California CPA March/April 2023 | Page 15

There are always some wrinkles to fiduciary tax return preparation to keep us alert .
estateplanning
BY WILLIAM DOWNS , CPA & JOHN WOODFORD , CPA

Software ’ s Pitfalls Dealing with

Distributions from Trusts to Beneficiaries when a trustee makes distributions to beneficiaries , the nature of those can often be a challenge to determine . And our tax preparation software doesn ’ t automatically get it right .

A “ simple ” trust may be anything but simple when dealing with distributions to beneficiaries .
A simple trust , by definition , is required to distribute all its income to beneficiaries . When the trust has received a variety of types of income , the character of the distributions can be a challenge for the preparer . A complex trust , for which the trustee makes distributions of income to beneficiaries , can face similar challenges .
Questions of Income An important number to determine is the fiduciary accounting income . Utilizing fiduciary accounting concepts , and with reference to the trust document and the Uniform Principal and Income Act , the return preparer will determine the dollar amount that is to be entered in Schedule B of the federal and California trust tax returns , which can impact the overall limit of taxable and tax-exempt income required to be distributed .
That number may be more or less than the distributable net income ( DNI ) determined using income tax rules . And while the accounting income amount is crucially important , your tax preparation software may not properly calculate it . It comes down to making your own calculation of accounting income and entering it as an override in tax software programs .
When preparing a beneficiary K-1 form for a simple trust , net amounts of the various items of income are reported , after subtracting expenses allocated against those items of income .
The first consideration is to determine the portion of expenses to be allocated to taxexempt income and therefore not deducted
against taxable income amounts . IRS instructions say that you may use “ any reasonable method ” to apportion . Your software will offer suggestions , but it is up to the preparer to determine a fraction that is reasonable . And be aware that your software may use a method that you would consider not reasonable .
For example , Lacerte fiduciary software has a user setting to allow , or not allow , capital gains to be included in the denominator of the fraction . If you include capital gains in the denominator , that will result in a smaller fraction to apply when assigning expenses to tax-exempt income .
Expenses to be allocated against items of taxable income can be apportioned among categories of taxable income . Perhaps your first choice would be to allocate expenses to offset interest income .
Next you may wish to allocate to nonqualified dividends , then qualified dividends and passive income . Once again , your

There are always some wrinkles to fiduciary tax return preparation to keep us alert .

software may do what you want , or you may have to tweak the input , or even override the calculation . For example , Lacerte software has a K-1 user option to allocate expenses pro-rata to all items of income , or to use what they call a “ tier ” allocation . The latter would normally be the better choice if you want to offset interest income first as mentioned above .
Schedule K-1 Tax credits , most commonly foreign taxes withheld on dividend income , can be passed through to beneficiaries on Schedule K-1 . For 2021 trust income tax returns , the IRS devised a new addition to the 1041 K-1 form , which was an attempt to provide more detailed information to beneficiaries about foreign source income . And again , you may have to devote more effort to be sure your software is producing the proper amount of foreign income distributed to beneficiaries .
Qualified business income ( QBI ) amounts ( Sec . 199A ) also would be reported on expanded Schedule K-1 forms . QBI flowing from REIT investments at a brokerage is one example . That particular source of income would likely be a last item you would allow expenses to offset , which is another reason to use the “ tier ” method .
If there is passive income , such as from rents , the preparer may want to avoid offsetting that income with expenses when determining the amounts to report on K-1 form .
Other Acts and Effects The Tax Cuts and Jobs Act eliminated deductions that were subject to the 2 percent of AGI limitation for 2018-25 . This can cause www . calcpa . org MARCH / APRIL 2023 CALIFORNIA CPA 13