Trusts Are Running Out of Time to Reduce 2021 Tax Liabilities by Rick Bazzani, CPA
Posted on February 28, 2022
by
Rick Bazzani
Under the IRS’s 65-day rule, estates and certain complex trusts still have some time to reduce their income-tax liabilities for 2021, but immediate action is required.
Calendar year-end trusts have until Sunday, March 6, to distribute trust income to beneficiaries and treat those payments as if they occurred in 2021. Doing so not only reduces the amount of trust income subject to tax at the highest ordinary income tax rate, but it also reduces the overall tax burdens for both the trust and its beneficiaries. It should be noted that this rule applies only to trusts for which a trustee has the power to distribute income; it does not apply to grantor trusts in which grantors report all trust activity nor does it apply to simple trusts that require fiduciary accounting of income to be distributed annually.
For the 2021 tax year, trusts with undistributed income of more than $13,051 are taxed at the highest federal rate of 37 percent plus a 3.8 percent Net Investment Income Tax (NIIT). By contrast, individual taxpayers do not reach this top tax bracket until their income reaches $523,601 (or $628,301 for married couples filing joint tax returns). Consequently, a trust can reduce its taxable income and pay a lower tax rate when it makes distributions to its beneficiaries, especially those in lower tax brackets who will pay far less tax on those amounts than that which the trust would be required to pay, even at the same ordinary income tax rates.
The 65-day rule applies because trusts cannot calculate the exact amount of Distributable Net Income (DNI) until after a tax-year ends. Under most circumstances, the DNI will not be known during the first quarter of a new tax year, in time for tax reporting purposes, which will require the trust to project an estimation of the distribution.
As an example, consider a trust that did not make any distributions to its beneficiaries in 2021 and estimates its DNI to be $30,000 for that year. If the trust distributes $30,000 to its beneficiaries by March 6, it can carry out the DNI on its K-1 and elect to have the entire amount distributed during calendar year 2021. If the trust distributes $29,000 from by March 6, the trustee can elect to consider any or all of that amount as being distributed and be exposed to tax on the $1,000 not distributed. By contrast, if the trust distributes $31,000 by March 6, the trustee can elect to treat $30,000 as being distributed in 2021 and the additional $1,000 distributed in 2022.
About the Author: Rick D. Bazzani, CPA, is an associate director of Tax Services with Berkowitz Pollack Brant Advisors + CPAs, where he provides individuals and entrepreneurs with a broad range of tax-efficient estate, trust and gift-planning services. He can be reached at the CPA firm’s Ft. Lauderdale, Fla., office at (954) 712-7000 or at info@bpbcpa.com.
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