Archive for the ‘beneficiary’ Tag

New Tax Impacts for Trusts with Capital Gains – Part II

Originally published in the Cedar Street Times

November 15, 2013

Two weeks ago I laid the groundwork of some of the basics on revocable and irrevocable trusts in order to start discussing new implications due to law changes in 2013.  Revocable trusts such as the common revocable living trust most people use for estate planning is disregarded for tax purposes as separate from the owner – in other words all of the income generated by its assets gets reported on your personal 1040 tax return.  Irrevocable trusts, such as a bypass trust commonly used in estate planning, or a gifting trust, are treated as separate tax paying entities, get their own taxpayer identification number, and file their own tax returns.

In early 2013 new laws were passed that increased the personal income tax rates from 35 percent to 39.6 percent on people in the highest tax bracket ($400,000 filing single or $450,000 married filing joint).  It also raised the capital gains rate to 20 percent for these same people (up from 15 percent).  In addition, a new 3.8 percent Medicare surtax is assessed on net investment income (think interest, dividends, capital gains, among others) for people making over $200,000 single or $250,000 filing joint.  Most people do not make $450,000 or even $250,000 a year, so this seems innocuous to many.

However, many people making less than these thresholds do have irrevocable trusts – most commonly after a spouse has passed away.  The problem with irrevocable trusts is that the thresholds to be impacted are so much lower.  Once your trust has just $11,950 (2013) of income, you have hit the top bracket and will be subject to the 39.6 percent income tax rate, 20 percent capital gains rate, and the 3.8 percent Medicare surcharge!  One stock sale could easily put you in the top bracket!  This effectively means an 8.8 percent tax increase on capital gains and 4.6 percent to 8.4 percent increase on other types of income.  That is a big hit every year, and will be something new to battle.

If you can avoid having the income taxed to the trust, and instead have it distributed out and taxed to the beneficiaries, you can probably save a chunk of taxes since it will be taxed at the lower rates on the beneficiary tax returns – assuming your individual beneficiaries are not in the top tax bracket!

Whether or not you have discretion or are required to distribute income to beneficiaries is defined in your trust document.  Even the very definition of “income” itself, for trust accounting purposes, is governed by your trust document primarily and the state’s principal and income act, secondarily.  The proper allocation of income and expenses to trust accounting income or principal is very important to beneficiaries (whether they realize it or not), since trust accounting income generally goes to one beneficiary, and the principal often goes to a different beneficiary down the road…so it determines the amount the beneficiaries receive.  Many common irrevocable trusts are written to require the distribution of trust accounting income each year to the current beneficiaries with rights to dip into principal as needed to maintain an ascertainable standard of living.  Upon death, the remaining principal goes to the remainder beneficiaries.

The California Uniform Principal and Income Act does not define capital gains as income, but as a principal transaction – basically an asset changing form – for instance from real estate to cash.  I hardly ever see trusts that even mention capital gains, much less defining it as a part of income.  In the absence of trust language, the principal and income act governs, therefore many trusts in California are not permitted to distribute capital gains to the beneficiaries.

It is amazing to me how many trust tax returns I have seen over the years that violate this – often because the preparer does not really understand trust taxation rules.  I have even run into cases where the prior preparer has never even asked for the trust document, and thus relies on the default settings in their tax software in conjunction with “the way we’ve always done it” to govern!  This would be analogous to creating a detailed shopping list and asking your neighbors to go shopping for you; in lieu of taking your list, they go on the internet and print out a list of common things people buy, and then supplement it with things they have bought for other neighbors in the past! Chances are pretty good; you will not get what you need!  Enforcement of correct trust income tax preparation comes much more often by threats of lawsuit against the trustee than by IRS audit. Keep in mind the remainder beneficiary’s attorney would be happy to sue the trustee for shorting his client’s share by not following the terms of the trust.

In two weeks we will conclude our discussion.

Prior articles are republished on my website at

IRS Circular 230 Notice: To the extent this article concerns tax matters, it is not intended to be used and cannot be used by a taxpayer for the purpose of avoiding penalties that may be imposed by law.

Travis H. Long, CPA is located at 706-B Forest Avenue, PG, 93950 and focuses on trust, estate, individual, and business taxation. He can be reached at 831-333-1041.

Ask Your Husband if He is Still Married to Someone Else!

Originally published in the Cedar Street Times

December 14, 2012

As professionals dealing with trust and estate issues, CPAs and attorneys talk a lot about making sure your beneficiary designations are up-to-date on any kind of retirement assets you may own, as they generally trump your estate plan.  There are many sad stories of widows or widowers losing assets to their deceased spouse’s ex-wife or ex-husband simply because they did not update the beneficiary designation forms.  But sometimes, even that is not enough.

At a tax seminar I attended last week, we discussed an interesting court case which makes you think you can never be too careful.  The case goes something like this: Wayne and Cleta Lee were married in the state of Washington in 1979.  In the early 1990s, Wayne moved to Mississippi.  They never got a divorce, but they went their separate ways.  In 1995, Wayne decided to marry a woman in Mississippi named Lois, but he did not bother to divorce Cleta.

Wayne was an electrical worker and was entitled to a pension when he retired in 1997.  On the pension application he listed himself as married and Lois as his wife.  He designated her specifically as the beneficiary and even attached a copy of the marriage certificate.  They both signed the application and he started receiving his pension.   In January 2007 Wayne passed away and Lois started receiving pension benefits in February.  Later that month, his first wife from Washington applied for pension benefits from the company as well!

The case eventually went to court and the district court ruled in favor of Lois since she was specifically identified in the pension application as the beneficiary for spousal benefits.  Cleta appealed and the case went to the U.S. Court of Appeals.  The U.S. Court of Appeals cited Employee Retirement Income Security Act (ERISA) rules and state laws and said the district court made its decision on the wrong basis.  They overturned the ruling and have now sent it back to the district court to determine the legal spouse.  They said the benefits go to the legal spouse at the time of his passing regardless of who was specifically named as the spouse.  If the district court determines Cleta to be the legal spouse, which the U.S. Court of Appeals hinted at quite heavily, Lois will lose out on her pension benefits.  (IBEW Pacific Coast Pension Fund v. Lee (2012) U.S. Court of Appeals for the Sixth Circuit, Case No. 10-6433)

So for all of you with spouses that have multiple wives or husbands, you may want to have a little chat!  Obviously the scary situation would be if you never knew your spouse was not officially divorced from a prior marriage, or worse, never knew they were married before.

Does this mean we will be advising clients in the future to have background checks done before picking out a ring?  I sure hope not.

Prior articles are republished on my website at

IRS Circular 230 Notice: To the extent this article concerns tax matters, it is not intended to be used and cannot be used by a taxpayer for the purpose of avoiding penalties that may be imposed by law.

Travis H. Long, CPA is located at 706-B Forest Avenue, PG, 93950 and focuses on trust, estate, individual, and business taxation. He can be reached at 831-333-1041.