1. Chapter 18
Income Taxation of
Trusts and Estates
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2. Chapter 18 Exhibits
1. Five Key Elements of Every Trust
2. Trust Life Cycle Illustrated
3. Definition of Terms
4. Computing Tax Liability—Fiduciary vs. Nonfiduciary
5. Gross Income—Income in Respect of Decedent
6. Income in Respect of Decedent—Tax Treatment
7. Gross Income—Property Distributions
8. Deductions—Depreciation and Depletion
9. Deductions—Capital Losses
10. Deductions—Miscellaneous Itemized Deductions
11. Deductions—Casualty Losses and Charitable Contributions
12. Personal Exemptions
Chapter 18, Exhibit Contents A CCH Federal Taxation Basic Principles 2 of 58

3. Chapter 18 Exhibits
13. Distribution Deduction—Simple Trusts
14. The Distribution Deduction—Step 1: Computing State Law/ Accounting Income
15. Assignments to Corpus and Income—Default Designations
16. The Distribution Deduction—Step 2: Computing Taxable Income Before
Distribution Deduction
17. The Distribution Deduction—Step 3: Computing Distributable Net Income
18. The Distribution Deduction—Step 4: Computing the Distribution Deduction
19. Computing Taxable Income of Simple Trusts—Example
20. Filing Requirements for Estates and Trusts
Chapter 18, Exhibit Contents B CCH Federal Taxation Basic Principles 3 of 58

4. Five Key Elements of Every Trust
1. Grantor. The grantor is the person who transfers
property to the trust. The grantor often referred to as
trustor, settlor or donor.
2. Trust property. Property must be transferred to the
trust. It can be transferred during life, after death through
the grantor’s will, through a gift, or by the exercise of a
power of appointment (“POA”). It can be cash, a life
insurance policy, stock, or any other asset that serves the
intent of the grantor.
Chapter 18, Exhibit 1a CCH Federal Taxation Basic Principles 4 of 58

5. Five Key Elements of Every Trust
3. Trustee. The trustee is the person responsible for managing and
administering a trust. The trustee may be the grantor, a trusted friend, a
family member, a bank trust department, or any combination of these
and other persons. The trustee generally will hold legal title to the
assets
in the trust but not beneficial title.
(a) Legal title means the trust assets are owned in the name of the
trustee, the trustee has specific duties and responsibilities for the
trust property, or has certain powers concerning the disposition of
the trust property.
(b) Beneficial title to the trust property is held by the beneficiaries of
the trust.
Chapter 18, Exhibit 1b CCH Federal Taxation Basic Principles 5 of 58

6. Five Key Elements of Every Trust
4. Beneficiary. It’s important to know that the persons who are
beneficiaries can be determined; that is, the description should
be clear and certain. If “my descendants” are the named
beneficiaries, there must be a time for making the determination
of who the descendants are. Otherwise, it would be impossible
to know when to make distributions from the trust.
(a) Possible issue. A possible issue might be: Are grandchildren
born after the trust had been established to be included as
beneficiaries?
(b) Remainderman. When the trust has fulfilled its purpose, the
money and assets it holds are distributed to the remainderman
and the trust is terminated.
Chapter 18, Exhibit 1c CCH Federal Taxation Basic Principles 6 of 58

7. Five Key Elements of Every Trust
5. Intent of Trust. Every trust has a purpose which motivates the grantor to
set the trust up in the first place. The intent can relate to one or a
combination of the following intents:
(a) Benefiting a particular beneficiary.
(b) Providing for the maintenance of certain assets, such as the old
family homestead.
(c) Achieving certain tax benefits, such as through charitable remainder
trusts or marital trusts.
Chapter 18, Exhibit 1d CCH Federal Taxation Basic Principles 7 of 58

8. Trust Life Cycle Illustrated
(a) Grandma has her attorney prepare a trust agreement.
(b) Grandma then transfers $100,000 in bonds to her daughter,
Tressie, as trustee of the trust.
(c) Tressie is required by the terms of the trust document to invest
the $100,000 in bonds and use all of the interest each year to pay
for the college expenses of Tressie’s two sons, Grandma’s
grandchildren.
(d) When the youngest of Tressie’s two sons reaches the age of 25,
Tressie is instructed to divide the money in the trust equally and
distribute it to each of the two boys.
(e) When the distribution is completed, the trust is terminated.
Chapter 18, Exhibit 2a CCH Federal Taxation Basic Principles 8 of 58

9. Trust Life Cycle Illustrated
Legal title. The $100,000 Grandma transferred is owned by
Tressie, as trustee of the trust. Thus, Tressie holds legal title to
the bonds “in trust” for the beneficiaries.
Beneficial title. Tressie’s two sons hold beneficial title. Only
they have the right to benefit from the interest and principal value
of the bonds.
Chapter 18, Exhibit 2b CCH Federal Taxation Basic Principles 9 of 58

10. Definition of Terms
Inter vivos trust. A trust created during the life of the grantor.
Testamentary trust. A trust created by the will of a decedent.
Chapter 18, Exhibit 3a CCH Federal Taxation Basic Principles 10 of 58

11. Definition of Terms
Simple trusts. The following characteristics are required:
(a) 100% of state law/accounting income must be
distributed currently. This term is explained later in
this chapter.
(b) None of the corpus,(often referred to as res or principal)
may be distributed.
(c) No charitable contributions may be made by the trust.
Complex trust. This is any trust other than a simple trust.
Chapter 18, Exhibit 3b CCH Federal Taxation Basic Principles 11 of 58

12. Definition of Terms
Grantor trust. This is any trust in which the grantor is the
constructive beneficiary. Income from the res of a trust that
constructively benefits the grantor is taxed to the grantor on
his/her personal return. The trust is disregarded for income tax
purposes.
Reversionary interest. If the grantor retains the remainder
interest, the interest is known as a reversionary interest. In
other words, the res, i.e., property, reverts to the grantor when
the trust terminates.
Chapter 18, Exhibit 3c CCH Federal Taxation Basic Principles 12 of 58

13. Definition of Terms
Beneficiary exposure. On certain fiduciary income, the
beneficiaries of these fiduciary entities, and not the fiduciary
(i.e., estate or trust), are personally subject to income tax.
Contrast with estate and gift taxes. Estate and gift taxes are
not income taxes. They are taxes on the transfer of assets from
one person to another. The donor or estate, not the recipient,
must generally pay the tax.
Chapter 18, Exhibit 3d CCH Federal Taxation Basic Principles 13 of 58

14. Computing Tax Liability—Fiduciary vs.
Nonfiduciary
Estates and Trust (Fiduciary) Individuals (Non-fiduciary)
Income “From Whatever Source Income “From Whatever Source
Derived,” including Income in Derived”
Respect of Decedent (IRD)
– Exclusions – Exclusions
– Cost of Goods Sold – Cost of Goods Sold
= Gross Income = Gross Income
– Deductions For AGI – Deductions For AGI
= AGI = AGI
Chapter 18, Exhibit 4a CCH Federal Taxation Basic Principles 14 of 58

15. Computing Tax Liability—Fiduciary vs.
Nonfiduciary
Estates and Trust (Fiduciary) Individuals (Non-fiduciary)
– Itemized Deductions – Greater Of:
(standard deduction. is not allowed)  Standard Deduction,
 Itemized Deductions
– Personal Exemptions: – Personal Exemptions
Estate: $600 total. $3,800 in 2012 per
Simple trust: $300 total. exemption
Complex trust: $100 total.
= Taxable Income Before Distribution
Deduction
Chapter 18, Exhibit 4b CCH Federal Taxation Basic Principles 15 of 58

16. Computing Tax Liability—Fiduciary vs.
Nonfiduciary
Estates and Trust (Fiduciary) Individuals (Non-fiduciary)
– Distribution Deduction: N/A
Lesser of:
(1) Distributed amount. (For
simple trusts, this is the
same as the trust
accounting income);
(2) Deductible “DNI.”
= Taxable Income = Taxable Income
x Fiduciary Tax Rate x Personal Tax Rates
(same for estates and trusts) (based on filing status)
= Gross Regular Tax Liability = Gross Regular Tax Liability
Chapter 18, Exhibit 4c CCH Federal Taxation Basic Principles 16 of 58

17. Computing Tax Liability—Fiduciary vs.
Nonfiduciary
Estates and Trust (Fiduciary) Individuals (Non-fiduciary)
– Credits & Prepayments (Apportioned – Credits & Prepayments
between fiduciary entity &
beneficiaries)
= Net Regular Tax Liability Or = Net Regular Tax Liability Or
Receivable Receivable
+ Alt. Min. Tax (If Any) + Alt. Min. Tax (If Any)
+ FICA Taxes + FICA Taxes
= Net Tax Due Or Refund = Net Tax Due Or Refund
Chapter 18, Exhibit 4d CCH Federal Taxation Basic Principles 17 of 58

18. Gross Income—Income in Respect of Decedent
Gross income (GI). GI for trusts and estates is similar to GI for
individuals, except for (1) income in respect of decedent (IRD) and (2)
property distributions to beneficiaries.
GI from income in respect of decedent (IRD). The gross income of an
estate or trust may include IRD that the entity received, if the property
from which the IRD is related has not been willed to a named
beneficiary. However, if a decedent’s will names an individual as heir
to specified property, then any IRD resulting from that property is
taxable to the individual, not to the estate or trust. IRD is all amounts to
which a decedent was entitled as gross income but which were not
includible in computing taxable income on the decedent’s final return.
For cash basis decedents, the income was earned but not received (e.g.,
payroll check). For accrual basis decedents, the income was not
properly accrued. Most decedents follow the cash basis of accounting.
Chapter 18, Exhibit 5a CCH Federal Taxation Basic Principles 18 of 58

19. Gross Income—Income in Respect of Decedent
Examples of IRD for Cash Basis Decedents:
Before Death: After Death:
Salary earned. Salary received.
Credit sales. Collection on A/R.
Gain on sale of property. Proceeds from sale received.
Rent accrued. Rent received.
Interest accrued on installment note. Interest received on installment note.
Cash dividends declared and recorded Cash dividends received.
(i.e., decedent was a stockholder on date
of record).
Chapter 18, Exhibit 5b CCH Federal Taxation Basic Principles 19 of 58

20. Income in Respect of Decedent—Tax Treatment
Double taxation. Income in respect of decedent (IRD) is
taxable as gross income to the recipient (i.e., estate or heir)
AND includible in the gross estate at asset value. Such
treatment may seem harsh. However, it is consistent with the
treatment of earned income for all taxpayers. For example, if a
taxpayer makes a cash gift derived from previously taxed
earned income, the cash gift would be subject to gift tax after
the appropriate exclusions.
Chapter 18, Exhibit 6a CCH Federal Taxation Basic Principles 20 of 58

21. Income in Respect of Decedent—Tax Treatment
IRD amount realized. IRD is valued at fair market value on
the date of death (or alternative valuation date).
Basis in IRD received by recipient. The basis of recipients
(i.e., estate or heirs) is the same as the decedent’s basis.
Gain or loss to recipient. Gain on IRD is taxable upon
receipt, on the difference between IRD value and IRD basis.
Character of gain or loss. Same as if recognized by the
decedent.
Chapter 18, Exhibit 6b CCH Federal Taxation Basic Principles 21 of 58

22. Income in Respect of Decedent—Tax Treatment
Deductions in respect of decedent (DRDs). DRDs are expenses
connected with IRD that were not reported on the decedent’s
final return.
(a) Examples. Examples include interest expense and state
income taxes, accrued but unpaid by decedent; and
fiduciary fees incurred after death but in connection with
IRD.
(b) Tax treatment. IRD expenses are deductible by both the
recipient and the estate. This slightly mitigates the double
taxation of IRD explained above. The deduction is for or
from AGI, depending upon the character of the related
IRD.
Chapter 18, Exhibit 6c CCH Federal Taxation Basic Principles 22 of 58

23. Gross Income—Property Distributions
Tax Treatment
An estate or trust may, from time to time, distribute property to a
beneficiary under the provisions of the will or trust document.
The tax treatment for property distributions depends on whether
the estate or trust elects to be taxed.
Chapter 18, Exhibit 7a CCH Federal Taxation Basic Principles 23 of 58

24. Gross Income—Property Distributions
Tax Treatment
(i) Property distributions WITHOUT election to be taxed. An
estate or trust does not recognize gain or loss upon its
distribution of property to a beneficiary under the provisions
of the will or trust document. The distributed property has the
same basis to the beneficiary as it did to the estate or trust.
(ii) Property distributions WITH election to be taxed. An
executor or trust can elect to recognize gain or loss on in-kind
property distributions (i.e., property specified in the will or
trust document for distribution). If the election is made, the
beneficiaries get a step-up basis equal to the FMV at date of
distribution.
Chapter 18, Exhibit 7b CCH Federal Taxation Basic Principles 24 of 58

25. Deductions—Depreciation and Depletion
General Rule. As a general rule, deductions for and from AGI are
treated the same as for individuals.
Postponed Loss Rules. Certain losses realized by the estate or trust
may be disallowed, as they are for individual taxpayers. Examples
include postponed losses under the Code Sec. 267 related party
rules, and postponed losses under the Code Sec. 1091 wash sale
rules.
Chapter 18, Exhibit 8a CCH Federal Taxation Basic Principles 25 of 58

26. Deductions—Depreciation and Depletion
Either an estate or trust may be entitled to a depreciation or
depletion deduction if it holds qualified property. Computations
are the same as for individuals. However, the special rules below
explain how much of a deduction can actually be taken by an
estate or trust.
Estates. The allowable deduction for depreciation or depletion
must be apportioned between the estate and the heirs on the basis
of fiduciary income allocable to each.
Chapter 18, Exhibit 8b CCH Federal Taxation Basic Principles 26 of 58

27. Deductions—Depreciation and Depletion
Trusts. Trusts are permitted greater flexibility than estates in
receiving depreciation and depletion deductions. A trust may
deduct depreciation or depletion from gross income to the extent
a reserve is required or permitted under the trust instrument or
local law, and income is set aside for the reserve and it actually
remains in the trust. Any part of the deduction in excess of the
reserve is then allocated between the income beneficiaries and
the trust in the same manner as with estates, i.e., on the basis of
the fiduciary income allocable to each. If all of the current
accounting income is distributed to the beneficiaries, e.g., in the
case of simple trusts, then the trust is not entitled to a
depreciation deduction.
Chapter 18, Exhibit 8c CCH Federal Taxation Basic Principles 27 of 58

28. Deductions—Depreciation and Depletion
Example: Determining the Trust Depreciation Deduction.
George creates a trust, naming Billy and Betty as income
beneficiaries. The property transferred to the trust is income
producing depreciable property. Pursuant to the trust instrument,
the income from the trust is to be distributed 60% to Billy and
40% to Betty. In addition, the trustee is permitted to set aside
income as a depreciation reserve. In the current year, depreciation
on the trust property amounts to $25,000, and the trustee allocates
$15,000 of trust income as a depreciation reserve. As a result, the
trust can claim a $15,000 depreciation deduction; Billy can claim
$6,000 ($6,000 = 60% x [$25,000 – $15,000]); and Betty can
claim $4,000 ($4,000 = 40% x [$25,000 – $15,000]).
Chapter 18, Exhibit 8d CCH Federal Taxation Basic Principles 28 of 58

29. Deductions—Capital Losses
Capital losses. Same treatment as for individual taxpayer. In
most cases, capital losses are allowable only on the fiduciary
income tax return, i.e., not on the estate tax return.
Chapter 18, Exhibit 9 CCH Federal Taxation Basic Principles 29 of 58

30. Deductions—Miscellaneous Itemized
Deductions
Assignment between entity and income beneficiary. As with
depreciation, the amount of fiduciary and other
miscellaneous itemized expenses deductible to an estate or
trust is based on the assignment of related income specified
in the trust instrument or by state law. Only the portion of
expenses related to income assigned to the estate or trust is
deductible by the entity.
Chapter 18, Exhibit 10a CCH Federal Taxation Basic Principles 30 of 58

31. Deductions—Miscellaneous Itemized
Deductions
Disallowed deductions. The portion of fiduciary and other
miscellaneous expenses attributable to tax-exempt income is
not deductible. Often this requires an allocation based on the
following formula:
(a) ÷ (b) x (c), where
(a) = Total expense;
(b) = Exempt income
(c) = Total accounting income (This is the amount that the
income beneficiaries of a simple trust are eligible to
receive from the entity.)
Chapter 18, Exhibit 10b CCH Federal Taxation Basic Principles 31 of 58

32. Deductions—Miscellaneous Itemized
Deductions
No 2% AGI floor. Fiduciary fees and other expenses that
would NOT be incurred by an individual taxpayer are NOT
subject to the 2%-of-AGI floor. All investment expenses are
subject to the tracing rules, i.e., any portion allocable to tax-
exempt income are not deductible. (Recall that miscellaneous
itemized deductions that could be incurred by an individual
taxpayer are subject to a 2%-of-AGI floor. These include
investment counseling fees and safe deposit boxes.)
Chapter 18, Exhibit 10c CCH Federal Taxation Basic Principles 32 of 58

33. Deductions—Casualty Losses and Charitable
Contributions
Casualty or Theft Losses. The tax treatment for these losses is the
same as for individual taxpayers.
 Election by executor. In some instances, casualty and theft losses
may be allowable deductions for either fiduciary income tax
purposes or estate tax purposes under Code Sec. 2054. In this
case, the fiduciary income tax deduction is NOT allowed unless
the executor elects to waive the estate tax deduction.
Chapter 18, Exhibit 11a CCH Federal Taxation Basic Principles 33 of 58

34. Deductions—Casualty Losses and Charitable
Contributions
Charitable Contributions. Bequests to qualified charitable
organizations are deductible from fiduciary gross income if the will
or trust instrument states that contributions are payable out of
income.
 No ceiling. The deduction is not subject to the usual
50%/30%/20% AGI ceilings for individuals, rather, 100% of the
estate income is deductible, regardless of the source (ordinary or
long-term capital gain) and regardless of the charity (public or
private).
Chapter 18, Exhibit 11b CCH Federal Taxation Basic Principles 34 of 58

35. Deductions—Casualty Losses and Charitable
Contributions
 Entire interest must be donated. The entire interest of the decedent in
the underlying property must generally be donated. Trust interests may
enable deductible transfers of partial interests in underlying property.
An inter vivos contribution (as opposed to a bequest) may result in
exclusion of the property value from the GE and a current deduction for
regular taxable income.
 Nondeductible if paid out of corpus. If contributions are paid out of
corpus, they are deductible for estate tax and NOT for fiduciary income
tax purposes.
 Complex trust characterization. If a trust makes a charitable
contribution, it is, by definition, a complex trust since simple trusts are
required to distribute all income currently and cannot set aside any
amount for charitable contributions.
Chapter 18, Exhibit 11c CCH Federal Taxation Basic Principles 35 of 58

36. Personal Exemptions
Allowable Amounts.
 Estates: $600
 Complex trusts: $100
 Simple trusts: $300
A personal exemption is not allowable for the year the
estate or trust terminates.
Chapter 18, Exhibit 12 CCH Federal Taxation Basic Principles 36 of 58

37. Distribution Deduction—Simple Trusts
Explanation of Distribution Deduction. Any trust, complex or simple,
or estate, is allowed a deduction for some or all of a distribution to an
income beneficiary (the “distribution deduction”). The income
beneficiary must report as gross income all or some portion of the
distribution.
Corporate Wages Analogy. Recall that a corporation is allowed a
deduction for employee wages; the employee receives gross income in
the form of compensation. To this extent, corporations and employees
are analogous to fiduciary entities and income beneficiaries. In the case
of the simple trust, the basic issue is the allocation of fiduciary income
between trust and beneficiaries.
Chapter 18, Exhibit 13a CCH Federal Taxation Basic Principles 37 of 58

38. Distribution Deduction—Simple Trusts
Steps in computing the distribution deduction:
1. Compute state law/accounting income;
2. Compute taxable income before the distribution deduction;
3. Compute distributable net income (DNI);
4. Compute the distribution deduction.
(Students may find the second and fourth steps to be conceptually easy;
the first and third steps conceptually difficult.)
Chapter 18, Exhibit 13b CCH Federal Taxation Basic Principles 38 of 58

39. The Distribution Deduction—
Step 1: Computing State Law/Accounting Income
This is the amount of income governed by state law that is used for
fiduciary accounting purposes. For simple trusts, it’s the amount
distributed to income beneficiaries. (Recall that a simple trust requires
current distribution of all its accounting income, while a complex trust
can accumulate income.)
Chapter 18, Exhibit 14a CCH Federal Taxation Basic Principles 39 of 58

40. The Distribution Deduction—
Step 1: Computing State Law/Accounting Income
Controlling the assignments to corpus and income.
State law governs what is principal and income of an estate or trust for
federal income tax purposes. However, many states have adopted the
Revised Uniform Principal and Income Act. The Act and state laws
provide that the estate or trust instrument controls how revenues and
expenditures will be assigned to corpus and fiduciary income. Thus, the
calculation of accounting income is virtually under the control of the
decedent (for estates) or grantor (for trusts), through a properly drafted
will or trust instrument. By allocating specific items of revenue and
expenditures either to corpus (i.e., accumulated income) or to income
beneficiaries (i.e., distributed income), the desires of the decedent or
grantor are put into effect.
Chapter 18, Exhibit 14b CCH Federal Taxation Basic Principles 40 of 58

41. Assignments to Corpus and Income—
Default Designations
State laws provide default designations in the event that
the will or trust instrument fails to assign revenue and
expenditures to corpus and income beneficiaries. Typical
default assignments are shown in the following slide.
Chapter 18, Exhibit 15a CCH Federal Taxation Basic Principles 41 of 58

42. Assignments to Corpus and Income—
Default Designations
Typical Assignments to Corpus and Income Beneficiaries.
Increasing Corpus Increasing Accounting Income
Proceeds from sale of rental property Rental income
Insurance proceeds for assets lost in casualties Insurance proceeds for lost profits
Nontaxable stock dividends Taxable stock dividends
Nontaxable stock rights Taxable stock rights
Liquidating dividends Cash dividends
Decreasing Corpus Decreasing Accounting Income
Principal payments on business loans Interest expense on business loans
Capital expenditures Depreciation
Fiduciary fees Rent collection fees
Federal and state tax on capital gains Federal and state tax on fiduciary income
Chapter 18, Exhibit 15b CCH Federal Taxation Basic Principles 42 of 58

43. Assignments to Corpus and Income—
Default Designations
Notes
These designations are provided for by the Revised Uniform
Principal and Income Act; however, they can be modified in a will
or trust instrument.
The net of increases and decreases to accounting income represents
the amount that the income beneficiaries of an estate or simple trust
are eligible to receive from the entity. It is often based on the
desires of the decedent or grantor rather than federal income tax
law. Therefore, entity accounting income does not affect the
determination of taxable income before the distribution deduction.
It does however, effect how much of a distribution deduction the
estate or trust is entitled to receive.
Chapter 18, Exhibit 15c CCH Federal Taxation Basic Principles 43 of 58

44. The Distribution Deduction—
Step 2: Computing Taxable Income Before
Distribution Deduction
Computation. These items are determined in much the same
way as for individual taxpayers:
Gross Income
Less: Exclusions
Less: Cost of goods sold
Less: Deductions for and from AGI
Less: Personal exemptions
Equal: Taxable income before distribution deduction
Chapter 18, Exhibit 16 CCH Federal Taxation Basic Principles 44 of 58

45. The Distribution Deduction—
Step 3: Computing Distributable Net Income
Function of Distributable Net Income (DNI). DNI is the
value necessary to determine any estate or trust’s distribution
deduction and therefore its taxable income for the year. It
serves two primary functions:
 DNI is the maximum amount of a distribution that is
taxable to beneficiaries.
 DNI is also the maximum amount that the estate or
trust can use as a distribution deduction for the year.
Chapter 18, Exhibit 17a CCH Federal Taxation Basic Principles 45 of 58

46. The Distribution Deduction—
Step 3: Computing Distributable Net Income
Formula for Computing DNI
Start with: taxable income before the distribution deduction
+ Personal exemptions (estates: $600, simple trusts: $300; complex trusts: $100).
+ Tax exempt interest, net of related expenses.
+ Net capital losses.
– Net capital gains allocable to corpus. (In other words, the only net capital gains
included in DNI are those attributable to income beneficiaries (or to charitable
contributions in the case of estates and complex trusts). Capital gains not included
in DNI will be taxable to the estate or trust.
= DNI
Chapter 18, Exhibit 17b CCH Federal Taxation Basic Principles 46 of 58

47. The Distribution Deduction—
Step 3: Computing Distributable Net Income
Observation
Since taxable income before distribution deduction (TIBDD)
is computed by deducting all of the allowable deductions
(whether allocated to corpus or entity accounting income),
these items must be “purged” from TIBDD to arrive at DNI.
The effect is to decrease the taxable income of the
beneficiaries. The actual distribution to the beneficiaries
may exceed DNI because the distributions are not reduced
by expenses allocable to corpus.
Chapter 18, Exhibit 17c CCH Federal Taxation Basic Principles 47 of 58

48. The Distribution Deduction—
Step 4: Computing the Distribution Deduction
Computation
Distributable net income (DNI) includes the net tax-exempt
income of the trust or estate. That amount must be removed
from DNI in computing the distribution deduction.
Computation of distribution deduction:
DNI - net tax exempt income.
Chapter 18, Exhibit 18 CCH Federal Taxation Basic Principles 48 of 58

49. Computing Taxable Income of Simple Trusts—Example
FACTS: The Caligari trust is required to distribute its
current accounting income annually to its two beneficiaries,
Bob and Bertha. Capital gains and losses and all other
expenses are allocable to corpus, pursuant to the trust
instrument. No provision is made for depreciation in the
trust instrument. Therefore, it will follow income. During
the taxable year, the Caligari trust incurs the following
items:
Chapter 18, Exhibit 19a CCH Federal Taxation Basic Principles 49 of 58

50. Computing Taxable Income of Simple Trusts—Example
Rental income $250,000
Rental expenses 80,000
Depreciation on rental property 70,000
Dividend income 60,000
Taxable interest income 50,000
Tax-exempt interest income 40,000
Net long-term capital gains 30,000
Fiduciary fees 20,000
Chapter 18, Exhibit 19b CCH Federal Taxation Basic Principles 50 of 58

51. Computing Taxable Income of Simple Trusts—Example
QUESTIONS:
(1) Determine trust accounting income.
(2) Determine taxable income before the distribution deduction.
(3) Determine DNI.
(4) Determine distribution deduction.
(5) Determine taxable income to the Caligari trust.
Chapter 18, Exhibit 19c CCH Federal Taxation Basic Principles 51 of 58

52. Computing Taxable Income of Simple Trusts—Example
Item Totals Step 1: Step 2 & 5: Step 3 & 4:
Accounting Taxable Income (TI) Before DNI &
Income & After Distrib. Deduction Distribution
Deduction
Rental income 250,000 250,000 * 250,000
Rental expenses 80,000 (80,000) (80,000)
Depreciation on 70,000 0 0
rental property (Amount is not (Deduction is available only
a distributable to beneficiaries since no
item) accounting income is
accumulated.)
Dividend income 60,000 60,000 * 60,000
Taxable int. inc. 50,000 50,000 * 50,000
Tax-exempt 40,000 40,000 * 0
interest income (since tax-exempt)
Chapter 18, Exhibit 19d CCH Federal Taxation Basic Principles 52 of 58

53. Computing Taxable Income of Simple Trusts—Example
Item Totals Step 1: Accounting Step 2 & 5: Step 3 & 4:
Income Taxable Income (TI) Before & DNI & Distribution
After Distrib. Deduction Deduction
Net long-term capital gains 30,000 0 30,000
(Allocable to corpus,
not income)
Fiduciary fees 20,000 0 (18,000 )
(Allocable to corpus, (20m-2m, where 2m =
not income) 20m x [40m÷400m*])
Acctg. Income 320,000
Exemption (300) (for simple trusts)
Taxable inc. before 291,700 ⇒⇒ ⇒⇒ 291,700
distribution. ded.
Exemption 300
Corpus capital gain/loss (30,000)
Chapter 18, Exhibit 19e CCH Federal Taxation Basic Principles 53 of 58

54. Computing Taxable Income of Simple Trusts—Example
Item Totals Step 1: Step 2 & 5: Step 3 & 4:
Acctg. Taxable Income (TI) Before & DNI & Distribution Deduction
Income After Distrib. Deduction
Addback: “Net” 38,000
tax-exempt interest (40m-2m)
income [$2m fid. exp. is related to tax exempt
income]
DNI 300,000
Less: “Net” tax- 38,000
exempt interest (40m-2m)
income [$2m fid. exp. is related to tax exempt
income]
Distribution ded. (262,000) ⇐⇐ 262,000
Taxable income 29,700
* These income elements of trust accounting income are used to allocate fiduciary expenses
between deductible and nondeductible portions.
Chapter 18, Exhibit 19f CCH Federal Taxation Basic Principles 54 of 58

55. Computing Taxable Income of Simple Trusts—Example
Notes
1. Trust Accounting Income, $320,000. This includes the tax-exempt interest income,
but not the fiduciary fees or capital gains, since, pursuant to the trust document, they
are assigned to corpus. Bob and Bertha receive $160,000 each from the trust for the
current year.
2. Taxable Income Before The Distribution Deduction, $291,700. This amount is
computed as directed by the Code. Tax-exempt interest is excluded under Code
Sec. 103. The trust properly does not deduct any depreciation for the rental
property. The depreciation deduction is available only to the recipients of the
Caligari trust’s accounting income for the year. Thus, the deduction will be split
equally between Bob and Bertha. Only a portion of the fiduciary fees are deductible
because some of the fees are traceable to the tax-exempt income.
Chapter 18, Exhibit 19g CCH Federal Taxation Basic Principles 55 of 58

56. Computing Taxable Income of Simple Trusts—Example
3. DNI, $300,000. This amount reflects the required adjustments.
4. Distribution Deduction, $262,000. The distribution deduction is the lesser of the
distributed amount, $320,000, or the deductible portion of DNI, $262,000. This
represents both a deduction to Caligari trust and gross income to Bob and Bertha
($131,000 each).
5. Taxable Income Of Caligari Trust, $29,700. This amount can be verified by a quick
check. Caligari has distributed all of its taxable income to Bob and Bertha except
the $30,000 capital gain. The $300 exemption reduces taxable income to $29,700.
Chapter 18, Exhibit 19h CCH Federal Taxation Basic Principles 56 of 58

57. Filing Requirements for Estates and Trusts
Estates Trusts
Minimum Gross Income Filing Gross income Gross income (GI)
Requirements ≥ $600 ≥ $600
Minimum Taxable Income Only gross income ≥ $600 Any taxable inc. requires filing,
Filing Requirements requires filing. even if GI < $600
IRS form for reporting income Form 1041 Form 1041
estate/trust income
IRS form for reporting estate Form 706 N/A
tax
Filing deadline for trust income 3-1/2 months after taxable 3-1/2 months after taxable
tax year-end year-end
Filing deadline for estate tax 9 months after death N/A
Chapter 18, Exhibit 20a CCH Federal Taxation Basic Principles 57 of 58

58. Filing Requirements for Estates and Trusts
Estates Trusts
Tax year Calendar or fiscal Calendar only
Accounting method Cash or accrual Cash or accrual
Standard deduction Not available Not available
Personal exemptions $600 $300
(simple trust)
$100 (complex trust)
Chapter 18, Exhibit 20b CCH Federal Taxation Basic Principles 58 of 58