Tax question(s) related to complex trust

[SecondCor521]

Hi all,

Given a complex trust which had the following forms of income in 2019:

1. Long term capital gain (1099-B).
2. Qualified dividends (1099-DIV box 1b).
3. Ordinary dividends (1099-DIV box 1a).
4. Federally tax-exempt dividends (1099-DIV box 11) from VWIUX.

The trust has a single trustee who is also the primary/current beneficiary. The trust instrument provides very wide latitude to the trustee. The trust is subject to Idaho state law (Title 68).

Q1. If it is permitted by the terms of the trust instrument and state law, can the trustee distribute different proportions of capital gains than he does of dividends?

For example, if the income amounts were:

1. $10K
2. $8K
3. $9K
4. $5K

Could the trustee elect to distribute for example $19K and say that it is $5K of the capital gain and $14K of the dividends, thus distributing 50% of the capital gains and 100% of the dividends, even though 50% != 100%?

Q2. If the trustee distributes $10K and says that it is all dividends, is it correct that this distribution is proportional across all of the three dividend categories of income listed above?

In other words, the K-1 would reflect $8K * $10K/$14K of qualified dividends, $9K * $10K/$14K of ordinary dividends, and $5K * $10K/$14K of tax-exempt dividends?

Q3. The portion of tax-exempt dividends allocable to the beneficiary should be reported on Schedule K-1 box 14 with code A, right?

...

This is not homework, it's me trying to fill out the tax returns for an actual complex trust. Any help is appreciated.

My answers by the way are:

Q1. Yes.
Q2. Yes.
Q3. Correct.

But I'm not sure.

I'll probably have more questions as this goes along.

 

[MBAustin]

Sounds like a question for a CPA experienced with complex trusts.

 

[pb4uski]

^^^^ Yup.

After reading the OP i'm glad that we keep my dad's trust simple... all investment results are distributed in cash to the beneficiary so while we do have to prepare a trust return, at the end of the day it is as if the assets were owned by the beneficiary.

I have a faint recollection that any income that isn't distributed is taxable to the trust but YMMV.

I don't know about 1 or 2, but agree with correct for 3.

 

[ncbill]

Since trust tax rates are much higher than individual, why not distribute all income/capital gains via the K-1?

Are you trying to preserve ACA subsidies?

 

[gauss]

Since trust tax rates are much higher than individual, why not distribute all income/capital gains via the K-1?

Are you trying to preserve ACA subsidies?

+1

Have you done a 1041 & issue K1's in the past or is this your first time through it?

If this is the first time, you might want to have a professional do it for you once, just so you can have an example going forward.

On the other hand, you might want to fill out a provisional/planning 1041 now to see how your strategy would work out.

My lay person understanding of this is that the trustee indeed has discretion on how to distribute assets subject to terms of the trust (and of course current law).

From a tax perspective you will need to make sure that the IRS can follow your work (ie all income accounted for on 1041 and/or K1s).

-gauss

p.s. Just saw via USPS Informed Delivery today, that DW and I will be receiving a couple of "official business" notices from the IRS today. First time that has ever happened to us. This should be interesting....

 

[OldShooter]

SGOTI is not a tax expert even though he sometimes thinks he is and can make himself sound like one.

 

[SecondCor521]

Since trust tax rates are much higher than individual, why not distribute all income/capital gains via the K-1?

Are you trying to preserve ACA subsidies?

A couple of reasons:

1. Distributing income makes both the trust's and the beneficiary's tax returns more complicated.

2. Some stuff I read says you can't distribute capital gains.

3. Distributing all of the income might create worse tax problems for the beneficiary (unlikely, but possible).

4. Beneficiary doesn't need the income and the intent was to leave it in the trust (it's a credit shelter / bypass trust).

No ACA subsidy involved. Beneficiary is 83.

+1

Have you done a 1041 & issue K1's in the past or is this your first time through it?

If this is the first time, you might want to have a professional do it for you once, just so you can have an example going forward.

On the other hand, you might want to fill out a provisional/planning 1041 now to see how your strategy would work out.

My lay person understanding of this is that the trustee indeed has discretion on how to distribute assets subject to terms of the trust (and of course current law).

From a tax perspective you will need to make sure that the IRS can follow your work (ie all income accounted for on 1041 and/or K1s).

-gauss

I did the trust returns last year. However last year did not have capital gains, and last year did not have any distribution or K-1.

The year before that there was a distribution and that return was prepared by a professional preparer, so I can use that to discern some things. The professional preparer made mistakes.

 

[SecondCor521]

^^^^ Yup.

After reading the OP i'm glad that we keep my dad's trust simple... all investment results are distributed in cash to the beneficiary so while we do have to prepare a trust return, at the end of the day it is as if the assets were owned by the beneficiary.

I have a faint recollection that any income that isn't distributed is taxable to the trust but YMMV.

I don't know about 1 or 2, but agree with correct for 3.

I can't remember why this one is "complex", but it's complex in IRS terminology only; it's not really that complex in real life. It's some stocks and mutual funds in a Vanguard trust account and has an EIN.

Normally nothing happens except dividends, but this year some stock was sold sort of by mistake. Thus my questions.

...

I am sort of discovering that the answer to Q1 seems to be yes after perusing one of the IRS regulations (1.643(a)-3 or something) referenced in the 1041 Schedule D instructions.

 

[ERD50]

I agree that you should probably seek professional help. But I'll say the following, based on my limited experience:

As long as someone pays the tax on gains, either the trust, or the individual who receives the K-1, the IRS is satisfied. They don't care who pays it, just that someone does.

Trust rates are generally a higher %, and maybe lower bracket points, so it generally makes sense to distribute as much as possible. Generally.

-ERD50

 

[meierlde]

If you buy turbotax business it will prepare 1041s for you. Generally when I did them, I would use up the old 15% bracket in the trust and distribute the rest via k-1s (since both beneficiaries where above the 15% bracket (also did the same for estates also involved). If you know the rough income of the beneficiaries of the trust you can manage the distributions so as to shelter some income in the lower bracket. It is not to hard with turbotax you just input the amounts to be distributed, and it generates the K-1s for you. Then for the personal return you just enter the data from the k-1 and everything is done for you.

 

[SecondCor521]

I certainly could ask for professional help. The people I would go to would be the professionals who prepared the trust tax return two years ago (the first year the trust was in existence and we didn't know how to fill out the form).

I'm not sure how much consulting they will do if they're not going to prepare either the trust returns or the beneficiary's returns. Probably not too much.

At this point my plan is to obtain the trust instrument and read the relevant state law. And of course, look at the return the professionals filed two years ago. If I can't prepare the return at that point I'll figure out what to do then.

It really is not that hard conceptually. The trust has dividends and a regular old vanilla LTCG. And there's some federally tax-free income. All I have to do is (a) figure out what distributions the trust instrument and state tax law allow, then (b) figure out how much to distribute (based mostly on trying to minimize income taxes across the returns), then (c) distribute it. The mostly confusing part for me is that there are all sorts of allocations and percentages that one has to do, and it can get to be percentages of percentages in some spots, I think.

 

[SecondCor521]

If you buy turbotax business it will prepare 1041s for you. Generally when I did them, I would use up the old 15% bracket in the trust and distribute the rest via k-1s (since both beneficiaries where above the 15% bracket (also did the same for estates also involved). If you know the rough income of the beneficiaries of the trust you can manage the distributions so as to shelter some income in the lower bracket. It is not to hard with turbotax you just input the amounts to be distributed, and it generates the K-1s for you. Then for the personal return you just enter the data from the k-1 and everything is done for you.

Thanks. I do know the income of the beneficiary, so I can balance it as you suggest. I won't have access to TT, but I may have access to another similar product. It is nice to know that they'll handle a 1041 and a K-1.

Generally I'm going to try to find the distribution that minimizes the top marginal rate between the trust and the beneficiary, while retaining as much income in the trust as possible.