Your client's mother left a trust that earned $48,000 by year-end. The trustee asks who pays the tax. The answer depends on whether the trust is simple or complex, how much was distributed, and whether grantor trust rules override everything.
HIGH-FREQUENCY: The simple/complex/grantor distinction drives nearly every trust tax question.
A simple trust meets all three conditions in a given year:
- Must distribute all income currently
- Does not distribute corpus (principal)
- No charitable beneficiaries
A complex trust is anything that does not qualify as simple, it accumulates income, distributes principal, or has charitable beneficiaries. Classification is determined year by year.
A grantor trust overrides simple/complex entirely. If the grantor retains certain powers (power to revoke, control beneficial enjoyment, receive income, or substitute assets) all income flows to the grantor's personal return. The trust is invisible for tax purposes. The most common grantor trust is a revocable living trust. When the grantor dies and the trust becomes irrevocable, grantor status ends.
Common mistakes
- Including capital gains in DNI when allocated to corpus. The exam tests this constantly. If gains are allocated to corpus, they are excluded from DNI. Trap: adding interest + dividends + capital gains to get inflated DNI.
- Calculating a distribution deduction for a grantor trust. If it is a grantor trust (revocable living trust during grantor's lifetime), the trust is disregarded. No DNI. No distribution deduction. Everything goes on the grantor's return. Trap: computing trust-level tax for a revocable trust.
- Treating IRD as receiving a step-up. The step-up applies to most inherited assets. IRD is the exception. Traditional IRA = $0 basis to the beneficiary. Trap: inherited IRA at FMV basis.
Bottom line
- Simple trust: distribute all income, no corpus, no charitable. Anything else is complex, and classification is determined year by year
- DNI = trust gross income - capital gains to corpus - deductible expenses + net tax-exempt interest. It caps both the distribution deduction and beneficiary taxation
- When distributions exceed DNI, the beneficiary is taxed only up to DNI; the excess is a tax-free return of corpus
- Trust brackets hit 37% at ~$16,000 (40.8% with NIIT); individuals do not reach 37% until ~$640,600. Distribute to lower-bracket beneficiaries whenever possible
Exam shortcut
When a trust question gives multiple income types and a distribution amount, do two things: (1) Calculate DNI by removing capital gains to corpus and subtracting expenses. (2) Compare the distribution to DNI. Distribution less than DNI: beneficiary taxed on the distribution, trust taxed on the rest. Distribution exceeds DNI: beneficiary taxed only up to DNI.
The full lesson (about 2,297 words, 15 min read) adds 2 worked examples, all 5 common mistakes, a self-check, free in the app.
Learning objectives
- E.39
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