652 MODULE 37 TAXES: GIFT AND ESTATE

1. Distributable net income (DNI) is the maximum amount of deduction for distributions to benefi-
ciaries in any taxable year and also determines the amounts and character of the income reported
by the beneficiaries.
2. Generally, DNI is the same as the estate's or trust's taxable income computed before the income
distribution deduction with the following modifications:
(1) Add
(a) Personal exemption
(b) Any net capital loss deduction (limited to $3,000)
(c) Tax exempt interest (reduced by related nondeductible expenses)
(2) Subtract
(a) Net capital gains allocable to corpus
(b) Extraordinary dividends and taxable stock dividends allocated to corpus of simple trust
3. Deduction will be the Iesser of DNI or the amount distributed to beneficiaries (i.e., taxable income
required to be distributed, plus other amount of taxable income distributed).
4. Treatment of Simple Trust and Beneficiaries
5. Income is taxed to beneficiaries, not to trust.
6. Beneficiaries are taxed on the income required to be distributed (up to DNI), even though not
actually
distributed during the year.
7. Income passes through to beneficiaries retaining its characteristics (e.g., tax-exempt income
passes
through retaining its exempt status).
8. If multiple beneficiaries, DNI is prorated in proportion to the amount of required distribution to
each
beneficiary .
9. Treatment of Complex Trust and Beneficiaries
10. A two-tier income distribution system is used.
11. First tier: Distributions of the first tier are income amounts that are required to be distributed and
include distributions that can be paid out of income or corpus, to the extent paid out of income.
12. Second tier: Distributions of the second tier are all other amounts that are actually paid during the
year or are required to be paid.
13. DNI is first allocated to distributions in the first tier. Any remaining DNIis prorated to distributions
in the second tier.
EXAMPLE: A trust has DNI of $9,000. The trust instrument requires that $6,000 of income be distributed annually to
Alan. Further, it permits distributions to Baker and Carr of income or corpus in the trustee's discretion. For the cur-
rent year, the trustee distributes $6,000 to Alan, $4,000 to Baker, and $2,000 to Carr.
Since Alan's distribution is afirst tier distribution, all $6,000 distributed is taxable to Alan. This leaves only
$3,000 of DNI to be allocated to the second tier distributions to Baker and Carr. Since DNI would be allocated in pro-
portion to the amounts distributed, $2,000 of Baker's distribution and $1,000 of Carr's distribution would be taxable.
14. Grantor Trusts are trusts over which the grantor (or grantor's spouse) retain substantial control. The in-
come from a grantor trust is generally taxed to the grantor, not to the trust or beneficiaries. A grantor trust
generally exists if any of the following conditions are present:
15. Trust income will, or in the grantor's or nonadverse party's discretion may be, distributed to the
grant-
or or grantor's spouse (or used to pay life insurance premiums of either).
16. The grantor (or nonadverse party) has the power-to revoke the trust.
17. The grantor (or grantor's spouse) holds a reversionary interest worth more than 5% of trust corpus.
18. The grantor (or nonadverse party) can deal with trust property in a nonfiduciary capacity (e.g.,
pur-
chase trust assets for less than adequate consideration or borrow trust property at below market rate).
19. The grantor (or grantor's spouse) or non adverse party controls the beneficial enjoyment of the
trust
 (e.g., ability to change beneficiaries).
20. Termination of Estate or Trust
1. An estate or trust is not entitled to a personal exemption on its final return.