Sec 642(c) Ordering Rules for Estates and Trusts

[PPJCPA]

I have a client who is an executor of his mom's estate and a trustee of a Qualified Revocable Trust. I made the election on Form 8855 to treat the Qual. Rev. Trust as Part of the Estate. In the Trust document, it states the following:

Upon the death of, Deceased Mom, the remaining balance of the trust estate including any accumulated but undistributed net income and capital gains distribution shall be distributed as follows (this return will be an initial and a final):

30% Beneficiary one
30% Beneficiary two

The remaining balance shall be distributed in equal shares as follows:

(1) equal share to Charity One
(2) equal shares to Charity Two
(1) equal share to Charity Three
(1) equal share to Charity Four

The Charities are defined and an address is also stated in the trust document.

The total amount distributed to the four charities is more than the total income by almost $32,000. At first I thought that since the charitable distributions were more than the adjusted total income, I wouldn't need to show distributions to beneficiary one or two and I could report the trust income and distributions to charities only. I determined this would be proper reporting after reading the following:

"Distributions from a trust to charitable organizations are not considered distributions to beneficiaries for purposes of the distribution deduction (Regs. Sec. 1.663(a)-2). Rather, distributions to charities are deductible only if they meet the requirements of Sec 642(c).

Under Sec. 642(c)(1), a trust is allowed a deduction in computing its taxable income for any amount of gross income, without limitation, that under the terms of the governing instrument is, during the tax year, paid for a charitable purpose. Because a charitable deduction is available only if the source of the contribution is gross income, tracing the contribution is required to determine its source."

Due to concerns that I may be looking at this too simply, I reached out to a trust department at a large bank to confirm that I could show all income was distributed to charities and therefore no tax would be due. They agreed that I was preparing the return correctly.

However I am concerned that I was given bad advice. After reading IRS Final Regulations on Sec 642(c), I now believe that the interest, dividends, cap gains, and other income has to be allocated pro rata shares.

Any guidance would be greatly appreciated.

[Burke]

An election has been made under IRC 645 which states: ".....such trust [IRT] shall be treated and taxed as part of such estate (and not as a separate trust) for all taxable years of the estate ending after the date of the decedent's death....." When distributions are made to Bene #1 and Bene #2 of their 60% share of the estate, are you saying the amounts do not exceed the net taxable income of the estate for the year? Their distributions most certainly would be shown on Page 2 under DNI and flow through as a deduction on Page 1. I am not an attorney, but IMO, the charities are also beneficiaries of the estate under the 645 election and the charities' 40% distribution would show a pro-rata portion of that income.

[taxea]

It sounds to me like Mom intended the following:
pay creditors, pay all taxes, balance remaining 30/30 to beneficiaries; only then, do distributions in equal amounts of the remaining balance go to charities.

[Golden Rocket]

Put numbers to crystallize thinking

I'll plead guilty to not knowing much about the subject matter, but maybe using hypothetical numbers may help to bring this into focus.

Firstly, if it was a recoverable trust, is there any concern about even filing a trust return? Most recoverable trusts are invisible entities to the IRS, or am I wrong about this? I didn't see a specific question about a 1041 but it is obvious there is a division between corpus and income which would not be necessary should the reporting occur on a personal return.

Also, out of ignorance, I am asking what the alternative election would have been, had the trust not be chosen to be evaluated in the decedent's estate.

Assume (if it is indeed necessary) that a 1041 is being filed. Assume the beginning corpus for the period was $500,000 and there was a large amount of income due to the sale of property of $280,000. This leaves $780,000 to be distributed. One human receives 30% ($234,000) and the other human receives $234,000 also, leaving $312,000 for the charities - or $78,000 apiece. According to the original post the $312,000 is more than the $80,000 of income for the period by $32,000.

If I understand the original question now becomes, "How is the beneficiary deduction computed?" Possibilities:
1) Since $280,000 is the maximum income, $84,000 to each human (30% each), leaving a total of $112,000 to the charities ($28K apiece).
2) Since $280,000 is the maximum income, $140,000 to each human, exhausting the total income to the extent human distributions are available.
3) Since $280,000 is the maximum income, $70,000 to each of the four charities, exhausting the total income to the extent charity distribution is available.
4) ???

The original post seems to prefer 1) after reading §642(c).

Of course, if the trust is a disregarded entity (because of its revocable nature), then the entire amount is reportable by the estate with no separation between corpus and income.

[Golden Rocket]

Cannot Edit

I need to edit my message above and cannot do so without somehow deleting it, so I'll make the following amendment:

If the trust is a disregarded entity, then corpus and income would not matter if the income occurred during the life of the decedent. If it occurred during the estate, then it would be reportable on an estate 1041 return.

I also needed to edit this sentence: "According to the original post the $312,000 is more than the $280,000 of income for the period by $32,000.

[Burke]

The original poster stated the executor/trustee was making an election to treat the RLT and the estate as one entity. This is allowed under Sect. 645 and he has sent in the proper forms to do so. Once done, it is irrevocable. This means no tax return is filed separately for the trust. All income, deductions, and distributions are treated as would be normally be on the estate return, Form 1041. It would help if the OP had given some figures as to the actual income of the estate to be reported on the 1041 (not principal/corpus) so it would have been clearer regarding the dilemma. Also, since all assets would have received a stepped-up basis at death, including those inside the RLT, where is all this "income" coming from? There is a separate share rule if assets are in both the probate estate and the trust, in order to calculate DNI.

[PPJCPA]

Sec 642(c) Ordering Rules for Estates and Trusts

Thank you for your responses. Burke, the majority of the income is derived from an IRA and a Roth IRA. The trust was named as the beneficiary for both IRAs. The two 30% beneficiaries wanted to liquidate the IRAs. The total amount given to the charities were higher than the total taxable income of the trust because of the Roth IRA.

The trust was revocable but as I am sure you know, upon death it becomes irrevocable. The main reason I made the section 645 election for a couple reasons. First so I could elect a fiscal year. Second, out of convenience to file one return instead of two since I knew this is an initial and final return. The estate did not have income, only the trust. However the law firm applied for an EIN for both the estate and the trust. To avoid possible notices for non-filing of the estate because no income to report (not sure my client would have received notices or not), I thought it would be best to file as one.

Per your responses, I was told I should have provided figures. Therefore I will provide income amounts (rounded up):

Estate income: zero

Trust income:

Roth IRA: $36,000 Gross Distribution
$ 9,000 Taxable Amount

IRA: $75,000 Gross Distribution
$75,000 Taxable Amount

Interest Income: $5
Dividend Income: $1,000
Capital Gains: $4,600

Total Income: $89,605

Attorney and Accounting Fees: $12,000

Distributions to Charities: $120,000

Since the amount of charitable distributions is higher than the income, I believe the trust has no income tax due. Therefore I didn't report any DNI to the two beneficiaries. My original question was whether I was correct with this reporting or not. However I reached out to a couple more of my resources and was told by both that I am correct with how I prepared the return.

Going forward I will keep in mind to use amounts with my questions. I agree this does help.

Thanks again for your feedback.

[Burke]

Just curious, if you did not show any DNI on the return, I am assuming you showed a charitable deduction on Line 13?

[PPJCPA]

Sec 642(c) Ordering Rules for Estates and Trusts

Just curious, if you did not show any DNI on the return, I am assuming you showed a charitable deduction on Line 13?

Yes, that's what I did. I also prepared from 1041-A.

[DonB]

As you quoted "a charitable deduction is available only if the source of the contribution is gross income", IMO 40% of the income can be taken as a charitable deduction. 60% will be taxable to beneficiaries 1 and 2.

[taxea]

Doesn''t a revocable living trust become irrevocable on the death of the grantor?

If the income, or what's left of it after all expenses are paid, is the only portion that can go to the charities then I would assign the income from the investments last.
Total cash remaining
1.be sure the trustee has been paid as allowed by law
2. distribute 30% to each beneficiary
3. distribute the balance to the charities.

does the Trust document or the law allow for the trust to pay any taxes on behalf of the beneficiaries? I would pay the beneficiaries estimated taxes through the trust and show it as paid on the K-1's before I would distribute the balance to the charities.