Background: Living will [grantor] trusts are typically AB trusts. After the 1st spouse dies, the assets are split into A and B trusts. Assets in the B trust get a stepped up basis and are excluded from the surviving spouse's estate. The surviving spouse is typically the trustee of the B trust and thus has control over its assets.
B Trust Background: One of the B trust downsides is that it requires a separate tax filing of Form 1041 [and separately titled bank accounts, etc.]. The B trust issues a Schedule K-1 to its beneficiaries. Income and deductions can flow thru the B trust to the beneficiary's personal 1040 return via the K-1. Dividends are generally required to be passed to the beneficiaries without being taxed in the B trust. Capital gains have the option of being taxed in the B trust or flowing to the K-1. [This cap gains option is dependent on the wording of the trust.]
Current Year: This year I had $100k LT cap gains in the B trust. [$45K of that was from mutual funds over which I have no control. The rest is from stocks that I sold. In previous years, the B trust's cap gains were $0, $18k, $7k, $0.]
2021 Tax Rates for Trust LT Cap Gains:
- 0%: $0 – $2,700
15%: $2,701 – $13,250
20%: $13,251 and higher
Question: How much of the cap gains should I allocate to the K-1?
The mathematical answer is to avoid paying the 20% cap gains rate in the trust. But doing that requires a huge distribution to the beneficiary, which I don't want to do. Because it means I would have to liquidate assets in the trust to make the distribution.
I know this is a "good" problem to have. And it's pretty esoteric. I appreciate any suggestions or past experience from others.