A previous trustee embezzled $1 million of corpus that was meant to be distributed tax-free to beneficiaries. Can future income be offset by the stolen amount?

[tax-numbers]

Yes, the trustee went to prison and a new trustee was appointed. The trust continues to receive income. Currently the interest received is taxable to the beneficiaries on a K-1. But since the beneficiaries were deprived of future non-taxable distribution of corpus, it seems unfair that any trust interest income should be taxable to them. Future income will never make up for the stolen money. Is there a workaround?"

[ScruffyCurmudgeon]

This is another case where the Tax Act of 2017, TCJA, effective for 2018, eliminated the tax deductibility of casualty losses such as the theft you mention.

This deduction used to cover a pretty wide-ranging set of circumstances, but that changed with the passage of the Tax Cuts and Jobs Act (TCJA) in December 2017. Beginning with tax year 2018 and through tax year 2025, you can only deduct casualty and theft losses if they're brought about due to an event that's been declared a disaster by the U.S. president.

You can still claim these losses on your 2017 Trust tax return, however, if you amend it—even without a presidential declaration.  So if the theft occurred in 2015-2017, you can file an amended return to reduce tax paid that year of theft [2015 if ame'nded before 4/15/2017].

[tax-numbers]

Good info. Now I wonder if date of loss can be the date of conviction, which was in 2016. Discovery of theft was 2014. I guess a legal opinion would be in order. It's interesting that IRS does not have any documentation regarding trust assets for a 1041 return, but for a 1120 corporate return there is a balance sheet. Considering that the trust will terminate in 2026 when a note becomes due, it seems prudent to make the loss amount large enough to cover anticipated income. The red flag for a $60,000 loss carried forward should be much smaller than flashing the million dollar amount.

[ScruffyCurmudgeon]

Casualty losses by regulation are of the date when finally a valuation of loss is realized.  Sounds like 2016 since it would be then it was clear no recovery possible.