Trusts typically have the highest marginal tax rates in the United States tax system, but there are ways to save through good tax planning and thoughtful timing. One very important date for a tax-saving opportunity is fast approaching, and the holiday I use to remind myself to look into capitalizing on it every year happens to be Valentine’s Day.
March 6, 2022, is the deadline to make distributions to beneficiaries under the “65-day rule” to avoid the much higher trust income tax rates, and if you want to take advantage of it, you should get started soon. It is generally advantageous to have trust income taxed to the individual beneficiaries whenever possible. And the 65-day rule can help with that. (Note that this article pertains to those with non-grantor, typically irrevocable trusts that are subject to income tax.)
How the 65-Day Rule Works
Many times when we think back on our lives, we wish we had a “do over.” Internal Revenue Code (“IRC”) section 663 (b) provides just that. IRC section 663 (b) simply provides that a distribution from a trust or an estate within the first 65 days of the tax year can be made effective as of the last day of the preceding tax year. For example, a distribution of trust income by the trustee to a beneficiary made as late as March 6, 2022, can be treated for income tax purposes as if it had been made on the last day of 2021.
Why do we care? The primary advantage is a unique (and often overlooked) opportunity for income tax savings. A trust, an estate or an individual all pay income under graduated rates up to a maximum rate of 37%. For 2021 this top rate for individuals is triggered only when incomes surpass $628,300 for married taxpayers, or $523,600 for singles (for 2022 the limits are $647,850 and $539,900 respectively). For a trust or an estate, however, for 2021 the top marginal tax rate is triggered with any income above just $13,050 (for 2022 it is just $13,450). To throw salt on the wound, an additional 3.8% Medicare surtax may also apply to a trust or an estate, creating an effective marginal tax rate of 40.8%.
There’s a way to avoid that high trust tax rate, though. Non-grantor trusts are taxed on retained income at the year end. Trusts can use an income distribution deduction, so income distributed to a beneficiary is deducted from the trust’s taxable income. This effectively passes the tax liability for the income from the highly taxed trust to the individual beneficiary, who is taxed at a much lower marginal rate.
Read the entire article at: https://www.kiplinger.com/retirement/estate-planning/604201/this-valentines-day-think-trust-income-tax-savings