Recently, there seems to be some confusion regarding section 643(b) of the Internal Revenue Code of 1986, as amended (the “Code”), and its application to trusts. Indeed, that provision—particularly to those not well-versed in federal trust taxation—can confound many. This article seeks to dispel some of the complexity surrounding section 643(b).
The Taxation of Trusts Generally
The federal income taxation of trusts and beneficiaries puzzles even tax professionals. Does the trust pay tax? What about the beneficiaries? What is the difference between a grantor trust and a complex trust? The questions can become endless.
I don’t seek to answer all those here. But I will try to provide some background on certain trust concepts so that you are more familiar with them. First, let’s start off with general concepts associated with the taxation of trusts. In Subchapter J of the Code (which addresses the taxation of trusts), it states in the very first provision: “[t]he tax imposed by section 1(e) shall apply to the taxable income of . . . any kind of property held in trust[.]”[i] That same provision further clarifies that this income includes: (i) income accumulated in trust (even contingent income or income for the benefit of unascertainable persons); (ii) income that a trustee is required distribute to the beneficiaries; and (iii) income that the trustee has discretion to retain in trust.[ii] Accordingly, as a general rule, a trust pays income tax on its activities.
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