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Consider Going Back in Time if You Are an Estate or Trust: 65-Day Rule
By Garrett Reuter, Jr. on January 26, 2021 at 11:15 AM

How many times have you prepared your income tax returns for the previous year, only wishing you knew then what you know now, so you could go back and make more advantageous tax decisions?  In most cases, you are stuck with the decisions you made before the new tax year began, even though you may not have all the relevant tax information available to assist with those decisions until several months into the new tax year.  Too bad for you, says the IRS, unless you are an estate or trust.

65-Day Rule Trust Distribution

Under Section 663(b) of the Internal Revenue Code, any distribution by an estate or trust within the first 65 days of the tax year can be treated as having been made on the last day of the preceding tax year.  For example, a distribution of $500 of trust income by the trustee to a beneficiary on January 30, 2021, can be treated as having been made in the 2020 tax year or the 2021 tax year.  In most years (including 2021), the last day for a distribution to be applied to the previous tax year is March 6 (in leap years, the last day is March 5).

The election to treat the distribution as being made in the previous tax year must be made by the fiduciary on a timely filed income tax return (including extensions) for the tax year to which the distribution is meant to apply.  A fiduciary may make the election for only a partial amount of the distribution(s) within the 65-day period, but the election is irrevocable once it is made.

The primary advantage of this tax rule is that it may provide an opportunity for tax savings.  An estate or trust pays income taxes at graduated rates, similar to individuals, with the top tax rate in 2020, 37 percent, applying to income in excess of $12,950.  However, married couples filing jointly pay the top tax rate only when income exceeds $622,051 (or $518,401 for single filers).  In some cases, an additional 3.8 percent Medicare surtax (also known as the Net Investment Income Tax) on the net investment income of the estate or trust may also apply, resulting in a total marginal tax rate of 40.8 percent. 

To minimize paying tax at compressed rates, income from the estate or trust may be distributed to a beneficiary. The beneficiary, rather than the estate or trust, will then pay any income taxes associated with the distribution at the beneficiary’s individual tax rate.  For example, a beneficiary who pays income taxes at a rate of 24 percent would pay less income tax on the distribution amount than a trust being taxed at the top tax rate of 37 percent (or even 40.8 percent).  In cases of an estate or trust with a large amount of taxable income and beneficiaries in lower tax brackets, the tax savings can be significant.

State income tax consequences may also apply to distributions made from a trust or estate, and there may be limitations on the amounts of distributions a fiduciary can apply using the 65-day rule.  It is recommended that you discuss all possible consequences with your tax advisor before trying to apply the rules discussed above.     

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