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Lane
Lane, JD, CFP, MBA, CRPS
Category: Tax
Satisfied Customers: 10476
Experience:  Law Degree, specialization in Tax Law and Corporate Law, CFP and MBA, Providing Financial & Tax advice since 1986
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This is a revision of a previous question. I am the trustee

Customer Question

This is a revision of a previous question. I am the trustee of a NY State complex trust.
The 1041 tax return requires calculation of the trust accounting income and DNI, which
may be different. Apart from the 1041 requirement, is there a legal requirement- Federal or NY State- to produce a separate,e annual accounting document, and if so, what
data does it have to contain?
Submitted: 3 years ago.
Category: Tax
Expert:  Lane replied 3 years ago.

NPVAdvisor :

A trust (except a grantor type trust) is a separate legal entity for federal tax purposes. A trust may be created during an individual's life (inter vivos) or at the time of his or her death under a will (testamentary). A trust figures its gross income in much the same manner as an individual. Most deductions and credits allowed to individuals are also allowed to trusts. However, there is one major distinction. A trust is allowed an income distribution deduction for distributions to beneficiaries. To figure this deduction, the fiduciary must complete Schedule B. The income distribution deduction determines the amount of any distributions taxed to the beneficiaries.


For this reason, a trust sometimes is referred to as a “pass-through” entity. The beneficiary, and not the trust, pays income tax on his or her distributive share of income. Schedule K-1 (Form 1041) is used to notify the beneficiaries of the amounts to be included on their income tax returns.


Before preparing Form 1041, the fiduciary must figure the accounting income of the estate under the will and applicable local to determine the amount, if any, of income that is required to be distributed, because the income distribution deduction is based, in part, on that amount.

NPVAdvisor :

One of the distinctions between and simple an complex trust is that a complex trust can distribute amounts allocated to the corpus of the trust (generally not shown on Form 1041).

NPVAdvisor :

In most respects income that is distributed to beneficiaries currently has the same character (tax exempt, capital versus ordinary, preference items for alternative minimum tax purposes, and such) in the beneficiaries' hands as it would on the fiduciary's return if it was not distributed.

NPVAdvisor :

But, with only one exception, the character of items accumulated in one year and distributed in another is not preserved under the accumulation distribution rules

NPVAdvisor :

Unique to the income taxation of trusts and estates is the concept of "distributable net income." DNI

NPVAdvisor :

Gifts of Corpus Are Income Tax Free, but income produced by the trust property after that initial transfer should not escape income taxation ... (either to the beneficiary or to the trust) ... BUT, of course the beneficiaries should be taxed only on their distributive share of any taxable income of the entity, which requires that the tax exempt character of the estate or trust's income must be preserved.


 

NPVAdvisor :

The challenge is to determine the extent to which distributions to beneficiaries are tax free distributions of corpus or of tax exempt income, or taxable income produced by corpus that is not yet distributable

NPVAdvisor :

Since 1954, Subchapter J has used the concept of distributable net income as the device to determine the extent to which distributions to beneficiaries are taxable.

NPVAdvisor :

DNI is defined in §643(a) as the taxable income of the estate or trust for the tax year, with a number of adjustments......

NPVAdvisor :

There are five

NPVAdvisor :

Deduction in Lieu of Personal Exemption

NPVAdvisor :

Tax Exempt Income

NPVAdvisor :

Distribution Deduction ( A circularity otherwise would develop if DNI were equal to taxable income after allowance of the distribution deduction: the deduction would be limited by DNI and DNI would be dependent for computation on the amount of the deduction).

NPVAdvisor :

The 4th and 5th adjustments relate to items of taxable income that are allocated to principal and not currently distributed.

NPVAdvisor :

Capital Gains; (Under §643(a)(3) and Treas. Reg. §1.643(a)-3, capital gains that are allocated to corpus (either under the terms of the document or under a local law such as §3(b)(8) of both Uniform Principal and Income Acts) and not distributed or set aside for charity, along with capital losses used in computing taxable income, are ignored for purposes of computing DNI).

NPVAdvisor :

Taxable Extraordinary and Stock Dividends (This one, however, only applies to simple trusts ... Under §643(a)(4), taxable extraordinary or stock-on-stock dividends that are allocated to principal under the instrument or local law (see the Uniform Acts §§3(b)(4) and (6)) and that are not currently distributed are excluded from DNI, again reducing the maximum distribution deduction and causing the tax thereon to fall on the entity. This is more complexity than you need to know) ... Again, this one can be ignored in your situation

NPVAdvisor :

These adjustments are what will allow you t get to DNI from Accounting income

NPVAdvisor :

If you need the citations for all of these I can given them to you

NPVAdvisor :

Let me know

NPVAdvisor :

Lane

Expert:  Lane replied 3 years ago.

Hi, just checking back in, as I've noticed that I gave you enough information to dig in, but, once understood, should have generated more questions.

If you'd like, I can go into further detail regarding the four adjustments that apply for COMPLEX trusts.

Let me know

Lane

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