Distributable Net Income is the tax concept used to allocate
taxable income between the trust or estate and the beneficiaries. Distributable
Net Income is an
approximation of the actual economic benefit available to the income
beneficiaries. Distributable Net Income is the maximum amount that can be taxed to the
beneficiaries. Distributions in excess of Distributable Net Income are generally treated as
tax-free distributions of principal.
To Calculate Distributable
Net Income:
Start With: Adjusted
total income (Line 17, Page 1 of Form 1041).
+ Plus net tax-exempt interest
(total tax-exempt interest less charitable contributions and expenses
allocated to tax-exempt interest).
+ Plus capital gains allocated to
accounting income or used to determine the amount distributed or required
to be distributed. Capital gains are generally not included in Distributable
Net Income even if
a trustee makes a discretionary distribution of principal. Capital gains
are included in Distributable Net Income in the year of termination. [Reg. §1.643(a)-3])
+ Plus charitable deduction for
charitable contributions made from capital gains.
+ Plus capital loss (Line 4).
– Less capital gain (Line 4).
Required Income Distributions (Tier 1): Income
required to be distributed to beneficiaries in the current year is entered
on Line 9 of Schedule B. For a simple trust, this amount is the net
accounting income. For a complex trust, this amount is generally a
percentage (0–100%) of net accounting income required to be distributed
under the trust instrument. For most estates, no income is required to be
distributed in the current year unless a support allowance gift of income
is made by will or under state law. Income is included on Line 9 if the
trustee is legally required to distribute it even if the income has not
been distributed when the return is filed. [Reg. §1.651(a)-2 and
§1.661(a)-2]
Other Distributions (Tier 2): Other
amounts actually paid to beneficiaries (including discretionary
distributions) are entered on Line 10. Gifts or bequests of specific sums
of money or of specific property that are paid all at once or in not more
than 3 installments are not included on Line 10. [IRC §663]
Apportionment of Distributable Net
Income to Beneficiaries: If
the estate or trust made distributions to beneficiaries during the tax
year, Distributable Net Income passes to the estate or trust beneficiaries. The apportionment of
Distributable Net Income among the beneficiaries depends on the amount and type of distribution
made to each. The actual source of payment for each distribution (whether
income or principal) is irrelevant. Tracing is not allowed; trustees
cannot designate which beneficiaries receive taxable income and which
receive nontaxable distributions of principal.
Apportionment:
– If Distributable Net Income is less than the income required
to be distributed currently, Distributable Net Income is distributed proportionately to the
beneficiaries receiving first-tier distributions.
– In a complex trust or estate, Distributable Net Income may exceed the income required to be
distributed currently. Distributable Net Income is first apportioned dollar for dollar to the
first-tier beneficiaries. Remaining Distributable Net Income is divided proportionately among
beneficiaries receiving second-tier distributions.
Discretionary Distributions and the
65-Day Rule: Amounts required to be distributed are deductible in the
current year whether distributed or not [IRC §662]. Discretionary
distributions, however, are generally deductible only if paid in the
current year. In order to allow a complex trust or estate time to finish
its year-end accounting and make appropriate distributions, a trust or
estate may elect to treat amounts distributed in the first 65 days of the
next tax year as though they were distributed in the current tax year [IRC
§663(b)]. To make the 65-day election, check Box 6 in "Other
Information" on Page 2 of Form 1041. The 65-day rule never applies to
simple trusts because simple trusts, by definition, cannot make
discretionary distributions.
Separate Share Rule: If
beneficiaries have substantially separate and independent shares in a
trust or estate, they are treated as having separate trusts for purposes
of determining Distributable Net Income. This rule prevents income accumulated for one
beneficiary from being taxed to another beneficiary who receives a
distribution of principal. Application of the rule is mandatory, not
elective. [Reg. §1.663(c)-1]
