Estates and trusts are permitted to take a deduction on their income tax return (Form 1041) for certain income that is distributed to the beneficiary(ies), reported to each beneficiary on their Schedule K-1 (Form 1041), Beneficiary's Share of Income, Deductions, Credits, etc.
The income distribution deduction is calculated on Schedule B (Form 1041). The allowable deduction is the lesser of the following:
(1) the distributable net income ("DNI"), or
(2) the amount actually distributed or required to be distributed to the beneficiaries under the terms of the will, governing instrument, or state law as appropriate.
Each of these limitations on the income distribution deduction need to be determined by the fiduciary in order to calculate the allowable income distribution deduction for the estate or trust.
Distributable Net Income (DNI)
The first limitation on the income distribution deduction is DNI, an amount that consists of the estate's or trust's taxable income before any income distribution deduction and with adjustments related to tax-exempt income and capital gains and losses. If a return includes no capital gains or losses or tax-exempt income, DNI will be the same as taxable income before any income distribution deduction is taken.
Thus DNI equals taxable income before the income distribution deduction, modified as follows:
1. Include in DNI any tax-exempt interest or tax-exempt dividends less:
- any expenses or deductions that were directly associated with the tax-exempt interest or dividends.
- any charitable contributions made by the estate or trust that are deemed to have been made out of tax-exempt interest or dividends.
2. Exclude from DNI the exemption deduction taken by either the estate or trust.
3. While capital gains are not automatically included in DNI, they can be included in the DNI calculation if any of the following apply:
- The gain is allocated to income in the accounts of the estate or by notice to the beneficiaries under the terms of the will or by local law.
- The gain is allocated to the corpus or principal of the estate and is actually distributed to the beneficiaries during the tax year.
- Under either the terms of the will or the practice of the personal representative, the gain is used to determine the amount that is distributed or must be distributed.
- Charitable contributions are made out of capital gains.
4. Exclude capital losses from DNI unless they enter into the computation of any net capital gain that is distributed or must be distributed during the year.
Actual or Required Distribution
The other limitation on the income distribution deduction is that it cannot be greater than the amount actually distributed to the beneficiaries or the amount that was required under the will, governing instrument, or state law to be distributed to the beneficiaries.
If no actual distributions were made to the beneficiaries, then no income distribution deduction is allowable regardless of any calculation of DNI unless distributions are required by the will, governing instrument, or state law to be made to the beneficiaries.
To calculate the income distribution deduction in TaxSlayer Pro, from the Main Menu of the tax return (Form 1041) select:
- Income Distribution Deduction (Sch. B)
- Adjusted Total Income - This amount is pulled from the return and cannot be edited. It is generally equal to Form 1041 line 17, otherwise if lines 4 and 17 are both a loss, this amount is the smaller of the losses, or if line 4 equals zero and line 17 is a loss, this amount is zero.
- Adjusted Tax-Exempt Interest - Enter here the tax-exempt interest received minus these three items:
(a) tax-exempt interest allocable to charitable contributions (Schedule A line 2).
(b) expenses allowed under section 212 that are allocable to the tax-exempt interest.
(c) interest expense that is allocable to the tax-exempt interest.
- Total Net Gain (Sch D) - This amount is pulled from Schedule D but can be adjusted if needed, e.g., based on the terms of the governing instrument. (Note that the amount on this line represents the capital gain or loss allocated to the beneficiaries, as shown on Schedule D Part III.)
- Amount from Sch A Line 4 - This amount is pulled from Schedule A line 4.
- Capital Gains included on Sch A Line 1 - If any amount has been paid or permanently set aside for charitable purposes from gross income (as indicated on Schedule A line 1), see the IRS form instructions for help determining the amount on this line.
- Capital Gain(-)/Capital Loss(+) from Pg 1, Line 4 - This is the total capital gain or loss in the return but with the sign reversed, subtracting the gain or adding the loss, as applicable.
- Distributable Net Income (DNI) - This is the sum of the preceding lines.
- Accounting Income for Tax Yr, if Complex Trust - For a complex trust only, enter the income for the tax year determined under the terms of the governing instrument and applicable local law.
- Income required to be Distributed Currently - Enter the amount of income required to be distributed based on the terms of the governing instrument or state law, aka "first tier distributions". A simple trust must complete this line. A complex trust and a decedent's estate must complete this line if required to distribute income currently, whether it is distributed or not.
- Other Amounts Paid, Credited or Distributed - For a complex trust or decedent's estate only, enter the total of other amounts actually distributed to the beneficiaries during the year, aka "second tier distributions". The amount on this line includes such items as the following:
(a) annuity payments (to the extent not paid out of income).
(b) mandatory and discretionary distributions of corpus.
(c) in-kind distributions of property.
(d) timely-filed estimated payments made on behalf of a beneficiary and reported on Form 1041-T.
- Total Distributions - This line shows the sum of the preceding two lines. (For a complex trust, Schedule J may be needed if the total distributions is more than the accounting income for the year and the trust has accumulated income. See the instructions here.)
- Tax-Exempt Income on Line 11 - The amount to enter on this line depends on several factors:
(a) If DNI is less than or equal to total distributions and tax-exempt interest is the only tax-exempt income included in total distributions, then enter the adjusted tax-exempt interest.
(b) If DNI is more than total distributions and tax-exempt interest is the only tax-exempt income included in total distributions, then calculate the amount to enter as follows:
Adjusted Tax-exempt Interest x ( Total Distributions / DNI )
(c) If total distributions includes tax-exempt income other than tax-exempt interest, enter the tax-exempt income included in total distributions minus the charitable contribution deduction allocable to the tax-exempt income minus expenses allocable to the tax-exempt income.
Once you have completed the Income Distribution Deduction, return to the Deductions Menu to complete the remainder of the tax return.
Note: This is a guide to entering the Income Distribution Deduction into the TaxSlayer Pro program. This is not intended as tax advice.