LTCG & Dividends: Complicated Issue - How to figure out how much LTCG to take?

[Steelart99]

It's been awhile since I've been here ... retired 9 years ago and doing great.

I have an issue more complicated than the title might suggest. My parents set up a generous trust for me as the main recipient with my daughter as a secondary. The trust is all stock with a VERY low cost basis associated with it and also generates yearly dividends.

I want to distribute funds to her before my death which will require selling stock and distributing the LTCG and dividends split between her and myself. Per my CPA, and distribution to both of us must be as a percentage of the combined dividends and LTCG; i.e., one of us can't take all the dividends and the other just the LTCG. So, if I distribute 40% of the LTCG to myself, I also have to take 40% of the dividend income. The other 60% of each would go to her. Note: Dividends are taxed as regular income.

The yearly dividend rates have been very stable year to year, so I know what that amount will be based on the know number of shares in the trust. I want to maximize the use of the 0% LTCG tax bracket for both of us while minimizing the gross tax burden.

I frankly have not come up with a good way to figure this out and I'm looking for some guidance ... or even better, a pointer to some calculator that might help me out.

 

[SecondCor521]

A couple of thoughts.

First, you need to comply with whatever the trust document says about distributions. If you are the main beneficiary, then probably the trust will say that any trust distributions are to you. If you then turn around and give money to your daughter, that is a separate gift and would probably *not* be treated as being a distribution from the trust to your daughter. Check the trust document to see what it says.

If, on the other hand, you and your daughter are 50/50 beneficiaries, then you would have to distribute equal dollar amounts to yourself and her. And yeah, what your CPA said sounds right - if the distribution is X% LTCG and Y% dividends, then you and your daughter would have to use those same ratios on the K-1.

Second, there are usually state trust taxation laws which limit how and whether you can distribute LTCG or not, so you may be constrained by state trust taxation law. Your CPA, if they're familiar with trusts, can hopefully help with this.

Filling up the 0% LTCG bracket isn't hard. Sit down with your tax return from last year, and add in a dummy LTCG entry for $5K and see if your federal tax bill goes up. Tweak the $5K up or down until you find the maximum number that you could have without increasing your federal taxes. You might also find looking at Line 9 of the Qualified Dividends and Capital Gains Worksheet helpful in this process.

Once you know that number, you can do similar calculations for the current year. You can probably sit down in December and get a tax return that is pretty close to final, then realize the LTCG in the trust in December. There is an election for trusts that you can distribute funds in the first two months or so of the following year and treat them, for tax purposes, as having been made in the previous tax year. It's called a section 663(b) election - see item 6 in Other Information on the Form 1041.

My state - and I understand most states do it this way - tax LTCG as ordinary income, so you might want to consider state tax implications too, especially if you or your daughter have any plans of moving to a lower cost tax state in the future.

Most of the time, it does probably make sense to just fill up the 0% LTCG bracket with whatever space you (and possibly your daughter) have. If you have $12K of space and she has $30K, I'd probably do the smaller amount if trust distributions have to be 50/50 - so $12K to you and $12K to her for a total of $24K.

If you overshoot a bit, the excess LTCG is probably at 15%, which still isn't bad in the big scheme of things.

If your life expectancy is not long, I would investigate and consider leaving stock in the trust as is. If there is a step up in basis at your death (there probably is *not*, but there might be), then if you're realizing LTCG now, then you (and maybe she) might be paying at least state taxes on that unnecessarily.

If the dividends are qualified, then they are not taxed as ordinary income. Qualified dividends, even those generated in a trust and then distributed to a beneficiary, retain their character, and would be given preferential LTCG rates.

Any distribution from the trust to you or your daughter would involve preparing K-1 forms. The CPA should know about this and help you with them.

HTH.

 

[Steelart99]

Thanks for that reply! First off, my CPA does not seem to be very good with trusts; I do know it is time to search for another. To address some of your comments.

My understanding from my Trust attorney is that the trust was written such that we are primary/secondary (per stirpes). I don't think that a distribution is considered a gift from me, but I will check. It would have to be distributed directly from the Trust. Thanks

Per my CPA, I don't have to distribute equally to each of us, but the percent of the dividend distributed must be the same percent as any LTCG distributed. So, 40%div + 40%LTCG to me and 60%div + 60%LTCG to my daughter. Or, whatever percentage distribution that works based on our two incomes.

I didn't know about section 663(b). That can be quite useful !!!

I have to pay LTCG tax in my state, but my daughter's state has no tax on LTGC. Just to make things more complicated ... sigh

There will be no step up in basis upon my death, so the basis passed on to me from my parents carries on to her upon my death.

Since the qualified dividends are part of the AGI calculation I presumed that they were taxed as ordinary income. I'll have to look that over ... a major miss on my part.

Yes, I've had to deal with K-1 forms for years.

Thanks for your input HTH

 

[SecondCor521]

Thanks for that reply! First off, my CPA does not seem to be very good with trusts; I do know it is time to search for another. To address some of your comments.

My understanding from my Trust attorney is that the trust was written such that we are primary/secondary (per stirpes).

I would check into this before making any moves. The way you've written it there is a bit unclear. Based on the totality of it, it does sound to me like you are the only current beneficiary of the trust. If so, then you can distribute from the trust to you and you would be taxed on that income. If you then turned around and gave money to your daughter, that would just be a gift and not a trust distribution.

The best person to ask would probably be the attorney who drafted the trust.

I don't think that a distribution is considered a gift from me, but I will check. It would have to be distributed directly from the Trust. Thanks

Per my CPA, I don't have to distribute equally to each of us,

I think your CPA is wrong on this. I would check with the attorney who drafted the trust.

but the percent of the dividend distributed must be the same percent as any LTCG distributed. So, 40%div + 40%LTCG to me and 60%div + 60%LTCG to my daughter.

This part sounds correct to me.

 

[pb4uski]

Sounds like OP is trustee and beneficiary of the trust and OPs daughter is a contingent beneficiary. If that is the case, the daughter can't receive distributions from the trust until the OP has passed on, at which point the daughter will become the beneficiary of the trust.

Qualified dividends and LTCG are both preferences income. But it is all moot because if my understanding is correct and the daughter is a contingent beneficiary then she can't receive distributions from the trust now anyway.

If OP wants to pass $$$ to his DD he would have to receive distributions from the trust and then gift them to the daughter but the OP would be responsible for any taxes.

 

[Steelart99]

Sounds like OP is trustee and beneficiary of the trust and OPs daughter is a contingent beneficiary. If that is the case, the daughter can't receive distributions from the trust until the OP has passed on, at which point the daughter will become the beneficiary of the trust.

Qualified dividends and LTCG are both preferences income. But it is all moot because if my understanding is correct and the daughter is a contingent beneficiary then she can't receive distributions from the trust now anyway.

If OP wants to pass $$$ to his DD he would have to receive distributions from the trust and then gift them to the daughter but the OP would be responsible for any taxes.

That is actually how I handled it last year. I took the max LTCG that kept me within the 0% tax bracket (after factoring in some losses from my personal stocks). I also had some solar tax credit which reduced my final tax due down considerably. Then gifted to them. Worked out well last year, but I was looking to attack this in a different way for current an future years.

 

[Steelart99]

I would check into this before making any moves. The way you've written it there is a bit unclear. Based on the totality of it, it does sound to me like you are the only current beneficiary of the trust. If so, then you can distribute from the trust to you and you would be taxed on that income. If you then turned around and gave money to your daughter, that would just be a gift and not a trust distribution.

The best person to ask would probably be the attorney who drafted the trust.



I think your CPA is wrong on this. I would check with the attorney who drafted the trust.



This part sounds correct to me.

I had contacted my trust attorney about this a couple of years ago, but frankly could not wrap my head around all the details. Time to call them again ...

 

[I am He]

Let's assume the OP is both the trustee (hat #1) and primary bene (hat #2) who is in a higher tax bracket than the secondary benes. Wearing hat #2 as the bene, isn't it possible to disclaim? Then wearing hat #1 acting as trustee, he distributes it directly to the secondary bene (as if he had pre-deceased the grantor). Then the secondary benes decide how and when they want to receive the distribution as either the stock or whether to let the trust sell it prior to the distribution?

I suppose another question (or perhaps the main question assuming the trustee/primary bene is nearing end of life) is if they want to finalize and close out the trust or to keep it going spreading things out over more time? There is something to be said for "cleaning things up" which probably contradicts the most lucrative outcome, post tax.

 

[SecondCor521]

Let's assume the OP is both the trustee (hat #1) and primary bene (hat #2) who is in a higher tax bracket than the secondary benes. Wearing hat #2 as the bene, isn't it possible to disclaim?

Maybe.

There are a number of rules about disclaimers that must be followed in order for the disclaimer to be valid.

First, they generally need to be done within nine months. OP may be outside this time window.

Second, the beneficiary can't have received any benefit. OP may have already received a distribution as primary beneficiary.

There are other rules, but those are the two that might be problematic.

If eligible, the OP could also partially disclaim if their state allows it. Partial disclaimers are allowed under federal law.

Then wearing hat #1 acting as trustee, he distributes it directly to the secondary bene (as if he had pre-deceased the grantor). Then the secondary benes decide how and when they want to receive the distribution as either the stock or whether to let the trust sell it prior to the distribution?

Regardless of disclaimer, as trustee OP would still need to follow the trust documents regarding distribution amounts and timing. I think most trusts allow the trustee the discretion to sell or distribute in kind, and whether to keep or distribute any resulting capital gains in the trust or to the beneficiaries (for tax purposes).

 

[I am He]

Many thanks, 2nd Cor.!

 

[Steelart99]

OP here. Per the trust, I have the discretion to sell or distribute in kind, and keep or distribute any resulting capital gains in the trust to the other beneficiaries. I frankly know nothing about disclaimers ... gonna have to research that and see if anything is even applicable. Whew ... hard for me to wrap my head around all the rules and laws.

 

[Steelart99]

Maybe some added text/content directly from my Trust document maybe helpful in my understanding of what I can do. I truly apologize for how wordy/long this gets.

Establishing the Trust
<paraphrase from Trust document> "The date of this Irrevocable Trust Agreement is December xx, 20xx. The parties to the agreement are <my Mom>, also known as <Mom's full name>, acting through her Agent, <myself> under her Durable Power of Attorney dated September xx, 20xx, (the “Grantor”), and <myself> and <my daughter> jointly (collectively, my “Trustee”)."

NOTE: At the time the trust was established, Mom was the Grantor and I had DPOA. As stated, my daughter and myself are collectively named the "Trustee."
Following my mom passing, and in order to minimize the need to have us both sign off on every Trust action, my daughter has resigned as co-Trustee leaving me as the sole Trustee.

My Beneficiaries
“The beneficiaries of my trust are my son, <myself>, and his descendants. <Myself> is the Primary Beneficiary.”

NOTE: I am noted as the Primary Beneficiary with any of my descendants also being beneficiaries.

Administration of Trust Property
Distributions of Income and Principal
"The Trustee, other than an Interested Trustee, may distribute to <myself> or his descendants as much of the income and principal of his trust as such Trustee may determine advisable for any purpose. If there is no Trustee that is not an Interested Trustee, the Trustee shall distribute to <myself> or his descendants as much of the income and principal of his trust as the Trustee determines is necessary or advisable for their health, education, maintenance, or support.

In determining whether or not to make distributions the Trustee will give consideration first to the needs of <myself> and only thereafter to the needs of his descendants."

NOTE: This seems to indicate that I, as Trustee, can distribute any Trust income/principal to myself and/or my descendants. Although the Trust does not use the exact terms here, I am noted as primary beneficiary.

Trust Administration
Distributions to Beneficiaries
"Whenever this trust authorizes or directs my Trustee to make a net income or principal distribution to a beneficiary, my Trustee may apply any property that otherwise could be distributed directly to the beneficiary for his or her benefit. My Trustee is not required to inquire into the beneficiary’s ultimate disposition of the distributed property unless specifically directed otherwise by this trust.

My Trustee may make cash distributions, in-kind distributions, or distributions partly in each, in proportions and at values determined by my Trustee. My Trustee may allocate undivided interests in specific assets to a beneficiary or trust in any proportion or manner that my Trustee determines, even though the property allocated to one beneficiary may be different from that allocated to another beneficiary.

My Trustee may make these determinations without regard to the income tax attributes of the property and without the consent of any beneficiary."

NOTE: The way I read this, it says that I (the Trustee) can make distributions in any way I want to and at any proportions. I do not know if there is a tax law that trumps this Trust direction. Which takes precedence, tax law or Trust direction?

 

[I am He]

OP here. Per the trust, I have the discretion to sell or distribute in kind, and keep or distribute any resulting capital gains in the trust to the other beneficiaries. I frankly know nothing about disclaimers ... gonna have to research that and see if anything is even applicable. Whew ... hard for me to wrap my head around all the rules and laws.

I think what's so complicated is that it's an instrument in two different camps: Income taxes (who pays: the trust vs the beneficiaries) and the legality of who's entitled to the distributions?

In my mind, you can distribute to whoever as the trustee. But legally, it would only go to the primary beneficiaries and not your kids because they are secondary beneficiaries.

I often wonder when the dollars are smaller (say a few hundred k) and the beneficiaries are few, who really gets into challenging anything? I mean is the IRS really hunting you down if you somehow moved stock directly into the wrong person's account if they were that secondary bene?

 

[SecondCor521]

NOTE: The way I read this, it says that I (the Trustee) can make distributions in any way I want to and at any proportions. I do not know if there is a tax law that trumps this Trust direction. Which takes precedence, tax law or Trust direction?

Trust law takes precedence.

 

[pb4uski]

Wow, I've never seen a trust structured as open ended at that. Chat with a lawyer, but from the wording it seems that you could distribute trust assets directly to your DD since she is your desendant.

... The beneficiaries of my trust are my son, <myself>, and his descendants. ...

... If there is no Trustee that is not an Interested Trustee, the Trustee shall distribute to <myself> or his descendants as much of the income and principal of his trust as the Trustee determines is necessary or advisable for their health, education, maintenance, or support. ...

 

[Steelart99]

Wow, I've never seen a trust structured as open ended at that. Chat with a lawyer, but from the wording it seems that you could distribute trust assets directly to your DD since she is your desendant.

That was the way I was reading it. Our Trust attorney went to great lengths to make this trust as complete, yet "open" to the beneficiaries as possible. That said ... 'tis a long document to cover as many contingencies and possible scenarios.