INCOME TAXATION OF TRUSTS AND ESTATES

CLASS PROBLEM #5

5.         In the following problems determine the taxable income of the trust and the taxable status (amount and character) of the distributions to beneficiaries. Assume that all parties are on the cash basis, calendar year method of accounting. In each problem assume that the provisions of Subpart C apply. Do not consider the problems of Subpart D.

(A)            Single Beneficiary Cases:

(1) Trust provides that all income is payable to W for life, remainder to the children.  Trustee has the power to invade corpus for benefit of W. In 2005, the trust received: Taxable interest, $5,100; income (allocable to corpus) from unexercised option on parcel of undeveloped real estate owned by the trust, $500. The trust incurred $100 of deductible commissions, which are chargeable to income. Trustee distributes $6,000 to W.

(2) Trust agreement provides that income may be accumulated or paid to W, the income beneficiary, during her life, at the trustee’s discretion. Accumulated undistributed income and corpus goes to W's children at the death of W. Trust had $10,000 of CD interest and $5,000 of tax-exempt interest in 2005 and trustee paid $6,000 to W. Trust paid a $3,000 deductible investment fee, allocable to the taxable interest, but chargeable to corpus.

(3) Same as question (2), except that the $3,000 investment fee is allocable to the tax-exempt interest rather than to the taxable interest.

(4) Same as question (2) except that the $3,000 investment fee is merely a general expense (i.e., not specifically allocable to a particular class of income).

(B)            Multiple Beneficiaries in General:

(1) Trust provides that first $10,000 of income must be distributed to W and trustee has discretion to accumulate or distribute any remaining income or corpus (including accumulated income) to and among W's children, X, Y and Z, in any amount or proportion that the trustee sees fit. Assume that DNI and "income" are both the same $40,000, consisting of $8,000 tax-exempt interest and $32,000 taxable dividends. Trustee distributes $10,000 of current income to W, $15,000 of prior accumulated income to X, $10,000 of corpus to Y and nothing to Z.

(2) Same as (1) except that trustee distributes: $10,000 of current income to W; $15,000 of prior accumulated income to X; $15,000 of corpus to Y; and $15,000 of current income to Z.

(3) Same as (2) except that both DNI and trust income were $25,000, consisting entirely of taxable interest.

(4) Same as (2) except that both DNI and trust income were $10,000 in taxable interest and Z's distribution was from corpus.

(C)            The Pure Accumulation/Spray Pattern

A testamentary trust provides that the trustee may accumulate the income, or distribute any or all of it, among the testator's wife, W, and children X, Y, and Z, as the trustee sees fit. W has a special inter-vivos power to appoint trust principal among the children as she sees fit. Trust income and DNI are $40,000 ($32,000 taxable interest and $8,000 tax-exempt interest).  Trustee distributes, alternatively:

(1) nothing

(2) $8,000 to W; $4,000 to X and $800 to Y.

(3) same as (1) except that W exercises her power of appointment by appointing $6,000 to her 17-year old son, X, to help him meet his college tuition costs.

(4) nothing prior to 12/13/2005, but the distributions in (2) are made on March 1, 2006.