The 65-Day Rule: What Every Trustee Should Know about Taxes
Happy New Year! With the close of the calendar year behind us, tax season is just beginning for individuals and many entities. If you are serving as the trustee of a complex trust, however, it’s not too late to take action that may reduce total taxes paid overall.
First, a couple of definitions: A “complex trust” is a trust that either retains current income in the trust, distributes trust principal, or has a charitable organization as a beneficiary. A “simple trust” is a trust that is required to distribute all of its annual income to the beneficiaries, but no principal may be distributed. Income of the trust is taxable to the recipient.
Trusts pay the highest federal income tax rate at a much lower threshold than individuals. Most trust beneficiaries have a lower tax rate than the trust; therefore, income that is distributed to the beneficiaries (which is then taxed to the beneficiaries instead of to the trust) ultimately results in a tax savings between the trust and the beneficiaries.
To manage the tax burden of a complex trust, trustees can use the “65-Day Rule” (also called a 663(b) election) to make distributions to trust beneficiaries for the first 65 days of a calendar year. The 65-Day Rule applies only to complex trusts, because by definition, a simple trust’s income is already taxed to the beneficiary at the beneficiary’s presumably lower tax rate.
If after the beginning of the New Year, the trustee realizes that there is excess income remaining after accounting for distributions made in the preceding year, the 65-Day Rule allows the trustee to treat distributions made within the first 65 days of the New Year as if the distributions were made in the preceding year. This means that trust distributions made through the beginning of March may be treated as having been made in 2016, the election could save a significant amount of tax! The fiduciary overseeing an estate or complex trust has the ability to treat distributions made during the first 65 days of the following tax year as part of the income distributions for the prior year. As such, the executor or trustee can potentially shift taxable income from the estate or trust to the beneficiaries on a K-1, which is often desirable given that the maximum income tax rates.
In order to use the 65-Day Rule, the trustee must make the 663(b) election on page two of IRS Form 1041, the trust’s income tax return. If the trustee makes this election, he should keep careful records to ensure that the tax return for the following year does not errantly treat those distributions as distributions made in the following tax year, as well.