Prior Year Accumulation Distribution Trust Allocation, Sec 666

An Accumulation Distribution Trust Allocation for Preceding Years

An Accumulation Distribution Trust Allocation for Preceding Years

When it comes to trust income for the current year, it is referred to as DNI, which is referred to as Distributable Net Income under 26 U.S.C. 643. The DNI refers to income that is allocated to the beneficiaries and it is deductible from the trust. In general, the trust income tax rules are punitive in nature in that the deductions are limited and the majority of taxable income gets taxed at the highest tax rate available (37%). When a trust is a complex trust (as opposed to a simple trust), it is not required to distribute all of the income in the current year – but this can make the tax and reporting even more complicated. Let’s take an introductory look at accumulation distributions for trusts.

26 U.S. Code Section 661- Deductions for Accumulating Estate & Trusts Income

• • • Deduction

      • In any taxable year there shall be allowed as a deduction in computing the taxable income of an estate or trust (other than a trust to which subpart B applies), the sum of—

• • • • • • any amount of income for such taxable year required to be distributed currently (including any amount required to be distributed which may be paid out of income or corpus to the extent such amount is paid out of income for such taxable year); and

          • any other amounts properly paid or credited or required to be distributed for such taxable year; but such deduction shall not exceed the distributable net income of the estate or trust.

What does this mean

It means that when a trust (or estate) computes its taxable income, they are entitled to a deduction involving the amount that is currently required to be distributed, but the deduction cannot exceed the Distributable Net Income (DNI)

26 U.S. Code Section 666 – Accumulation Distribution Allocated to Preceding Years 

(a)   Amount allocated

• • • In the case of a trust which is subject to subpart C, the amount of the accumulation distribution of such trust for a taxable year shall be deemed to be an amount within the meaning of paragraph (2) of section 661(a) distributed on the last day of each of the preceding taxable years, commencing with the earliest of such years, to the extent that such amount exceeds the total of any undistributed net income for all earlier preceding taxable years. The amount deemed to be distributed in any such preceding taxable year under the preceding sentence shall not exceed the undistributed net income for such preceding taxable year. For purposes of this subsection, undistributed net income for each of such preceding taxable years shall be computed without regard to such accumulation distribution and without regard to any accumulation distribution determined for any succeeding taxable year.

(b)   Total taxes deemed distributed

• • • If any portion of an accumulation distribution for any taxable year is deemed under subsection (a) to be an amount within the meaning of paragraph (2) of section 661(a) distributed on the last day of any preceding taxable year, and such portion of such distribution is not less than the undistributed net income for such preceding taxable year, the trust shall be deemed to have distributed on the last day of such preceding taxable year an additional amount within the meaning of paragraph (2) of section 661(a). Such additional amount shall be equal to the taxes (other than the tax imposed by section 55) imposed on the trust for such preceding taxable year attributable to the undistributed net income. For purposes of this subsection, the undistributed net income and the taxes imposed on the trust for such preceding taxable year attributable to such undistributed net income shall be computed without regard to such accumulation distribution and without regard to any accumulation distribution determined for any succeeding taxable year.

(c)    Pro rata portion of taxes deemed distributed

• • • If any portion of an accumulation distribution for any taxable year is deemed under subsection (a) to be an amount within the meaning of paragraph (2) of section 661(a) distributed on the last day of any preceding taxable year and such portion of the accumulation distribution is less than the undistributed net income for such preceding taxable year, the trust shall be deemed to have distributed on the last day of such preceding taxable year an additional amount within the meaning of paragraph (2) of section 661(a). Such additional amount shall be equal to the taxes (other than the tax imposed by section 55) imposed on the trust for such taxable year attributable to the undistributed net income multiplied by the ratio of the portion of the accumulation distribution to the undistributed net income of the trust for such year. For purposes of this subsection, the undistributed net income and the taxes imposed on the trust for such preceding taxable year attributable to such undistributed net income shall be computed without regard to the accumulation distribution and without regard to any accumulation distribution determined for any succeeding taxable year.

(d)  Rule when information is not available

• • • If adequate records are not available to determine the proper application of this subpart to an amount distributed by a trust, such amount shall be deemed to be an accumulation distribution consisting of undistributed net income earned during the earliest preceding taxable year of the trust in which it can be established that the trust was in existence.

(e)  Denial of refund to trusts and beneficiaries

• • • No refund or credit shall be allowed to a trust or a beneficiary of such trust for any preceding taxable year by reason of a distribution deemed to have been made by such trust in such year under this section.

What does this mean?

This code section breaks down the computation of the distribution involving the prior year’s undistributed income (accumulation distribution) – and limitations in the calculation in order to prevent double-counting. And, if the trust does not have sufficient records to track and allocate the income annually, it will be determined to date back to the earliest preceding taxable year in which the trust was in existence.

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