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There are numerous elections that fiduciaries can make on estate and trust federal income tax re- turns to help maximize tax efficiency for the entity and its beneficiaries. One such election is the Sec- tion 643(e)(3) election, which permits a fiduciary to treat the distribution of in-kind property as having been sold by the entity to the beneficiaries at fair market value (FMV), thereby triggering po- tential gain,1 among other consequences.
Practitioners must be well-versed in the consequences of this election to advise fiduci- aries properly on whether it should be made. An understanding of the statutory framework for income taxation2 of estates, trusts, and ben- eficiaries is necessary to provide context for the Section 643(e)(3) election. Further, it is impor- tant to know the types of distributions subject to the election, what the election achieves, when it might make sense, and how it is made or revoked, as appropriate.
Statutory framework
The income taxation of trusts or estates (hereafter collectively "entity") and beneficiaries is governed by Subchapter J of the Code, which reflects a hy- brid theory of taxation. This theory is embodied in the income distribution deduction (IDD), which an entity is allowed to claim for distribu- tions made (or treated as made) to beneficiaries during the year. The taxable portion of any distri- bution that a beneficiary receives from an entity will be subject to income tax on the beneficiary's personal income tax return. Correspondingly, the distributing entity is permitted to deduct the tax- able portion of the distribution. Any of the entity's taxable income remaining after claiming the IDD is subject to income tax on the entity's return. The result is that the taxable income for the year is gen - erally taxed at either the entity level or the benefi- ciary level, but usually not both.
Income distribution deduction
The IDD may be computed differently for a sim- ple trust than for a complex trust or estate. A sim- ple trust must distribute all of its income currently, has no charitable beneficiaries in the current year, and does not distribute corpus during the current year.3 "Income" means fiduciary accounting in- come (FAI), which is defined generally as "the amount of income of the estate or trust for the tax-...