Articles

Trusts Still Have Time to Reduce Taxable Income in 2020 by Jeffrey M. Mutnik, CPA/PFS

Posted on February 25, 2021

Rarely do taxpayers have an opportunity to reduce their taxable income and related tax liabilities in a given year after the clock strikes midnight on December 31. This is not the case for certain trusts, which the IRS grants an additional 65 days after year-end to distribute income to beneficiaries and treat it as if it occurred on the last day of the preceding year. For taxpayers filing tax returns for 2020, this 65-day deadline occurs on March 6, 2021.

Trusts and estates generally pay income tax at the same graduated rates as individual taxpayers, which for 2020 tops out at 37 percent plus an addition 3.8 percent Net Investment Income Tax (NIIT), for a total tax rate of 40.8 percent. However, the income thresholds that apply the top 37 percent rate to trusts is much more compressed and far lower than that which applies to individual taxpayers. For example, in 2020, a single individual taxpayer will pay the highest marginal tax rate when taxable income reaches $518,400, and the NIIT will apply when modified adjusted gross income (MAGI) exceeds $200,000. By contrast, a trust’s income will be taxed at the 37 percent rate, plus the 3.8 percent NIIT, when taxable income exceeds a mere $12,950.

Trusts may reduce their annual tax liabilities by distributing income to beneficiaries. When recipient beneficiaries are in lower income tax brackets and therefore subject to lower tax rates, additional and often significant tax savings can occur. However, it is important to note that trusts generally are not able to calculate the exact amount of distributable net income (DNI) until after the close of a calendar year. Therefore, the Internal Revenue Code allows calendar-year complex trusts to distribute income to beneficiaries during the first 65 days of the following tax year and elect to treat those transaction as if they occurred in the prior year. These elections are irrevocable and must be made on a timely filed income tax return for the tax year to which the distribution applies. Trustees should meet with financial advisors and CPAs to project the consequences income distributions will have on the trust and the beneficiaries who receive them.

About the Author: Jeffrey M. Mutnik, CPA/PFS, is a director of Taxation and Financial Services with Berkowitz Pollack Brant Advisors + CPAs, where he provides tax- and estate-planning counsel to high-net-worth families, closely held businesses and professional services firms. He can be reached at the CPA firm’s Ft. Lauderdale, Fla., office at (954) 712-7000 or via email at info@bpbcpa.com.