2013 Tax Planning Options Remain for Non-Grantor Trusts – But Not for Long
Author: Robert Conner
We would like to introduce you to the Halley’s Comet of the tax world—the opportunity to implement a tax planning strategy affecting the prior year after year-end. This tax rarity does not show itself often, but when it does, its results can be impactful. We’re referring to the “65-day election,” whereby a trust may elect to treat distributions made within 65 days after the trust’s year-end as having been made in the prior year. Distributions must be made by March 6, 2014, or this opportunity will vanish into thin air and not show itself again until next year.
Trust distributions made before year-end generally are taxable to the beneficiary in the year of receipt, and the trust is allowed an offsetting deduction for the income distributed. Distributing investment income to a beneficiary can be a powerful strategy due to the new 3.8 percent net investment income tax (NIIT), coupled with the wide disparity between the threshold onset of the top federal tax bracket for trusts and individual beneficiaries.
Beginning in 2013, certain trusts will be subject to the new 3.8 percent NIIT on undistributed net investment income in excess of $11,950. One possible way to reduce or eliminate exposure to this tax is to distribute net investment income to beneficiaries. Individual beneficiaries have a much higher threshold—$200,000 ($250,000 for joint filers)—for imposing the 3.8 percent NIIT, which may result in distributed net investment income avoiding the NIIT altogether.
In addition, tax brackets for individuals are much more graduated than for trusts. For example, a trust will pay 2013 federal income tax at a rate of 39.6 percent on ordinary income in excess of $11,950. On the other hand, individuals are not subject to this top rate until their income exceeds $400,000 ($450,000 for joint filers). Absent any kiddie tax implications, this tax rate disparity could effectively cause distributed income to be pulled out of the 39.6 percent bracket and taxed at a much lower rate by the individual beneficiary.
With hindsight as a guide, a trust can make a distribution to a beneficiary by March 6, 2014, and apply the deduction to the trust’s 2013 tax year by making a 65-day election. This election preserves the aforementioned distribution strategy benefits and provides the opportunity to review actual trust income after the end of the year to develop a targeted distribution plan. Amounts included under the 65-day election also will be considered received by the beneficiary in the prior year.
While there is no one-size-fits-all solution for effective tax planning, trust taxpayers must educate themselves on the available options, coordinate distribution strategies with the beneficiary’s overall tax situation and make the most informed decision possible on course of action.
To learn more about how these distribution strategies may be incorporated into your overall tax plan, contact your BKD advisor.