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Can the Income Distribution Deduction for a Trust be $0, even if distributions are made?

Bry
Level 3

Can the Income Distribution Deduction for a Trust be $0, even if distributions are made? Client would like all income taxable to the trust rather than taxable to the beneficiaries. IRC 661 (below) says the income distribution deduction is "allowed," but I don't see anywhere that says it is required. Form 1041 Schedule B seems to force you to take the deduction.

 
Internal Revenue Code, § 661. Deduction For Estates And Trusts Accumulating Income Or Distributing Corpus
 
661(a)
 Deduction 
In any taxable year there shall be allowed as a deduction in computing the taxable income of an estate or trust (other than a trust to which subpart B applies), the sum of—
 
661(a)(1)
   any amount of income for such taxable year required to be distributed currently (including any amount required to be distributed which may be paid out of income or corpus to the extent such amount is paid out of income for such taxable year); and
 
661(a)(2)
   any other amounts properly paid or credited or required to be distributed for such taxable year; but such deduction shall not exceed the distributable net income of the estate or trust.
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Bry
Level 3

Looks like that logic holds true. Here is the IRS answer from Chief Council Advice:

https://www.irs.gov/pub/irs-wd/1016073.pdf

You have requested our guidance regarding practitioner inquiries as to whether a trustee is required to
take an income distribution deduction under § 661 of the Internal Revenue Code. These inquiries were
based on an assumption that if the trustee chooses not to take the deduction, the result would be to shift
the tax liability for distributions made to beneficiaries to the trust. Our response is that the amount
potentially reportable in the gross income of the beneficiary under § 662 is unchanged by the amount of
the allowable distribution deduction under § 661, even if the fiduciary chooses not to claim the § 661
deduction on the Form 1041, U.S. Income Tax Return for Estates and Trusts. Any distribution to a
beneficiary described in § 661 that is properly paid, credited, or required to be distributed is considered a
distribution of the trust or estate's current income to the extent of that trust or estate's distributable net
income ("DNI"), as described in § 643(a), that is allocable to such beneficiary in the taxable year.
Therefore, the effect of a trustee not claiming the distribution deduction would be to subject the same
income to taxation at both the trust and beneficiary levels, not to shift the incidence of taxation. The
legislative history surrounding the enactment of § 662 states that the effect of limiting the taxation of a
beneficiary to his proportionate share of the DNI serves to avoid to the necessity for tracing of income.
The House report states that "[i]nstead of determining whether a particular distribution represents
amounts of current or accumulated trust income, this revision, broadly speaking, provides that any
distribution is considered a distribution of the trust or estate's current income to the extent of its taxable
income for the year." Committee on Ways and Means, Report on H.R. 8300 (1954) at 199. Please
contact us with any additional questions.

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5 Replies 5
BobKamman
Level 14

"Shall" means "shall."

Bry
Level 3

Thank you for the response, but I don't think that actually answers my question. I think the more pertinent word is "allowed."

To compare it to a different tax issue, IRC 167 states, "There shall be allowed as a depreciation deduction...". When dealing with depreciation recapture, you have to recapture the amount allowed or allowable, which means you aren't required to deduct depreciation but you must recapture it even if you didn't deduct it.

Do you disagree?

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BobKamman
Level 14

Using your logic, the trust is not required to deduct it but the beneficiaries are still required to pay tax on it.

Bry
Level 3

Looks like that logic holds true. Here is the IRS answer from Chief Council Advice:

https://www.irs.gov/pub/irs-wd/1016073.pdf

You have requested our guidance regarding practitioner inquiries as to whether a trustee is required to
take an income distribution deduction under § 661 of the Internal Revenue Code. These inquiries were
based on an assumption that if the trustee chooses not to take the deduction, the result would be to shift
the tax liability for distributions made to beneficiaries to the trust. Our response is that the amount
potentially reportable in the gross income of the beneficiary under § 662 is unchanged by the amount of
the allowable distribution deduction under § 661, even if the fiduciary chooses not to claim the § 661
deduction on the Form 1041, U.S. Income Tax Return for Estates and Trusts. Any distribution to a
beneficiary described in § 661 that is properly paid, credited, or required to be distributed is considered a
distribution of the trust or estate's current income to the extent of that trust or estate's distributable net
income ("DNI"), as described in § 643(a), that is allocable to such beneficiary in the taxable year.
Therefore, the effect of a trustee not claiming the distribution deduction would be to subject the same
income to taxation at both the trust and beneficiary levels, not to shift the incidence of taxation. The
legislative history surrounding the enactment of § 662 states that the effect of limiting the taxation of a
beneficiary to his proportionate share of the DNI serves to avoid to the necessity for tracing of income.
The House report states that "[i]nstead of determining whether a particular distribution represents
amounts of current or accumulated trust income, this revision, broadly speaking, provides that any
distribution is considered a distribution of the trust or estate's current income to the extent of its taxable
income for the year." Committee on Ways and Means, Report on H.R. 8300 (1954) at 199. Please
contact us with any additional questions.

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cjc_07
Level 1

I'm no expert, but here's what I think might work to achieve the desired end....It is my understanding that distributions above DNI are considered to be tax-free return of principal. These distributions can be made within the first 65 days of the year and be elected to count as distributions for the prior year. Assuming the trust is supposed to distribute the entire DNI amount, it could then distribute an amount above that to cover the additional taxes the beneficiary will have to pay. The bonus is that the tax due will likely be less than if being paid on the trust's tax return. Here's an example. Let's say, in 2020, the trust's DNI was $10,000 and that $10,000 was distributed to the beneficiary. Now within the first 65 days of 2021 the beneficiary figures their taxes and the effect of the $10,000 distribution cost them an extra $1,200 in taxes due. Then the trust could distribute $1,200 from principal, by electing to count the distribution toward the 2020 distributions made (by following the 65-day rule). I'm not an expert and don't know if this would work for your situation, but that's my 2 cents worth. Obviously, it's too late for 2020 taxes, but maybe next year????

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