Accounting 815

Taxation of Transfers and Fiduciaries

Week 3: Fiduciary Accounting for Income

Special Issues and Income in Respect of a Decedent

Second Week Summary

Concepts of income:

Fiduciary income is generated by assets during the period of administration The emphasis is on principal and income distinction to structure interests over time. Taxable income is defined by revenue considerations, and the major areas of difference include Capital gains, Tax Exempt income, Fiduciary expenses, and treatment of Charitable beneficiaries. The bridging concept is Distributable Net Income ("DNI"). The fiduciary deducts and beneficiary includes in income the taxable portion of DNI. DNI = (roughly) taxable income w/out capital gains and with addback of net exempt income.

Try to apply these concepts to the Marguarite Evans estate

What is the non-income fiduciary "starting point" or "corpus"?

What are the fiduciary income and expense items?

What are the fiduciary to tax differences?

Special rules for fiduciary taxable income

Exempt income and its cost

Sec. 265: No deduction for cost of taxfree income

Often, tho not always, state and local exempt bonds

As financial planning matter: are mutual funds with full spectrum of maturities and qualities.

market looks roughly efficient in detail, but why do exempts yield more than 1-top rate = 60% of treasuries?

Calculation

Have to determine what expenses are direct, what are allocable and what non allocable

No deduction for direct or for proportionate share of allocable

May be a tax disaster if there are a lot of expenses, and very little income, most of which is taxfree

Manufacturer's Hanover case re allocation

Bank trustee had $27K dividends, $8K exempt interest, $71K Capital Gains and $54K in legal fees, fiduciary fees and state taxes

Issue: were the capital gains in the denominator of the formula for allocating the fees? Held: no

Reasoning: Regs. Sec. 1.652(c)-4 and 1.265-1(c) are controlling. Both taxable income and DNI allocate fiduciary fees entirely to the income account. It's not clearly unreasonable to use the DNI concept of income, which excludes capital gains

Simple vs. complex trusts (Can it accumulate fiduciary income?)

"Simple", Sec. 651 trust

deducts income (all) required to be distributed currently: Sec. 651(a)

"Complex", Sec. 661 trusts, and all estates

Deduct income and any other amount paid out

But not to exceed the taxable portion of DNI: Sec. 661(c)

Generally, all distributions, carry out DNI

Whether called Corpus or income.
But not specific bequests of specific sum or specific property: 663(a)(1)

"Tiering"

For complex trusts/estates, "tier" required income distributions and other distributions

DNI allocated 1st proportionately among first tier -- the mandatory income recipients. If excess, allocate proportionately among second tier -- the discretionary recipients: Sec. 662(a)(2)

Example of Tiering.

Trust must pay 50 to S and 25 to Br, has discretion to pay excess to S and C, discretion to use principal

Y is 65, pays S 60, Br 25, C 10

the 65 is 2/3 S and 1/3 BR Rest is principal

Y is 90, pays S 60, Br 25, C 10

first, S 50 and BR 25. The other 15 is equal to S and C

Trust Sale of gifted property w/in 2 years

Sec. 644 tax at grantor's rates

Relic of the income splitting days
Like the installment sale anti-rushin-trust rules

Distributions in kind: Sec. 643(e)

Property distributions generally not a taxable event

If not meeting specific legacy: eg will gives X $50 K, stock w/ FMV 50K but different basis is sold . Or is not sold, but distributed to X

Distributions carry out DNI=Basis (or FMV if less), and basis carryover

If elect, recognize gain or loss, and use FMV as DNI carryout and as basis

Depreciation follows the income: Sec. 642(e)

No double estate tax and Y tax deduction: Sec. 642(g) waiver

Unused loss CF and excess deductions jump to bene in final year: 642(h)

Income in respect of a decedent

IRD Defined: Sec. 691(a)(1):

item of gross Y, not properly includible before death, received by estate or heir

Significance:

is both property (estate tax) and income (income tax)
estate tax is basically an accrual system

common examples

cash method biz receivables

installment sales

dividends in transit

deferred compensation/ PPS/ IRA's

deferred interest on Govt. bonds

IRD is Taxed to person who receives it.

IF IRD rights sold, include at greater of FMV or amount received

IF installment obligation, IRD is FMV less basis: if satisfied below face, include lesser amount. 1.691(a)-5

IRD retains its character

Special feature of IRD: potential double tax because no stepup

Sec, 1014. Death makes income tax go away, even if estate too small to pay estate tax

Exception to Sec. 1014: IRD doesn't step up

otherwise, could increase basis, sell the right, report 0 Y

Case illustrating IRD: Rollert Trust (para. 32,019)

D an exec VP of GM. Prior to death, a tentative decision to pay bonus. Three months after death, formally awarded

Issue: is this an "entitlement" to income w/in the Regs
Held: yes

Reasoning: not a legally enforceable right at death, but a reasonable expectation suffices. Otherwise, parties could avoid tax by failing to document their expectations

Query: how good a policy reason for the result?

Deductions in Respect of a Decedent

DRD includes Secs. 162, 163, 164 and 212, and foreign tax credits,
Again, general concepts of expenses accrued before death but not paid

Income Taxation of inherited retirement benefits

Not part of probatable estate: bene designation controls

Are part of taxable estate: property right to deferred income

Mechanics of retirement payouts: the 3 key questions (Prop Regs. 1.401-9)

Has D attained mandatory starting date? 70 1/2

If yes, what mandatory payout formula has been selected: recalculation or nonrecalcaultion

Who is the beneficiary? None (estate), individual, spouse?

Build Date 2/10/98