Balancing income tax and estate tax?

[SecondCor521]

Hi all,

Can an AB trust simultaneously "distribute" income on a K-1 to a beneficiary to minimize income taxes *and* actually retain the funds in the trust to minimize estate tax exposure by the beneficiary?

I'm hoping that it could be considered some sort of contribution to the trust by the beneficiary in an amount equal to the K-1 distribution. (I've seen the trust document but don't have a copy handy, but it's written pretty well and includes a lot of discretion for the trustee.)

Which leads to a second question: If such a contribution exceeds $15K, does that trigger a gift tax liability for the beneficiary?

 

[ERD50]

From what I saw of my MIL/FIL trust, the tax guy assumes (or is required) that all div/int is distributed, and all cap gains are retained.

I wondered about this when I reviewed their taxes, because I realized we never gave him any document that said the money was distributed or not (at that point, FIL had passed, and MIL was the beneficiary of his trust). She just got a K1 based on the 1099 INT, DIV, and B. He had no way of knowing, and didn't ask.

Is it required? Would any tax authority ever look into it or care? I have no idea, but since they don't seem to look for any proof, and I didn't see anything about retaining those records, I think not.

Somewhat related, when MIL passed and funds were distributed to all the beneficiaries (3 siblings and a bunch of grand-kids), I proposed that the three siblings claim 1/3rd of the total K-1 amounts, to save the trouble of each grandchild having to deal with K-1s on their taxes. The tax guy was fine with that, but suggested we get it in writing from each sibling that they agree to take on the extra tax burden. IOW, the IRS does not know who received the funds, and probably doesn't care as long as the tax is paid via the K-1.

In your case, you would want all beneficiaries to agree. And this is just me read of it, I am just a guy on the internet, so do your own due diligence, but that's some food for thought.

-ERD50

 

[SecondCor521]

^

Thank you.

Some trusts require distribution of the income, for some it's optional. In the case of this particular AB trust, the distribution is optional.

I'm *assuming* that the actual distribution is supposed to match the K-1. While not doing so is probably something the IRS would never catch, the beneficiary in question prefers doing things by the book.

In theory the IRS cares, because the taxed but undistributed amount is something that later might be subject to estate taxes, so they'd get 40% or 45% of those funds.

In this case, there's only one current beneficiary.

 

[pb4uski]

The language in my Dad's trust was unclear on the point of whether income needed to be distributed to the beneficiary (my Mom) or not.

I decided to make it simple and distribute the income to her each year commensurate with the K-1. For stock and bond funds, I have the all dividends and capital gain distributions paid to her checking account. While we rarely have realized gains, when we do I then transfer an amount equal to the realized gain to her checking account when I finish up the trust tax return.

I have yet to have a realized loss so I'm not sure what I would do, but I would probably have her checking account pay the trust for the realized loss so it is the inverse of how realized gains are treated. Alternatively, I could keep running track of any realized losses and to offset future distributions for realized gains first.

 

[SecondCor521]

^

Thanks.

So far we've done similarly. The actually distributed amount matches the K-1. Although we accumulate the income inside the trust and do a yearly distribution at tax time after figuring out the tax situation.

Your Mom's trust may be different, but I've read some stuff that capital losses can't be passed through to a beneficiary until the trust is dissolved. They can still offset gains and be carried forward in approximately the same way as for regular individuals.

 

[ERD50]

... but I've read some stuff that capital losses can't be passed through to a beneficiary until the trust is dissolved. They can still offset gains and be carried forward in approximately the same way as for regular individuals.

That is my (admittedly limited) understanding as well. Not sure why losses are not passed on to beneficiaries until the end, but that seems to be the rule.

FWIW, my first search hit agreed:

https://www.legacyenhancement.org/blog/2020/november/can-trusts-distribute-losses-/

How Losses Can Pass to Beneficiaries

Your trust can offset capital gains and up to $3,000 of standard income with capital losses. Any losses in excess may be pushed forward and used in future tax years. However, they may not pass through to the beneficiaries prior to the year that the trust concludes.

-ERD50

 

[SecondCor521]

Follow up.

My language in post #3 was inaccurate. There are three beneficiaries of the trust, but they don't receive anything until the death of the second grantor. Currently the second grantor is the trustee, and the second grantor as trustee can distribute income to themselves for HEMS.

I've read the trust document, which does give the grantor power to add property to the trust.

I've also read stuff on the internet saying that people can contribute property to an irrevocable trust (which a B trust appears to be). Doing so is treated as a gift to the beneficiaries of the trust. And, if a Crummey letter is issued, it appears that such gift can be ignored under the $15K per person gift limit because it would be a "present interest gift".

I'm planning on doing this after talking with a CPA to confirm my understanding.