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seadrag76
Level 1

Distribution to the beneficiary

I'm stuck in discretionary distribution as TurboTax stated from the following link.  https://turbotax.intuit.com/tax-tools/tax-tips/IRS-Tax-Forms/What-is-a-Schedule-K-1-Form-1041--Estat....  The link stated that "If the income distribution is discretionary, meaning the trustee or estate administrator has authority to decide whether beneficiaries will receive distributions, the payments aren’t deductible on 1041 and are not reported on Schedule K-1. The trust or estate is responsible for paying the income tax on these distributions, not the beneficiaries."

However, my accountant insisted that no matter the character of the distribution, if the trustee distributed to the beneficiary, then it will be taxable on beneficiary's individual tax return.  Is this correct?

1 Best answer

Accepted Solutions
dmertz
Level 15

Distribution to the beneficiary

The FAQ appears to be wrong.  Distributions from the estate to beneficiaries come first from the income received by the estate during the estate's tax year (Distributable Net Income or DNI).  Any amount of taxable DNI required to be distributed currently (tier 1) plus any additional amounts of income actually distributed (tier 2) to beneficiaries are reported as an income distribution deduction on the estate's tax return and are reported via the Forms K-1 to beneficiaries for taxation on the beneficiaries' individual tax returns.  The income is only taxed once, either on the estate's income tax return because income not required to be distributed was retained, or on the beneficiaries' tax returns because the income was distributed or required to be distributed.

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27 Replies
dmertz
Level 15

Distribution to the beneficiary

The FAQ appears to be wrong.  Distributions from the estate to beneficiaries come first from the income received by the estate during the estate's tax year (Distributable Net Income or DNI).  Any amount of taxable DNI required to be distributed currently (tier 1) plus any additional amounts of income actually distributed (tier 2) to beneficiaries are reported as an income distribution deduction on the estate's tax return and are reported via the Forms K-1 to beneficiaries for taxation on the beneficiaries' individual tax returns.  The income is only taxed once, either on the estate's income tax return because income not required to be distributed was retained, or on the beneficiaries' tax returns because the income was distributed or required to be distributed.

seadrag761
New Member

Distribution to the beneficiary

I appreciate your answer.  I'm stuck in another situation.  What if the estate and trust distributed property to the beneficiaries?  Should the beneficiaries also recognize capital gain in their Sch. K-1?

In brief, the trustee accidentally put property in its management company's QB (3 trust are the partners of this management company and they are the only partners), but the actual investors are the beneficiaries and not the management company.  Accordingly, the accountant recognize this as property distribution to the beneficiary, but when I file 2014 1041, I did not enter the distribution (property distribution) since it was mistakenly entered in management QB.  Was this a wrong tax treatement?  Thank you for your answer!!
dmertz
Level 15

Distribution to the beneficiary

Form 1041 is an estate *income* tax return.  Distributions of corpus are only included on the Schedule B line 10 to ensure that amounts distributed are treated as first coming from DNI.  Distributions of corpus are not reported on Schedule K-1 (Form 1041); Schedule K-1 reports the the beneficiaries the beneficiaries share of the items that must be reported on the beneficiaries' individual tax return, i.e., estate income, deductions and credits.

seadrag76, if the property was owned directly by the individuals and not by the estate/trust, what does the trustee have to do with this property?  If the property is not part of the estate/trust, it seems that the trustee simply make a bookkeeping error that needs to be corrected and the estate/trust did not receive or distribute any income having to do with this property.
seadrag761
New Member

Distribution to the beneficiary

I think I get the point.  Each trust (three trusts total) directly owned the property, in which the trustee invested in 2013 in the name of each trust.  Accordingly, each trust has to keep tracking of its FMV to recognize gain or loss in the future and that is why the property distribution should be not included in beneficiaries' Schedule K-1.  Am I understanding correctly?
dmertz
Level 15

Distribution to the beneficiary

If the trusts own the property and the property was never sold by the trusts, the trusts did not realized any capital gains or losses from the property that need to be passed through to the beneficiaries of the trust.  If the trust distributed the property to the beneficiaries, the distribution would not be taxable income to the beneficiary and would not be included on the Schedule K-1.  I'm not particularly familiar with such transactions, but I believe that the trust's cost basis in the property generally transfers to the beneficiary along with the property.  This cost basis would be used to determine the capital gain or loss reportable by the individual when the property is sold by the individual.

Given the complexities of trusts, it might be best to have this gone over by a local tax professional.  This is getting way off of the topic of the original question here.
intothenight65
New Member

Distribution to the beneficiary

So, as the "personal representative" of my parent's estate, there was income into the estate by sale of stocks.  Does that mean I have to file a tax return for the estate due to the income, then once distributed, that same money is taxed a second time on the individual basis?
vendor
New Member

Distribution to the beneficiary

Unsure of the tax law for discretionary income distributions, but the majority of the trusts I have seen which allow for discretionary payments of principal  also require distribution of all income.   Maybe that's not your situation, but if it is, the distribution should be deductible by the trust to the extent that it is from income which the beneficiary is entitled to.   If indeed distribution of income is discretionary and taxed at the trust level regardless of whether or not it is distributed, which I think is correct,  it would seem to be trust principal at at point.  As a lay trustee of various trusts, I can't recall every observing my CPAs charging the beneficiary with income if it was principal they received rather than distributable net income. I would get a second opinion if I were you!
wlee1120
Level 2

Distribution to the beneficiary

@dmertz 

Following your response that distribution from a trust principal is not reported on Schedule K-1...  I thought the trust needs to inform the IRS who it distributed principal to and how much.  If so, where is it reported if not on Schedule K-1?  By the way, in my process of completing the tax return for the trust and the schedules K-1, I noticed an entry on the K-1 for AMT adjustment.  Does this take care of the distributed principal?

Thanks

dmertz
Level 15

Distribution to the beneficiary

"Following your response that distribution from a trust principal is not reported on Schedule K-1"

 

The Schedule K-1 reports items of income, deductions and credits that are necessary for the beneficiary to complete the beneficiary's tax return.  Nontaxable amounts distributed are not reportable on the beneficiary's tax return.

wlee1120
Level 2

Distribution to the beneficiary

@dmertz 

Does this mean the principal in an irrevocable trust is not considered a taxable income for the beneficiary regardless of the amount?

 

 

dmertz
Level 15

Distribution to the beneficiary

The only amounts that are taxable income to the beneficiary are those that would be taxable to the trust if they were retained by the trust instead of being distributed.

vstar58
Level 2

Distribution to the beneficiary

Reading through this thread I get partial answers.  I'm dealing with an irrevocable trust and understand that if any current year income is distributed, it is reported on a K1 and the beneficiary has to report it on their taxes and pay tax.  I also understand that if trust principal is distributed, it is at the discretion of the trustee and that this is not taxable to the beneficiary since tax has already been paid on this money.  The definitive answer I'm looking for is (1) does the trust have to report a distribution of principal and if so, on what form and (2) does the beneficiary have to report the distribution of principal and if so, where on form 1040?  Someone answered schedule B, line 10 but that is obviously incorrect as there is no line 10.  If anyone can answer, I would appreciate it, thanks. 

dmertz
Level 15

Distribution to the beneficiary

Line 10 of Schedule B (Form 1041), not Schedule B (Form 1040).

vstar58
Level 2

Distribution to the beneficiary

Thanks for the quick reply, duh, I misread, you clearly responded form 1041.  Looking at this form, I assume distribution of principal qualifies as "other amounts".  So does the beneficiary report anything?  One other question that I believe is obvious but will ask anyway, if current year income is distributed and a K1 is issued for that amount, does the money actually have to be paid/transferred to the beneficiary or can the beneficiary elect to leave it in the trust, even though they are responsible for paying the tax?  Many thanks.

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