Using the 65-day rule as an opportunity for income tax savings for estate

One of the tax planning tools available to executors of estates is the 663(b) election, also known as the “65-day rule.” Simply put, a 663(b) election allows distributions made to beneficiaries within 65 days of year-end to be counted as prior-year distributions.

How can a 663(b) election be beneficial?

The tax brackets for estates are 0%, 15%, 25%, 28%, 33% and 39.6%, similar to individuals. The critical difference between estates and individuals is that estates reach the maximum tax bracket of 39.6% once their taxable income is over $12,400, compared to $466,950 for a couple married filing jointly (MFJ).  So the highest tax rates are paid starting at extremely low-income levels, which leads to very high income tax.

Net investment income tax may also be imposed on estates that have undistributed net investment income and adjusted gross income exceeding $12,400 vs. $250,000 for a couple MFJ.

As a result, executors of estates may want to shift the income from the estates that are in a high tax bracket to beneficiaries in lower tax brackets. Executors achieve this shifting of income through the mechanism of distributions to beneficiaries. This mechanism in effect flows some or all of the trust income from the trust to the K-1s of beneficiaries who, in turn, report the income on their 1040 form.

The maximum amount of distributions covered by the election is limited to the greater of (1) fiduciary accounting income for the tax year for which the election is made, or (2) distributable net income (DNI).

Because executors have 65 days after year-end to make 663(b) election distributions, executors are afforded some flexibility as to the timing of the distributions. They are sometimes able to wait until 1099s are actually issued to determine if a distribution under IRC 663(b) is indeed beneficial.

How is the election made?  

The 663(b) election is made by checking the box on line 6 under “Other Information” at the bottom of page 2 of form 1041. The question on line 6 says “If this is an estate or complex trust making the section 663(b) election, check here.” To be valid, the election must be made by filing form 1041 by its due date, including extension. Once made, the election is irrevocable.

While a 663(b) can be a helpful trust and estate tax planning tool, executors need to keep a few things in mind when making the election:

• Executors need to keep careful records as to what years the distributions apply
• Executors also need to keep in mind the provisions of the Last Will and Testament. Making distributions to beneficiaries just to save on taxes may conflict with the decedent’s wishes as to the timing and amount of the distributions.

If you need help determining if a 663(b) election makes sense for you, or if you have any other tax questions, please contact us.

Patel Law Offices offers a strategy session to discuss how to resolve your legal problem. Conveniently schedule online today with our online scheduler and questionnaire.