If you are the trustee of a particular trust, you have a fiduciary duty to follow the trust agreement impartially in the interests of the grantor and the beneficiaries. Simple trusts will include a clause in its trust agreement that requires all distributable net income from the current year to be distributed to the beneficiaries in the current year. For more complex trusts without such a clause, the trust agreement may state that a certain amount of income must be distributed to a beneficiary once he or she reaches a certain age (i.e. 18, 21, or 25), or when he or she reaches college to pay for educational expenses. It is critical to make the distributions when required, as there are legal ramifications when distributions are not made when required including but not limited to: appointment of a receiver or temporary trustee to administer the trust, removal of the trustee, reduction of trustee compensation, and/or legal action.
From a tax standpoint, the distributions made or not made can affect the distribution deduction allowed on the trust’s Form 1041 tax return, thus affecting the tax liability at the trust level. Sections 651 and 661 of the Internal Revenue Code (IRC) discusses the deduction allowed for simple and complex trusts, respectively, to the extent of net income in the current year. Whereas simple trusts can deduct only the income required to be distributed currently, complex trusts may be able to deduct any income required to be distributed along with any principal distributed during the current year, if total distributions are below the distributable net income limitation. Additionally, under Section 643(b) of the IRC, trustors of complex trusts may grant the power to trustees to treat capital gains as income instead of principal, allowing further deductions from distributions.
In situations where principal assets are to be distributed, such as a rental property or marketable securities, the trustee is allowed to discuss the timing of the distribution of these assets with the beneficiary to determine the most appropriate time to transfer these assets. However, the trustee’s discretion must follow the terms of the trust agreement and could be subject to similar legal ramifications as mentioned earlier.