Income Taxation of Trusts and Estates

Sonja Pippin (Assistant Professor of Accounting and Information Systems, University of Nevada—Reno) recently published her article entitled Income Tax Accounting for Trusts and Estates, J. of Accountancy, Oct. 2010. The executive summary is below:

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    • Income taxation of estates and trusts may not receive the same attention as individual income taxes or estate taxes. This article describes some of the general income tax rules of these entities, such as the different rules for allocation of income and deduction items between principal and distributable income, between tax- exempt and taxable income, and between trusts/estates and beneficiaries.
    • These allocations are prescribed either by the trust instrument, state law or the Internal Revenue Code. In some cases, taxpayers have flexibility. Generally, it is advisable to “push” the taxable income and the income taxed at higher rates to the beneficiary, because the tax rate schedule for trusts and estates is depressed, with the highest bracket currently starting at $11,200.
    • Pushing income to beneficiaries may become still more important if lower tax rates under the Economic Growth and Tax Relief Reconciliation Act are allowed to sunset as scheduled at the end of 2010.
    • Also, since income from estates and trusts is mostly investment income, the new 3.8% unearned income Medicare contribution tax will apply to most, if not all, of the trust’s income falling in the highest tax bracket. Individuals are not subject to this tax until their modified AGI reaches $250,000 (married filing jointly and surviving spouses) or $200,000. Thus, distributing trust income to beneficiaries can lower the amount subject to this extra tax.

Special thanks to Jim Hillhouse (WealthCounsel) for bringing this to my attention.