As the close of 2014 neared, many estate planners and their clients were probably getting nervous about what moves they needed to make before end of year. With the holidays at hand, December was not an especially propitious time to be executing, for example, distributions from trusts.
Fortunately, there’s a fair amount of leeway for many of these transactions. The so-called 65-day rule — originally enacted as part of the Taxpayer Relief Act of 1997 — allows some trust distributions to be made into the New Year and still apply toward 2014.
It’s important for clients to recognize the benefits of this provision, not just before the tax year ends but into the first couple of months of the New Year, when they can still make changes that will affect their 2014 planning. Clients who are considering setting up a trust may also want to be apprised of the flexibility they can potentially have.
One especially useful tax planning strategy for trustees of irrevocable trusts is to make distributions to trust beneficiaries who are in lower income tax brackets. For a non-grantor trust, the portion of annual income retained in the trust is taxed to the trust.
If that income is distributed to the beneficiaries, those beneficiaries are taxed on that income. Capital gains are generally taxed as part of the trust whether or not the proceeds are distributed to the beneficiary.
This is particularly important because trusts have such compressed income tax brackets. The graduated tax rate for a non-grantor trust reaches the highest possible marginal tax rate of 39.6 percent at just $12,150 of taxable income, at 2014 rates. The 3.8 percent Medicare surtax applies to this income as well, so the total marginal tax charged to the trust would be 43.4 percent.