Accounting Income - Based on the trust document and applicable state laws, this is the income of the trust. Unless otherwise specified in the trust agreement, capital gains are not included, and interest, dividends, rent, royalties, etc. are included in it. The use of it is to determine the amount of income that is distributed to beneficiaries.
Taxable Income - The calculation is done in accordance with federal tax rules (IRS guidelines). Start with the trust's total income, subtract expenses (such as trustee fees, attorney fees, and other administrative expenses) and apply any permitted exemptions. The trust usually deducts distributions to beneficiaries, but they must be reported as income by the beneficiaries.
Distributable Net Income (DNI) - The amount of income beneficiaries report and the trust's deductions for distributions are governed by DNI, a critical measure. Taxable income is included, but capital gains are excluded unless they are distributed or included in distributions according to the trust document. Tax-exempt income (like municipal bond interest) is added back to the calculation because it's taken into account when determining distributions.
The purpose of each of these figures is unique: accounting income affects distributions, taxable income determines how much tax is paid, and DNI connects them for tax reporting purposes.
An illustration is provided to explain the distinction between accounting income, taxable income, and distributable income of a trust.
"Trust A" is a simple trust requiring all its income to be distributed currently. Trust-a reported the followin for the current year.
"Trust A" is a trust that requires all its income to be distributed at present. Trust-A provided an update on the follow-up for the current year.
- Ordinary interest income $10,000.
- Tax-exempt interest income $2,000
- Dividend income $38,000.
- Fees charged by the trust $5,000.
- Capital gain allocated to principal $22,000.
We will recall the simple definition of trust to solve the above problem:
A trust that is simply established primarily for tax purposes has specific characteristics defined by the Internal Revenue Code (IRC). It has the following main attributes:
Definition - A simple trust requires the trust income to be distributed to beneficiaries in the year it is earned or each year. Retaining income or distributing principal (corpus) during the year is not allowed unless specifically required by the trust agreement. Furthermore, a simple trust is unable to make charitable contributions.
Characteristics
- It is mandatory for the trust to distribute all income generated annually to beneficiaries.
- The trust is unable to accumulate income or reinvest it within itself due to its lack of retained earnings.
- The trust corpus (principal) is left unaltered and only income is given except as specified in the trust terms.
- The trust is prohibited from contributing to charitable organizations, which is an option in complex trusts.
- The income of beneficiaries is taxed, but the trust is not generally taxed on the income it distributes.
- The trust's income distribution and tax reporting are made simpler by these rules.
What is the accounting income/book-income in this example?
The trust accounting income will be determined by adding all income and subtracting expenses. Thus, $10,000 + $2,000 + $38,000 - $5,000 + $22,000 = $67,000 is accounting or book-income of Trust A.
What is the taxable income of Trust A?
Before distribution to beneficiaries, the Trust has taxable income of $64,700, which is $67,000 - $300 - $2,000.
What is Trust A's distributable net income to beneficiaries?
$64,700 + $300 + $2,000 - $22,000 = $45,000
