Life and Death Planning for Retirement Benefits

Chapter 7: Charitable Giving

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§ 662 . The amount the trust or estate can deduct is limited to the amount of its “distributable net income” or “DNI.” § 651 , § 661 . Because of this limitation, the deduction is often called the “DNI deduction.” See ¶ 6.5 for more discussion. Here are the DNI rules that particularly affect retirement benefits payable to a trust with one or more charitable beneficiaries:  There is no DNI deduction allowed for a distribution from an estate or trust to a charity , although a distribution to a charitable remainder trust may be eligible for the DNI deduction. See ¶ 7.4.02 .

 A distribution to a charity (but not to a charitable remainder trust) from an estate or trust is deductible, if at all, only as a charitable deduction. See ¶ 7.4.03 .

 Under the “ separate share” rule of § 663(c) , the gross income that results when a trust receives a distribution from a retirement plan might have to be allocated among all of the trust’s residuary beneficiaries, even if the trust instrument gives the trustee the power to pick and choose which beneficiary receives which asset. See ¶ 7.4.05 . Another tax the trust must contend with is the 3.8 percent additional income tax on the trust’s undistributed net investment income (NII), sometimes called the net investment income tax (NIIT). The tax is imposed on the recipient’s income of a certain type, namely “investment income” (interest, dividends, gains, etc.) if the recipient’s income exceeds certain thresholds. Retirement plan distributions are exempt from this tax, but taxable distributions from retirement plans (because they go into the recipient’s gross income) do count for purposes of determining whether the recipient’s adjusted gross income exceeds the applicable threshold. The NIIT “threshold” for individuals ($200,000 for single, $250,000 if married filing jointly) is much higher than the threshold for trusts and estates ($12,300 as of 2015). However, a trust is liable for the tax only on its undistributed NII, while for individuals, the tax applies to the lesser of the individual’s NII or the individual’s adjusted gross income in excess of a certain threshold, with no option to reduce the tax by somehow “distributing” the NII to another taxpayer. Since the trust pays NIIT only on its undistributed NII (a term not defined in the Code), the IRS had to create a system for determining which distributions from the trust would “carry out” NII. In Reg. § 1.1411-3(e)(3) , the IRS provides that a distribution to noncharitable beneficiaries would carry out NII using a proportionate rule. Whatever percentage of the trust’s DNI consisted of investment income or exempt income ( e.g. , a retirement plan distribution) that percentage would apply for purposes of determining the NIIT consequences also. Using that principle, one would conclude that if a nongrantor trust received (for example) a $10,000 taxable IRA distribution (NIIT-exempt) and $10,000 of ordinary dividends (subject to NIIT) as its only gross income for the year, and the trust distributed (say) $10,000 to its only beneficiary, the distribution would be deemed to consist equally of NII and NIIT-exempt income. The beneficiary would therefore have to report $5,000 of NII attributable to this distribution, leaving the trust with the other $5,000 of NII to report on its fiduciary income tax return. For how distributions to charity do or do not carry out the trust’s NII, see the next Section.