New tax laws that took effect on Jan. 1, 2013 have complicated the already complex playing field of the income taxation of estates and trusts. Here are some of the strategies that fiduciaries can use to minimize income taxes under the new regime.


Distribute to Beneficiaries in Lower Income Tax Brackets

This year, the top tax rate on ordinary income increased from 35 percent to 39.6 percent, and the rate on long-term capital gains and qualified dividends increased from 15 percent to 20 percent.  Individuals reach the top ordinary income tax rate at income of $400,000 (or $450,000 if married filing jointly), whereas estates and trusts reach the top rate at income of just $11,950.  Therefore, if estate or trust income exceeds $11,950, distributing ordinary income to beneficiaries may result in a decrease of the applicable tax rate.  Of course, the income tax benefits of distributions must be weighed against potential disadvantages, such as exposing the distributed income to the beneficiaries’ creditors and spouses and jeopardizing transfer tax savings if the trust is exempt from generation-skipping transfer (GST) taxes.


Minimize the Medicare Surtax

The Medicare surtax, a 3.8 percent tax on “net investment income,” is new for 2013.  Net investment income generally includes: (1) interest, dividends, annuities, royalties and rents; (2) gains attributable to the disposition of property; and (3) income and gains from a trade or business, if such trade or business is a passive activity with respect to the taxpayer or involves trading in financial instruments or commodities.  For individuals, the surtax applies to the lesser of net investment income and the excess of modified adjusted gross income (AGI) over $200,000 (or $250,000 if married filing jointly).  For estates and trusts, the surtax applies to the lesser of undistributed net investment income and the excess of AGI over the threshold for the highest income tax bracket, which is $11,950 in 2013.

·       Distribute net investment income to beneficiaries whose modified AGI is less than the $200,000 (or $250,000) threshold at which the surtax applies.

·       Convert passive activities to active.  Generally, an activity is active if the trustee materially participates in the activity.  (Grantor trusts are an exception; the grantor’s participation counts, not that of the trustee.)  If possible, appoint a trustee who materially participates in the activity.  If the trustee doesn’t materially participate, consider distributing income from the activity to beneficiaries who actively participate in the activity.


Elect a Fiscal Year

Generally, estates and trusts are taxed on a calendar year basis, but estates may elect to be taxed on a fiscal year basis.  Furthermore, an election may be made to treat a decedent’s qualified revocable trust as part of the estate, which would allow the trust to also be taxed on a fiscal year basis.

·       Opportunity for accumulated income in 2012/2013.  If an estate (or revocable trust) elects a fiscal year ending in 2012, then the 2012 tax rules (lower rates and no Medicare surtax) will apply to the estate’s undistributed income until the beginning of its 2013 fiscal year.  The beneficiaries, who typically are taxed on a calendar year basis, will report income received from the estate or trust in the year in which the its tax year ends. 

·       Elect a Nov. 30, 2012, fiscal year for decedents who died between Dec. 1, 2011 and Nov. 30, 2012.  If the election is made, then, in Year 1 (ending on November 30, 2012), income will be taxed at pre-2013 rates, without any Medicare surtax.  The deadline is fast approaching to file the Year 1 return for those who choose this strategy.  If you elect a Nov. 30, 2012, fiscal year, the Year 1 return is due on March 15, 2013 (unless extended).

In Year 2 (running from Dec. 1, 2012 to Nov. 30, 2013), any undistributed income will be taxed at 2012 rates, without any surtax.  However, any income distributed to the beneficiaries will be taxed at 2013 rates and potentially be subject to the surtax.  Thus, if the beneficiaries need money in Year 2, rather than distributing it to them in Year 2, consider having the estate or trust loan it to them.  Memorialize the loan with a promissory note, and charge interest at the applicable federal rate.


Elect to Recognize Gain on In-Kind Distributions

Typically, when an estate or trust distributes an asset in-kind to a beneficiary (as opposed to liquidating the asset and distributing cash), there is no gain or loss to the estate or trust, and the beneficiary takes a carryover basis in the asset.  But, the estate or trust may elect to recognize the gain, so that the beneficiary can take a basis in the asset equal to its fair market value on the date of distribution.  If made, the election applies to all in-kind distributions made during the tax year.

An election may be desirable in at least two circumstances:  (1) if the trust has capital loss carryovers that can be absorbed by the gain; and (2) if the election would result in the gain being taxed to the estate or trust under the 2012 tax rules (15 percent capital gains rate and no Medicare surtax), rather than to the beneficiary under the post-2012 tax rules when he sells the asset (20 percent rate plus 3.8 percent surtax).  However, if the beneficiary expects to hold the asset until he dies, the election isn’t desirable because, upon death, the basis will be increased to its fair market value.  Nor is the election desirable if the beneficiary plans to hold the asset for a long time before selling it, because the recognition of gain may be deferred until the sale.

In summary, there are several strategies that can be used to minimize income taxes for estates and trusts under the new tax laws.  Talk to an estate and trust income tax specialist to learn how you can best take advantage of these opportunities.

About the Authors

Scott Goldberger, J.D., is an estate and trust director in Kaufman, Rossin’s Boca Raton office. Kaufman, Rossin & Co. is one of the top CPA firmsin the country and offers a wide variety of services for high-net-worth individuals. Scott can be reached at

John Anzivino, CPAis in charge of Kaufman, Rossin’sestate, trust and exempt organization practice. Kaufman, Rossin & Co. is one of the top CPA firmsin the state and offers a wide variety of services for high-net-worth-individuals. John can be reached at