If you are the executor of an estate or the trustee of a trust, you should know that egregiously high income tax rates apply to estates and trusts at very low levels of income. In 2016, for estates and trusts, the 39.6% income tax rate as well as the 3.8% Net Investment Income (NII) tax kicks in at $12,400 of income. That’s not very high. And don’t forget, you don’t need $12,400 of investment income to pay the NII tax. If the total income exceeds the $12,400 threshold, the NII tax might be due on all of the investment income. For example, let’s say an estate has income of $212,400. The tax on the $200,000 (income in excess of the $12,400 threshold), at 43.4% equals a tax of $86,800. Ouch!
Help! Is there any hope?
Yes, the estate and trust only pays tax on what’s not distributed. Distributions lower the income tax for the trust and at the same time increase the recipient’s personal income tax. However, individuals do not pay the highest rates unless they are wealthy. In our example, if there are four beneficiaries and each receives $50,000 (one-fourth of the $200,000) many individuals will only pay 15% on that $50,000. That’s $7,500 per beneficiary for a total of $30,000 instead of $86,800 for a tax savings of $56,800.
Is there anything I can do?
It’s not too late. There’s a rule allowing distributions made in the first 65 days of the next year to be treated as if made in the preceding year. A special election must be made on the Fiduciary Income Tax Return. This year’s deadline is March 6, 2017. Executors and trustees should act soon to take advantage of this opportunity for substantial tax savings.
Please contact us for assistance with making distributions or any other tax related questions about managing a trust or estate.