Should a complex trust take a $100 or $300 exemption?

[hntrust]

A trust was originally written as a complex trust since trustee had discretion to distribute income and principal or add it back into the trust corpus. As a result of litigation, trustee is now required by a settlement agreement to distribute 3% of trust value each year. This means all of the income and principal (if interest does not cover the 3% payout) will be distributed. Does the trust take a $100 or $300 exemption on the 1041?

[tagteam · Accepted solution]

" This means all of the income and principal (if interest does not cover the 3% payout) will be distributed."

A trust whose governing instrument requires that all income be distributed currently is allowed a $300 exemption, even if it distributed amounts other than income during the tax year. 

See https://www.irs.gov/instructions/i1041/ch02.html#d0e3675 and IRC §642(b)(2)(B)

Since the "governing instrument" now appears to be a settlement agreement that requires all income be distributed currently, the trust should be entitled to the $300 exemption.

[jtax]

Possibly an interesting question is whether requiring a fixed percentage distribution is the same as requiring all income to be distributed. What if the trust earns 5% in one year (sells a stock) but only distributes the required 3%. I'm not sure it is now a simple trust.

[tagteam]

Interesting and possibly **moot** for a couple of reasons. First, if all of the income plus some principal is being distributed, the exemption does not even factor into the equation; there is no income/gain left to be offset.

Second, capital gain/loss typically remains with the trust so a big gain in one year (i.e., the trust earns 5% including a sale of stock), could still mean that the trust is technically distributing all of its income (interest, dividends, et al).

Regardless, this is most likely going to be moot in most tax years since the amount of the exemption will not come into play as a result of the trust being forced to make (probably) larger than anticipated distributions.

[jtax]

True on the capital gains (depending upon the trust instrument and the state's principal and interest statue and the trustees ability and decision to allocate capital gains to income as is being done more and more given the net investment income tax). But still, perhaps the trust earns 5% or 4%, then it is an issue. If it weren't an issue, why ask the question? But these are small amounts not likely to be material.