Capital Gains for Trusts

[Corduroy Frog]

I've raised the issue about taxation of capital gains in Trusts, and have understood that the Trust pays the tax on Capital Gains rather than allocating the income to the beneficiaries.

However, Schedule D (Form 1041) has a Part III, which has a column allocating some or all of the capital gains to the beneficiaries. If the above is true, how is this possible?

[Lion EA]

Start by reading the trust document.

[Margaret CPA in OH]

There is also an election that can be made to pass through the gains to the beneficiaries. I was trustee for several trusts so made this election titled, 'Trustee makes a regular practice of distributing capital gains.  Pursuant to Reg. 1.643 (A)(B), trustee is making a regular practice of distributing capital gains to the beneficiary as trust instrument permits.'

So, as Lion noted, read the trust document and see whether it is permitted and whether the trustee has made a regular practice of distributing the cap gains.

[Corduroy Frog]

Thanks Margaret.  The trust in question has no such provision.  In addition, it is not a simple trust, having no provision to distribute all income currently.

[Lion EA]

If it's a complex trust, then maybe the trustee has some discretion re distributions of capital gains, corpus, whatever. If the trust document doesn't specify, then look to state law. Have your client contact the lawyer who set up the trust or their current family/trust lawyer.

[Roberts]

The Trustee / fiduciary has discretion usually. With ultra low interest rates, many states have written rules that allow for the fiduciary to include capital gains in total income and have them distributed to the beneficiaries. I 100% agree with having the client contact the attorney and see if that is possible. 30 years ago, it was common for a retired person to have a portfolio of 80% bonds and 20% equities. Today it is very common to have a portfolio of 80% equities and 20% fixed income because they can't live on 1%. If you have a laddered portfolio going out 7 years, your yield would be about .51%.

About 5 years ago I had an attorney instruct a trustee to talk with the beneficiaries, see if they wanted to include capital gains as income and if they ALL agreed (including the fiduciary / trustee), write a letter saying this was their new policy going forward and include it with trust documents. The key is that once you declare it, you can't decide to reverse it later. I have a trustee who refuses to do this because he knows it is counter to why the trust was generated in the first place. That trust has been operating since about 1940 and is still going and will until it hits 100 years of age. The trustee knows it was started to make sure the grantor's kids didn't blow the estate via divorce (and just blowing it). Now the great grandkids are getting checks every year.

[Roberts]

Edit: I've had multiple trusts where the attorney wants the trust to pay the higher tax bill on capital gains simply because they recognize the beneficiaries don't save anything and can't afford to pay taxes on a large capital gains tax bill every few years. I also have a family where I do the 1040 for the beneficiaries, the attorney writes a check to the IRS for the tax amount owed and then deduct that from their income check in late February.