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Trust Distributions and Navigating the 65-Day Rule

Well, it is officially 2024. Happy New Year! Since 2023 has ended, so has your 2023 tax planning, right? Not necessarily. For trusts and estates there is an underutilized planning opportunity that can be used during the first 65 days of the following tax year. Internal Revenue Code Section 663(b) details what is commonly known as the “65-day rule”. The 65-day rule allows for trusts (and estates) to make an election to treat distributions made during the first 65 days of the following tax year as having been made on the last day of the prior tax year. For tax year 2023, the election can be made for distributions made between January 1, 2024 and March 5, 2024. Utilizing this rule allows trustees the flexibility to manage tax implications and optimize distributions to beneficiaries.

How do you make the election?

To take advantage of the 65-Day rule, the trustee must make distributions to beneficiaries within the first 65 days of the tax year. A formal election needs to be made on the trust’s income tax return (Form 1041). There is a box that must be checked on page 3 of the Form 1041. Additionally, a statement should be attached specifying the amount of the distribution the election is being made on and which beneficiary the distribution was made to. The election must be made on a timely filed return, including extensions, and is irrevocable once made.

Why make the election?

The primary purpose of the 65-Day rule is to allow trustees to make strategic decisions regarding income distributions. By electing to treat distributions made within the first 65 days of the tax year as if they happened in the prior year, trustees can potentially allocate income in a way that minimizes tax liability for both the trust and its beneficiaries.

Making the election can help lower the tax rate if the trust is reporting at a higher tax rate than the beneficiary. Trusts reach the top tax rate at income of $14,450, while a single individual reaches the top tax rate at income of $578,125. If the beneficiary is at a lower tax rate than the trust, then moving income from the trust to the beneficiary can save money overall. Additionally, making distributions from the trust could help the trust avoid the 3.8% Net Investment Income Tax, which comes into play if the AGI of the trust exceeds $14,450.

The 65-Day rule is a valuable tool that the trustee can use for effective tax planning and income distribution. Understanding its provisions and implications can empower trustees to make informed decisions that align with the objectives of both the grantor and the beneficiaries. As tax laws evolve and change, it is crucial to consult with a tax professional to ensure compliance and the optimal utilization of the 65-Day rule. Let us know if we can help.

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