Managing Trust Distributions to Minimize Overall Tax

Trustees have a small window of opportunity to save potentially thousands in tax dollars if they act quickly by March 6, 2014.  Trust distributions have always been an important planning tool to maximize tax savings for trusts and beneficiaries. Now, it is taking on a more critical role due to the increased tax rates and the net investment tax.

For the 2013 tax year, trusts jump into the highest income tax bracket of 39.6% at only $11,950 of income, whereas a single individual does not reach this bracket until they have $400,000 of income. Trusts are also subject to the new 3.8% Medicare Surtax on undistributed investment income in excess of $11,950, making the total top federal rate for trusts 43.4%.  The 3.8% tax would apply to a single individual at the $200,000 level of income.  However, when beneficiaries receive distributions from a trust, it is the beneficiary who pays the tax on that income, not the trust.  As a result, to lower a trust’s tax liability, additional distributions can be made to the beneficiaries, who are often in a lower tax bracket than the trust itself.

The 65-day rule provides trustees of non-grantor trusts additional time after the end the tax year to assess the income and tax liability of the trust and make additional discretionary distributions in order to shift income to beneficiaries. Trusts with a calendar year-end can make distributions by March 6, 2014 and elect to have the distribution treated as being made on December 31, 2013. This will shift income out of the trust and to the beneficiary.  The trust will receive a deduction for the distribution made and the beneficiary will recognize the income on their individual tax return.

For instance, if a trust with $30,000 in taxable income that is set up for the benefit of a single individual with taxable income of $100,000 distributes $20,000 to the beneficiary, this would result in a combined tax savings of $2,877 as illustrated below:

Trustees still need to keep other considerations in mind before making distributions to save taxes. Trustees need to decide if it is time to release more funds to current generations or beneficiaries or to hold on to trust assets for future generations and pay the higher tax.

There is still time for non-grantor trusts to take advantage of the 65-day rule and to make a discretionary distribution to lower the overall tax impact for the 2013 tax year.

If you have immediate questions or would like more information, please contact us.