Dividends discrepancy on K-1

[Anonymous_]

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@Steelydan989 wrote:

If this is the case, how is the benefit of the capital losses ever realized?

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You cannot pass net capital losses through to the beneficiary(ies) until such time as the trust is terminated and a final return is filed; they are carried forward.

The carryover capital losses will then appear on Line 11 of the K-1(s) as final year deductions.

[Steelydan989]

There's still something I don't understand about what you're saying. Per the trust, I may pay out income to the beneficiary but do not have to and can pay out any amount. Why can the taxable income in the trust ($41,000 in my example) not be reduced by the loss carryover first and the remainder paid to the beneficiary? I'm not suggesting I pass the loss onto the beneficiary. Looking at my example, I'm suggesting I pay out $38,000 to the beneficiary (who will pay the tax on it), leaving no taxable income in the trust, as it was reduced by the loss carryover. What is the problem with this scenario?

[Anonymous_]

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@Steelydan989 wrote:

What is the problem with this scenario?

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There is an order of precedence (priority) in the taxation of trusts and estates. To the extent you make a distribution, DNI is carried out (pass through to the beneficiary(ies)). You cannot use an offset and also get an income distribution deduction in the manner you proposed.

[Anonymous_]

I am not sure if the Regulation will help, but the link appears below.

https://www.law.cornell.edu/cfr/text/26/1.643(a)-3

[Steelydan989]

Ok, I do think I understand now. Thank you for your time and explanation. Very much appreciated.

[Steelydan989]

I'm back with another question about this. I pay out all income to the beneficiary each year. If I cannot offset that income with the loss carryover, what happens to any loss carryover each year? When I complete the 1041, taxable income turns out to be a loss ($3,000 carryover plus $100 exemption). What then happens with this loss?

[Anonymous_]

The loss will be carried forward by the program.

[Steelydan989]

If we were talking about a 1040, a $3,000 loss carryover would reduce the taxable income and the capital loss carryover worksheet would calculate the new loss carryovers next year. Here we're talking about a 1041 where the trust has short and long term capital losses being carried over from last year. If the $3,000 loss carryover isn't being used to reduce taxable income now, what effect does it have on the 1041 and how does it affect the things going forward? You say it will be carried forward by the program. Where is it being carried forward to?

[Anonymous_]

It will be carried forward to the following tax year. Enter Forms Mode and look at the carryover worksheet.

[Steelydan989]

Turbotax is showing a negative taxable income of ($3,100) on Form 1041, Line 23. This is due to a $3,000 loss carryover plus $100 exemption from Line 21, having paid out income to the beneficiary. What effect does a negative taxable income have? Who benefits from this "credit" and how (given that the taxable income paid to beneficiary doesn't get reduced by the loss carryover)? The Capital Loss Carryover Worksheet shows that the loss carryover to '22 is reduced but how does the ($3,100) affect '21 taxes, whether the trust's or the beneficiary's?

[Anonymous_]

What you are seeing is a math issue, nothing more. 

The figure is irrelevant unless the entity has an NOL (which it certainly does not).

[Steelydan989]

So why include it on the tax return if it reduces the loss carryover each year but doesn't get utilized in any way?

[Anonymous_]

Did you look at the worksheet? The loss is carried forward in full.

[Steelydan989]

Okay, yes I see now. Thank you again for your help.

[jtax]

One thing you could do as trustee (using your example of $41k in dividends and a $3k capital loss) is not to distribute $41k (if the trust instrument gives you that discretion) in that tax year. Instead distribute $38k or something less. Say $38k. That gives the trust (assuming no other deductions)  $3k of dividend income and the bene $38k of dividend income. At the trust level the $3k loss would wipe out the tax.

The next year, if the trust instrument/state law allow you to distribute more than taxable income (e.g. principal or even maybe even trust accounting income (if defined usefully) or the ability to make an allocation from principal to income), you could distribute the $3k from the prior year along with any dividends. The $3k would be (for 1041/tax purposes) considered principal and would not be taxed.

In fact if you have enough discretion as trustee look at filling to fill the lowest trust bracket with income. Especially to the extent the income is long-term capital gain or qualified dividends. For 2021 up to $2650 of LTCG/qual div for trusts is taxed at 0%! If that is less than the bene's rate (0% up to $40k single/$80 married) it can be worth doing. admittedly it is a small optimization.

[Note that LTCG/Qual divs to be taxed @ 0% are the last income that counts in that bracket. So for a trust in 2021 if you had $1k of ordinary divs and $2650 of qual divs, only $1650 of the qual divs would be taxed @ 0%. The rest would be taxed @ 15%. Take a look at 1041 Schedule D part V (lines 30 and 37 and what goes into them).

Also not that most trusts and state law allocate capital gains to stay with the trust. But not all do. A trust can allocate capital gains to a bene. You just have to have the authority and be consistent. Particularly in the modern age of total-return investing with low dividends and high capital gains, it is very reasonable (perhaps necessary) to think that way.