Tax efficient irrevocable trust distribution

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plebeian
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Joined: Wed Mar 28, 2018 2:47 pm

Tax efficient irrevocable trust distribution

Post by plebeian » Mon Aug 27, 2018 6:29 pm

I am soon to become a trustee of an irrevocable trust and have been researching my responsibilities. I am trying to find the most tax efficient manner to make distributions to the beneficiary. My understanding is that assets can be transferred to the beneficiary in-kind. The cost basis of those assets is then subtracted from the distributable net income (DNI) and the beneficiary pays the taxes on the distribution instead of the trust.

Here is a hypothetical situation:

Beneficiary has $0 earned income.

Trust has $100,000 DNI.

As the trustee, I elect to have taxes passed to beneficiary instead of having the trust pay.

Trust distributes $120,000 of assets with a cost basis of $77,000 in-kind to beneficiary. The assets were purchased over one year ago.

Beneficiary is married and files taxes jointly. The couple would now be at the top of the 12% income tax bracket.

Beneficiary would pay the 12% marginal income tax rate on the $77,000 (the cost basis of the assets)

Beneficiary immediately sells the $120,000 of assets and has a gain of $43,000.

There are zero taxes on the $43,000 capital gain because the beneficiary would be in the 12% tax bracket and long term gains taxes are 0%. The beneficiary would also avoid paying Net Investment Income Tax (NIIT).

The trust had DNI of $100,000 but $77,000 of it was distributed to the beneficiary. The trust retains $23,00 of the DNI and as a result pays the 37% marginal tax rate, as well as the 3.8% NIIT on that remainder.

Is my understanding of the tax situation correct?

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