Life and Death Planning for Retirement Benefits

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Life and Death Planning for Retirement Benefits

and $10,000 of bank interest. The trustee distributes $35,000 to the daughter and $100,000 to Charity Y. Here’s how Steve’s trustee will report these transactions on the trust’s tax return for Year 1:

Gross income: $100,000 IRA distribution plus $10,000 taxable interest = $110,000

DNI: $100,000 IRA distribution plus $10,000 taxable interest plus

$25,000 municipal bond interest = $135,000

The trustee would like to allocate the $100,000 of taxable IRD to the charity and allocate to the daughter $25,000 of tax-exempt interest and $10,000 of taxable interest. That way, the trustee hopes, the trustee would get a $100,000 charitable deduction for the distribution to Charity Y and a $35,000 DNI deduction for the distribution to the daughter, and the daughter would pay tax on only $10,000 because $25,000 of her distribution would be tax-exempt interest. But the trustee will find it doesn’t work that way. The governing instrument’s requirement that the Charity Y’s bequest be paid out of “income” (namely, the IRA distribution) is respected. Thus, the charity is deemed to have received its $100,000 from the trust’s income, and that requirement of § 642(c) is met. However, the governing instrument’s requirement that the charity be paid “first” out of the IRA proceeds means that the allocation of a particular class of income (in this case IRD) to the charity does not have any economic effect independent of income tax consequences. The charity is to receive no more or less than $100,000 from the trust, regardless of the IRA value and regardless of how much gross income the trust has. Accordingly, the IRD, along with all other classes of the trust’s income, must be allocated pro rata to both of the beneficiaries. The proportion of tax-exempt income to the trust’s total income is $25,000/$135,000. Thus, $18,518 of the $100,000 distributed to Charity Y is deemed to come from the trust’s tax-exempt income and the trust does not get a charitable deduction for that portion. The trust’s charitable deduction is limited to the $81,481 that is deemed to have been distributed to the charity out of “income” that is includible in “gross income” for federal income tax purposes. The daughter is deemed to have received $6,481 of tax-exempt income and $28,519 of taxable income, some of which is IRD. So the trust’s DNI deduction is only $28,519. Thus the trust’s taxable income is:

Gross income

$110,000

Less: Charitable deduction and

$81,481 $28,519

DNI deduction

Equals taxable income

Zero