CTFA Trust Taxation and Accounting 2 — Questions and Answers
Question 1: Under the principal and income rules, how are stock dividends typically allocated between income and principal in a trust?
- Cash dividends are income; stock dividends are principal (Correct answer)
- All dividends are income regardless of form
- All dividends are principal and cannot be distributed to income beneficiaries
- Stock dividends are income; cash dividends are principal
Correct answer: Cash dividends are income; stock dividends are principal
Under the Uniform Principal and Income Act, cash dividends are allocated to income while stock dividends and stock splits are allocated to principal.
Question 2: What is the purpose of a unitrust conversion in a traditional income trust?
- To pay beneficiaries a fixed percentage of trust assets annually instead of actual accounting income (Correct answer)
- To convert a revocable trust into an irrevocable trust for tax purposes
- To allow the trustee to use trust principal for investment expenses
- To merge multiple trusts into a single administrative unit
Correct answer: To pay beneficiaries a fixed percentage of trust assets annually instead of actual accounting income
A unitrust conversion replaces the trust's accounting income with a set percentage of the trust's value (e.g., 3–5%), aligning distributions with total return investing.
Question 3: Which IRS form do trust beneficiaries receive to report their share of trust income?
- Schedule K-1 (Form 1041) (Correct answer)
- Form 1099-INT
- Form W-2
- Schedule B (Form 1040)
Correct answer: Schedule K-1 (Form 1041)
Schedule K-1 (Form 1041) reports each beneficiary's allocable share of trust income, deductions, and credits that must be included in their personal tax return.
Question 4: A charitable remainder trust (CRT) provides which primary tax benefit to the donor at the time of contribution?
- A partial charitable income tax deduction based on the present value of the remainder interest (Correct answer)
- A full deduction equal to 100% of the asset's fair market value
- Complete avoidance of estate and gift taxes on contributed assets
- Immediate exclusion of all future appreciation from the donor's estate
Correct answer: A partial charitable income tax deduction based on the present value of the remainder interest
The donor receives an income tax deduction equal to the actuarial present value of the remainder interest that will pass to the charity at the trust's termination.
Question 5: Under IRC Section 642(c), charitable deductions for trusts differ from individual charitable deductions in which way?
- Trust charitable deductions are limited to amounts actually paid from gross income pursuant to the trust instrument (Correct answer)
- Trust charitable deductions are unlimited with no percentage-of-income limitation
- Trust charitable deductions require IRS approval before the return is filed
- Trust charitable deductions apply only to cash gifts, not property
Correct answer: Trust charitable deductions are limited to amounts actually paid from gross income pursuant to the trust instrument
Under IRC Section 642(c), a trust may deduct amounts paid for charitable purposes only if the trust document specifically authorizes charitable distributions from gross income.
Question 6: What is the net investment income tax (NIIT) rate imposed on undistributed trust net investment income?
- 3.8% (Correct answer)
- 0.9%
- 2.5%
- 5.0%
Correct answer: 3.8%
Trusts pay an additional 3.8% net investment income tax on undistributed net investment income above a very low threshold (approximately $3,100 in 2024).
CTFA Trust Taxation and Accounting 2
Under the principal and income rules, how are stock dividends typically allocated between income and principal in a trust?