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Ask Jonathan Tierney Your Own Question
Jonathan Tierney
Jonathan Tierney, Certified Public Accountant (CPA)
Category: Tax
Satisfied Customers: 322
Experience:  Tax Accountant at Praxair, Inc.
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IN you post a number of years back you stated that a trustee

Customer Question

IN you post a number of years back you stated that a trustee MAY ELECT to pass a depletion allowance to trust beneficiaries? I have six questions: How and where does the trustee make that election?; is that election discretionary?; if so and the trustee elects not to make the election does the trust use the entire depletion allowance against trust income?; is there a limit on the amount of depletion that can be used against trust income? Thank you for your assistance!; and am I correct in presuming that the election if discretionary must be made for all the beneficiaries and not just for some? and, is the use of the depletion allowance capped at 65% of the trusts or the beneficiaries "taxable income" or "adjusted gross income"?
Submitted: 1 year ago.
Category: Tax
Customer: replied 1 year ago.
If income is not all distributed but is distributed in a later year ( in other words the trust already paid tax on this money) ALONG WITH ALL the trust income for that year will the amount of the income distributed from prior years (which the trust already paid taxes on) be non taxable to the trust beneficiaries in the year it is received?
Expert:  Jonathan Tierney replied 1 year ago.

Hi, my name is ***** ***** my goal here is to provide you with the most complete and accurate answer as possible.

First point, there are three types of trust: grantor, simple, and complex. Grantor trusts are treated as the property of the grantor (the person that set up the trust) and are used to keep property out of an individual's estate that is probated. For the other two types of trust its important to understand the concept of income and corpus. The corpus is any property that is contributed to the trust initially or added later by the grantor. The corpus can increase or decrease as a result of capital gains. Income consists of interest, dividends, royalties, and any current ordinary income passed through from another entity on a K-1. There are frequently different income and remainder beneficiaries, with the income beneficiaries receiving the current income and the remainder beneficiaries receiving the corpus at trust termination. Expenses are generally (under the trust instrument or state law) divided between income and corpus to provide a fair allocation of trust expenses between the income and remainder beneficiaries.

Simple trusts are required, under its governing instrument, to distribute all income currently, does not make any charitable contributions, and is not allowed to make distributions from the corpus of the trust. They simply distribute its current income and then the corpus is distributed to the remainder beneficiaries upon the trust's termination. Alternatively, an event, such a the death of an income beneficiaries, may allow the trust to be a complex one.

Complex trusts are any trust that does not meet the requirements of a simple trust. Complex trust may take charitable deductions for amounts paid to charities, make distribution out of corpus, or may not be required to distribute any of its income (income can be added to corpus).

Federal tax law governs how individuals' property or rights to property are taxed. However, it is state law that generally governs those rights to property. Furthermore, under most states' laws, trust grantors have a great deal of discretion to direct the trustee to distribute such items as capital gain (corpus), current income, and how expenses should be allocated to different beneficiaries. However, if there is not direction given in the trust instrument, each state has a Principal and Income Act that determines the methods of allocating income and expenses. Any allocation on a trust's tax return must be valid under its respective governing state law.

So finally to answer your question about depletion, the answer is there is not really any tax "election." In the case of a simple trust, current income will be offset by current expenses, which include depletion. The trustee is required to follow the trust instrument or state law, and if he/she is allowed or required, can/will allocate depletion to the income beneficiary. Depletion can also be allocated to corpus and if that is the case the trust itself takes the deduction. A equal split between income and corpus is common.

Any item of income or expense allocated to corpus is taken by the trust itself in the current year, unless the complex trust is distributing corpus in which case those items can be distributed to the beneficiaries as well. Actual distributions of assets from trust to beneficiaries are generally nontaxable. There is only tax to the beneficiary if he or she is being allocated any items of income for the current year that is related to its distribution. The beneficiaries' taxable income being passed through by the trust is reported on Schedule K-1.

Lastly, whether there is a 65% of income cap for depletion? That is the correct limit for percentage depletion. There is no limit on cost depletion. You need to determine what method of depletion you are using. When you receive a K-1 from a partnership that is passing through depletion deduction, the K-1 usually tells you the depletion amounts calculated using percentage or cost methods. The partner receiving the K-1 can elect the method it wants to use to calculate depletion and is generally stuck with that method for as long as it maintains an interest in the partnership.

I hope that answers your question. Let me know if I can clarify anything or answer additional. Jonathan