Estates and Trusts are permitted to take a deduction on their tax return (Form 1041) for certain income that is distributed to the beneficiaries. This income is then reported to the beneficiary on a Schedule K-1 (Form 1041) Beneficiary's Share of Income, Deductions, Credits, etc. and is reported on the beneficiary's tax return.
This Income Distribution Deduction is calculated on Schedule B, Form 1041, and 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 under the terms of the will (or trust) or state law to the beneficiary.
Each of these limitations on the Income Distribution Deduction need to be determine by the fiduciary/taxpayer in order to calculate the allowable deduction for the estate or trust. See: Instructions for Form 1041 and Schedules A, B, G, J, and K-1 - U.S Income Tax Return for Estates and Trusts.
Distributable Net Income is a calculated amount that consists of the estate's (or trust's) taxable income (prior to any income distribution deduction) with certain modifications due to the impact tax-exempt items and capital gains can have on the income of the entity. If none of these items are present on the return, DNI will be the same as taxable income before any income distribution deduction is taken. The modification to the estate or trust's taxable income to calculate Distributable Net Income are as follows:
First, any Tax-exempt Interest or Tax-exempt Dividends are included in the DNI calculation, less any expenses or deductions that were directly associated with the Tax-exempt Interest or Dividends. Also any Charitable Contributions made by the estate or trust that are deemed to have been made out of any Tax-exempt Interest or Tax-exempt Dividends will be excluded from the calculation of DNI.
Second, the Exemption Deduction taken by either the estate or trust is not included in the DNI calculation.
Third, any Capital Gains will not automatically be included in DNI. However, Capital Gains can under certain conditions 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.
The gain is used, under either the terms of the will to determine the amount that is distributed or must be distributed.
Charitable contributions are made out of capital gains. (Generally, when you determine any capital gains to be included in distributable net income, the exclusion for gain from the sale or exchange of qualified small business stock is not taken into account.)
Finally, capital losses are normally excluded in figuring DNI unless they enter into the computation of any net capital gain that is distributed or must be distributed during the year.
The other limitation on the Income Distribution Deduction is that this deduction cannot be greater than the amount actually distributed to the beneficiaries or the amount that was required under the will or trust document or state law to be distributed to the beneficiaries. If actual distributions were made, the determination is easily ascertained. However, if no actual distributions were made to the beneficiaries, than no Income Distribution Deduction is allowable regardless of any calculation of DNI, unless distributions were required by the will, trust document or state law to be made to the beneficiaries.
To enter the Income Distribution Deduction into a 1041 tax return, from the Main Menu of the Tax Return (Form 1041):
- Select, 'Deductions', then
- Select, 'Income Distribution Deduction (Sch. B)'
The amount that is automatically calculated as DNI, is the first limit on the Income Distribution Deduction. As part of the calculation of Distributable Net Income (Schedule B, Line 7), on this menu, TaxSlayer Pro pulls the Adjusted Total Income, (Schedule B, Line 1), and Adjusted Tax-Exempt Income (Schedule B, Line 2), from the tax return (Form 1041). Adjustments to the Total Income or Tax-Exempt Income should be made in the section of the tax return (Form 1041) that contains the income or deduction activity for it to flow into this calculation of DNI.
However, TaxSlayer Pro also pulls any net amount allocated to the beneficiaries from Capital Gains (Schedule D, Line 19, Column 1), for inclusion into this calculation of DNI. If no Capital Gains are allocated for distribution to the beneficiaries, this income item will remain with the entity and not be included in DNI. Non-distributed Capital Gains will also be included in the taxable income of the Estate or Trust.
The amount actually distributed or required to be distributed under the terms of the will (or trust) or state law to the beneficiary is the second limitation on the Income Distribution Deduction. On this section, the user may enter under "Income required to be Distributed Currently" any amount that was required to be distributed to the beneficiaries under the terms of will or trust document. Many wills or trust documents have specific terms that dictate when income from an estate or trust may be distributed to a beneficiary, or otherwise have limitations on when distributions can occur based on certain conditions, age restrictions or specified use of income. Moreover, certain state laws may require fiduciaries to distribute (or not distribute) income amounts from an estate or trust to beneficiaries.
If the entity made an actual distribution to the beneficiaries, that amount should be enter as 'Other Amounts Paid, Credited or Distributed'. This distribution amount should include any actual distributions from income regardless of the source, and should include both taxable income and tax-exempt income. If there was tax-exempt income on the return, the user may then also need to make entries regarding whether it was distributed to the beneficiaries. Any amount of tax-exempt income that is distributed to the beneficiaries may reduce the Income Distribution Deduction if the net amount distributed to the beneficiaries is less than the Distributable Net Income (DNI).
Once you have completed the Income Distribution Deduction, return to the Deductions Menu to complete the tax return.
NOTE: This is a guide on entering the Income Distribution Deduction into the TaxSlayer Pro program. This is not intended as tax advice.