Trustees Should Consider Making Distributions With the 65 Day Rule



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The “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.

Taxpayers should consider this move because the graduated tax rate for the trust reaches the highest marginal tax rate of 37% at just $12,500 of taxable income for 2018.  In addition, the 3.8% Medicare surtax applies to this income, making the total marginal tax 40.8%.  Single individuals reach this maximum marginal tax rate at income of $500,000 and married individuals filing a joint return reach this maximum at $600,000.

For example, let’s take a trust with taxable investment 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 $10,152 $18,290 $28,442
Highest marginal tax rate 40.8% 24%
Income and tax after 65 Day distribution:
Trust Beneficiary Total Tax
Taxable Income $ 10,000 120,000
Tax $2,137 $23,090 $25,227
Highest marginal tax rate 35% 24%

By taking a distribution, the combined tax savings is $3,215.  This example ignores many of the finer points of the tax calculation, but effectively illustrates the benefits of the election.  Note that capital gains are generally not considered as distributions but distributions can include other income, including  dividends and royalties which may be subject to the highest rates.

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 the calculation of an exact tax amount, to achieve the desired tax result.   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, in the proper situation, this is a technique that can result in significant tax savings.

Horizon Wealth Advisors is a Houston based fee-only wealth management firm. Horizon is a fiduciary advisor. We specialize in helping successful individuals and families understand, organize, and manage their often complex financial situations. Horizon offers integrated financial planning and investment management services.

Larry Maddox, CFP®, CPA
Larry founded Horizon Advisors, LLC in Houston, Texas in 1999 with fellow business partner Joe Thomson. He collaborates with our wealth management team and other external advisors to provide comprehensive wealth management services.

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