There is Still Time to do 2014 Tax Planning for Trusts and Estates

While the time for most people to do tax planning for 2014 ended on December 31, 2014, most trusts and estates have an additional window to adjust their income for that year. Section 663(b) of the Internal Revenue Code allows the trustee of most trusts or the personal representative of an estate to elect to treat distributions to beneficiaries that are made during the first 65 days of a tax year to be treated as if they were made on the last day of the preceding tax year. Since distributions to beneficiaries reduce the income of the trust or estate, this provision effectively allows the trustee or personal representative to retroactively reduce the income of the trust or estate for its preceding tax year. (Distributions to beneficiaries may transfer the income tax obligation from the trust/estate to the beneficiary.) Given the differences in tax rates between trusts and estates and their beneficiaries, careful use of this election can reduce overall taxes. Of course, trustees and personal representatives have other factors to consider in deciding to whether make distributions to beneficiaries and, if so, the amount of such distributions, and should balance those factors against the potential tax planning afforded by this provision.

Most trusts and estates are subject to income tax in the same manner as individuals, but the tax rates apply at much lower levels of income. The following chart shows the tax rates in effect for 2014 for taxable income of trusts and estates in comparison to the tax rates for single individuals and for married individuals filing joint returns.

and Estates
Filing Joint Return
10%N/AUp to
Up to
15%Up to

In addition to these tax rates, the health reform law introduced an extra 3.8% tax on unearned income in excess of certain levels. “Unearned income” is generally passive income, such as interest, dividends, and capital gains (with certain exceptions for income from a business in which the taxpayer “materially participates,” which is itself a fairly complicated determination). For a single individual, the threshold at which this extra 3.8% tax is imposed is $200,000 of “modified adjusted gross income,” which is different than taxable income. (It is essentially taxable income but adding back the amounts for personal exemptions, itemized deductions, and certain other deductions.) For a married individual filing a joint return, the level is $250,000 of modified adjusted gross income. For a trust or estate, however, the 3.8% tax applies once the trust or estate is in the highest income tax rate, which for 2014 was once it had more than $12,150 of taxable income.

To illustrate the impact of these tax differences, consider a trust which earned $100,000 from its investments in 2014 (interest, dividends, and capital gains) and assume that none of that income qualifies for the “material participation” exception from the extra 3.8% tax. Assume there are three beneficiaries: a surviving spouse, whose taxable income was $75,000; her married son, whose taxable income with this wife was $150,000; and her single daughter, who is a junior in college and whose taxable income from part-time jobs was $6,000. The trust provides that the trustee has the discretion to distribute any or all of its income and principal to or among the beneficiaries.

Looking at this situation from a purely tax standpoint, if the trust retained all of its income, it would pay $37,929.10 in regular income tax plus an additional $3,338.30, since it had unearned income in excess of its applicable threshold, for a total payment of $41,267.40. On the other hand, if it distributed that $100,000 equally among the three beneficiaries, the combined tax on that distributed income would be:

  • Surviving Spouse $8,902.83
  • Son $9,333.33
  • Daughter $5,089.68
  • Total $23,325.84

So by electing to distribute the trust’s income equally among its beneficiaries, the trustee will reduce the total amount of taxes paid on that $100,000 of income by $17,941.56. If the trustee chose to make unequal distributions, which in this example is permitted under the trust document (and is a common provision), the total taxes could be reduced further since more of the income could be distributed to the beneficiaries in the lower tax brackets.

While the tax savings are certainly an important consideration in deciding whether to make distributions to beneficiaries and, if so, how much to distribute and to which beneficiaries, trustees and personal representatives need to remember that they have fiduciary duties in administering the trust or estate for which they are responsible; and these duties may outweigh the potential tax savings. For example, making a distribution to a beneficiary who is not capable of properly managing that distribution may be unwise, even if the alternative is to pay a higher tax on the retained income. Similarly, making unequal distributions among beneficiaries simply to save taxes may cause resentment and potential disputes among and with those beneficiaries. Trustees and personal representatives should carefully evaluate all these factors, but the ability to alter the tax consequences for 65 days after the close of the tax year is a valuable tool that should be considered.

For more information, please call our office at 770-379-1450 or visit



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