By Jessica A. Hayes
Hook Law Center
Happy New Year! We hope you and yours had an enjoyable holiday season and that 2017 brings you happiness and good health. With the close of the calendar year behind us, tax season is just beginning for individuals and many entities. If you are serving as the trustee of a complex trust, however, it’s not too late to take action that may reduce total taxes paid overall.
First, a couple of definitions: A “complex trust” is a trust that either retains current income in the trust, distributes trust principal, or has a charitable organization as a beneficiary. A “simple trust” is a trust that is required to distribute all of its annual income to the beneficiaries, but no principal may be distributed. Income of the trust is taxable to the recipient.
Trusts pay the highest federal income tax rate of 39.6% at a much lower threshold than individuals (at $12,400 as opposed to $415,050 for a single individual in 2016). Most trust beneficiaries have a lower tax rate than the trust; therefore, income that is distributed to the beneficiaries (which is then taxed to the beneficiaries instead of to the trust) ultimately results in a tax savings between the trust and the beneficiaries.
To manage the tax burden of a complex trust, trustees can use the “65-Day Rule” (also called a 663(b) election) to make distributions to trust beneficiaries for the first 65 days of a calendar year. The 65-Day Rule applies only to complex trusts, because by definition, a simple trust’s income is already taxed to the beneficiary at the beneficiary’s presumably lower tax rate.
If after the beginning of the New Year, the trustee realizes that there is excess income remaining after accounting for distributions made in the preceding year, the 65-Day Rule allows the trustee to treat distributions made within the first 65 days of the New Year as if the distributions were made in the preceding year. This means that trust distributions made through Monday, March 6, 2017 may be treated as having been made in 2016.
In order to use the 65-Day Rule, the trustee must make the 663(b) election on page two of IRS Form 1041, the trust’s income tax return. If the trustee makes this election, he should keep careful records to ensure that the tax return for the following year does not errantly treat those distributions as distributions made in the following tax year, as well.