chapter c14

Prentice Hall's Federal Taxation 2016: Corporations, 29e (Pope)Chapter C14: Income Taxation of Trusts and Estates

LO1: Basic Concepts

1) For purposes of trust administration, the term "sprinkling" relates to the mandatory distribution of income among various beneficiaries.Answer: FALSEPage Ref.: C:14-3Objective: 1

2) A tax entity, often called a fiduciary, includes all of the following exceptA) estates.B) complex trusts.C) testamentary trusts.D) All of the above are fiduciaries.Answer: DPage Ref.: C:14-2Objective: 1

3) Which of the following statements is incorrect?A) The income tax rules governing estates and trusts are generally identical.B) Income generated by property owned by an estate or trust is reported on that entity's tax return.C) Subchapter K contains the special rules applicable to estates and trusts.D) All of the above are correct.Answer: CExplanation: Subchapter J contains the rules.Page Ref.: C:14-2Objective: 1

4) An inter vivos trust may be created by all of the following exceptA) a grantor.B) a trustor.C) an executor.D) a transferor.Answer: CPage Ref.: C:14-2Objective: 1

5) The executor or administrator is responsible for all the following estate duties exceptA) preserving the estate's existence as a separate taxpayer.B) collecting the assets.C) paying the debts and taxes.D) distributing the property.Answer: APage Ref.: C:14-2Objective: 1

6) Beneficiaries of a trust may receive A) an income interest only.B) a remainder interest only.C) both an income and a remainder interest.D) Any of the above is correct.Answer: DPage Ref.: C:14-3

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Objective: 1

7) Revocable trusts meansA) the transferor may not demand the assets be returned.B) income or estate tax savings for the grantor.C) the assets in the trust avoid probate.D) the grantor is always the beneficiary.Answer: CPage Ref.: C:14-3Objective: 1

8) Identify which of the following statements is false.A) For purposes of trust administration, the term "sprinkling" relates to the discretionary authority of the trustee to distribute income among various beneficiaries.B) The IRS may terminate an estate as a taxpayer after the expiration of a reasonable period of time for performance of the administrative duties.C) Assets in a revocable trust do not avoid probate.D) Assets in a revocable trust are included in the gross estate.Answer: CPage Ref.: C:14-3Objective: 1

9) Which of the following statements regarding the taxation of a trust is incorrect?A) An irrevocable trust's income is taxed to the grantor.B) Trusts are generally not taxed at favorable rates for income shifting.C) Trusts are not subject to double taxation.D) A trust's long-term capital gains are taxed at a top rate of 15%.Answer: APage Ref.: C:14-3Objective: 1

10) Identify which of the following statements is false.A) A conduit approach—that is, the income has the same character in the hands of the beneficiary as it has to the trust—governs for fiduciary income taxation.B) Essentially, an estate or trust is taxed on any income it earns, whether retained or distributed.C) Many of the same rules that determine the calculation of taxable income for individuals apply to trusts.D) Trusts receive a personal exemption.Answer: BPage Ref.: C:14-3Objective: 1

11) The conduit approach for fiduciary income tax meansA) the distributed income has the same character in the hands of the beneficiary as it has to the trust.B) the distributed income goes to all beneficiaries proportionately.C) the distributed income is determined by the trustee annually.D) the distributed income of a remainder interest is determined by the property.Answer: APage Ref.: C:14-4Objective: 1

12) Texas Trust receives $10,000 interest on U.S. Treasury bonds and $15,000 interest on State of New York bonds. All $25,000 is distributed to the trust beneficiary, Gary. Which of the following statements is correct?A) Gary has $25,000 of ordinary gross income.


B) Gary has $10,000 of taxable interest income and $15,000 of tax-free interest income.C) Gary has no taxable income because the trust must pay the tax.D) Gary has $10,000 of capital gain and $15,000 of tax-free interest income.Answer: BPage Ref.: C:14-4; Example C:14-3Objective: 1

13) Briefly discuss the reasons for establishing a trust.Answer: Possible tax savings, professional management of assets, restrictions on the donee's use or consumption of assets, protect assets from creditors.Page Ref.: C:14-3Objective: 1

14) Briefly discuss some of the reasons for using a revocable trust.Answer: The grantor may wish to have his property managed by an individual or institution with superior management skills.The grantor may wish to avoid high probate costs. The grantor may wish to avoid the publicity of probate.Page Ref.: C:14-3Objective: 1

15) This year, the Huang Trust received $20,000 of dividends and $30,000 of tax-free interest. It distributes all of its receipts to its beneficiary. How should the beneficiary treat the distribution?Answer: The beneficiary is deemed to receive $20,000 of taxable dividend income and $30,000 of tax-free interest.Page Ref.: C:14-4; Example C:14-3Objective: 1


LO2: Principles of Fiduciary Accounting

1) The term "trust income" when not preceded by an explanatory word relates most closely toA) gross income.B) taxable income.C) distributable net income.D) net accounting income.Answer: DPage Ref.: C:14-5Objective: 2

2) A trust has net accounting income of $15,000. In addition, the trust has a $10,000 capital gain, which is not included in net accounting income. The trust is required to distribute the trust income to the beneficiary. The beneficiary will receiveA) $10,000.B) $15,000.C) $24,700.D) $25,000.Answer: BPage Ref.: C:14-6Objective: 2

3) If a state has adopted the Revised Uniform Principal and Income Act, which of the following statements is correct?A) The state law definition of trust income will preempt any other definitions.B) The definition of trust income in the trust document will preempt all other definitions.C) Under state law, tax-exempt interest will not be allocated to income.D) The definition of principal in the trust document must classify capital gains as principal.Answer: BPage Ref.: C:14-5Objective: 2

4) Identify which of the following statements is false.A) State trust law preempts the trust document when defining income.B) The Uniform Act on principal and income requires depreciation to be charged against income.C) A statement in the trust instrument concerning the allocation of depreciation to principal or income overrides a provision of state law.D) The Uniform Act allocates royalties to both principal and income.Answer: APage Ref.: C:14-5Objective: 2


5) The governing instrument for the Lopez Trust contains no definitions of income and principal. The Trust is located in a state that has adopted the Uniform Act. In the current year, the trust reports the following receipts and disbursements:

Dividends $10,000Proceeds from sales of stock, including $10,000 of gain$40,000Trustee's fee, all charged to income $ 500CPA's fee for preparation of tax return $ 200

What is the trust's net accounting income?Answer: $10,000 - $500 - $200 = $9,300. The gain on the sale of stock and the rest of the sales proceeds constitute corpus.Page Ref.: C:14-5; Example C:14-4Objective: 2

6) A trust document does not define income and principal. The state in which the trust is operated has adopted the Uniform Act. The trust reports the following:

Dividends $2,500Capital gain 1,500Tax return preparation fee 200Trustee fees, all charged to income 100

What is the amount of trust's net accounting income?Answer: $2,500 - ($200 + $100) = $2,200Page Ref.: C:14-6; Example C:14-5Objective: 2

7) Little Trust, whose trust instrument is silent with respect to depreciation, collects rental income of $20,000 and pays property taxes of $1,000. Depreciation expense is $5,000.

Little Trust is in a state where all depreciation is charged to principal. What is the trust's net accounting income?Answer: $20,000 - $1,000 = $19,000Page Ref.: C:14-6; Example C:14-6Objective: 2


8) A trust document does not define income or principal. The state in which the trust is operated has adopted the Uniform Act, including allocation of depreciation to income. The trust reports the following:

Net business profits $20,000Net rental income 5,000Proceeds from stock sale

(including $10,000 gain) 50,000Trustee fee (charged to income) 2,000Depreciation 3,000

What is the amount of the trust's net accounting income?Answer: $20,000 + $5,000 - $2,000 - $3,000 = $20,000Page Ref.: C:14-6Objective: 2

9) A trust document does not mention the treatment for depreciation. The state has adopted the Uniform Act. The trust document states that depreciation is a charge against corpus. The trust results are the following:

Business net profits $2,000Rental income 1,000Depreciation 100Rent expense 100

Calculate net accounting income.Answer: $2,000 + $1,000 - $100 - $100 = $2,800. Page Ref.: C:14-6Objective: 2

10) Explain to a client the significance of the income and principal categorization scheme used for fiduciary accounting purposes.Answer: Often the trustee cannot distribute principal, or can do so only in limited circumstances. Many trust instruments mandate that all of the income (meaning income in the accounting, not tax, context) be distributed annually. Thus, the categorization of an income, gain, deduction, or loss item as principal or income often affects the dollar amount that the beneficiary can receive.Page Ref.: C:14-4 and C:14-5Objective: 2


11) Outline the classification of principal and income under the Revised Uniform Principal and Income Act.Answer: Income account:Income: rent, interest, dividends, net business profits, 72 1/2% of royalties.Expenses: ordinary expenses (e.g., property taxes, insurance, interest, ordinary repairs), taxes

levied on accounting income, and depreciation.

Principal account:Income: consideration (including gains) received upon disposition of property, stock dividends,

27-1/2% of royalties.Expenses: principal payments on debt, extraordinary repairs and capital improvements, taxes on

gains and other items of principal.Page Ref.: C:14-5 and C:14-6Objective: 2

12) A client asks about the relevance of state law in classifying items as principal or income. Explain the relevance.Answer: In general, state law controls; however, in the event of a discrepancy, provisions in the trust instrument prevail over state law.Page Ref.: C:14-4; Example C:14-3Objective: 2

13) List some common examples of principal and income items.Answer: A common example of principal includes the gain (plus return of capital) upon the disposition of an asset owned by the fiduciary. Common examples of income include dividends, interest, and rents.Page Ref.: C:14-4 and C:14-5Objective: 2

LO3: Formula for Taxable Income and Tax Liability

1) A trust receives no standard deduction when computing taxable income.Answer: TRUEPage Ref.: C:14-7Objective: 3

2) A complex trust permits accumulation of current income, provides for charitable contributions, or distributes principal during the taxable year.Answer: TRUEPage Ref.: C:14-9Objective: 3

3) The personal exemption available to a trust is adjusted annually based on changes in the consumer price index.Answer: FALSEPage Ref.: C:14-10Objective: 3


4) Estates and trustsA) are taxed on state and municipal bond interest.B) are not taxed on capital gains.C) receive a deduction for administrative expenses not otherwise deducted on the estate tax return (Form 706).D) receive a $1,000 personal exemption.Answer: CPage Ref.: C:14-9Objective: 3

5) Identify which of the following statements is false.A) A trust receives no standard deduction when computing taxable income.B) Trust tax preparation fees are miscellaneous itemized deductions and subject to the 2% nondeductible floor.C) There is no limit on a fiduciary's charitable contribution deduction if such a contribution is authorized in the trust instrument.D) All of the above are false.Answer: BPage Ref.: C:14-8Objective: 3

6) Identify which of the following statements is false.A) The personal exemption for a trust provides a tax savings when some income is allocated to principal.B) Distributable net income (DNI) sets the ceiling on the amount of distributions taxed to the beneficiaries.C) A complex trust must distribute all its income annually.D) The beneficiaries of a simple trust are taxed on their share of DNI irrespective of the amount they receive.Answer: CPage Ref.: C:14-9Objective: 3

7) Charitable contributions made by a fiduciaryA) are limited to 50% of fiduciary income.B) must be authorized in the trust instrument in order to be deductible.C) flows through to be deducted on the beneficiary's tax return.D) are subject to the 2% floor.Answer: BPage Ref.: C:14-9Objective: 3


8) A trust distributes 30% of its income to Mark and 20% to Nancy. The remaining 50% is accumulated. The trust's depreciation is $1,000. The trust instrument is silent regarding the depreciation deduction. State law requires the depreciation be charged to principal. What part of the depreciation deduction will be allocated to Mark?A) $0B) $200C) $300D) $1,000Answer: CExplanation: Mark receives a $300 (0.30 × $1,000) depreciation deduction even though net accounting income is not reduced by depreciation.Page Ref.: C:14-9Objective: 3

9) A simple trustA) may make charitable distributions.B) may make discretionary distributions of principal.C) may accumulate income.D) is required to distribute all of its income currently.Answer: DPage Ref.: C:14-8Objective: 3

10) A trust is required to distribute 10% of its income to Eleanor. In addition, the trustee in his discretion may distribute income to Eleanor and/or Marshall. The trust has net accounting income of $50,000, none of which is tax-exempt. The trust distributes the $5,000 mandatory payment to Eleanor and also distributes discretionary amounts of $5,000 to Eleanor and $5,000 to Marshall. How much must Eleanor include in income?A) $5,000B) $10,000C) $50,000D) none of the aboveAnswer: BPage Ref.: C:14-9Objective: 3


11) Yellow Trust must distribute 33% of its income annually to Patrick. In addition, the trustee in its discretion may distribute additional income to Minna or Patrick. In the current year, the trust has net accounting income and distributable net income of $150,000, none from tax-exempt sources. The trust makes a $50,000 mandatory distribution to Patrick and a discretionary distribution of $20,000 each to Patrick and Minna. What amounts of income do Patrick and Minna report?

A) Patrick Minna$ 50,000 $0

B) Patrick Minna$ 70,000 $20,000

C) Patrick Minna$170,000 $0

D) Patrick Minna$150,000 $20,000

Answer: BPage Ref.: C:14-9Objective: 3

12) The exemption amount for an estate isA) $0.B) $100.C) $300.D) $600.Answer: DPage Ref.: C:14-10Objective: 3

13) A trust that is required to distribute all of its income annually receives a personal exemption for the year ofA) $0, because it retains no income.B) $100.C) $300.D) $600.Answer: CPage Ref.: C:14-10Objective: 3


14) A trust is required to distribute all of its income annually. It distributes all of the income and $2,000 of principal to the beneficiary. Which of the following statements is correct?A) The trust is a complex trust and is allowed a $300 exemption.B) The trust is a complex trust and is allowed a $100 exemption.C) The trust is a simple trust and is allowed a $300 exemption.D) The trust is a simple trust and is allowed a $100 exemption.Answer: APage Ref.: C:14-10Objective: 3

15) Ebony Trust was established two years ago with Brent as the beneficiary. The trust instrument instructed the trustee last year to make discretionary distributions of income to Brent. Beginning in two years, the trustee is instructed to pay all of the trust income earned that year to Brent. What was the trust's personal exemption last year? What will the personal exemption be in two years?Answer: Last year, the exemption was $100 since the trust did not have to distribute all of its income. Two years from now the personal exemption will be $300 since it will be required to distribute all of its income.Page Ref.: C:14-10Objective: 3

16) A trust must distribute all of its income annually. Capital gains are allocated to principal. The trust has dividend income of $12,000, capital gains of $6,000, and no expenses. Calculate the trust's taxable income.Answer: $6,000 - $300 = $5,700Page Ref.: C:14-10; Example C:14-11Objective: 3

LO4: Distributable Net Income

1) Distributable net income (DNI) does not include capital gains allocated to principal.Answer: TRUEPage Ref.: C:14-11Objective: 4

2) Which of the following is not an addition to trust taxable income when computing distributable net income (DNI)?A) distribution deductionB) capital gains allocated to principalC) tax-exempt interestD) personal exemptionAnswer: BPage Ref.: C:14-11Objective: 4


3) Identify which of the following statements is true.A) The personal exemption available to a trust is adjusted annually based on changes in the consumer price index.B) Income received by a trust beneficiary has the same character it had at the trust level.C) Distributable net income (DNI) excludes tax-exempt income.D) All of the above are false.Answer: BPage Ref.: C:14-11Objective: 4

4) Melody Trust has $60,000 of DNI for the current year, $20,000 of rental income and $40,000 of corporate bond interest. The trust instrument requires the trustee to distribute 30% of the trust income to Lee and 70% to Sarah, annually. The trust instrument does not require an allocation of the different types of income to the two beneficiaries. What is the amount and composition of the income reported by Lee and Sarah, respectively?Answer: Lee reports $18,000 (30% of $60,000) of trust income and Sarah reports $42,000 (70% of $60,000). Because rents make up one-third ($20,000/$60,000) of DNI, the composition of the income reported by Lee and Sarah is one-third rental income and two-thirds corporate bond interest.Page Ref.: C:14-11Objective: 4

5) A trust reports the following results:

Allocable toIncome Principal

Taxable bond interest $20,000Rental income 10,000Gain on sale of investment land 10,000Property taxes 2,000Trustee fees 500

The trust must distribute all of its income annually. Calculate taxable income after the distribution deduction.Answer: $20,000 Taxable bond interest10,000 Rental income10,000 Capital gain( 2,000) Property taxes

( 500) Trustee fees( 300) Personal exemption

(27,500) Distribution deduction$ 9,700 Taxable income

Verification of this amount is possible by subtracting the personal exemption ($300) from the capital gain ($10,000) to arrive at taxable income ($9,700).Page Ref.: C:14-12; Example C:14-13Objective: 4


6) Explain the three functions of distributable net income (DNI).Answer: DNI establishes the maximum amount on which the beneficiaries may be taxed. DNI establishes the maximum amount the trust or estate may deduct as a distribution deduction. DNI establishes the character of the income or expense in DNI that flows to the beneficiaries.Page Ref.: C:14-11Objective: 4

LO5: Determining a Simple Trust's Taxable Income

1) The $3,000 limitation on deducting net capital losses does not apply to a trust.Answer: FALSEPage Ref.: C:14-16Objective: 5

2) A trust has the following results:

Net tax-exempt interest $10,000Net accounting income 64,000Trustee fees charged to corpus 2,000

The Uniform Act is followed. The trust document requires one-fifth of the income to be distributed annually to David and the remainder of the income to Patty. What is distributable net income?A) $74,000B) $72,000C) $64,000D) $62,000Answer: DExplanation: $62,000 net accounting income (which includes the tax-exempt interest), minus $2,000 trustee fee charged to corpus.Page Ref.: C:14-12; Example C:14-13Objective: 4

3) A simple trust has a distributable net income (DNI) of $50,000 and net accounting income of $60,000, all from taxable sources. The trust has a sole beneficiary, Marty. The trust reports on a calendar tax year and distributes the $60,000 of 2008's net accounting income to Marty on January 20, 2009. No other distributions are made in the current year. Marty's taxable income from the trust this year isA) $0.B) $49,700.C) $50,000.D) $60,000.Answer: CPage Ref.: C:14-16Objective: 5


4) Identify which of the following statements is true.A) Beneficiaries of simple trusts are taxed currently on their pro rata share of taxable distributable net income (DNI) regardless of the actual amount distributed to them during the period.B) The income received by the beneficiaries of the trust loses its character once it is distributed.C) Capital losses remaining in the final year of a trust do not pass through to the beneficiaries succeeding to the trust property.D) All of the above are false.Answer: APage Ref.: C:14-16Objective: 5

5) A trust is required to distribute all of its income currently. Two years ago, it had a $10,000 capital loss. Last year, it had a $3,000 capital gain. This year, the trust is terminated. Albert has a 40% interest in the trust, and Barbara has a 60% interest. Barbara receives a capital loss pass-through ofA) $0.B) $2,400.C) $4,200.D) $7,000.Answer: CExplanation: 0.60 × $7,000 = $4,200Page Ref.: C:14-16; Example C:14-18Objective: 5

6) In the current year, a trust has distributable net income (DNI) of $30,000. During the year, the trust makes a mandatory distribution to Sarah of $5,000 and a discretionary distribution of $10,000 to Kyle. The trust has no tax-exempt income. The distribution deduction of the trust isA) $30,000.B) $15,000.C) $10,000.D) $5,000.Answer: BPage Ref.: C:14-15Objective: 5

7) Panther Trust has net accounting income and distributable net income of $100,000, $75,000 from taxable sources and $25,000 from tax-exempt sources. During the year, the trust makes a mandatory distribution to Julius and Steve of $50,000 each. The distribution deduction isA) $25,000.B) $50,000.C) $75,000.D) $100,000.Answer: CPage Ref.: C:14-15Objective: 5


8) Panther Trust has net accounting income and distributable net income of $100,000, $75,000 from taxable sources and $25,000 from tax-exempt sources. During the year, the trust makes a mandatory distribution to Julius and Steve of $50,000 each. How much of Steve's distribution is taxable?A) $12,500B) $25,000C) $37,500D) $50,000Answer: CPage Ref.: C:14-15Objective: 5


Interest from corporate bonds $20,000Dividends 10,000Tax-exempt interest 20,000Trustee fees 6,000Capital gain 10,000

All of the items are allocated to income except the capital gains. Calculate the maximum amount of trustee fees that are deductible.Answer: ($30,000/$50,000) × $6,000 = $3,600. The remaining $2,400 of trustee fees is allocable to tax-exempt income and nondeductible under Sec. 275.Page Ref.: C:14-14 and C:14-15; Example C:14-15Objective: 5


Dividend income $20,000Capital gains 10,000Tax-exempt interest 10,000Trustee fees 3,000

All of the items above are allocated to income. Calculate the maximum amount of trustee fees that are deductible.Answer: ($10,000/$30,000) × $3,000 = $1,000 allocated to tax-exempt income

$3,000 - $1,000 = $2,000 deductiblePage Ref.: C:14-14 and C:14-15; Example C:14-15Objective: 5


11) A trust has distributable net income (DNI) of $50,000, including $30,000 tax-exempt interest income and $20,000 taxable interest income. The trust instrument requires that all income be distributed at least annually, 30% to Jane and 70% to Joe. What is the amount and character of the income that Jane receives?Answer: $50,000 × 0.30 = $15,000 × ($30,000/$50,000) = $9,000 tax-exempt interest income

$15,000 - $9,000 = $6,000 taxable interest incomePage Ref.: C:14-14 and C:14-15; Example C:14-15Objective: 5

12) A simple trust has the following results:

DNI $60,000Net tax-exempt interest 8,000Net accounting income 62,000

Calculate the distribution deduction.Answer: $60,000 - $8,000 = $52,000Page Ref.: C:14-15Objective: 5

13) In the year of termination, a trust incurs a $20,000 NOL. In addition, it has a $30,000 NOL carryover from the two preceding tax years. The trust distributes 40% of its assets to Sam, 30% of its assets to Alex, and 30% of its assets to Catherine. How much of the NOL can Sam (who has $150,000 of gross income) deduct on his return in the year that the trust terminates?Answer: ($20,000 + $30,000) × 0.40 = $20,000Page Ref.: C:14-16; Example C:14-18Objective: 5

14) Explain how to determine the deductible portion of trustee's fees.Answer: If the trust has any tax-exempt income, only a portion of the trustee's fees is deductible. The nondeductible amount of the trustee's fee is the following portion of the total fee: tax-exempt income divided by gross accounting income times total trustee's fees. Alternatively, the denominator can be accounting income net of all direct expenses.Page Ref.: C:14-14 and C:14-15; Example C:14-15Objective: 5


15) The Tucker Trust was established six years ago. The trust is required to distribute all of the trust income at least annually to Betty for life. Capital gains are credited to principal. The current year results of the trust are as follows:

Amounts Allocable ToIncome Principal

Dividends $15,000Rental income from land 2,500Tax-exempt interest 7,500Rental expenses 500Trustee fees $600Tax return preparation fee 250Capital gain on stock sale (stock purchased five years ago)24,250 6,000Distribution of net accounting income 1,300Payment of estimated taxes

Compute (a) distributable net income (DNI), (b) the distribution deduction, (c) trust taxable income, and (d) Betty's reportable income and its classification. Charge all of the deductible expenses against rent income.Answer: (a) DNI = $23,650 ($15,000 + $2,500 + $7,500 - $500 - $250 - $600)(b) Distribution deduction = $16,330 [$23,650 - $7,320 (net tax-exempt income)]. Note the nondeductible trustee's fee is $180 [($7,500/$25,000) × $600].(c) Trust taxable income = $5,700 ($6,000 - $300)(d) Betty's dividends = $15,000; Betty's rental income = $1,330 ($2,500 - $500 - $250 - $420 deductible trustee's fees); Betty's tax-exempt interest = $7,320 ($7,500 - $180)Page Ref.: C:14-17 through C14-19Objective: 5

16) Sukdev Basi funded an irrevocable simple trust in May 2008. The trust benefits Sukdev's son for life and grandson upon the son's death. One of the assets he transferred to the trust was Jetco stock, which had an FMV on the transfer date of $40,000. Sukdev's basis in the stock was $44,000, and he paid no gift tax on the transfer. The stock's value has dropped to $33,000, and the trustee thinks that now, October 2011, might be the time to sell the stock and take the loss deduction. For 2011, the trust will have $20,000 of income exclusive of any gain or loss. Sukdev's taxable income is approximately $15,000. What tax and nontax issues should the trustee consider concerning the possible sale of the stock?Answer: Sukdev transferred depreciated property to the trust, something he should not have done. If the trustee sells the Jetco stock at a loss, the trust's basis for determining loss will be $40,000, the stock's value on the date of the gift. (If the trustee sells the property at a gain, the basis will be Sukdev's basis of $44,000.) Thus, if the trust sells the stock for its current value of $33,000, it can recognize only $7,000 of loss (less than the economic loss). Because the trust must distribute all of its income, there will be no noncapital gain income against which to offset the capital loss. The only time the trust will get a tax benefit from the capital loss will be when it has capital gains. Any unused loss will pass through to the beneficiaries when the trust terminates in the distant future. Deferring the stock sale is not necessarily the best strategy, however, because there may be little expectation that the value of the stock will "recover," and, in fact, it could decline further.Page Ref.: C:14-16Objective: 5

LO6: Determining Taxable Income for Complex Trusts and Estates

1) The distribution deduction for a complex trust is the lesser of the amount distributed or distributable net income, reduced by net tax-exempt income.


Answer: TRUEPage Ref.: C:14-20Objective: 6

2) Distributable net income (DNI) is not reduced by the charitable contribution deduction when calculating the deductible discretionary distributions for a complex trust.Answer: FALSEPage Ref.: C:14-20Objective: 6

3) Identify which of the following statements is true.A) In a complex trust, distributable net income (DNI) does not act as a ceiling on the amount of the distribution deduction.B) Distributable net income (DNI) is not reduced by the charitable contribution deduction when calculating the deductible discretionary distributions for a complex trust.C) In a complex trust, distributable net income (DNI) is not reduced by the charitable contribution deduction when comparing DNI with the mandatory distributions in order to determine the amount of the distribution deduction.D) All of the above are false.Answer: CPage Ref.: C:14-20Objective: 6

4) Identify which of the following statements is true.A) Tax-exempt income is allocated among beneficiaries in the proportion that total tax-exempt income bears to total distributable net income (DNI).B) Both income required to be distributed currently and discretionary income distributions are included in tier-1 distributions.C) Under the tier system, tier-2 beneficiaries are the first to absorb income.D) All are false.Answer: APage Ref.: C:14-21Objective: 6


5) Apple Trust reports net accounting income of $40,000, all from taxable sources. The trustee is required to distribute $15,000 annually to Megan. The trustee also makes discretionary distributions of $30,000, $7,500 to Megan and $22,500 to Caroline. The trust pays $5,000 of the discretionary distributions from corpus. What is the taxable amount of the Megan's tier-2 distribution?A) $7,500B) $6,250C) $15,000D) $22,500Answer: BExplanation: 40,000 - 15,000 tier-1 distribution = $25,000. (7,500/30,000) × 25,000 = 6,250.Page Ref.: C:14-21 and C:14-22Objective: 6

6) Identify which of the following statements is true.A) An individual cannot be both a tier-1 and tier-2 beneficiary in the same year.B) Tier-2 beneficiaries potentially can receive more favorable tax treatment than tier-1 beneficiaries.C) Bequests of specific sums of money when distributed out of an estate result in the recognition of gross income by the beneficiary receiving the bequest.D) All of the above are false.Answer: BPage Ref.: C:14-21Objective: 6

7) A trust has net accounting income of $30,000, but distributable net income (DNI) of only $25,000 because certain expenses are charged to principal. The trust is required to distribute $10,000 to Alice and it makes a discretionary distribution of $20,000 to Ben. The trust has no tax-exempt income. The amount that Ben reports as gross income isA) $20,000.B) $16,667.C) $15,000.D) none of the aboveAnswer: CExplanation: $25,000 DNI (the smaller of the net accounting income or DNI numbers) - $10,000 mandatory distribution to Alice = $15,000Page Ref.: C:14-21 and C:14-22Objective: 6


8) A trust has net accounting income and distributable net income (DNI) of $60,000, all from taxable sources. The trustee is required to distribute $40,000 of current income to Harry. In addition, the trustee makes a discretionary distribution to Harry of $10,000 and a discretionary distribution to Susan of $30,000. $20,000 of the $40,000 total discretionary distributions is from corpus. Gross income reportable by Harry isA) $50,000.B) $45,000.C) $37,500.D) $30,000.Answer: BExplanation: $20,000 × ($10,000/$40,000) = $5,000 discretionary distribution + $40,000 mandatory distribution = $45,000Page Ref.: C:14-21 and C:14-22Objective: 6

9) Martha died and by her will, specifically bequeathed, and the executor distributed, $20,000 cash and a $70,000 house to Harold. The distributions were made in a year in which the estate had $65,000 of DNI, all from taxable sources. The maximum Harold will be required to report as gross income as a result of these distributions isA) $0.B) $20,000.C) $65,000.D) $70,000.Answer: APage Ref.: C:14-23Objective: 6

10) An estate made a distribution to its sole beneficiary of $15,000 for the year. This distribution was not the result of a specific bequest. The estate had $40,000 of taxable interest and $34,000 of expenses attributable to earning that interest. What amount of the distribution is taxable to the beneficiary?A) $40,000B) $15,000C) $6,000D) $0Answer: CPage Ref.: C:14-21 and C:14-22Objective: 6

11) Fred, a cash-basis taxpayer, died on January 15, 2012. In 2013, the estate made a $9,000 distribution from estate income to Fred's sole heir. The estate had $20,000 of taxable interest and a $10,000 net long-term capital gain allocable to corpus. The estate incurred $5,000 in expenses attributable to the estate income. What is the estate's distributable net income (DNI)?A) $15,000B) $20,000C) $25,000D) $30,000Answer: APage Ref.: C:14-21 and C:14-22Objective: 6

12) Apple Trust reports net accounting income of $40,000, all from taxable sources. The trustee is required to distribute $15,000 annually to Megan. The trustee also makes discretionary distributions of $30,000, $7,500 to Megan and $22,500 to Caroline. The trust pays $5,000 of the discretionary distributions from corpus. What is the amount of the distribution deduction?


A) $40,000B) $45,000C) $15,000D) $30,000Answer: APage Ref.: C:14-21 and C:14-22Objective: 6

13) Describe the tier system for trust beneficiaries.Answer: The tier system distinguishes between mandatory (tier-one) distributions and discretionary (tier-two) distributions. Tier-one beneficiaries are taxed on the smaller of DNI or the amount of the mandatory distributions. Tier-two beneficiaries are taxed on the lesser of DNI remaining after the mandatory distributions or the amount of the discretionary distributions.Page Ref.: C:14-21Objective: 6

14) The Williams Trust was established six years ago. The trust document allows the trustee to distribute income in its discretion to beneficiaries Carol and Karen for the next 15 years. The trust will then be terminated and the trust assets will be divided equally between Carol and Karen. Capital gains are part of principal.

The current year income and expenses of the trust are reported below.

Amounts Allocable ToIncome Principal

Dividends $15,000Rental income from land 2,500Tax-exempt interest 7,500Rental expenses 500Trustee's fees $600Tax return preparation fee 250Capital gain on stock sale (stock purchased four years ago) 6,000Distribution of net accounting income to:

Carol 7,000Karen 3,500

Payment of estimated tax 2,620 1,680

Compute (a) distributable net income (DNI), (b) distribution deduction, (c) trust taxable income, and (d) Carol's and Karen's reportable income and its classification. Charge all of the deductible expenses against the rental income.


Answer: (a) DNI = $23,650 ($15,000 + $2,500 + $7,500 - $500 - $250 - $600)(b) Distribution deduction = $7,250 [$10,500 - ($7,320/$23,650 × $10,500)]. Note that $7,320 is the $7,500 of tax-exempt income minus the nondeductible trustee's fee of $180 [($7,500/$25,000) × $600].(c) Trust taxable income = $14,980 ($15,000 + $2,500 + $6,000 - $500 - $250 - $420 - $100 exemption - $7,250)(d) Carol receives 0.296 ($7,000/$23,650) of the income, and Karen receives 0.148 ($3,500/$23,650) of the income; Carol receives dividends, $4,439.50; rents, $394; and tax-exempt interest, $2,166.50. Karen receives dividends, $2,220; rents, $196.50; and tax-exempt interest, $1,083.50.Page Ref.: C:14-25 through C:14-27Objective: 6

LO7: Income in Respect of a Decedent

1) Income in respect of a decedent (IRD) is included in the decedent's final income tax return.Answer: FALSEPage Ref.: C:14-28Objective: 7

2) Income in respect of a decedent (IRD) includes interest earned by a cash-basis taxpayer but not received by the taxpayer before death.Answer: TRUEPage Ref.: C:14-28Objective: 7

3) An example of income in respect to a decedent (IRD) for a cash method of accounting taxpayer isA) interest earned but not received prior to death.B) salary earned but not received prior to death.C) gain from an installment sale entered into before death.D) All of the above are examples.Answer: DPage Ref.: C:14-28Objective: 7

4) Joyce passed away on January 3 while on an extended holiday cruise celebrating a very successful, and most profitable previous year. Joyce was the chief executive officer of the Quillip Corporation. After the independent audit of Quillip's last year's financial statements was completed in February of this year, Joyce's estate received a $1,000,000 bonus check resulting from last year's corporate profits. Joyce's estate also sold Quillip stock for $500,000 in February of this year. Joyce originally purchased this stock eight years ago for $10,000. The stock was valued at $495,000 on her date of death. Solely based on the above facts, how much income in respect of a decedent should Joyce's estate report in the current year?A) $1,485,000B) $1,000,000C) $485,000D) $5,000Answer: BPage Ref.: C:14-28Objective: 7

5) Identify which of the following statements is true.A) Income in respect of a decedent (IRD) is the gross income the decedent earned before


death but had not collected before death.B) An estate may deduct up to $5,000 of capital losses against the ordinary income taxable in the estate.C) An example of income in respect of a decedent (IRD) is the gain recognized on property sold by the estate after the decedent's death.D) All of the above are false.Answer: APage Ref.: C:14-28Objective: 7

6) Identify which of the following statements is false.A) Federal estate taxes related to income in respect of a decedent (IRD) is deductible by the estate in the year the IRD is includible in the estate's gross income.B) An example of deductions in respect of a decedent (DRD) are property taxes that accrued prior to the decedent's death but were not paid until after death.C) Items of IRD receive a step-up in basis as a result of the decedent's death.D) Interest earned but not received before death is IRD.Answer: CPage Ref.: C:14-29; Example C:14-31Objective: 7

7) Michael died in 2013 with a taxable estate and estate tax base of $6,000,000. Michael's estate owed no state death taxes. Michael's estate includes $250,000 of income in respect of a decedent (IRD), none of which is received by his surviving spouse. His estate had no DRD. The estate collects $200,000 of the IRD during its current tax year. The Sec. 691(c) deduction for the estate in current year isA) $153,000.B) $122,400.C) $90,000.D) $80,000.Answer: DExplanation: Estate tax on $250,000 100,000Estate tax on $200,000 80,000

Tax on IRD collected will all be taxed at 40% marginal estate tax rate for estates over $5MPage Ref.: C:14-29; Example C:14-31Objective: 7

8) What is the basis of inherited IRD items to the beneficiary?Answer: If an item is considered IRD, its basis carries over from the decedent to the beneficiary.Page Ref.: C:14-28Objective: 7


9) Describe the double taxation of income in respect of a decedent and how it can be reduced.Answer: The taxable estate contains all income earned but not received before death. This income is also taxed to the person entitled to receive it after death. For example, a decedent may have an IRA which is included in his estate. The IRA payments will also be taxed to the person entitled to collect them upon the decedent's death. Section 691(c) provides relief against this double taxation by permitting a deduction for the federal estate tax attributable to IRS on the estate's income tax return.Page Ref.: C:14-28Objective: 7

10) Ed Camby sold an apartment building in May 2008 for a small amount of cash and a note payable over five years. Principal and interest payments are due annually on the note in April of 2009 through 2013. Ed died in August 2008. He willed all his assets to his daughter Anna. Ed's gross estate is about $3 million, and his estate tax deductions are very small. What tax issues should the executor of his estate consider with respect to reporting the sale of the building and the collection of the installments?Answer: • When and where will the gain on the sale of the building be reported?• Will there be any income in respect of a decedent (IRD)?• If there will be IRD, will there be a 691(c) deduction?

Unless Ed's executor elects on Ed's final individual return (for 2008) not to use installment reporting for the gain, the portion of the gain attributable to the down payment will be reported on Ed's 2008 individual return, and the remaining gain will be reported on the estate's income tax returns when the principal is collected. The estate need not use a calendar year. If the estate terminates prior to collecting all of the principal, Anna will report the remaining gain as she collects the principal. If the executor elects out of installment reporting, all the gain will be reported on Ed's 2008 return. This election would be a favorable option if Ed has losses that the gain would offset because the losses would otherwise "die" with Ed.

The gain inherent in the principal payments on the note will be IRD unless the executor elects out of installment reporting. No step-up in basis is allowed for IRD items.

Ed's estate will owe estate taxes, and a 691(c) deduction will be allowed for the estate taxes attributable to the gain inherent in the note included in the gross estate.Page Ref.: C:14-29; Example C:14-31Objective: 7


LO8: Grantor Trust Provisions

1) Grantor trusts are taxed as complex trusts.Answer: FALSEPage Ref.: C:14-30Objective: 8

2) Identify which of the following statements is true.A) Under the grantor trust rules, a grantor may be taxed on all or a portion of the trust's income even though the income is distributed to the named beneficiary or someone else.B) An irrevocable trust cannot be a grantor trust.C) Large amounts of income can be shifted to children under the age of 18 through the use of trusts that make distributions, and the income will be taxed at the lower rates of the children.D) All of the above are false.Answer: APage Ref.: C:14-30Objective: 8

3) Sally transfers property to a revocable trust. Under the terms of the trust agreement, Allison is to receive income for ten years at which time the remainder is to go to Tom. During the year, the trust earns $10,000 in corporate bond interest income and recognizes a capital gain of $20,000. The interest is distributed to Allison and the capital gain is properly allocated to principal. Allison (not Sally) will pay tax onA) $0.B) $10,000.C) $20,000.D) $30,000.Answer: AExplanation: The revocable trust is a grantor trust.Page Ref.: C:14-31Objective: 8

4) Five years ago, Jon transferred stock to an irrevocable trust with First Bank named as trustee, and provided that the trustee is to pay some or all of the trust income to the beneficiary Dan for 15 years. At the end of the 15th year, the trust property, including any undistributed income, will revert to Jon. In the current year, the trust collected $52,000 of dividend income, and distributed $30,000 of this amount to Dan. In addition, the trust sold some of the stock at a $6,000 capital gain. For the current year, the tax results occurred?A) Dan is taxed on $30,000 of dividends and the trust on the remaining dividends, plus the capital gain, less the $100 personal exemption.B) The trust is taxed on the $52,000 of dividends less the $100 personal exemption, and Jon is taxed on the capital gain.C) Dan is taxed on $30,000 of dividends, and the remaining dividends plus the capital gain are taxed to Jon.D) Jon is taxed on all of the dividends and on the capital gain.Answer: DPage Ref.: C:14-31Objective: 8

5) In which of the following situations will the grantor trust rules apply?A) The trust is revocable and mandates the distribution of income to the named beneficiary.B) The trust is irrevocable, and the trustee, who is also the grantor, has the power to distribute or accumulate income for the named beneficiary.C) The trust is irrevocable, the income must be paid out currently, and the trust assets will revert to the grantor at the end of nine years.D) The grantor trust rules will apply in each of the situations.


Answer: DPage Ref.: C:14-30 through C:14-33Objective: 8

6) Karly created a $300,000 trust that provided her mother with a lifetime income interest starting on January 1, with the remainder to go to her son. Karly expressly retained the power to revoke both the income and remainder interests at any time. Who will be taxed on the trust's income?A) Karly's motherB) Karly's sonC) KarlyD) the trustAnswer: CPage Ref.: C:14-31Objective: 8

7) Which of the following is the most accurate statement concerning the use of trusts in tax planning?A) The grantor trust rules allow grantors to shift income into trusts and reduce their own taxes.B) Nontax reasons for the use of trusts (such as avoidance of probate) typically outweigh tax reasons for creating trusts today.C) The large 15% tax bracket available to trusts allows complex trusts to be used as an income-shifting device.D) None of the above statements are correct.Answer: BPage Ref.: C:14-30Objective: 8


LO9: Tax Planning Considerations

1) All of the following are advantages of a sprinkling trust, exceptA) the trustee can choose the amount to distribute among multiple beneficiaries.B) the trustee can determine the amount to retain in the trust.C) the trustee can determine the amount to distribute to the sole trust beneficiary.D) the trustee can consider the tax rates of the beneficiaries and trust.Answer: CPage Ref.: C:14-34Objective: 9

2) Marge died on August 24 of the current year. Her estate collected taxable bond interest of $10,000 per month beginning in September. The only beneficiary of Marge's estate is Art, a calendar-year taxpayer. Which of the following statements is correct?A) If the estate selects November 30 as a year-end and makes no distributions prior to that date, the estate will be taxed on $30,000 less a $600 personal exemption for its first tax year.B) If the estate selects January 31 of next year at its year-end and distributes $40,000 to Art in December of this year and nothing in January, the $40,000 will be taxed on Art's next year's tax return.C) If the estate selects December 31 as its year-end and distributes nothing to Art in December and $40,000 in January of next year, $40,000 less the $600 personal exemption will be taxed on the estate's first tax return.D) All of the above are correct.Answer: DPage Ref.: C:14-34Objective: 9

3) Mary died this year. Her will creates a trust for the benefit of her children. A portion of the estate's assets are placed in this trust. The estate has income from assets it will transfer to other beneficiaries at a later date. Mary's brother Joe is the trustee of the trust and executor of the estate. Which of the following statements is true?A) Joe must choose December 31 as the tax year-end for both the estate and trust.B) Joe is free to choose any tax year-end for both the trust and estate.C) Joe must choose December 31 as the estate tax year-end but is free to choose any tax year-end for the trust.D) Joe must choose December 31 as the trust tax year-end but is free to choose any tax year-end for the estate.Answer: DPage Ref.: C:14-34Objective: 9

4) Administration expenses incurred by an estateA) are deductions in respect of a decedent and may be deducted on both the estate tax return (Form 706) and the estate income tax return (Form 1041).B) an executor must elect where to deduct administration expenses (Form 706 or Form 1041).C) such expenses are only deductible on Form 706.D) such expenses are only deductible on Form 1041.Answer: BPage Ref.: C:14-34Objective: 9

5) What is the benefit of the 65-day rule?Answer: The benefit of the 65-day rule is that it allows estates or trusts to shift income from being taxed on the fiduciary's tax return to a beneficiary's (or beneficiaries') tax return(s). Sometimes by the end of the year the exact amount of the fiduciary's income will


not be known nor will the tax situation of the beneficiaries necessarily be known. The 65-day rule lets fiduciaries postpone making distributions until early in the next year so that the tax situation of the fiduciary and the beneficiaries can be assessed and an intelligent decision made concerning whether to have income taxed at the fiduciary or the beneficiary level.Page Ref.: C:14-33 and C:14-34Objective: 9

6) For the first five months of its existence (August through December 2008), the Estate of Christine Lowry had gross income (net of expenses) of $7,000 per month. For January through July 2009, the executor estimates that the estate will have gross income (net of expenses) totaling $5,000. The estate's sole beneficiary is Christine's son, Jonathan, who is a calendar-year taxpayer. Jonathan incurred a large NOL from his sole proprietorship years ago, and $34,000 of the NOL carryover remains but expires at the end of 2008. During 2008, Jonathan received only $5,000 of income from part-time employment. What tax issues should the executor of Christine's estate consider with respect to the reporting of the estate's income?Answer: • May the estate elect to use a tax year-end other than December 31?• What year-end should the estate elect if a December 31 year-end is not mandatory?• What distributions (if any) should the estate make to Jonathan prior to the termination of the estate?

The estate may elect a year-end other than December 31. To do so, it must file an income tax return on a timely basis, meaning by the fifteenth day of the fourth month after the desired year-end.

The estate should consider a December 31 year-end for the reasons discussed below.

The estate should distribute $34,000 to Jonathan by December 31, 2011 and elect a December 31 year-end. The estate will have $35,000 of DNI by December 31, and if it distributes $34,000 to Jonathan by this date, the estate will receive a $34,000 distribution deduction, and Jonathan will have $34,000 of income to offset against his NOL, which otherwise will expire. Thus, $34,000 will wind up being untaxed for all practical purposes. The rest, $1,000, will be taxed to the estate at a 15% rate. If the estate chooses a year-end later than December 31 and makes distributions to Jonathan, such distributions will be income on Jonathan's 2012 return and his NOL will have expired and been wasted. Likewise, if the estate makes no distribution, the income will be taxed to the estate, and Jonathan's NOL will be wasted.Page Ref.: C:14-33 and C:14-34Objective: 9


L10: Compliance and Procedural Considerations

1) Trusts are required to make estimated tax payments.Answer: TRUEPage Ref.: C:14-35Objective: 10

2) Identify which of the following statements is true.A) All trusts and estates must use a calendar year-end.B) All estates with gross income of at least $500 must file an income tax return.C) Trusts are required to make estimated tax payments.D) All of the above are false.Answer: CPage Ref.: C:14-35Objective: 10


chapter c14

Documents

c trusts

c page

c assets

c subchapter

c testamentary trusts

c explanation

d trusts

b income