Trusts and Taxation on Distributions

[sali]

A trust is created as a result of the death of a spouse. There are stocks and bonds and cash in the trust. The trust documents say that the surviving spouse (the only beneficiary) can receive all of the income and can receive principal to be used for the beneficiary’s well being.

Is it possible to distribute everything currently in the trust (the principal) to the beneficiary (close the trust) without having any tax consequences? Throughout the years, the trust has distributed all of the earnings to the beneficiary and the beneficiary has received a K-1 showing taxable interest and dividends. Thanks.

[mastertaxguy]

Trust final distribution of assets?

1. You did not indicate a time line (such as how long the trust has been in existance, fiscal or calendar year, etc). YOu don't indicate if the trust has some significant carry over capital or other losses that might pass to the beneficiary upon final distribution.
2. You also don't indicate if such a distribution would be permitted by the trust but then again, we are not lawyers.
3. Assuming such a distribution is permitted by the trust instrument or by court order, it is likely that the basis of corpus of the trust (capital assets) have increased, or decreased, in value.
4. The surv. spouse and trustee, and well intentionedl tax pro, may have an issue if assets, held by a stock broker, are "sold" by the trust and on the same day purchased by the broker in the name of the beneficary and seemingly transferred to the beneficiary, in which case the trust will have a tax return and (apparently) pass through of any gains, losses and other income to the beneficiary. Some brokers can handle such direct transfers, but they of course prefer sales to general commissions.
5. As to your question: while almost anything is possible (except perhaps dribbling a football), my own experience is that it is very unlikley that a dissolution/distribution of all asssets would be entirely free of income tax consequences both to the beneficary and/or the trust. In any event, the trust would file a final return.

[Kram BergGold]

You are Looking at the Wrong Issue

From my experiences this Trust was set up to avoid probate and control Estate and Inheritance Taxes. Currently, the spouse is the beneficiary. However, when the spouse dies the assets will go to someone else. To take all of the money out of the trust now would be a violation of fiduciary responsibilty to the ultimate beneficiary. The spouse is only entitled to current year income and a reasonable amount of corpus, just like you stated, no more.

[TXEA]

KramBerg makes an excellent point. If this is QTIP trust or even a bypass trust (and kind of sounds like one from you description of terms) then the fiduciary must consider the secondary beneficiary when making principal distributions.

[Burke]

There is not enough information here to give you a correct answer. All of the points posted above are valid ones, and hinge on only one factor. The terms of the trust document. You need a copy of this document to determine:

1. What type of trust this is.
2. How long it lasts.
3. Who the residual beneficiary is. (i.e, to whom do the assets pass when the primary beneficiary dies.) Is it the intention to preserve the principal for the residual beneficiary, allowing invasion of that principal only when necessary?
4. Who the trustee is.
5. What it says about final distributions of its principal.


As far as taxes go, the beneficiary will pay income tax on the earnings of this particular trust (interest, dividends) while the trust remains in effect. Capital gains/losses usually stay within the trust as long as it exists. When property is distributed to any beneficiary from a trust, the basis is the trust's basis. Its principal is not taxed to the beneficiary when received.

[Bees Knees]

KramBerg makes an excellent point. If this is QTIP trust or even a bypass trust (and kind of sounds like one from you description of terms) then the fiduciary must consider the secondary beneficiary when making principal distributions.

True, but it does illustrate a problem with trusts when the guy setting it up thinks it will be honored after his death. There is no such thing as the trust police. Nobody watches over these things to make sure the fiduciary is following the terms of the trust. The only way these things are enforced is either when the fiduciary follows the terms of the trust, or some beneficiary takes the fiduciary to court and claims he/she did not follow the terms of the trust.

Thus, if the ultimate final beneficiary is unaware of the trust or the terms of the trust (like a kid too young to know or understand), the fiduciary can liquidate the trust and give all its assets to the surviving spouse without anyone to protest what just happened. This might happen more than one would think, especially when the decedent's kids are not the kids of the surviving spouse, like in the case of a second marriage where the father wants current income to go to his surviving second wife, but the remainder to go to his kids from his first wife after wife No. 2 dies. If wife No. 2 gets the fiduciary to liquidate the trust, and the kids of wife No. 1 are too young or unaware of the trust, wife No. 2 can get her hands on everything without anyone objecting.

[Mo Sheets]

Agree with Bees

I completely agree with Bees....I've seen this happen before and it is tragically sad for the intended beneficiaries.

Before you do anything, GET THE TRUST DOCUMENT!!! The trust document should outline how the money (corpus/income) should be distributed and who is to receive the remaining money upon the death of current income recipient.

Good luck!

Mo