Distributable Net Income: Mastering Difficult DNI Calculations for Estates and Complex Trusts Case Study on DNI Computations and Tax Planning Opportunities THURSDAY , DECEMBER 10, 2015, 1:00-2:50 pm Eastern IMPORTANT INFORMATION This program is approved for 2 CPE credit hours . To earn credit you must: • Participate in the program on your own computer connection (no sharing) – if you need to register additional people, please call customer service at 1-800-926-7926 x10 (or 404-881-1141 x10). Strafford accepts American Express, Visa, MasterCard, Discover . Listen on-line via your computer speakers. • Respond to five prompts during the program plus a single verification code . You will have to write down • only the final verification code on the attestation form, which will be emailed to registered attendees. To earn full credit, you must remain connected for the entire program. • WHO TO CONTACT For Additional Registrations : -Call Strafford Customer Service 1-800-926-7926 x10 (or 404-881-1141 x10) For Assistance During the Program : -On the web, use the chat box at the bottom left of the screen If you get disconnected during the program, you can simply log in using your original instructions and PIN.
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Distributable Net Income Dec. 10, 2015 Jeremiah W. Doyle Jacqueline Patterson BNY Mellon Wealth Management Buchanan & Patterson jere.doyle@bnymellon.com jpatterson@bplawllp.com
Notice ANY TAX ADVICE IN THIS COMMUNICATION IS NOT INTENDED OR WRITTEN BY THE SPEAKERS’ FIRMS TO BE USED, AND CANNOT BE USED, BY A CLIENT OR ANY OTHER PERSON OR ENTITY FOR THE PURPOSE OF (i) AVOIDING PENALTIES THAT MAY BE IMPOSED ON ANY TAXPAYER OR (ii) PROMOTING, MARKETING OR RECOMMENDING TO ANOTHER PARTY ANY MATTERS ADDRESSED HEREIN. You (and your employees, representatives, or agents) may disclose to any and all persons, without limitation, the tax treatment or tax structure, or both, of any transaction described in the associated materials we provide to you, including, but not limited to, any tax opinions, memoranda, or other tax analyses contained in those materials. The information contained herein is of a general nature and based on authorities that are subject to change. Applicability of the information to specific situations should be determined through consultation with your tax adviser.
Distributable Net Income: Mastering Difficult DNI Calculations for Estates and Complex Trusts Jeremiah W. Doyle IV, Esq. Jacqueline A. Patterson, Esq. Buchanan & Patterson, LLP Senior Vice President 1000 Wilshire Blvd. BNY Mellon Wealth Management Suite 570 One Boston Place Los Angeles, CA 90017 Boston, MA jpatterson@bplawllp.com Jere.doyle@bnymellon.com December, 2015 5
What We’ll Cover • Structure of Subchapter J • Basic Rules and Tax Rates • Types of Trusts • Trust Accounting Income (TAI) • Taxable Income • Distributable Net Income (DNI) – Including Capital Gains in DNI • Distribution System - Simple Trusts • • Distribution System – Complex Trusts - How DNI Gets Allocated – Tier System – Separate Share Rule – 65 Day Rule – Specific Bequests – Distributions in Kind 6
Income Taxation of Trusts and Estates Code Outline • PART I, SUBCHAPTER J – Subpart A - Sec. 641-646 - General Rules – Subpart B - Sec. 651-652 - Simple Trusts – Subpart C - Sec. 661-664 - Complex Trusts and CRTs – Subpart D - Sec. 665-668 - Accumulation Distributions – Subpart E - Sec. 671-679 - Grantor Trusts – Subpart F - Sec. 681-685 - Misc. Rules • PART II, SUBCHAPTER J – Sec. 691-692 - Income in Respect of a Decedent 7
Income Taxation of Trusts and Estates • Separate Taxable Entities • Taxable Income Computed in Same Manner as Individuals (Sec. 641(b)) • Own Tax Year and Method of Accounting • Receive Income/Pay Expenses • Income Taxed to Entity or Beneficiary 8
2015 Fiduciary Income Tax Rates Over Not Over 0 2,500 15% 2,500 5,900 25% 5,900 9,050 28% 9,050 12,300 33% 12,300 39.6% 9
Non-Deductible Expenses - Sec. 265 • Sec. 265 disallows any deduction attributable to T/E income • Generally applies to deductions for production of income, usually trustee’s fees and executor’s fees • If trust/estate has T/E income, portion of trustee’s and executor’s fees are nondeductible • No specific allocation formula – Fiduciary can use any reasonable method 10
Non-Deductible Expenses - Sec. 265 Example • FACTS: • Trust has $30,000 taxable interest and $10,000 T/E interest • Incurs $20,000 trustee fee • Portion of trustee fee attributable to T/E income is non- deductible $10,000 T/E income x $20,000 fees = $5,000 non-deductible $40,000 Total income 11
Types of Trusts • Simple • Complex • Grantor 12
Simple Trust • Required to distribute accounting income annually • Makes no principal distributions, and • Makes no distributions to charity 13
Complex Trust • Accumulates income • Makes discretionary distributions of income or mandatory or discretionary distributions of principal, or • Makes distributions to charity 14
Grantor Trust • Grantor or beneficiary has one or more “powers” described in Sec. 673-678 • Result: All income, expenses and credits “flow through” and are taxed to the Grantor or beneficiary regardless of whether distributions are made • Subpart A-D, Subchapter J (rules for taxation of trusts and estates) do not apply to Grantor trusts 15
Trust Accounting Income (TAI) • Governs amount of distributions • Trustee allocates receipts/disbursements between accounting income and principal • Accounting income and principal is determined by governing instrument or, if instrument silent, by state law – May be governed by UPIA or unitrust statute 16
Trust Accounting Income (TAI) TAI Taxable Income Corp Bond Int Capital Gains Muni Bond Int Expenses ? ? 17
Trust Accounting Income - TAI • BACKGROUND • Prudent Investor Act – Modern portfolio theory – invest for total return • Replaces the traditional notions of income and principal – Enactment of the Uniform Principal and Income Act – Enactment of Unitrust statutes 18
Trust Accounting Income - TAI • TRUST ACCOUNTING INCOME – Could be TAI defined under: • Traditional definition of income and principal • Unitrust statute – Must be no less than 3%, no more than 5% of FMV of trust assets • Uniform Principal and Income Act – Requirements: » Trust is managed under the Uniform Prudent Investor Act » The beneficiary must be eligible for income distributions » The distribution is not favorable to one beneficiary over another 19
Taxable Income of Trust or Estate • Computed same as individual • Exemptions: $600/$300/$100 • Different rules for charitable deductions • Depreciation deduction allocated between entity and beneficiary • Distribution deduction • Administration expenses - some not subject to 2% floor • AGI - same as individual reduced by (1) personal exemption, (2) distribution deduction and (3) some administration expenses are subtracted “off the top,” i.e. subtracted from taxable income to arrive at AGI 20
Income Taxation of Trusts and Estates • Income Taxed to Either Entity or Beneficiary – If income is accumulated and not deemed distributed, it is taxed to the trust or estate – If income distributed : • Trust gets deduction for amount of distribution, limited to DNI • Beneficiary accounts for income distributed on his own tax return, limited to DNI 21
Income Taxation of Trusts and Estates - Distributable Net Income (DNI) • Distributable Net Income (DNI) governs: – Amount of trust or estate’s distribution deduction – Amount beneficiary accounts for on his own return – Character of income in beneficiary’s hands 22
Income Taxation of Trusts and Estates DNI DNI acts as ceiling DNI acts as ceiling on entity’s on amount distribution beneficiary deduction accounts for on his return Trust/Estate Beneficiary 23
DNI - Sec. 643(a) • Start With Taxable Income and . . . – Add back the distribution deduction – Add back the personal exemption – Subtract out capital gains/ add back capital losses allocable to principal (except in the year of termination) – Subtract out extraordinary dividends and taxable stock dividends allocated to corpus for simple trust – Add back net tax-exempt income 24
DNI – Easy Example Facts – Trust income: DNI: – Interest $10,000 Taxable income $19,900 – Dividends $15,000 Add: Exemption $100 – Trustee’s fees 5,000 DNI $20,000 Taxable income: Interest $10,000 Dividends $15,000 Less: Tr fees ($5,000) Net $20,000 Less: exemption ($100) Taxable income $19,900 25
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