Simple and Complex Trusts

Simple trusts

• Three conditions for the year (Reg. §1.651(a)-1): the document requires all accounting income to be distributed currently; nothing other than income is actually distributed; no charitable deduction is taken. Status is retested every year, and a trust flips.
• Failing to pay out required income does not make the trust complex (the beneficiary is taxed anyway, Reg. §1.651(a)-2(a)). Making any corpus distribution does, including the terminating distribution. Every trust is complex in its final year. Receiving tax-exempt income or being newly funded does not make it complex.
• Deduction: the lesser of the income required to be distributed or DNI, each reduced by net tax-exempt income (§651(b)). The beneficiary reports the same amount, with DNI’s character, in his year that includes the trust’s year end (§652(c)).
• Exemption $300. Capital gains stay in the trust unless the document allocates them to income.

Complex trusts and estates: the two tiers

• Tier I: income required to be distributed currently, including an annuity payable from income or corpus to the extent actually paid from income. Tier II: every other amount properly paid, credited or required to be distributed — discretionary income, corpus, property in kind, a family allowance under a court order. “Credited” means made available on demand.
• Deduction = Tier I + Tier II, limited to DNI, less the tax-exempt portion (§661(c)): if 20% of DNI is municipal interest, 20% of each distribution carries out tax-exempt income and the fiduciary deducts only 80%.
• DNI is absorbed by Tier I first. Tier I beneficiaries are measured against DNI computed without the charitable deduction; Tier II beneficiaries against DNI with it (Reg. §§1.662(a)-2, -3). The charity sits between the tiers.
• In-kind distributions count as Tier II amounts at the lesser of basis or FMV (§643(e)(2)) unless the §643(e)(3) election is made, in which case FMV is used and the fiduciary recognizes gain (never loss — related party). See The Termination Year.
• Not distributions at all: payments to charity (§642(c) instead); real estate that vests directly in heirs under state law (Reg. §1.661(a)-2(e)); specific bequests; amounts already counted in a prior year, including 65-day amounts carried back.

Specific bequests

• §663(a)(1); Reg. §1.663(a)-1: a gift of a specific sum of money or specific property, ascertainable under the instrument at the date of death (or the trust’s inception), paid all at once or in three or fewer installments, is not a distribution. No deduction to the fiduciary; no K-1 to the recipient; the fiduciary pays the tax on the income the estate earned.
• Not a specific bequest: anything payable only from income; an annuity; the residue; a gift the instrument requires to be paid in more than three installments, even if actually paid in one. A lump sum accepted in lieu of a ten-year annuity is a distribution.
• A payment the trustee may make from either income or principal at his discretion can still be a specific bequest if the amount is fixed (Study Question 15). All the shares of a named corporation under a specific provision of the will: specific bequest (Study Question 16).
• Client line: the beneficiary who gets a dollar amount or the grandfather clock carries out none of the estate’s income; the residuary beneficiaries carry it all. The will decides who is taxed.

Separate shares

• §663(c); Reg. §§1.663(c)-1 to -5: where a trust or estate has substantially separate and independent shares for different beneficiaries, DNI is computed share by share, so a principal distribution to one beneficiary does not carry out income accumulated for another. Mandatory, not elective.
• A surviving spouse’s elective share and a pecuniary formula bequest are separate shares (unless the pecuniary share has no right to income or appreciation and can be paid in more than three installments). A §645 trust and its related estate are separate shares while the election is in effect.

The 65-day election

• §663(b); Reg. §1.663(b)-1: a complex trust or estate may treat distributions made in the first 65 days of the following year as made on December 31. Made by the fiduciary alone on the return (Other Information question 6 checkbox); no beneficiary consent; irrevocable after the due date. For 2026 the date is March 6, 2027.
• Cap: the greater of accounting income or DNI for the year, reduced by amounts already distributed during the year (other than amounts carried back by the prior year’s election). Course Example 6.1: $1,000 accounting income, $800 DNI, $600 paid in July → at most $400 can be elected.
• The fiduciary must designate which payments are covered; the balance of the 65-day payments is a current-year distribution. A simple trust does not need the election.
• Practice: consolidated 1099s arrive February 15 and are often corrected; the March 6 decision is made from year-end statements with a cushion. An IRA distribution to a trust is the classic reason to use it.

Character and allocation of deductions

• Each distribution carries a pro rata share of every class of DNI (Reg. §§1.652(b)-2, 1.662(b)-1) unless the document allocates a class to a particular beneficiary with real economic effect independent of tax: “half the municipal interest to A” has effect; “the first $10,000 to A is tax-exempt” does not.
• Deductions directly attributable to a class offset that class first (rental expenses against rents, Reg. §1.652(b)-3(a)). Indirect deductions — trustee commissions, state income and personal property taxes, safe-deposit rent — go to any class the trustee chooses, except a ratable share must be charged against tax-exempt income (§265), and excess deductions attributable to tax-exempt income are lost.
• Reg. example: $10,000 each of dividends, municipal interest and rents, $3,000 of commissions → $1,000 against the munis, the other $2,000 wherever the trustee elects. Software has a default; the trustee decides, and the choice changes the K-1.
• The charitable deduction is allocated ratably across all classes, including tax-exempt, before other deductions (Reg. §§1.643(a)-5, 1.662(b)-2), unless the instrument directs a source.
• Timing: the beneficiary reports in his year that includes the last day of the fiduciary’s year (§§652(c), 662(c)). A fiscal-year estate’s K-1 for the year ended June 30, 2026 is 2026 income to the beneficiary even for income the estate earned in 2025.
• Throwback rules (§§665–668) now apply only to foreign trusts and certain pre-March 1, 1984 domestic trusts; estates never.

Study questions 13–16

• SQ 13. DNI includes 100% of a taxable IRA distribution even if 90% is principal for accounting; includes the exemption added back; allows no §691(c) deduction; leaves capital losses out rather than adding them back.
• SQ 14. A simple trust deducts required income whether or not paid by year end; DNI less net tax-exempt income is the ceiling; estates and complex trusts use the same §661 rules; DNI attaches to Tier I first.
• SQ 15. A fixed $20,000 payable from income or principal at the trustee’s discretion is a specific bequest; an annuity over six years, an amount payable only from income, and a lump sum in lieu of a ten-year annuity are distributions.
• SQ 16. All the shares of a named corporation under the will: specific bequest.

Private reference, not client advice. Notes taken from two continuing-education courses: Form 1041: A Practical Guide (Hadges & Zollars, Thomson Reuters Checkpoint Learning, 10 hours, written on 2019 law) and Taxation of Trusts, Estates, and Decedents (DeScherer & Rodda, CeriFi, 2025 printing on 2024 law). Figures and rules brought current to 2026 in October 2026 (P.L. 119-21, Rev. Proc. 2025-32, T.D. 9918). Items tagged check are to be confirmed against primary sources before they are relied on.