Rubin on Tax: Income Tax Assessment on Beneficiary Allowed Even Though the Statute of Limitations Had Expired

Charles Rubin discusses the case of Sally Costello v. Commissioner. The case shows how the IRS was able to assess income taxes against two trust beneficiaries even though the statute of limitations for assessment has expired due to the mitigation provisions of the Internal Revenue Code.

The article begins as follows:

FACTS: A father established a revocable trust during his lifetime. Several IRAs of father named the trust as beneficiary. Father then died on June 21, 1998. In 2001, $228,530.44 was distributed to the trust from the IRAs. In the same year, the trust distributed the same amount to two beneficiaries of the trust (who were children of the father).

On its timely Form 1041 for 2001, the trust reported $228,530 in gross income, and also deducted that amount as an income distribution, so that it had no net income. It reported the distributions to the beneficiaries on Schedules K-1. The two beneficiaries each reported $114,265 in income from the distributions on their Forms 1040 for 2001.

The Form 1041 was selected for audit, and in 2004 the IRS disallowed the income distribution deductions, and determined an $80,302 deficiency for the trust for 2001. The IRS also adjusted the beneficiaries’ Forms 1040 by removing the trust distributions from gross income. The beneficiaries paid the additional tax due that the trust owed 2001, and they received refunds for their 2001 taxes.

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Posted by Pooja Shivaprasad, Associate Editor, Wealth Strategies Journal