Trust Planning with the 65 Day Rule



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Tax planningThe “65 Day Rule” allows a trustee to elect to make a trust distribution within 65 days of the end of the preceding tax year and effectively transfer some of the tax liability from the trust to the trust beneficiary who received the distribution.  Utilizing this rule can provide a significant tax savings to the trust, possibly at a lower tax cost to the beneficiary.

The reason to consider this is that the graduated tax rate for the trust reaches the highest marginal tax rate of 39.6% at just $12,300 of taxable income.  In addition, the additional 3.8% Medicare surtax applies to this income as well, making the total marginal tax 43.4%.  Single individuals reach this maximum threshold at income of $413,200 and married individuals filing a joint return reach this maximum at $464,850.

For example, let’s take a trust with taxable income of $30,000 and a single beneficiary who has taxable income of $100,000 before any trust distributions.  Let’s assume that the trust elects to make a 65 Day distribution of $20,000.

Income and tax before 65 Day distribution:

Trust Beneficiary Total Tax
Taxable Income $ 30,000 $100,000
Tax $10,861 $21,071 $31,932
Highest marginal tax rate 43.4% 28%

Income and tax after 65 Day distribution:

Trust Beneficiary Total T ax
Taxable Income $ 10,000 120,000
Tax $2,421 $26,671 $29,092
Highest marginal tax rate 33% 28%

By taking a distribution, the combined tax savings is $2,840.  This example ignores many of the finer points of the tax calculation, but effectively illustrates the benefits of the election.  Unfortunately, capital gains are generally not able to be distributed to beneficiaries but distributions can be made of income, dividends, royalties, and other income subject to the highest rates.  Dividends continue to enjoy more favorable tax rates at 20%, but the 3.8% surtax is added to this rate as well, so savings opportunities remain.

All of the distributions during a calendar year from a trust have the same effect (of transferring the trust’s income to the beneficiary), however, the 65 Day Rule allows a “look back” period to make any appropriate adjustments.  With many trusts, this look back period allows an exact calculation to be made, so that the best tax result is achieved.   A word of caution – trustees should not let the tail wag the dog.  There are cases where it may be wiser for the trustee to retain the income in the trust than to distribute it to a particular beneficiary.  But this is a technique that can result in significant tax savings should certainly be considered each year.

Horizon Wealth Advisors
Horizon Wealth Advisors is a Houston-based, privately owned, fee-only financial advisor established in 1999. Our mission is to develop long-term relationships with thoughtful, successful individuals, families, and organizations by supporting and assisting them in achieving their financial goals.

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