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This is my first post, please forgive any etiquette violations.
Client is the widow/trustee. The B trust consisted solely of an investment account. During 2005 some holdings were liquidated creating capital gains, and disbursed (loaned) to client to invest in a condo. Assuming client has authority for discretionary distributions (client says yes, but I'm confirming with trust document and attorney), is it possible to deem a portion of the disbursed funds as a distribution of capital gain to the client? This would save significant tax at the trust level and allow client to take advantage of capital loss carryforwards on the 1040.
I realize this would set a precedent for any future distributions, and would, I believe, put the distributed amount back into the client's estate. All remainder beneficiaries are the same for both client's trust and the B trust.
Per Reg . 1.643(a)-3 as amended for taxable years ending after January 2, 2004, capital gains may be included in DNI if allocated to corpus, but “actually distributed to the beneficiary or utilized by the fiduciary in determining the amount that is distributed or required to be distributed to a beneficiary. This treatment of the capital gains is a reasonable exercise of the trustee’s discretion. In future years Trustee must treat all discretionary distributions as being made first from any realized capital gains.”
I appreciate any comments or ideas to consider as I research this further.
Kim Zwick, CPA
Grass Valley
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Welcome to the Forum Kim, hopefully you will find this a useful resource and continue to avail yourself of what it offers. The only mistake you have made so far it your humble introduction.
One thing that you didn't mention in your initial question which would be important in responding to your question, is how was the distribution, loan characterized? Was there a note created? If so is it secured and interest bearing? Have there been terms for repayment established?
Assuming that none of the above formalities were observed, I would think that you would still have a substantial hurdle in establishing that the distribution was a "reasonable exercise of her descretion as trustee" in making the distribution. A descretionary distribution to an income beneficiary, trustee to purchase a condo in Hawaii, for which one would presume to be for personal use, if allowed under the trust docment would be consider a general power of appointment over the corpus of the B Trust and would bring the corpus of the B Trust into widow's estate.
I see other problems with regard to many issues but will happily defer comment to some of the other more experienced and wise amongst us.
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Power Member
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| I'm curious as to what the trust actually says. Mine give the trustee the power to make discretionary principal distributions under the ascertainable standard, but not if the trustee is the beneficiary\recipient. If your client's trust has this language, the principal now in the hands of the beneficiary would seem to be a loan. You are wise to shift the burden of commenting on this to your client's attorney, especially if he or she drafted the plan, because there is usually a written history of counseling against such a move. This is a common issue on this forum, because many times the surviving spouse wants to "raid the piggy bank," or the tax preparer wants to help all he or she can to avoid tax results like yours. The sale of a personal residence, part of which is in the bypass trust, yields similar issues. To add to John's thoughts, the problems arise later on if the (usually unaware) children (remainder beneficiaries) come looking for recourse against the advisors if they must pay more estate tax because of a partial or complete inclusion of the bypass trust in the taxable estate of mom or dad. You might look at some of the prior posts and in the archives for similar situations.
John Jacobson
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| Thank you both for your comments. No official loan was established. The attorney responded that the client did have this distributive power. The distributed amount will be back in her estate, and the remainder will be repaid to the trust. The client also discussed this with the 4 children/remainder beneficiaries and they verbally approved the distribution. I urged them to commit this to writing just in case there are questions in the future. Kim Zwick
Kim Zwick, CPA
Grass Valley
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