there are various types of trusts from a tax standpoint. These are not all of them but are likely to be the most relevant. See BOX A on previous returns.
decedent's estate - may pay taxes on all income. The income earned from the assets of the estate during the period of administration or settlement must be accounted for and reported by the estate.
grantor - it's a disregarded entity and doesn't pay income taxes. rather each beneficiary pays taxes on their share of the trust income.
simple trust - is required to distribute all ordinary income currently. Whether capital gains (the land sale) can be distributed is a matter of provisions in the trust document and state law governing the trust. it's not a simple trust if principal (corpus) can be distributed.
complex trust - may make distributions of ordinary income and corpus. must be done within 65 days of its year-end. again the trust document and state law determine whether capital gains can be distributed.
Whether the trustee of an existing trust can distribute capital gains to its beneficiaries depends on the terms of the trust agreement. If the trust agreement specifies that the trustee may distribute principal as he or she sees fit or must distribute principal if income is insufficient to fund the required distribution for the year, capital gains may be distributed to the beneficiaries. If the trust agreement is completely silent on the topic of the distribution of principal the trustee is able to rely on the Uniform Principal and Income Act (UPIA), which gives the trustee the discretion to distribute capital gains as he or she sees fit.
The Internal Revenue Code provides that capital gains may be passed out to the beneficiary and be taxed at the beneficiary level if:
Under the trust agreement or local law, capital gains are considered trust income;
The trust agreement or local law allocates capital gains to principal, but they are consistently treated as part of distributions to the beneficiaries on the trust’s books, records, and tax returns; or
The trust agreement or local law allocates capital gains to principal, but they are actually distributed to the beneficiaries or utilized by the trustee in determining the beneficiaries’ distributions.
consider consulting with a trust lawyer if other than a grantor trust and the trust does not contain specific wording allowing the distribution of principal
