Form 1041 Distribution Suggestions

[TAXNJ]

Need some suggestions regarding distribution of "principal" as mentioned in # 2 below

SITUATION:

1- Distribution to trust beneficiaries was made out of interest and dividends earned on the Principal - so was able to find in The TaxBook that this is a deduction on Line 15 of the Form 1041 (along with the appropriate Schedule k-1s) - So this was handled.

But,
2 - Also, the Trust paid out of the Principal a specific amount to buy out the auto lease for one of the beneficiaries

QUESTION: Need some suggestions regarding distribution of "principal" to buy out the auto lease for one of the beneficiaries - e.g.,
- is it reported on Form 1041 ?
- if so, where ?
- is it taxable income to the specific beneficiary ?

If you have any suggestions, where in The TaxBook can it be referenced.

Thanks in advance

[jerome]

You can't pick and choose if a distribution is from income or if it is from principal. The Tax Book page 21-14 says "The income distribution deduction is the amount of income taxed to the beneficiaries. It is the lesser of:

- Distributable net income (less tax-exempt interest), or
- Distributions (less tax-exempt income distributed).

In other words, any distribution to an income beneficiary during the life of a trust is going to first be a distribution of income, and then the portion of the distribution that is in excess of distributable net income will be a non-taxable distribution out of principal.

[TAXNJ]

Jerome - one more question with clearer background info

Jerome,
First thanks for your quick response. I have one remaining question, see third & fourth paragraphs below, with some clearer background.

Recognizing that it cannot be a pick and choose, the remaining question is: Since the distribution of current year Income (Interest & Dividends) become taxable to the beneficiaries and as you suggest, then the portion of the distribution that is in excess of distributable net income will be a non-taxable distribution out of principal.

Remaining Questions:
So if the Trust paid out all of the current year income and THEN paid off auto lease for one of the beneficiaries (which is in excess of the DNI) it becomes a Non-Taxable distribution of principal?

- This payment of the auto lease makes the distribution GREATER than the Income required to be distributed currently! This has an affect on the type of Trust – It looks as if it now would be a Complex and not a Simple Trust.

- the excess of DNI pmt of the auto lease ?
- Would it be reported?
-If so, where on the Form 1041?
-report it on Line 10 on schedule B?

Further background scenario:
Clarifications to the original question hopefully shown below – (what is reported on form 1041 for the principal paid to one of the beneficiaries used to pay off auto lease ?)

The scenario using hypothetical numbers, if say a Trust for the year had:

1 –beneficiaries received the "current" trust accounting income of Interest & Dividends shown below

Interest = 3618
Ordinary dividends = 5942
TOTAL INCOME = 9560 (tentative trust accounting income)

Less professional fee = (165)

DNI = 9395 (schedule b line 7 form 1041) (line 17 page 1 form 1041)

So the Income Distribution Deduction would be the 9395 (Taxable to the beneficiaries – Schedule k-1) (this would be their % of trust accounting income)

But then an additional amount of 10000 was paid to settle an auto lease buy out. Question is how to handle and report this buyout?

[jerome]

So if the Trust paid out all of the current year income and THEN paid off auto lease for one of the beneficiaries (which is in excess of the DNI) it becomes a Non-Taxable distribution of principal?

That is correct.

- This payment of the auto lease makes the distribution GREATER than the Income required to be distributed currently! This has an affect on the type of Trust – It looks as if it now would be a Complex and not a Simple Trust.

- the excess of DNI pmt of the auto lease ?
- Would it be reported?
-If so, where on the Form 1041?
-report it on Line 10 on schedule B?

The Tax Book, page 21-9 says a trust is a simple trust if….the trust did not distribute principal in the tax year.

Therefore, if the trust distributes in excess of its income, it is a complex trust, not a simple trust.

By putting the entire distribution on line 10 of Schedule B (other than amounts that must be distributed and reported on line 9), the taxable amount is the lesser of the distributable net income (line 7 minus line 2), or the total amount distributed, not counting tax-exempt income (Line 9 + 10 minus tax exempt income). Since any excess distribution over taxable income is a result of your line 9 + 10 amount exceeding distributable net income, then in effect you have reported the principal being distributed by including it in the line 10 amount. Principal distributions do not need to be reported any where else.

The scenario using hypothetical numbers, if say a Trust for the year had:

1 –beneficiaries received the "current" trust accounting income of Interest & Dividends shown below

Interest = 3618
Ordinary dividends = 5942
TOTAL INCOME = 9560 (tentative trust accounting income)

Less professional fee = (165)

DNI = 9395 (schedule b line 7 form 1041) (line 17 page 1 form 1041)

So the Income Distribution Deduction would be the 9395 (Taxable to the beneficiaries – Schedule k-1) (this would be their % of trust accounting income)

But then an additional amount of 10000 was paid to settle an auto lease buy out. Question is how to handle and report this buyout?

The total distribution would be the current trust accounting income of $9,395 + $10,000 to settle an auto lease buy out = $19,395.

If the $9,395 is required to be distributed, it is reported on line 9 of Schedule B, with the remaining $10,000 going to line 10 of Schedule B. If the $9,395 is not required to be distributed, then you would put the full $19,395 on line 10 of Schedule B. Either way, the income distribution deduction is still limited by the $9,395 of distributable net income.

[George Boutwell]

Specified Property or Amounts

If the trust directs that a specific amount, or asset, be distributed to a beneficiary from the trust principal, it is not charged to DNI. How did it come about that the lease was paid off? Does the trustee have the authority to make discretionary distributions as needed? Or does the trust say, "Give Charlie $10,000 to pay off his lease" ?

[TAXNJ]

Jerome & George - expert suggestions - tks

Jerome,
Thanks for staying with me on this and addressing such an interesting area. Your suggestions were very expertise, clear and helpful.

George
What can I say other then when potential clients present info after the fact and then one has to ask the client such questions that you raised.

Best to you both

[Snaggletooth]

Biased Distribution

Am I missing something, or has the trustee distributed $10,000 to one of the beneficiaries and not the others?

[George Boutwell]

George
What can I say other than when potential clients present info after the fact and then one has to ask the client such questions that you raised.

I never do a trust return without having a copy of the trust instrument, so I know what instructions the trustee followed.

[Bees Knees]

If the trust directs that a specific amount, or asset, be distributed to a beneficiary from the trust principal, it is not charged to DNI.

Yes, but it has to be a specified amount. It cannot be a discretionary distribution by the trustee, which is what this poster is implying.

Line 18, Form 1041 instructions say:

If the estate or trust was required to
distribute income currently or if it paid,
credited, or was required to distribute any
other amounts to beneficiaries during the
tax year, complete Schedule B to
determine the estate’s or trust’s income
distribution deduction.

Lines 9 and 10 instructions for Schedule B say:

Do not include any:
• Amounts deducted on prior year’s
Return that were required to be distributed
In the prior year;
• Amount that is properly paid or credited
as a gift or bequest of a specific amount
of money or specific property. (To qualify
as a gift or bequest, the amount must be
paid in three or fewer installments.) An
amount that can be paid or credited only
from income is not considered a gift or
bequest; or
• Amount paid or permanently set aside
for charitable purposes or otherwise
qualifying for the charitable deduction.

Line 10 instructions continue:

Line 10 is to be completed only by a
Decedent’s estate or complex turst. These
Distributions consist of any other amounts
Paid, credited, or required to be
Distributed and are referred to as second
Tier distributions. Such amounts include
annuities to the extent not paid out of
income, mandatory and discretionary
distributions of corpus, and distributions
of property in kind.

You will note that even discretionary distributions of principal (corpus) are included in line 10, and will thus cause the beneficiary to pay tax on DNI. You can’t distribute principal before income, even when allowed by the trust instrument, with the exception of a specified gift or charitable distribution.

[George Boutwell]

Yes, but it has to be a specified amount. It cannot be a discretionary distribution by the trustee, which is what this poster is implying.

The post I am reading says

>>Also, the Trust paid out of the Principal a specific amount<<

[TAXNJ]

Additional Info

Client states it is a "Sprinkle" Trust. It gives the two people responsible for admininstering the trust alot of "freedom" for the distribution. That is not to say freedom from tax consequences.

I will also be reviewing the trust papers prior to finalizing the return.

I appreciate your continued comments.

[TAXNJ]

George Thanks Again

George

Any more "insight" since Snagletooth's post?

Think the situation is now covered well