Form 1041 for simple estate says taxes are due. Can the estate pay the tax if the income has not been distributed, avoiding K-1 to beneficiaries?

[tagteam · Accepted solution]

"Can the estate pay the tax if the income has not been distributed, avoiding K-1 to beneficiaries?"

It cannot do so and also be in strict compliance with the Internal Revenue Code and Treasury Regulations. 

Income for the taxable year that is required to be distributed currently to the beneficiary(ies) is included in the gross income of the beneficiary(ies) whether it is actually distributed or not. See IRC §662(a)(1), Treas. Reg. §1.662(a)-2

[note that the IRS is probably not going to put up a huge fuss if an estate or trust insists on paying income tax at the ridiculously compressed tax rates applicable to those entities if income was not distributed but retained. However, handling the affairs of an estate or trust in such a manner is neither in compliance with the tax law nor with a will or trust instrument that requires income to be distributed currently]

[2davidc8]

OK, I understand that Income for the taxable year that is required to be distributed currently to the beneficiary(ies) is included in the gross income of the beneficiary(ies) whether it is actually distributed or not.  But what if there is no timetable for the distribution to beneficiaries specified in either the will or the trust, and the income is not necessarily required to be distributed in the tax year in question?  Can the estate pay the tax, and later distribute the income to the beneficiaries?

[tagteam]

Yes, but you have to understand that a distribution will carry out DNI (distributable net income).

To the extent that income is taxable, it will appear on the beneficiaries' K-1s and will be included in their gross income.

[2davidc8]

Ah, but the bulk of each beneficiary's distribution consists of inheritance (basis?), which is not taxable.  What is taxable is the income generated by the estate after the date of death.  I plan to pay the taxes on this income, then distribute the remainder to the beneficiaries.  I understand that I will be paying higher taxes this way, because the estate rate is higher, but that's how everyone wants it.  This way, I will not have to deal with K-1's.  Is this OK?

[tagteam]

The distributions will carry out DNI, regardless, but the IRS is not going to dispute the methodology used where taxes are paid at a higher marginal rate.

[2davidc8]

Hi @tagteam
Sorry, due to personal issues, I've not followed up til now.  I'm ready to resume.  If you're still following this tread, may I ask:
The cost basis of assets are NOT part of DNI, right?  That is, DNI (that is distributed to beneficiaries) consists only of gain (capital gains, interest, dividends, and such), correct?
Thanks for your attention and time!

[tagteam]

You are essentially correct (cap gains usually excluded, but can definitely be included under certain circumstances consistent with law and the trust doc) and that term (DNI) is defined in the Internal Revenue Code.

See https://www.law.cornell.edu/uscode/text/26/643#

[2davidc8]

@tagteam Thank you so much for your help!