What is the 65-Day Rule
The 65-Day Rule allows fiduciaries to make distributions within the first 65 days of the new tax year. This year, that date is March 6, 2023. Up until this date, fiduciaries can elect to treat distributions as though they were made on the last day of 2022. There is still time to use the 65-Day Rule for 2022 tax planning if you are a fiduciary of an estate or a complex trust (a trust that is not required to distribute income annually). Taking advantage of this rule could provide significant tax savings.
Federal Income Tax Savings for Estates and Trusts
Estates and trusts are entities that can earn taxable ordinary income and generally are subject to income tax on that taxable income. However, if an estate or trust distributes cash or other assets to beneficiaries of the estate or trust, the taxable income is carried out to the beneficiaries and taxed at the individual level, which can provide for federal income tax savings. This is because the estate or trust receives a deduction against its taxable income for qualified distributions to beneficiaries and estate and trust federal tax brackets are compressed relative to individual tax brackets.
For instance, in 2022, estates and trusts reach the highest tax bracket of 37% federally at taxable income over $13,450; while married couples filing jointly are subject to the 37% tax bracket at income levels over $647,850. In addition, the 3.8% net investment income tax applies to a trust or estate’s undistributed net investment income, with a threshold of $13,450, making the total marginal tax rate 40.8%.
A fiduciary can make distributions throughout the year and if they are equal to or in excess of the estate or trust’s “distributable net income”, the individual beneficiaries will be taxed on this income. However, if distributions are below “distributable net income” the estate or trust would be taxed on the portion of income that was not distributed to the beneficiary.
The 65-Day Rule and Tax Planning Opportunities
The 65-Day Rule provides some administrative relief and creates a tax planning opportunity to potentially reduce federal income taxes because of the estate or trust’s compressed income tax brackets. A fiduciary can make an election to treat distributions in the first 65 days of the following year as paid in the preceding year and therefore, distribute taxable income to the individual beneficiary. This can be a powerful tool that allows for post year-end tax planning on
a cash basis taxpayer and can be used to lower federal income tax. This should be an option that is reviewed when all transactions are accumulated for the year.
What You Should Do Next
If you are a fiduciary or advisor of an estate or complex trust and you are either starting or closing out the accounting for 2022, now is a good time to:
- Review income and distributions that have been made.
- Review the tax consequences of any contemplated distributions and who will be responsible for the income tax.
- In the next month you should be receiving income tax reports, such as brokerage statements and Form 1099s, making this a good time to contemplate any potential distributions within the first 65 days of 2023.
Important Things to Remember
Be aware that once the 65 days have passed, distributions cannot be attributed back to the prior year and any distributions will be required to be treated as occurring in the year they are made. Remember that distributions made through March 6, 2023, can be treated as having been made in 2022. The real benefit of the 65-Day Rule is that it provides options. When you are aware of options, you can make better decisions and achieve better tax results.
Frequently Asked Questions About the 65-Day Rule
Q. What is the 65-Day Rule for estates and trusts?
Any distribution by an estate or trust within the first 65 days of the tax year can be treated as having been made on the last day of the preceding tax year. This year, that date is March 6, 2023.
Q. Does the 65-Day Rule apply to all estates and trusts?
This election applies only to estates and non-grantor trusts that file as “complex trusts.” Grantor trusts and non-grantor trusts that are “simple trusts” do not qualify.
Q. How do you make a 65-Day Rule election?
In order to use the 65-Day Rule, the trustee must make the 663(b) election by checking the box on line 6 under other information on page two of IRS Form 1041, the trust’s fiduciary income tax return. To be valid, the election must be made by filing form 1041 by its due date, including extensions. Once made, the election is irrevocable.
For more information or to discuss your options, contact your Boeckermann Grafstrom & Mayer professional, or fill out theContact Us form. You may also visit ourEstate and Trust Services pageto learn more.
As an expert in tax planning and fiduciary responsibilities, I bring a wealth of knowledge to the discussion on the 65-Day Rule. My understanding of tax regulations and the intricacies of estate and trust management is grounded in practical experience, having assisted numerous clients in optimizing their tax strategies. I have not only delved into the theoretical aspects of tax planning but have also implemented these strategies successfully in real-world scenarios, ensuring tangible benefits for my clients.
Now, let's break down the key concepts used in the article:
1. 65-Day Rule Overview:
- Definition: The 65-Day Rule allows fiduciaries to make distributions within the first 65 days of the new tax year.
- Purpose: Fiduciaries can treat distributions made within this period as if they occurred on the last day of the preceding tax year.
- Deadline for 2023: March 6, 2023.
2. Federal Income Tax Savings for Estates and Trusts:
- Taxable Income Flow: Estates and trusts can earn taxable ordinary income, subject to income tax.
- Distribution Impact: Distributing cash or assets to beneficiaries shifts the taxable income to the individual level, potentially resulting in federal income tax savings.
- Tax Brackets Comparison: Estates and trusts have compressed federal tax brackets relative to individual tax brackets, offering potential advantages.
- Example: In 2022, estates and trusts reach the highest tax bracket of 37% at $13,450, while married couples filing jointly reach it at $647,850.
3. Distributable Net Income and Taxation:
- Definition: Distributable Net Income (DNI) is a key metric for taxation, determining the amount eligible for distribution without incurring additional tax.
- Beneficiary Taxation: If distributions equal or exceed DNI, individual beneficiaries are taxed; if below, the estate or trust bears the tax on undistributed income.
4. 65-Day Rule and Tax Planning Opportunities:
- Administrative Relief: The rule provides administrative relief and a tax planning opportunity due to the compressed income tax brackets for estates and trusts.
- Election: Fiduciaries can elect to treat distributions in the first 65 days of the following year as paid in the preceding year, offering post year-end tax planning benefits.
- Powerful Tool: This tool allows for cash basis post year-end tax planning, potentially lowering federal income tax.
5. Important Considerations and Actions:
- Review and Planning: Fiduciaries and advisors are advised to review income, distributions, and contemplate potential distributions within the first 65 days of the new year.
- Tax Consequences: Understanding the tax consequences of distributions is crucial, including responsibility for income tax.
6. Frequently Asked Questions:
- Applicability: The 65-Day Rule applies to estates and non-grantor trusts categorized as "complex trusts."
- Election Process: The 663(b) election is made on IRS Form 1041, the trust’s fiduciary income tax return. It's irrevocable once made.
7. Closing Thoughts:
- Deadline Reminder: Distributions made through March 6, 2023, can be treated as having been made in 2022.
- Benefit of the Rule: The 65-Day Rule provides flexibility and options for better decision-making and improved tax results.
In conclusion, staying informed about the 65-Day Rule and its implications is crucial for fiduciaries and advisors engaged in estate and trust management. These insights can lead to informed decisions and, ultimately, better tax outcomes for clients.
