Fiduciary Income Tax Planning: Strategies for Minimizing Income Tax on Trusts and Estates

“Fiduciary Income Tax Planning: Strategies for Minimizing Income Tax on Trusts and Estates,” that’s the subject of today’s ACTEC Trust and Estate Talk.

Transcript/Show Notes

This is ACTEC Fellow Travis Hayes of Naples, Florida.

Fiduciary income tax planning involves managing the tax obligations of trusts and estates and ensuring compliance with tax laws, while also minimizing tax liability. Professionals involved in estate planning, taxation, and wealth management find fiduciary income tax planning crucial for optimizing financial outcomes.

An expert on this topic, ACTEC Fellow Steve Gorin of St. Louis, Missouri, joins us today to dig into the details of fiduciary income tax planning and to offer recommendations to practitioners. Welcome, Steve.

Overview of Fiduciary Income Tax Planning

Steve Gorin: Thank you, Travis. It’s a pleasure to be here. Let’s talk some about how we can minimize income taxes when we have assets in a trust or estate.

After a trust or estate gets to about $15,000 or $16,000 of taxable income, it’s going to be in the highest bracket. And often a beneficiary may be in a much lower bracket. To get to the highest bracket tends to require somewhere, you know, several hundred thousand dollars’ worth of taxable income, and a lot of beneficiaries don’t have as much of that. So there may be some opportunities to push income out to beneficiaries so that they can be taxed at a lower rate than what the trust might have.

Now, instead of letting the tax-tail wag the dog though, first, we need to double-check to make sure that a distribution is available under the trust agreement, that it is authorized, that the trustee can make the distribution, and also that it’s advisable. You’re not going to make a distribution to a beneficiary to feed a drug habit. Although you certainly might make a distribution to help out with rehab for the same beneficiary. So you may have some beneficiaries who are very responsible for the money, some of them who might need coaching, and then of course you have others who are just hopeless.

The beneficiaries – if you’re going to make a distribution to save tax, you don’t want to have money going out the window – so you’re not going to make a distribution to a beneficiary who’s not going to use it wisely. But to the extent you do have a beneficiary, you can use it wisely, and the distribution is authorized – you should take a look at the different tax brackets involved.

Questions for Fiduciary Income Tax Consideration

You want to look at the trust federal income tax bracket and also the state income tax bracket.

• Is the trust a resident trust or a non-resident trust?
• And how about the beneficiary?
• Does the beneficiary live in a low-tax state or a high-tax state?
• What’s the beneficiary’s tax bracket?
• Does the beneficiary have any losses or deductions that they can use to offset this income?

So, you really want to get to know both the circumstances, the trustee, and the beneficiary.

Distributable Net Income

Now, the whole point about fiduciary income taxation is you have whatever the trust taxable income is, an idea called distributable net income (DNI), which is basically the trust taxable income before certain adjustments, and before you consider how much gets split between the trust and the beneficiary.

You take this distributable net income, this DNI, to the extent that the trust makes a distribution to the beneficiary, the trust gets the deduction for it and the beneficiary gets a K-1 saying the beneficiary has to report that DNI and the beneficiary’s income. So it is a zero-sum game – in terms of you have a finite amount of taxable income, and it’s simply allocated between the trust and the beneficiary.

Capital Gains and DNI

Now, one thing that a lot of people don’t appreciate is the way it works with capital gains. A lot of people think that capital gains need to stay inside the trust – they’re not part of DNI. But, in fact, they can be allocated to DNI. They can be allocated to income by exercising the power to adjust, where you say: “Okay, we have a trust that has total return, the income is really not big enough to support the income beneficiary, and it would be nice to take some of that total return and share it with the beneficiary so that you’re investing in the wisest way possible.” But at the same time, you’re leaving adequate income for the beneficiary. So you can do an adjustment to count capital gain as income.

There’s another thing – it has to do when you have an allocation to principal – there’s a consistency rule. I’m not going to really cover that because I want to just kind of skip past that. There are three different ways to get the capital gain out to the beneficiary, and the third way is the fiduciary refer to the capital gain when making the distribution. So the trustee can make a distribution to say to the beneficiary: “I’m distributing $10,000 of capital gain, here it is.” And that would be sufficient to let that capital gain pass out to the beneficiary.

The whole point about some of this planning is that during the first 65 days of the year, you can make distributions that will count for the prior year. For 2025, any distributions from January 1st, 2025 to March 6th, 2025 can count as a 2024 or a 2025 distribution. We can now, right now, before filing a tax return, take a look at the income and rough up the figures for the trust and the beneficiary and see what distribution would be advisable to do between now and March 6th. And then you can do the appropriate planning and minimize taxes.

I hope this has been helpful and look forward to future contact with you.

Travis Hayes: Thank you, Steve, for briefing us on fiduciary income tax planning strategies that can help minimize income tax and optimize our client’s financial outcomes.

 

You may also be interested in:

• Fiduciary Income Tax Planning of Distributions In-Kind and Specific Bequests (Aug 2024)
• Addressing Incomplete or Lost Records During Fiduciary Administration (Aug 2024)

 

A video to share with your clients:

The Basics of Fiduciary Income Taxation

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