Income Taxation Valencia Roxas Tax Chapter 14: Income Taxes of Estates &Trusts

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CHAPTER 14

INCOME TAXES OF ESTATES & TRUSTS

Problem 14 – 1 TRUE OR FALSE

1. False – P20,000 2. True 3. True 4. True 5. True 6. True

7. False – It shall be in writing either as trust inter-vivos or through a will. 8. False – A trustor is the person who establishes the trust, not the trustee. 9. True

10. True 11. True 12. True

Problem 14 – 2 TRUE OR FALSE

1. False – A taxpayer is required to file ITR regardless of the result of business whether there is income or loss; hence, the ITR of irrevocable trust should be filed if its income is P20,000 and below.

2. True 3. True 4. True

5. False – The income is taxable. 6. True

7. True

8. False – special deduction related to amount distributed to beneficiary is not allowed when a trust is administered in a foreign country. [Sec. 61 (C), NIRC]

9. True

10. False – Since the trusts are irrevocable, their income should not be combined with the income of the trustor.

Problem 14 – 3 1. B 2. C 3. A 4. D 5. B 6. A 7. A 8. B 9. D 10. C 11. C

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Problem 14 – 4 D

Gross income

Less: OSD (P200,000) Net income

Less: Basic personal exemption Net taxable income

P200,000 80,000 P120,000 50,000 P 7 0 , 0 0 0

The estate can deduct greater amount of deductions by using OSD. Section 35(C) of NIRC provides that if the taxpayer dies during the taxable year, his estate may still claim personal and additional exemptions for himself and his dependents.

In the given problem, Mrs. Ayugat can claim her basic personal exemption of P50,000 but she cannot claim additional exemptions because her husband is the proper claimant of the additional exemptions unless the husband waives his right or has no income taxable in the Philippines.. [Sec. 79(F), NIRC]

Problem 14 – 5

Note: Since the requirement is tax savings, if is to be assumed that OSD shall be used to determine the lower amount of tax.

Correction: Requirement 2 should be: … of the estate of Mathai’s mother. 1. Letter B

Gross business receipts of Mathai’s estate after death P400,000

Less: OSD (P400,000 x 40%) 160,000

Net income before personal exemption P240,000

Less: Absolute exemption 20,000

Net income subject to income tax P220,000

It must be noted that the P400,000 represents the income of the estate after death. It does not include the income before death. In this case, the applicable exemption would be P20,000 because the income of Mathai before his death could deduct the basic personal exemption of P50,000.

2. Not in the choices = P5,000

Income tax when no income of estate was distributed (Case 1 + Case 3)

(P59,000 + P8,500) P 67,500

Less: Income tax when P150,000 of estate’s income was distributed

(Case 2 + Case 4) = (P35,000 + P27,500) 62,500

Tax savings

P 5,000

Supporting computations:

Case 1 Case 2 Case 3 Case 4

Gross business receipts 500,000 500,000 200,000 200,000 Distribution to the beneficiary . (150,000) . 150,000 Balance 500,000 350,000 200,000 350,000 OSD – 40% (200,000) (140,000) (80,000) (140,000) Net income before personal exemption 300,000 210,000 120,000 210,000 Personal exemption (20,000) (20,000) (50,000) (50,000) Net taxable income 280,000 190,000 70,000 160,000 Income tax for first bracket 50,000 22,500 8,500 22,500 Income tax on excess

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Case 2: (P190,000 – P140,000) x 25% 12,500

Case 4: (160,000 – 140,000) x 25% . . . 5,000 Total income taxes 59,000 35,000 8,500 27,500

Problem 14 – 6

1. Letter C

Gross business income P320,000 Less: Business expenses 200,000 Net income before personal exemption P120,000 Less: Personal exemption – basic 50,000 Net taxable income P 70,000

Tax on P70,000 P 8,500

Naty Goc cannot claim the additional exemption of her minor child because her husband is deemed head of family and proper claimant of the additional exemption. [Sec. 79(F), NIRC]

2. Letter A

Income tax due – case 2 & case 3 (P2,500 + P4,000) P 6,500 Less: Income tax due – case 1 32,500 Income tax savings – 200y (P26,000)

Case 1* Case 2* Case 3* Gross income P500,000 P500,000

Itemized (300,000) (300,000)

Amount distributed – child (150,000) P150,000 OSD (P200,000 x 40%) . . ( 60,000) Net income before exemption P200,000 P 50,000 P 90,000 Personal exemption ( 20,000) ( 20,000) ( 50,000) Net taxable income P180,000 P 30.000 P 40,000 Tax on P140,000 P22,500

Tax on P30,000 P 2,500 P2,500 Tax on excess:

Case 1: (P40,000 x 25%) 10,000

Case 3: (P10,000 x 15%) . . 1,500 Income tax due P32,500 P 2,500 P 4,000

*Case 1 – Income tax of the estate (no portion is distributed to heir).

*Case 2 – Income tax of the estate (P150,000 is distributed to heir).

*Case 3 – Income tax of the heir (P150,000 is received from estate).

The tax saving is brought about by splitting the taxable income between taxpayers

thus lowering the taxable income to lower tax rate and availing two personal

exemptions.

Problem 14 – 7

1. Letter C

200x 200y

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Operating expenses allowed (2,800,000) (3,200,000) Amounts given to beneficiaries

200x (P680,000/85%) ( 800,000)

200y (P765,000/85%) ( 900,000)

Personal exemption ( 20,000) ( 20,000)

Net taxable income P1,380,000 P1,880,000

Tax on P500,000 P125,000 P125,000

Tax on excess:

200x: (P880,000 x 32%) 281,600

200y: (P1,380,000 x 32%) . 441,600

Income tax due P406,600 P566,600

The absolute exemption of P20,000 is to be used for the income of Mr. Anao’s estate while Mr. Anao’s income will used the basic personal exemption of P50,000.

2. Letter A

200x 200y Amounts received by wife

200x: (P425,000/85%) P500,000

200y: (P510,000/85%) P600,000

OSD (40%) (200,000) (240,000)

Personal exemption ( 50,000) ( 50,000)

Net taxable income P250,000 P310,000

Tax on P250,000 P 50,000 P 50,000

Tax on excess (P60,000) . 18,000

Income tax due P 50,000 P 68,000

Less: Creditable withholding tax

200x: (P500,000 x 15%) 75,000

200y: (P600,000 x 15%) . 90,000

Income tax refund P 25,000 P 22,000

Less: 200x income tax refund 25,000

200y’s tax refund is lower by (P 3,000)

3. Letter C

Amount received by Mr. Tag Anao, son in 200y

(P255,000/85%) P300,000

OSD (40%) (120,000)

Personal exemption ( 50,000)

Net taxable income P130,000

Tax on P70,000 P 8,500

Tax on excess (P60,000 x 20%) 12,000

Income tax due P 20,500

Less: 200y Creditable withholding tax (P300,000 x 15%) 45,000

Income tax refund (P24,500)

A beneficiary of an estate engaged in business has the status of self-employed individual taxpayer. It follows, therefore, that such beneficiary can claim the itemized deduction or optional deduction in the computation of his net taxable income. Furthermore, the amount paid to the beneficiary has not been subjected to business expenses.

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Problem 14 – 8 C

Income of trust P400,000

Less: Amount distributed to the heir (P85,000/85%) P100,000

Absolute exemption 20,000 120,000

Net taxable income of trust P280,000

Problem 14 – 9

1. Letter B

Amount received from trust B (P4,800,000/80%) x 20% P1,200,000

Rent income (P285,000/95%) 300,000

Total income before OSD P1,500,000

Less: OSD (P1,500,000 x 40%) P600,000

Basic personal exemption 50,000 650,000

Net taxable income P 850,000

Tax on P500,000 P125,000

Tax on excess (P350,000 x 32%) 112,000

Income tax due P237,000

Less: CWT on amount received from trust

(P1,200,000 x 15%) P180,000

CWT from rent income (P300,000 x 5%) 15,000 195,000

Income tax still due and payable P 42,000

2. Letter C

Trust A Trust B

Net income before exemption P4,000,000 P4,800,000

Less: Exemption 20,000 20,000

Net taxable income P3,980,000 P4,780,000

Tax on P500,000 P 125,000 P 125,000

Tax on excess:

Trust A (P3,480,000 x 32%) 1,113,600

Trust B (P4,280,000 x 32%) . 1,369,600

Income tax due of each trust P1,238,600 P1,494,600

Total income tax due (P1,238,600 + P1,494,600) P2,733,200

In case of more than one trust, the creator of the trust in each instance is the same person and the trustee in each instance is the same but the beneficiaries are different, the trustee should make a separate return for each of the trusts in his hands. When a trustee holds trust created by different persons for the benefit of the same beneficiary, he should also make a return for each trust separately. (Sections 208 & 215, Rev. Regs. No. 2; Sec. 60 (C)(2), NIRC]

Problem 14 – 10 1. Letter B

Income of the grantor Income of trust A - revocable Total income of the grantor Less: Total expenses

P1,000,000

500,000 P1,500,000

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Grantor – business expense Trust A – business expense

Grantor’s income before personal exemptions

P400,000

200,000 600,000 P 900,000

2. Letter D

Income of trust B – irrevocable trust Less: Expenses of irrevocable trust – B Net income before exemption

Less: Exemption

Net taxable income of all the trust

P200,000 100,000 P100,000 20,000 P 80,000

Assume beneficiary opted to use OSD. 3. Letter D

Income of beneficiary Add: Share from trust Total gross income

P100,000 50,000 P150,000

Less: OSD (P150,000 x 40%) 60,000

Net income before personal exemption P 90,000

Less: Personal exemption 50,000

Net income P 40,000

Problem 14 – 11

1. Letter A

The trust is not taxable because it is revocable. The supposed income tax of the trust shall be included in the income tax of Mr. Tan.

2. Letter D

Net income of Mr. Tan P2,000,000

Less: Basic personal exemption 50,000

Net taxable income P1,950,000

Tax on P500,000 P125,000

Tax on excess (P1,450,000 x 32%) 464,000

Note: Only the income of irrevocable trust is entitled for special deduction.

3. Letter A

Since the amount given to the daughter is not considered as deduction from

irrevocable trust, such amount is considered allowance. Therefore, not subject to tax.

Problem 14 – 12

1.

Conjugal gross income from estate

Less: Business expense (P5,000,000 x 40%) Income distributed to beneficiaries Conjugal net income

P2,000,000 600,000 P5,000,000 2,600,000 P2,400,000 200x income tax due from the estate of Mr. Baguingan:

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Income share of Mr. Baguingan’ estate (P2,400,000 x 50%) Less: Exemption Taxable income Tax on P500,000 Tax on excess (P680,000) x 32%) Income tax due

P1,200,000 20,000 P1,180,000 P 125,000 217,600 P 342,600 The estate of Mr. Baguingan will acquire a new TIN and file a separate ITR claiming P20,000 absolute exemption. If Mr. Baguingan has income in 200x prior to his death, such income shall be filed separately using his TIN and allowed to deduct basic exemption as if he died at the close of the taxable year.

2.

Compensation income P250,000

Add: Income received from trust 200,000

Total income before personal exemption P450,000

Less: Personal exemptions (P50,000 + P100,000) 150,000

Tax on P250,000 P50,000

Tax on excess (P50,000 x 30%) 15,000

Note: Unless the taxpayer signifies in his ITR his intention to elect the OSD, he shall be

considered as having availed himself of the itemized deductions. (Sec. 34(L), NIRC)

Alternative solution: If beneficiary opted to use OSD

Compensation income

Add: Income received from trust, net of OSD (P200,000 x 60%) Total income before exemption

Less: Personal exemptions: Basic

Additional (P25,000 x 4)

Taxable income of Mrs. Diana Nievera Tax on P140,000

Tax on excess (P80,000 x 30%) Income tax due

P 50,000 100,000 P250,000 120,000 P370,000 150,000 P220,000 P 22,500 24,000 P 46,500 3.

Total amount received by the children Multiply by withholding tax rate Total withholding taxes

P600,000 15% P 90,000

Problem 14 – 13

Tax savings:

Income tax when no income of estate was distributed (Case 1 + Case 3)

(P122,000 + P8,500) P131,400

(Case 2 + Case 4) = (P86,000 + P42,500) 128,500

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Supporting computations year

after death: Case 1 Case 2 Case 3 Case 4

Gross income 800,000 800,000 300,000 300,000 Business deductions:

Itemized deductions (260,000) (260,000) (180,000) (180,000) Distribution to beneficiary . (150,000) . 150,000 Net income before personal exemption 540,000 390,000 120,000 270,000 Personal exemption (20,000) (20,000) (50,000) (50,000) Net taxable income 520,000 370,000 70,000 220,000 Income tax for first bracket, P500,000 125,000

Income tax for first bracket, P250,000 50,000

Income tax for first bracket, P140,000 22,500 Income tax for first bracket, P70,000 8,500

Income tax on excess

Case 1: (520,000 – 500,000) x 32% 6,400

Case 2: (370,000 – 250,000) x 30% 36,000

Problem 14 – 14

1. Income tax payable by the trust in 200x: Income from house and lot

Income from hollow block business (P10,000 x 12) Income from farm

Total gross income from trust

Less: Related expenses (P250,000 x 30%) Amount distributed to the beneficiary Net income before exemption

Less: Exemption Net taxable income Tax on P70,000

Tax on excess (P35,000 x 20%) Total income tax payable

P 75,000 50,000 P 80,000 120,000 50,000 P 250,000 125,000 P 125,000 20,000 P 105,000 P 8,500 10,500 P 19,000 2. Income tax payable from the beneficiary in 200x:

Gross income received from income of trust Less: Personal exemption

Net taxable income Total income tax payable

P 50,000 50,000

P 0 . P 0 .

Note: Unless the taxpayer signifies in his ITR his intention to elect the OSD, he shall be

considered as having availed himself of the itemized deductions. (Sec. 34(L), NIRC)

Alternative solution – if Trust and beneficiary opted to use OSD

1. Total gross income – trust P250,000

Less: OSD (P250,000 x 40%) P100,000

Amount distributed to the beneficiary 50,000 150,000

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Tax on excess (P10,000 x 20%) 2,000

Total income tax payable P10,500

2. Gross income received from income of trust P50,000

Less: Optional standard deduction (P50,000 x 40%) 20,000

Net income before exemption P30,000

Net taxable income (P30,000)

Total income tax payable P 0 .

Problem 14 – 15

Correction: The requirement should be stated as: How much is the income tax due of the

two trusts?

Total net income of trusts (P50,000 + P1,000,000) Less: Distribution to beneficiary (P10,000 + P20,000) Exemption

Net taxable income Tax on P500,000

Tax on excess (P500,000 x 32%) Income tax due and payable

P 30,000 20,000 P1,050,000 50,000 P1,000,000 P125,000 160,000 P285,000 Problem 14 – 16

Note: Since the topic is tax planning and the requirement is tax savings, OSD can

automatically assumed to be used to determine the lower tax.

1. Gross receipts P300,000

Less: OSD (P300,000 x 40%) 120,000

Less: Exemption 20,000

Net income subject to income tax P160,000

The P300,000 is the business gross receipts of the estate; therefore, subject to P20,000 exemption.

2. Income tax when no income of estate was distributed (Case 1 + Case 3)

(P59,000 + P8,500) P 67,500

(Case 2 + Case 4) = (P35,000 + P27,500) 62,500

Tax savings

P 5,000

Supporting computations:

Case 1 Case 2 Case 3 Case 4

Gross business receipts 500,000 500,000 200,000 200,000 Distribution to the beneficiary . (150,000) . 150,000 Balance 500,000 350,000 200,000 350,000 OSD – 40% (200,000) (140,000) (80,000) (140,000) Net income before personal exemption 300,000 210,000 120,000 210,000 Exemption (20,000) (20,000) (50,000) (50,000) Net taxable income 280,000 190,000 70,000 160,000

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Income tax for first bracket 50,000 22,500 8,500 22,500 Income tax on excess

Case 1 (P280,000 – P250,000) x 30% 9,000

Case 2 (P190,000 – P140,000) x 25% 12,500

Problem 14 – 17

1. To minimize income tax, Dokling can do the following: a. Put his business under irrevocable trust

b. Use OSD instead of itemized deduction because the OSD is greater than the itemized deduction, and

c. Claim his child’s allowance as amount of distribution to beneficiary from the income of the trust.

2. Tax exposure before the creation of trust:

Gross income P400,000

Less: OSD (P400,000 x 40%) 160,000

Tax on P140,000 P22,500

Tax on excess (P50,000 x 25%) 12,500

Note: The allowance is not deductible because the child is not established

as beneficiary of the trust. Furthermore, the business is not in trust. 50% of the business is created as irrevocable trust:

Grantor:

Income tax if 50% is held in trust (irrevocable)

Gross income (50%) P200,000

Less: OSD (P200,000 x 40%) 80,000

Tax on P70,000 ( 8,500)

Trust:

Income tax if 50% is held in trust (irrevocable)

Gross income (50%) P200,000

Less: OSD (P200,000 x 40%) P 80,000

Distribution to beneficiary 100,000 P180,000

Less: Exemption 20,000

Net taxable income P 0

-Beneficiary:

Share from the income of trust P100,000

Less: OSD (P100,000 x 40%) 40,000

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Tax on P10,000 ( 500)

Tax savings P26,000

Problem 14 – 18

Note: Since the topic is tax planning, the taxpayer should use OSD instead of itemized

deduction because using OSD can give a greater tax savings based on the given data of this case.

1. Rent income P 800,000

Less: OSD (P800,000 x 40%) 320,000

Net income P 430,000

Tax on P250,000 P 50,000

Add: Tax on excess (P180,000 x 30%) 54,000

2. Rent income – Property 2 P 300,000

Less: OSD (P300,000 x 40%) 120,000

Tax on P70,000 P 8,500

Add: Tax on excess (P60,000 x 20%) 12,000

Income tax due ( 20,500)

Less: Income tax property no. 1

2. Rent income – Property 1 P 500,000

Less: OSD (P500,000 x 40%) 200,000

Tax on P250,000 P 50,000

Tax on excess (P30,000 x 30%) 9,000 ( 59,000)