16357
• If a trustee plans to make a large, unusual expenditure, the trustee
can reduce income in order to reimburse principal or establish a
reserve. Section 16373
California Principal & Income Law, as effective
from Jan. 1, 2000

Taxed as an Individual
• Example:
An estate receives income items during its tax year:
• interest income
• Dividends
• Rents
• Royalties
• short and long term capital gains
All of the above items represent taxable income to the estate.
‒ If any of the interest income is tax-exempt pursuant to §103, such income also
will be tax exempt to the estate.
‒ If any of the transactions that gave rise to capital gains would not be recognized
for tax purposes by an individual because of the sections that permit or require
non-recognition (for example, §1031 dealing with like-kind exchanges), such gain
also would not be recognized by the estate.

Taxed as an Individual
• Example:
A trust owns a residence that is used by a
beneficiary as her principal residence. The
trust sells the residence for a gain.
‒ It is income to the trust!
‒ Because an estate or trust cannot have
a principal residence, an estate or trust
cannot take advantage of section 121.
This is so even though the beneficiary
would have qualified under this section.

Interests and Dividends
• Interests
‒ Line 1, Form 1041
‒ Form 1099
‒ Tax-exempted Interests reported separately
• Dividends
‒ Qualified Dividend
1. The dividend must have been paid by an American company or a qualifying foreign
company.
2. The dividends are not listed with the IRS as those that do not qualify.
3. The required dividend holding period has been met.
4. Taxed at the same rate as capital gain.
‒ Allocation between beneficiary and the Estate
Qualified dividends allocated to the beneficiaries is determined according to the following formula:
(Total Income Distribution/Distributable Net Income) Total Qualified Dividends

Income in Respect of a Decedent (IRD)
• What is IRD?
‒ Reg. §1.691(a)-1(b) : In general, the term “income in
respect of a decedent” refers to those amounts to
which a decedent was entitled as gross income but
which were not properly includible in computing his
taxable income for the taxable year ending with the
date of his death or for a previous taxable year under
the method of accounting employed by the decedent.
• IRD can come from various sources:
‒ Unpaid salary, fees, commissions or bonuses,
‒ Distributions from traditional IRAs and employer-provided retirement plans,
‒ Deferred compensation benefits, and
‒ Accrued but unpaid interest, dividends and rent.
• IRD retains the character it would have had in the
deceased’s hands.

Income in Respect of a Decedent (IRD)
Example:
A is a cash basis individual, invested $100,000 in a 4%, one year certificate of deposit on
October 1, 2010, with interest credited to his account on a monthly basis. A died on
December 1, 2010. The CD matured, and the principal and interest were paid to his
estate on October 1, 2011. The Form 1099INT reported the entire $4,000 interest
income in 2011 to A, using his social security number.
Since A was a cash basis taxpayer, but was in constructive receipt of the interest income
earned up to the date of his death, $667 of the $4,000 interest income should be
reported on his final Form 1040, whereas $3,333 is taxable to the estate in 2011.
Variation: If the interest earned on the certificate of deposit was not credited to A’s
account until the maturity date, none of the interest would be reported on his final
Form 1040 because he was not in constructive receipt of the interest before then. The
entire $4,000 interest income would be reported on the estate’s Form 1041. The $667
interest earned through A’s date of death is IRD.

Business Income
• Schedule C or Schedule C-EZ
‒ Whether the trust/estate has a business or not?
‒ Deduction under section 162 and section 212
• No self-employment tax
‒ Section 1402(a)
• Sale of business property
‒ Form 4797
‒ Line 7 of Form 1041

Capital Gains
• Schedule D
• Short term vs. Long term
• Form 8949
Sales and Other Dispositions of
Capital Assets
• IRD does not have step-up
basis

Special Rules – Rental and Royalty Income
• Decedent’s Former Residents
– The tax reporting depends on how the property is used after the owner's death.
– A dwelling unit used for personal purposes by the estate's or trust's beneficiaries will
be treated as personal use property unless the beneficiaries pay the entity a fair rent.
– If there is no personal use of the property by the beneficiaries, and the property is
held for the production of income, any loss on the sale should be deductible by the
beneficiaries.

Special Rules – Partnership Income
• Allocation of tax between income and
principal
– Tax is paid from income to the extent of receipts from
the entity allocable to income, with the balance paid
from principal.
– A Partnership's capital gain allocated to a trust are
included in the income of the trust.
• The deductibility of a loss must be considered
in view of three possible limitations,
considered in the following order:
1. tax basis,
2. at risk (section 465), and
3. passive activity rules (section 469).

Special Rules – Depreciation and Depletion
• Who’s entitled to the Depreciation?
‒ The deduction is to be apportioned among “the estate and the heirs, legatees, and
devisees on the basis of the income of the estate allocable to each.” Section 611(b)(4)
‒ The income referred to is fiduciary accounting income (FAI). Section 643(b)
‒ In the case of a trust, apportioned between the income beneficiaries and the trust in
accordance with the pertinent provisions of the trust instrument. Section 611(b)(3)
• A Depreciation Reserve
‒ The amount of the reserve will not necessarily be the same as the amount of the
depreciation deduction for federal income tax purposes.
‒ If a reserve is established, the amount of the reserve will affect the extent to which
the trustee is entitled to the depreciation deduction.

Special Rules – Depreciation and Depletion
• Example: All of the income of a trust is to be distributed currently to B. No provision
fundamentally departs from local law. The trust income for the year is $90,000. The trustee
does not establish a depreciation reserve. B is entitled to all of the depreciation deduction.
This is true regardless of the value of the depreciation deduction.
• Example: A trust has gross income of $60,000 for the year before creating any depreciation
reserve. The trustee is required to charge the income with an expense of $10,000 in order to
create a depreciation reserve of $10,000. Thus, the trust's FAI is $50,000. The trustee
distributes this $50,000 of income to B, the income beneficiary. If the depreciation deduction
is $10,000 or less, the trust is entitled to the entire deduction. If the depreciation deduction is
more than $10,000, the first $10,000 is allocated to the trustee, because of the depreciation
reserve, and the balance is allocated to B, who received all the FAI.
• Example: A trust has a net income of $30,000. The trustee is not allowed to establish a
depreciation reserve. The trustee exercises its discretion and distributes one-half or $15,000
of the trust's income to B, one of the beneficiaries. If the allowable depreciation deduction is
$10,000, $5,000 is allocated to the trust and $5,000 to B, because she received one-half of the
trust income.

DEDUCTIONS AVAILABLE TO FIDUCIARIES
MICHAEL L. ZOSKY, ESQ.
ROYSE LAW FIRM, PC
mzosky@rroyselaw.com
www.rroyselaw.com
650.813.9700

• Deductions Generally:
– Trusts and estates are entitled to many of the same
deductions as are allowed to individuals
General Rules

• Allocation and Reduction of Deductions When
Tax-Exempt Income is Present
– A portion of otherwise allowable deductions may
have to be allocated to tax-exempt income, and are
consequently rendered non-deductible
– “Disallowance ratio” – Expressed as a fraction as
follows:
• The amount of tax-exempt income
The income included in DNI (generally not capital gains)
General Rules (Cont.)

• No standard deduction nor credit or deduction
for dependents
• Exemption:
– Estates: $600
– Simple Trusts: $300
– Complex Trusts: $100
Exemptions and Standard Deductions

• Double Deductions Are Generally Prohibited
– Estate Tax Return (Form 706) vs. 1041
• Certain Deductions Are Not Allowed on Form
1041
– Ex. Funeral expenses
– Ex. Medical expenses
Double Deductions

• Limited Exceptions to the Prohibition on Double
Deductions – “Deductions in Respect of the
Decedent”
– Some items which constitute deductible debts of a
decedent on Form 706 and also constitute deductible
expenses on Form 1041 when paid by the fiduciary
after the decedent’s death. Ex.:
• Business expenses
• Interest expenses
• Certain state or local taxes owed at time of death and paid after death
Double Deductions

• The Income Distribution Deduction
• Depreciation
• Required Association of Expense Items with
Related Income Items
– Items of deduction that are directly attributable to a
specific type of income must be deducted from that
income
Deductions

• Line 10, Form 1041
• In general, may deduct interest like an individual
• Interest payments made in connection with a
deferred payment of federal estate tax per Code
Section 6166 are not deductible on Form 1041
Deduction – Interest Expenses

• Federal taxes are not deductible
– Note - Generation-skipping transfer tax on taxable
income distributions is deductible
– A special exception to this general rule may be
invoked when an item is subject to double taxation as
income in respect of a decedent (Ex. IRA)
• State and local taxes (other than inheritance and
estate taxes) are deductible
Deduction – Taxes

• Special deduction for trusts and estates
• May not be deducted on Form 1041 if previously
deducted on Form 706
Deduction – Fiduciary Fees

• Line 13 and Schedule A, Form 1041
• Unlimited charitable deduction against their
gross income
• Not available for simple trusts
Deduction – Charitable Deductions

• Actually paid or permanently set aside for a
charitable purpose
• Amounts contributed to charity must be paid
from gross income
• Special (irrevocable) election for charitable
contributions made after close of taxable year
Deduction – Charitable Deductions (Cont.)

• Form 706 vs. Form 1041
– When claimed on Form 1041, not subject to 2% AGI
limitation
• If incurred in the entity’s final year, may rise to
excess deductions which are indicated on
Schedule K-1 and carried to beneficiaries’
personal income tax returns as excess deductions
– a miscellaneous itemized deduction subject to
2% AGI limitation
Deduction – Attorney, Accountant, Return Preparer Fees

• Deductions for “costs which are paid or incurred
in connection with the administration of the
estate or trust… would not have been incurred if
the property were not held in such trust or
estate.” Section 67(e)(1). Examples include:
– Appraisal fees
– Probate fees
– Fiduciary bonds
– Fees to prepare fiduciary accountings
Deduction – Other Deductions

• Investment Advisor Fees and Similar
Expenditures
– Controversial
– Final Regs. – expenses “commonly” or “customarily”
incurred by individuals as well as trusts and estates
should be subject to the 2% floor
Deduction – Other Deductions (Cont.)

• Investment Advisor Fees and Similar Expenditures
(Cont.)
– Ownership costs: Subject to the 2% floor
• Expenses for real estate taxes or “ordinary and necessary” trade
or business expenses are not subject to the 2% floor; however,
and are generally fully deductible
– Tax preparation fees
• Fiduciary income tax returns and the decedent’s final income tax
return not subject to 2% Floor
– Investment advisory fees: Subject to the 2% floor
– Appraisal fees: Generally fully deductible
– Certain fiduciary expenses: Generally fully deductible

• “Bundled” fees
– Single fiduciary fee that might include investment
advisor fees (or other fees subject to 2% floor)
– Allocation of fees – “Reasonable Method”

• Line 15b Form 1041
• Only available when the trade or business is
actually conducted within the fiduciary entity
– Two year carryback, 20 year carryforward
– Unused NOLs may be passed through to beneficiaries
in final year of trust or estate
Deduction - Net Operating Loss Deductions

• Unique to Fiduciary Income Taxation
– Deduction for income distributed to beneficiaries
– Deduction cannot exceed DNI
• Distributions Carry Out DNI-with exceptions
– Specific bequests of property or specific bequests of
a specified sum of money payable in not more than
three installments
– Payments of required bequests to charity
Deduction – Income Distribution Deduction

• Distributions in excess of DNI
• Character of Income to Beneficiaries
• Beneficiary Income Reporting
Deduction – Income Distribution Deduction (Cont.)

• Distributions of Simple Trusts
– Deduction = Amount required to be distributed,
whether or not actually distributed
• Distributions of Complex Trusts
– Deduction = income required to be distributed
currently plus any other amounts of income properly
paid, credited or required to be distributed
– The 65-Day Rule for Distributions

• Determining Income Distribution Deduction -
Schedule B of Form 1041 (Simplified) – Lesser of:
– FAI
– DNI
– MODIFIED DNI (FAI less tax exempt income and
associated deductions, which means net tax exempt
income)
– MODIFIED FAI (DNI less tax exempt income and
associated deductions, which means net tax exempt
income)

• Income in respect of a decedent (IRD)
• Difference between estate’s actual federal estate
tax liability and the federal estate tax that would
have been paid if the IRD item(s) had been
excluded from the estate tax calculation:
– IRD Item x Estate Tax Paid
Total Estate Assets
• Not subject to the 2% of AGI floor
Deduction – Estate Tax Deduction

• Annual exemptions as follows:
– Estate: $600.00
– Simple Trust: $300.00
– Complex Trust: $100.00
– Grantor Trust: No exemption allowed
• No annual exemption is permitted for the final
year of an entity
Deduction – Exemption

• Payments are not deductible as alimony
expenses
• To the extent paid from income, payments may
be deducted as an income distribution deduction
• Do carry out DNI
Deduction – Alimony Deduction

• Net Operating Loss Issues
• Related Party Loss Issues
Deduction – Losses

Chapter 8
Tax Calculations, Credits, Payments and Special Rules
JENNIFER HAN, ESQ.
ROYSE LAW FIRM, PC
jhan@rroyselaw.com
www.rroyselaw.com
149 COMMONWEALTH DRIVE, SUITE 1001, MENLO PARK, CA 94025
650.813.9700

• Where to Calculate the Income Tax Liability.
– Taxable income present - Schedule G of Form 1041.
– No long-term capital gains or qualified dividends - Tax Rate
Schedule
– Long-term capital gains and qualified dividends - Part V of
Schedule D.
– If qualified dividends, section 1250 gain or 28% gain are
present - Form 1041 Instructions or Instructions to Schedule D
of Form 1041.
How to Handle Taxable Income Realized by the Trust or Estate

• Lump-sum distributions from qualified retirement plans
- Form 4972
• Alternative minimum tax
– Calculation - Schedule I
– Report - Schedule G.
• Net investment income tax
– Form 8960
Other Taxes

• General rule: Credits are apportioned between the entity and its
beneficiaries on the basis of the income allocated to the entity
and its beneficiaries.
• Income distributed to the beneficiaries carries out the credits
that correspond to that income.
(a) The foreign tax credit:
• Calculation - Form 1116
• Report - Line 2a of Schedule G of Form 1041.
(b) “General Business Credit”
• Report - Line 2b of Schedule G
• More than one Credit - Form 3800, General Business
Credit
• See list on pg 79-80
Credits Available

(c) Paid alternative minimum tax in a previous year
– Attach Form 8801
– Report - Line 2c of Schedule G
(d) Holding a tax credit bond
– Attach Form 8912, Credit to Holders of Tax Credit Bonds
– Included in interest income;
– Report - Line 2d of Schedule G
(e) Qualified Zone Academy Bond Credit as an S corporation shareholder
– Calculation – Form 8860
– Report - Line 2(e) of Schedule G with notation “QZAB”.
(f) Clean Renewable Energy or Gulf Tax Credit Bond
Form 8912; Line 2e with either “CREB” or “GTCB” inserted on the dotted line
– Attach 8912
– Report – Line 2e with either notation “CREB” or “GTCB”
• Sum of all credits totaled on Line 2e
• Amount of total credits (Line 2e) subtracted from the total tax liability (Line 1d)
– Final amount reported on Line 3 of Schedule G.
• Line 4 to Schedule G of Form 1041
– Report amount of net investment income tax (Line 21 of Form 8960)
Credits Available (Cont.)

Specific recapture taxes (Line 5 of Schedule G)
(a) Form 4255 - Investment credit recapture
(b) Form 8611 - Low-income housing credit recapture tax
(c) Qualified electric vehicle recapture tax
– Line 5 – notation “LIHCR”
(d) Form 8845 - The Indian Employment Credit
– Line 5 – notation “IECR”
(e) Form 8882 - Employer-Provided Child Care Facilities
– Line 5 – notation “ECCFR”
(f) New markets recapture tax (IRC 45D(g))
– Line 5 – notation “NMCR”
(g) Form 4255 - Recapture of investment tax credit
– Line 5 – notation “ICR”
Recapture Taxes

• Household employee
– Schedule H of Form 1040;
– Report - Line 6 of Schedule G.
• Triggering Circumstances (IRS Publication 926)
(a) Pay any one household employee cash wages of $2,000 or
more during 2016 ($2000 - 2017) (the FICA threshold); or
(b) Withheld federal income tax; or
(c) Paid total cash wages of $1000 or more in any calendar
quarter during 2016/2017 (the FUTA threshold)
Household Employment Tax

Certain other taxes that may be applicable
• Line 7 of Schedule G
• Add reported amount of tax to reach the total tax due
These include:
(a) Form 4970 - Tax due on an accumulation distribution from a trust
(b) Form 5329 - Excise tax due if the trust or estate fails to receive the minimum
required distribution from a qualified retirement plan or Individual Retirement
Account
(c) Interest due on an outstanding deferred tax liability arising from the
installment sale or real property. Code Section 453A(c).
(d) Form 8697 - Interest due under the look-back method of accounting for
certain long term contracts. Code Section 460(b)(2).
(e) Form 8866 - Interest due under the look-back method for property
depreciated under the income forecast method
(f) Tax due on the portion of an Electing Small Business Trust (ESBT) consisting of
stock in one or more S Corporations
Additional Special Situation Taxes

• Line 7 of Schedule G  Line 23, pg 1, Form 1041
• Various possible prepayments:
(a) Estimated tax payments (Form 1041-ES) or overpayments – report on Line 24a
(b) Estimated tax payments made by an individual prior to death - final Form 1040
- If this results in a refund, file Form 1310
(c) Treating estimated taxes paid by the entity as paid by beneficiaries (Code Section 643(g))
- Report - Line 24b of Form 1041
- Election - Form 1041-T –file by 65th day after close of entity’s taxable year
- Line 24b  Line 13A of Schedule K-1 of beneficiary
(d) Amount of tax paid with the Extension Request Form (Form 7004)
- Report - Line 24d of Form 1041
(e) Tax withheld for any reason
- Report - Line 24e
- Attach appropriate W-2, 1099, etc. forms to Form 1041
- No withheld income taxes (except backup withholding) may be passed
through to beneficiaries via Schedule K-1 or Form 1041-T.
(f) The refundable tax credits for taxes paid on undistributed capital gains by regulated
investment companies (Form 2439)(Line 24f) and for Federal excise taxes on certain
fuels (Form 4136) (Line 24g) - Totaled on Line 24h.
Prepayment of Tax

Form 2210
– Utilized to determine the existence of a penalty (or
the availability of an exception to an otherwise
applicable penalty)
– Indicate amount on Line 26
Underpayment of Estimated Tax

• The total tax due, less payments made, plus any
penalties due for underpaying estimated taxes
– calculated on Line 27 and 28 to indicate either a balance
due or an overpayment.
• Overpayment
– refunded or credited to the estimated tax due for the
following tax year
– Line 29 of Form 1041
Balance Due or Overpayment

• IRS Center indicated in the instructions for Form
1041
• Filing location = the location of the trust or estate
• Check or money order:
– “United States Treasury”
– “[Entity’s federal identification number]”
– “ [TAX YEAR], Form 1041”
• Payment should accompany the completed Form 1041
• Different zip codes to be used for returns with payment versus
return without payment
Where to File Form 1041

• Form 1041, Page 2
• Preparer must be certain that the nine questions
appearing under “Other Information” have been
answered
Addressing the “Other Information” Questions and Elections

Question 1: Total the tax-exempt interest income
received and exempt-interest dividends received
from a mutual fund
– Any allocation of expenses to the tax exempt income is
calculated and submitted on an attached sheet
– Necessary to compute the income distribution deduction
Addressing the “Other Information” Questions and Elections (Cont.)

Question 2: Entity’s receipt of an individual’s earnings via
a contract assignment or similar arrangement
Question 3: Foreign bank accounts (broader inquiry)
• “Yes” - estate or trust had an interest in/ signature /other authority
over a bank, securities or other account in a foreign country.
– Must note foreign country/countries and file FinCen Form 114
» Filed electronically with the Department of Treasury by April 15th.
• “No” - value of the accounts maintained by the trust or estate was less
than $10,000 for the whole year.

Question 4: Any relationship with a foreign trust,
including as a grantor, distributee or transferor to
such a trust.
- If answered “Yes”
- Form 3520, Annual Return to Report Transactions
with Foreign Trusts and Receipt of Certain Foreign
Gifts

Question 5: Qualified residence interest
• If “yes”:
– attachment must provide the name, address and
identifying number of the person to whom qualified
residence interest was paid, or from whom it was
received.

Question 6: Sec. 663(b) election to treat payments
made to a beneficiary within 65 days of the end of
the entity’s taxable year as made in the prior year

Question 7: Section 643(e) (3) election
• treat a noncash distribution of property as a sale to the beneficiary at FMV and
recognize gain accordingly (no loss deductions available -Section 267)
– General rule: an in-kind distribution of property by an estate or trust to its
beneficiaries does not result in the recognition of gain or loss to the
distributing entity. Code Section 643(e).
• The distribution is valued at the lower of the basis of the property in
the hands of the entity or its FMV on the date of distribution.
– Recipient beneficiary takes the distributed property with a carryover basis
from the entity. Section 643(e)(1).
– A special election is available to enable the estate or trust to:
• treat distribution as sale at FMV,
• recognize the gain at the trust/estate level
• No election on asset-by asset basis.
• Election applies to all of the distributions during the taxable year.
Section 643(e)(3).

Question 7 continued…
– If the election is made, beneficiary takes a basis equal to the adjusted basis of the
entity, plus any gain recognized on the distribution, i.e., typically FMV of property
on date of disposition
– The distribution of property carries out DNI to the beneficiaries.
• If election: DNI carried out = FMV of distributed property.
• If no election: DNI carried out = lesser of FMV of the distributed property OR
basis of property
– If basis is carryover basis, tacking on of holding period of transferring entity
• If not, when election is made and transaction deemed a sale, transferee must
begin a new holding period
– If value of property has declined, fiduciary cannot recognize a loss on distribution
to beneficiary, since the transaction is treated as a sale to a related party. Section
267(b).
• The only exception: Loss can be deducted when the estate is funding a
pecuniary bequest and realizes a loss. Section 267(b)(13).
– To make the election: check “Section 643(e) election” box on page 2 of Form 1041
• deemed sale of the property reported by entity - Schedule D, Form 1041
• Annual election; can only be revoked with the consent of the IRS

Planning: When to Make a Section 643(e) Election:
• Ideally when estate or trust has large capital losses, and
the election will result in a gain at the entity level that will
be offset by the available losses.
• If property depreciable, be careful of ordinary income recapture
• Generally, election should not be made if:
– beneficiary in a lower tax bracket than entity, or
– if beneficiary will likely retain the property and not sell it for a
long time, or hold the property until death – step-up basis for
beneficiary’s heirs

Question 8: If estate has been open for more than two years
and, if so, requests an explanation for the delay in closing the
estate.
- Exception: Estates continuing to hold S corporation stock
during the period that the estate is paying estate tax in
installments pursuant to Section 6166 is not considered to
be using an unreasonably prolonged time to keep the
estate open. PLR 200226031.
- If estate kept open “too long”, potential recharacterization
as a trust, with the calendar year filing requirement,
reduced exemption, etc. requirements imposed.

Question 9: Beneficiaries who are “skip persons”
• beneficiaries who are part of a generation that is
two or more generations younger than the
transferor of property.
• Potential liability for the generation-skipping
transfer tax when certain transfers are made
from the trust or estate.

Question 10: Whether trust was a specified domestic
entity required to file Form 8938 for the tax year
• appears for the first time in the 2016 Form 1041
• if the trust held foreign financial assets of $50,000
on the last day of its tax year, or $75,000 at any time
during its tax year, attach to Form 1041

• Extension of time to file ≠ no accrual of interest
• Late filing penalty
– 5% of the tax due for each month or part of a month that
the return is late, maximum 25%.
– reasonable cause available
• Late payment penalty
– ½ of 1% of the unpaid amount of tax for each month or
part of a month that payment remains outstanding;
maximum is 25% of the unpaid tax
Interest and Penalties

The Separate Share Rule Applied to Trusts and Estates
Trust
Beneficiary
S1
BeneficiaryBeneficiary
S2 S3
Single Trust with more that one beneficiary, each beneficiary has separate and independent
shares and distinct economic interest, shares treated as separate trusts solely for purpose of
determining amount of DNI allocable to each beneficiary. Section 663(c); Treas. Reg. 1.663(c)-
1(a) and (c)-4(a).

• The beneficiary of a separate share may not be taxed on
more than his or her pro rata share of DNI.
• It does not require separate identifying numbers,
additional trust income return filings, or separately
maintained accounts, nor does it permit additional
personal exemptions
• Separate share treatment is not elective.
The Separate Share Rule Applied to Trusts and Estates (Cont.)

Application to Estates – 1997 Act
• Substantially separate and independent shares of different
beneficiaries in an estate having more than one beneficiary
• Separate share rule will be applied to determine the estate’s
deduction for distributions to beneficiaries and the income
taxable to the estate and to such beneficiaries.
• Similar to the case with trusts, the application of these rules to
estates is mandatory.
• Effect: limit the application of Code Section 661 and 662 to
distributions to beneficiaries so that no beneficiary is subjected to
income tax on more than his or her pro rata share of the entity’s
DNI.
– promote fairness among the beneficiaries and to prevent
manipulation of the entity’s taxable income

Estate
B1 B2 B3
TI: $3,000
Absent Separate Share Rule
$2,000
Distribution
1) A reports $2,000 income (B&C report nothing)
2) Estate reports $1,000 TI (after claiming $2,000 income distribution deduction)

Estate
B1 B2 B3
TI: $3,000
Applying Separate Share Rule
$2,000
Distribution
1) A treated as receiving and reports $1,000 income (A’s 1/3 share of $3,000)
2) A also treated as receiving principal distributions of $1,000
3) B&C treated as receiving nothing and report nothing
4) Estate reports $2,000 TI (after claiming $1,000 income distribution deduction)

System for the allocation of DNI
• “Separate economic interests” exist where the economic interests
of the beneficiaries are not interdependent.
• DNI is calculated separately for each separate share, and the
estate’s gross income is allocated in accordance with the income
to which each share is entitled under the governing instrument or
applicable state law. Treas. Reg. 1.663(c)-2(a) and (b).
– Income earned on assets allocated to one share, or the
appreciation or depreciation of assets in one separate share
has no effect on any other share. Treas. Reg. 1.663(c)-4(a).
– A qualified revocable trust will always be deemed a separate
share, regardless of whether the Section 645 election is made.
• Such trust may itself be further divided into additional
separate shares. Treas. Reg. 1.663(c)-4(a).

– Specific bequests are not classified as separate shares - not the basis for
allocation of DNI. Treas. Reg.1.663(c)-4(a).
– However, earnings from specific bequests of property, if included as part of
the bequest, may be treated as separate shares. Treas. Reg. 1.663(c)-
1(b)(3); 1.663(c)-5.
– Rights to items of income in respect of a decedent (IRD) are allocated
among the various separate shares that could potentially be funded with
the IRD amounts, whether or not such shares otherwise participate in
income.
• allocation is pro rata, based on the relative value of each share. Treas. Reg.
1.663(c)-2(b)(3).
• allocation of IRD could shift income tax liability to trusts otherwise
protected from estate tax or generation-skipping transfer tax by the
use of the decedent’s exemptions (language should be specifically
drafted to limit the possible recipients of IRD items)
– The Regulations will allow directions in the governing instrument to
override the requirements regarding allocation among potential recipients.
Treas. Reg. 1.663(c)-5, Example 10.

• Income allocated to charities
– rules of Section 642(c), not separate share rules
(See Chapter 7, section II.D.)
• Show separate share calculations and attach to Form
1041.

TRUST AND ESTATE DISTRIBUTIONS
Special Issues and Situations
_______________________________________
ALLISON KROEKER, ESQ.
ROYSE LAW FIRM, PC
akroeker@rroyselaw.com
www.rroyselaw.com
149 COMMONWEALTH DRIVE, SUITE 1001, MENLO PARK, CA 94025
650.813.9700 EXT. 211

• Pro rata allocation of tax items at
termination
• NOLs and capital losses continue
to carry forward
• Excess deductions on termination
are miscellaneous itemized
deductions and subject to the 2%
floor
 Use it or lose it
 They won’t be back, baby
 All losses reported on the beneficiary’s
Schedule K-1
Distributions in the Year of Termination

Suspended Passive Losses
 Suspended passive losses do not become
available as a deduction to the beneficiaries
 Suspended passive losses may be used to
increase the income tax basis of the passive
activity property immediately before
distribution
§ 469(j)(12)
Passive Losses at Termination

Certain deductions to which a trust or estate may otherwise
be entitled do not survive the entity:
The fiduciary may not claim a personal
exemption
And the amount of such exemption may not
be added to the excess deduction available
to beneficiaries in the year of termination
• Excess charitable contributions
Consider making the election to treat a
charitable contribution as made in the prior
tax year
Investment interest expense carryovers
Excess percentage depletion carryovers
Retired Deductions

• Kenan Rule
 A distribution of non-cash assets by a fiduciary in satisfaction of
a pecuniary obligation triggers realization of gain by the estate
or trust, see Treas. Reg. § 1.661(a)-2(f); Kenan v. Comm’r, 114 F.
2d 217 (2d Cir. 1940)
• Application of the Kenan Rule
 Two factor test: (1) Obligation to pay a specific amount of
money or to transfer specific property; and (2) satisfaction of
that obligation by the transfer of other property
- The residue of an estate/share of an entity’s assets (by fraction or by
formula) is not a “specific amount of money” under the Kenan Rule
• Hypothetical Sale
 Beneficiary takes basis equal to the distributed property’s fair
market value at distribution; entity may recognize gain or loss
Distributions in Kind

Accumulation Distributions
• Throwback Rules: A beneficiary receiving an accumulation distribution
(i.e., a distribution that exceeds current income) is taxed as if the trust
made the distribution in the year of accumulation
 Prior to 1993, these rules were in place to limit the possibility that
accumulated income in a trust would be taxed at lower rates than those rates
applicable to trust beneficiaries
 After tax law changes in 1993, high marginal tax rates at low levels of trust
income made these rules unnecessary
• Substantial Repeal under the Taxpayer Relief Act of 1997
 Distributions to trust beneficiaries from “qualified trusts” are computed
without regard to any previously undistributed income (effective for
distributions made after Aug. 5, 1997)
• What is a “qualified trust?”
– Generally, any domestic trust that has never been treated as a foreign trust

Accumulation Distributions
Non-Qualified Trusts
 Any foreign trust
 Any domestic trust that was previously
treated at any time as a foreign trust
 Any trust created for the purpose of tax
avoidance before March 1, 1984
Calculating Tax Liability
 The trustee completes Schedule J of Form
1041 to calculate an accumulation
distribution which indicates the amounts
to be “thrown back”
 Form 4970 is used to calculate the
beneficiary’s tax liability on this amount
 Beneficiaries may offset their tax liability
for taxes paid by the trust on the
accumulated income in prior tax years
 No refund or credit is available to the
beneficiary if there was an excess tax
payment made by the trust

Exempt Accumulation Distributions
There are several important exceptions to the imposition of the
throwback rules where they remain applicable:
 Estates are not subject to the throwback rules
 Distributions of amounts paid, credited, or required to be
distributed in a taxable year in which it qualifies as a simple trust
 Distributions from a trust representing income accumulated before
the birth of a beneficiary or before such beneficiary is 21
 Gifts or bequests of a specific sum of money or specific property so
long as it is paid all at once or in not more than three installments
and not exclusively from trust income
 Amounts paid, permanently set aside, or credited to a charitable
organization within Section 642(c)

Distributions in Excess of DNI
How is income allocated when distributions are made to multiple
beneficiaries in excess of distributable net income (DNI)?
• Tier 1: Beneficiaries having a direct, nondiscretionary right to
income are allocated DNI on a priority basis
– If Tier 1 distributions use all of the entity’s DNI, any remaining
distributions are made from the principal
• Tier 2: Distributions from estates, required distributions of
corpus, and discretionary distributions of income and corpus
from a complex trust
– These distributions only decrease DNI to the extent that there is
remaining DNI after the full absorption of DNI by Tier 1 payments
 A beneficiary being charged with a proportionate share of DNI may
not trace the distribution to its actual source to claim it is a
distribution of principal instead of a distribution of income, see
Section 662(a)(2)(B); Harkness v. U.S., 469 F. 2d 310 (1972)

Example: Grantor creates a trust for the benefit of A, B, and
C. The trust terms require annual income payments to A of
$20,000. Any remaining income may either be paid to A, B,
C, or accumulated at the discretion of the trustee.
Assume the trust has total DNI of $60,000 for the current
tax year. The trustee distributes an additional $25,000
(beyond the $20,000 distribution to A) to each of A, B, and
C for a total distribution of $95,000 for the current tax year.
DNI $60,000
Tier 1 Distributions
A: $20,000
Tier 2 Distributions
A: $25,000
B: $25,000
C: $25,000

Example
DNI for the year $60,000
Tier 1 distribution to A - $20,000
Remaining DNI balance $40,000
Tier 2 distributions to A, B, and C
A: 25,000/75,000 x 40,000 = 13,333
B: 25,000/75,000 x 40,000 = 13,333
C: 25,000/75,000 x 40,000 = 13,333
$40,000 DNI distributed
$35,000 principal distributed (the amount in excess of DNI)
A has taxable income of $33,333 (the tier 1 distribution + the tier 2 distribution)
B and C each have taxable income of $13,333 (the tier 2 distribution)
A, B, and C each have accumulation distributions of $11,667 (the amount in excess of DNI)
These accumulation distributions may be subject to the throwback rules §§ 665-68
DNI for the year $60,000
Tier 1 distribution to A - $20,000
Remaining DNI balance $40,000
Tier 2 distributions to A, B, and C
A: 25,000/75,000 x 40,000 = 13,333
B: 25,000/75,000 x 40,000 = 13,333
C: 25,000/75,000 x 40,000 = 13,333
$40,000
Remaining DNI balance -0-

Alternative Minimum Tax (AMT)
The AMT is a separate calculation of income tax liability that disallows many of the
exclusions and deductions available in the taxable income base of the regular tax
The AMT rules have been applicable to trusts and estates since January 1, 1987
The general intent of these AMT rules are to assure that all trusts and estates which
have income in excess of the AMT exemption ($24,100 for 2017) that is not
distributed in full to the beneficiaries of the entity will pay some tax, notwithstanding
the various deductions which may be allowed for regular income tax purposes
Policy Debates
• AMT increases progressivity of the tax system
• Rule complexity raises administrative and compliance costs
• Disproportionately affects taxpayers who live in high-tax states
• The two most important tax preferences for investment income in the Code are
not disallowed for purposes of the AMT
– Long-term capital gains
– Qualified dividend income
• Trump’s tax plan and the GOP blueprint both propose to repeal the AMT and most
tax preferences under the Code

AMT Calculation
AMT Adjustments
Disallow deductions allowed for regular tax purposes
Income Distribution Deduction
Calculate the distribution deduction for AMT purposes
AMT Exemption
Undistributed income is not taxable until it is in excess of the AMT exemption,
which is indexed for inflation ($23,900 for 2016; $24,100 for 2017)
Tentative Minimum Tax
If the entity’s minimum taxable income exceeds the AMT exemption, it
calculates a tentative minimum tax
AMT Liability
If the tentative minimum tax is higher than the regular tax liability, then the
entity must pay AMT

Net Investment Income Tax (NIIT)
As part of the Affordable Care Act, a 3.8% Net Investment Income Tax (also
called the “Medicare Tax” or “Obamacare Tax”) applies to net investment
income if MAGI of an individual taxpayer is over the $200k single/$250k
married threshold
Tax based upon the lesser of the taxpayer’s net investment income or the
excess of the taxpayer’s MAGI over the threshold amounts
Not indexed for inflation

Application of NIIT to Trusts and Estates
The NIIT applies to the investment income received by
estates and trusts along with its application to individuals
§ 1411(a)(2)
An estate or trust will pay the NIIT on investment income
based on the lesser of the estate or trust’s undistributed
net investment income, or the excess of the estate or
trust’s adjusted gross income as determined under
Section 67(e) over the dollar amount threshold at which
the estate or trust is taxed at the highest marginal tax
rate for the tax year § 1.1411-3
$12,400 for 2016; $12,500 for 2017
Adjusted annually for inflation

NIIT Considerations for Trusts and Estates
• It is fair to assume that most of the income realized by
trusts and estates is net investment income
• Where applicable, the Form 8960 computes the NIIT and
should be attached to the Form 1041
• There is likely increased pressure on
fiduciaries to distribute the net investment
income to beneficiaries with MAGI below the
threshold (where discretion to do so exists)
• The NIIT follows the same rules as the “regular” tax on
trusts and estates, i.e., income will be taxed once—
either to the entity if it retains the income, or to the
beneficiary to the extent it is distributed

And Now, The Test…
Just Kidding

ROYSE LAW FIRM, P.C.
WEALTH STRATEGIES AND TAX TEAM
C. David Spence Michael L. Zosky
Jennifer Han Fiona Xu Allison Kroeker

Federal Fiduciary Income Tax Workshop

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