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Chapter 23 Income Taxation of Trusts and Estates

Chapter 23 Income Taxation of Trusts and Estates. ©2008 CCH. All Rights Reserved. 4025 W. Peterson Ave. Chicago, IL 60646-6085 1 800 248 3248 www.CCHGroup.com. Taxation of Estates. Decedent's final income tax return Income/Deductions on final return Standard deduction/exemption

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Chapter 23 Income Taxation of Trusts and Estates

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  1. Chapter 23Income Taxation of Trusts and Estates ©2008 CCH. All Rights Reserved. 4025 W. Peterson Ave. Chicago, IL 60646-6085 1 800 248 3248 www.CCHGroup.com

  2. Taxation of Estates • Decedent's final income tax return • Income/Deductions on final return • Standard deduction/exemption • IRD (Income in Respect of a Decedent) • DRD (Deductions in Respect of a Decedent) • Must file if estate has gross income of $600 or more on Form 1041. CCH Federal Taxation Comprehensive Topics

  3. Fiduciary Responsibilities • A fiduciary is a person such as an administrator, trustee or executor who has been given a special confidence and responsibility to manage property in a trust or estate according to some legal document and in the best interests of the beneficiaries of the trust or estate. The main responsibility is to settle the affairs of the decedent, file tax returns and pay any liabilities. CCH Federal Taxation Comprehensive Topics

  4. Five Key Elements of Every Trust 1. Grantor. The grantor is the person who transfers property to the trust. The grantor often referred to as trustor, settlor or donor. 2.  Trust property. Property must be transferred to the trust. It can be transferred during life, after death through the grantor’s will, through a gift, or by the exercise of a power of appointment (“POA”). It can be cash, a life insurance policy, stock, or any other asset that serves the intent of the grantor. Chapter 23, Exhibit 1a CCH Federal Taxation Comprehensive Topics

  5. Five Key Elements of Every Trust 3. Trustee. The trustee is the person responsible for managing and administering a trust. The trustee may be the grantor, a trusted friend, a family member, a bank trust department, or any combination of these and other persons. The trustee generally will hold legal title to the assets in the trust but not beneficial title. (a) Legal title means the trust assets are owned in the name of the trustee, the trustee has specific duties and responsibilities for the trust property, or has certain powers concerning the disposition of the trust property. (b) Beneficial title to the trust property is held by the beneficiaries of the trust. Chapter 23, Exhibit 1b CCH Federal Taxation Comprehensive Topics

  6. Five Key Elements of Every Trust 4. Beneficiary. It’s important to know that the persons who are beneficiaries can be determined; that is, the description should be clear and certain. If “my descendants” are the named beneficiaries, there must be a time for making the determination of who the descendants are. Otherwise, it would be impossible to know when to make distributions from the trust. (a) Possible issue. A possible issue might be: Are grandchildren born after the trust had been established to be included as beneficiaries? (b) Remainderman. When the trust has fulfilled its purpose, the money and assets it holds are distributed to the remainderman and the trust is terminated. Chapter 23, Exhibit 1c CCH Federal Taxation Comprehensive Topics

  7. Five Key Elements of Every Trust 5. Intent of Trust. Every trust has a purpose which motivates the grantor to set the trust up in the first place. The intent can relate to one or a combination of the following intents: (a) Benefiting a particular beneficiary. (b) Providing for the maintenance of certain assets, such as the old family homestead. (c) Achieving certain tax benefits, such as through charitable remainder trusts or marital trusts. Chapter 23, Exhibit 1d CCH Federal Taxation Comprehensive Topics

  8. Trust Life Cycle Illustrated (a)  Grandma has her attorney prepare a trust agreement. (b) Grandma then transfers $100,000 in bonds to her daughter, Tressie, as trustee of the trust. (c)   Tressie is required by the terms of the trust document to invest the $100,000 in bonds and use all of the interest each year to pay for the college expenses of Tressie’s two sons, Grandma’s grandchildren. (d)  When the youngest of Tressie’s two sons reaches the age of 25, Tressie is instructed to divide the money in the trust equally and distribute it to each of the two boys. (e)  When the distribution is completed, the trust is terminated. Chapter 23, Exhibit 2a CCH Federal Taxation Comprehensive Topics

  9. Trust Life Cycle Illustrated Legal title. The $100,000 Grandma transferred is owned by Tressie, as trustee of the trust. Thus, Tressie holds legal title to the bonds “in trust” for the beneficiaries. Beneficial title. Tressie’s two sons hold beneficial title. Only they have the right to benefit from the interest and principal value of the bonds. Chapter 23, Exhibit 2b CCH Federal Taxation Comprehensive Topics

  10. Definition of Terms Inter vivos trust. A trust created during the life of the grantor. Testamentary trust. A trust created by the will of a decedent. Chapter 23, Exhibit 3a CCH Federal Taxation Comprehensive Topics

  11. Definition of Terms Simple trusts. The following characteristics are required: (a) 100% of state law accounting income must be distributed currently. This term is explained later in this chapter. (b) None of the corpus,(often referred to as res or principal) may be distributed. (c) No charitable contributions may be made by the trust. Complex trust. This is any trust other than a simple trust. Chapter 23, Exhibit 3b CCH Federal Taxation Comprehensive Topics

  12. Definition of Terms Grantor trust. This is any trust in which the grantor is the constructive beneficiary. Income from the res of a trust that constructively benefits the grantor is taxed to the grantor on his/her personal return. The trust is disregarded for income tax purposes. Reversionary interest. If the grantor retains the remainder interest, the interest is known as a reversionary interest. In other words, the res, i.e., property, reverts to the grantor when the trust terminates. Chapter 23, Exhibit 3c CCH Federal Taxation Comprehensive Topics

  13. Definition of Terms Beneficiary exposure. On certain fiduciary income, the beneficiaries of these fiduciary entities, and not the fiduciary (i.e., estate or trust), are personally subject to income tax. Contrast with estate and gift taxes. Estate and gift taxes are not income taxes. They are taxes on the transfer of assets from one person to another. The donor or estate, not the recipient, must generally pay the tax. Chapter 23, Exhibit 3d CCH Federal Taxation Comprehensive Topics

  14. Personal Exemptions Allowable Amounts. • Estates: $600 • Complex trusts: $100 • Simple trusts: $300 A personal exemption is not allowable for the year the estate or trust terminates. Chapter 23, Exhibit 12 CCH Federal Taxation Comprehensive Topics

  15. Termination of Estate or Trust • Ended with the fiduciaries’ administrative responsibilities being completed • AND distribution of assets to beneficiaries • In year of termination – NOL, capital losses, and excess deductions may be utilized by beneficiaries on their own tax returns. CCH Federal Taxation Comprehensive Topics

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