How does the 65 day election affect trust distributions?
Key takeaway
A timely annual 65-day election lets a complex trust’s fiduciary or a decedent’s estate’s executor designate qualifying amounts properly paid or credited to beneficiaries during the first 65 days after year-end as prior-year distributions, limited to the greater of that prior year’s accounting income or DNI minus amounts already paid, credited, or required to be distributed for that year, excluding amounts treated as distributed in an earlier year.
Who can make the election?
The fiduciary of a complex trust or the executor of a decedent’s estate can make the election.
A complex trust is a trust that does not qualify as a simple trust. A simple trust must meet all three conditions:
- The trust instrument requires all income to be distributed currently.
- The instrument provides no charitable payments, permanent set asides, or uses.
- The trust makes no distributions of corpus.
Simple trusts fall outside the stated election categories. If only part of a trust is grantor owned, the nongrantor portion follows normal fiduciary income tax return reporting rules.
Which distributions qualify?
Only amounts properly paid or credited to beneficiaries within the first 65 days after the elected tax year and designated by the fiduciary qualify, within the amount cap described next.
The election treats those amounts as paid or credited on the last day of the preceding tax year. A separate election is needed for each tax year in which this treatment is desired.
Does an amount cap apply?
The cap is the greater of the prior year’s trust accounting income or DNI, minus amounts paid, credited, or required to be distributed for that year, excluding from that reduction amounts already assigned to an earlier year under section 663(b).
How do you make the election?
For an eligible trust or estate filing a fiduciary income tax return, check the section 663(b) election box under Other Information, Question 6, and file the return by its due date, including extensions.
Once made, the election is irrevocable. The return filing deadline, including extensions, is separate from the qualifying distribution period.
If a trust is not required to file a return for the elected year, make the election in a statement filed with the internal revenue office where its return would otherwise be filed.
File that statement by the legally prescribed filing deadline that would apply if the trust had to file a return for that year. That election becomes irrevocable after the last day prescribed for making it.
Which year does the beneficiary report?
For an elected trust distribution, the beneficiary treats the amount as received in the beneficiary tax year in which, or with which, the last day of the trust’s preceding tax year ends.
For distributions governed by sections 661 and 662, beneficiary income inclusion is generally limited by distributable net income, subject to the exclusions below. When required distributions exceed distributable net income, each beneficiary takes a proportionate share.
Amounts retain the same character in the beneficiary’s hands as in the estate or trust.
Specific gifts or bequests of money or property under the governing instrument, paid all at once or in no more than three installments, do not carry out distributable net income. An amount payable only from income is not a specific sum.
Amounts qualifying for the section 642(c) charitable deduction also do not carry out distributable net income.
Two related terms
Distributable net income
Distributable net income, or DNI, is the estate’s or trust’s taxable income with statutory modifications.
Trust accounting income
Trust accounting income is income determined under the governing instrument and applicable local law. Trust provisions that depart fundamentally from traditional income and principal principles generally are not recognized.
Frequently asked questions
Does the election automatically include every payment during the qualifying period?
No. It applies only to qualifying amounts designated by the fiduciary for the elected tax year.
Can the same payment receive distribution treatment twice?
No. A current payment cannot qualify again under sections 661(a) or 662(a) if section 651 or 661 already applied for a preceding year because the amount was credited or required to be distributed then.
Does the timing election alone put capital gains into DNI?
No. The timing election alone does not establish that capital gains enter DNI.
Gains from sales or exchanges of capital assets allocated to corpus are excluded from DNI only to the extent both conditions hold:
- The gains are not paid, credited, or required to be distributed to a beneficiary during the tax year.
- The gains are not paid, permanently set aside, or to be used for section 642(c) purposes.
How are beneficiary items reported?
Report the beneficiary’s share of trust or estate income, deductions, and credits on Schedule K‑1, attach a copy to the fiduciary income tax return, and give the beneficiary a copy.
Schedule K‑1 does not report items taxable directly to a grantor or other deemed owner. For a partially grantor owned trust, it reports distributed income from the portion not taxable directly to that owner.
Sources
- IRS Instructions for Form 1041 and Schedule K-1, eligibility, filing the election, and beneficiary reporting.
- Internal Revenue Code section 663, timing election and distribution exclusions.
- Treasury Regulation section 1.663(b)-1, designated amounts, cap calculation, annual election, and beneficiary timing.
- Treasury Regulation section 1.663(b)-2, election procedure when no trust return is required.
- Internal Revenue Code section 643, DNI, accounting income, and capital gains.
- Treasury Regulation section 1.643(b)-1, accounting income under trust terms and local law.
- Internal Revenue Code section 662, beneficiary inclusion and character.