Before you can understand whether a trust can distribute losses, it’s important to first understand the term distributable net income (DNI). This term refers to income that is allocated from a trust to its unitholders or beneficiaries. The DNI is the maximum amount received by a unitholder or beneficiary that is taxable.
The DNI is capped so that there are no double taxation instances. In addition, the amount that exceeds the DNI is tax-free.
Keep reading to learn how the DNI relates to dispensable losses.
According to the United States tax code, estates and trusts may deduct the DNI or the sum of the trust income required to be distributed—whichever is less—and other amounts sufficiently paid, credited, or obligated to be distributed to beneficiaries in order to avoid double taxation on income.
An income trust identifies DNI as an amount relocated to unitholders. By contrast, an estate trust identifies DNI as the amount to be distributed to a beneficiary.
Calculating the Distributable Net Income
The equation used to calculate the distributable net income is as follows:
DNI = Taxable Income - Capital Gains + Tax Exemption
It’s important to keep in mind that if you have capital losses, you will replace the capital gains portion of the equation with capital losses.
If you’d like to calculate the taxable income, you’ll need to add the interest income, dividends, and capital gains. Then, you’ll subtract the fees and tax exemptions. Dissimilar to the DNI formula, capital gains are added in the taxable income calculation while capital losses are subtracted.
How Losses Can Pass to Beneficiaries
Your trust can offset capital gains and up to $3,000 of standard income with capital losses. Any losses in excess may be pushed forward and used in future tax years. However, they may not pass through to the beneficiaries prior to the year that the trust concludes.
Keep in mind that the related party rule may cause a declared loss to be rejected.
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