Still Time for 2021 Trust Distributions - the 65 Day Rule
While most opportunities for income tax planning for 2021 have come and gone with the new year, there are a few exceptions. One such exception exists for non-grantor trusts. Trustees of non-grantor trusts still have the opportunity to take action to reduce the trust’s 2021 income tax liability. A grantor trust is a trust that is disregarded for income tax purposes. Income taxes on trust income are paid by the grantor (the person who created the trust). A non-grantor trust, on the other hand, is subject to income taxation on taxable income retained by the trust at the trust level.
While a trust is subject to the same marginal tax rates as individuals, a trust reaches the highest marginal rate at a much faster pace. The highest marginal income tax rate for individuals and trusts for 2021 is 37%. An individual whose filing status is single does not reach this rate bracket until reaching taxable income of $523,601. Whereas, a trust reaches this rate bracket with taxable income of only $13,051. Because of this difference, trust beneficiaries are more likely to be in a lower tax bracket than the trust.
If a non-grantor trust makes a distribution to a beneficiary, such distribution will pass the taxable ordinary income (but generally not capital gains) to the beneficiary, to be taxed on the beneficiary’s personal income tax return. Unfortunately, a trustee doesn’t always know what the trust’s taxable income will be until the end of the calendar year. Fortunately, Internal Revenue Code Section 663(b) allows a trustee of a trust additional time to determine the trust’s taxable income for the prior tax year and distribute that income to the trust’s beneficiaries. The trustee may make distributions to the trust beneficiaries during the first 65 days of the current tax year and treat those distributions as distributions of income to the beneficiaries for the previous tax year.
The trustee must make the election on a timely filed tax return. If it is ultimately determined that distributions made during the first 65 days of the current tax year were in excess of what was necessary, the election may be made for only a portion of those distributions. As always, the trustee should carefully follow the terms of the trust and keep accurate records as to distributions and to what year it applied.
This post is for informational purposes only and not for the purpose of providing legal advice. You should contact an attorney to obtain advice with respect to any particular issue or problem. Nothing herein creates an attorney-client relationship between Hallock & Hallock and the reader.