May 2020 TAXATION OF ESTATES AND TRUSTS Atty. C, Llamado ESTATES Estate Defined Estate refers to the mass of all the property, rights, and obligations of a person which are not extinguished by his death.! Itincludes not only the property and transmissible rights and obligations existing at the time of his death, but also those which have accrued thereto since the opening of the succession? Decedent Defined Decedent is the general term applied to the person whose property is transmitted through succession, whether or not he left a will. If he left a will, he is also called the testator. Heir Defined An heir is a person called to the succession either by the provision of a will or by operation of law.* Devisee Defined A devise is a person to whom a gift of real property is given by virtue of a will. Legatee Defined A legatee is a person to whom a gift of personal property is given by virtue of a will. Classification of Estates Estates, for purposes of the income tax, are classified into: 1. Estate under judicial administration (the settlement of which is the object of judicial testamentary or intestate proceedings); and ' Art. 776, Civil Code. 2 an. 781, “Art. 782, Ci * Secs. 209 and 210, Rev. Reg, No, 2-1940.May 2020 2. Estate not under judicial administration (the settlement of which is not the object of judicial testamentary or intestate proceedings). To Whom Income of Estate Shall be Taxed The income of an estate may be taxable to the estate or heirs and beneficiaries, as follows: 1, Generally, the income of the estate shall be taxable to the fiduciary or trustee. The fiduciary or trustee (executor or administrator) shall file the return for the estate and pay the income tax due thereon. 2. Where the estate is not under judicial administration and there is no executor or administrator, the income of the estate shall be taxable to the heirs and beneficiaries. Each heir and beneficiary shall include in his return his distributive share of the net income of the estate. Taxable Income of Estates The taxable income of the estate shall be computed in the same manner and on the same basis as in the case of a self-employed individual. Gross Income of Estates The items of gross income taxable to individuals (as defined in Section 32(A) of the Tax Code) are also the same items of gross income which are taxable to estates. Excluded from Gross Income of an Estate: The passage of property to the executor or administrator on the death of the decedent, even though the property may have appreciated in value since the decedent acquired it. Included in Gross Income of an Estate 1. Income received by the estate of a deceased person during the period of administration or settlement of the estate. The “period of administration or settlement of the estate” is the period required by the executor or administrator to perform the ordinary duties pertaining to administration, such as the collection of assets and payment of debts and legacies. Estates during the period of administration have but one beneficiary and that beneficiary is the estate,May 2020 2. Where, prior to the settlement of the estate, the executor or administrator sells property of a decedent's estate for more than the appraised value placed upon it at the death of the decedent, the excess is income taxable to the estate. Notes: 1. In the event of delivery of property in kind to a legatee or distributee, no income is realized by the legatee or distributee. 2. Where the property is sold after the settlement of the estate by the devisee, legatee, or heir at a price greater than the appraised value placed upon it at the time he inherited the property from the decedent, the devisee, legatee or heir is taxable individually on any profit derived. Deduction of Estates An estate can take up the same items of deduction authorized under Section 34 of the Tax Code and allowed an individual taxpayer. Special Deduction of Estates Estates can also deduct, in addition to the deduction authorized under Section 34 of the Tax Code, the amount of income of the estate for the taxable year which is properly paid or credited during such year to apy legate, heir, or beneficiary. The income distributed to beneficiaries of an estate is subject to a 15% CWT to be withheld by the estate. Notes: (a) The amount so allowed as a deduction shall be included in computing the taxable income of the legatee, heir, or beneficiary.* However, where no such distribution to the heirs is made during the taxable year that such income is subjected to income tax payments by the estate, the subsequent distribution thereof is no longer taxable on the part of the recipient heir. (b) An allowance paid to an heir out of the corpus (i.e. property) of the estate is not deductible from gross income.” © Sec. 61(B), NIRC. 7 Sec. 211, Rev. Reg. No. 2-40.May 2020 Rates of Tax ‘The rates of tax under Section 24(A)(2) of the Tax Code, which are prescribed for individuals earning purely self-employment or professional income, shall be used in computing the income tax of estates. An estate shall thus have the following tax rates: |A) Ifthe estate’s gross sales/receipts plus other non-operating income exceeds the VAT threshold of P3,000,000 as provided in Section 109(BB) of the Tax Code, it shall be taxed on its net taxable income using the graduated rates under Section 24(A)(2)(a) of the Tax Code. (B) If such estate’s gross sales/receipts plus other non-operating income does not exceed the VAT threshold of 3,000,000, the estate’s executor/administrator shall have the option for the estate to be taxed at: (1) Eight percent (8%) of gross sales or gross receipts, plus other non- operating income in excess of Two Hundred Fifty Thousand Pesos (P250,000); Note: This 8% tax. on gross sales/receipts plus other non-operating income shall be in lieu of (a) the progressive income tax rates under Section 24(A)(2)(a) of the Tax Code, and (b) the 3% Other Percentage Tax (“OPT”) under Section 116 of the Tax Code. OR (2) The graduated (progressive) rates under Section 24(A)(2)(a) of the Tax Code. Computation of Tax Accounting Period - —Callendar year Tax Base : (a) Taxable net income or (b) Gross sales/receipts + non-operating income, if 8% income tax rate is availed of. Rate of Tax : (a) Graduated rates or (b) 8% Income tax rate (if qualified and elected) TRUSTS Trust defined A trust is a right of property, real or personal, held by one party (trustee) for the benefit of another (beneficiary). A trust is an obligation imposed either expressly or by implication of law, whereby the trustee is bound to deal with property over which he has control, for the benefit of certain persons of whom he may himself be one, and anyone of them may enforce the obligation.May 2020 Parties to a Trust A person who establishes a trust is called the Zrustor or Grantor. The one in whom confidence is reposed as regards the property for the benefit of another person is known as the Trustee (or Fiduciary), and the person for whose benefit the trust has been created is referred to as the Beneficiary. Fiduciary Defined A fiduciary, for income tax purposes, is any person or corporation that holds in trust an estate (or properties) of another person or persons. In order that a fiduciary relationship may exist, it is necessary that a legal trust be created.* Classification of Trusts Trusts may be classified into the following categories: (1) Ordinary trust; (2) Revocable trust; (3) Employees trust. id Ordinary Trust In an ordinary trust’, the income and corpus of the trust do not revert to the grantor. The trust income is accumulated and held for distribution to the beneficiaries. Revocable Trust A revocable trust is a trust in which the power to revest in the grantor title to any part of the corpus of the trust is vested in the grantor himself or any person not having any substantial adverse interest in the trust corpus or in its income. The income of such part of the trust estate title to which may be revested in the grantor, or held or distributed for the benefit of the grantor shall be included in computing the taxable income of the grantor.'* * Sec, 207, Rev. Reg. No. 2-40. ° Ordinary trust is any of the following trusts; i. A trust where the income is accumulated or held for future distribution under the terms of a will or trust, ii, A trust where the income is to be distributed currently by the fiduciary to the beneficiaries; iii. A trust where the income is accumulated for the benefit of unborn or unascertained person or persons with contingent interest; ’ iv, A trust where the income collected by a guardian of an infant is held or distributed as the court may direct; and . A trust where the income, in the discretion of the fiduciary, may be either distributed to the beneficiaries or accumulated (Sec, 60 (A), NIRC). ' Sec. 63, NIRC; Sec. 207, Rev. Reg. No, 2-40.May 2020 “Income For the Benefit of the Grantor” A trust income is considered for the benefit of the grantor where any part of the “income of the trust — (1)is, or in the discretion of the grantor or of any person not having a substantial adverse interest in the disposition of such part of the income may be held or accumulated for future distribution to the grantor; or (2) may, or in the discretion of the grantor or of any person not having a substantial adverse interest in the disposition of such part of the income, be ted to the grantor; or (3) is, or in the discretion of the grantor or of any person not having a substantial adverse interest in the disposition of such part of the income may be applied to the payment of premiums upon policies of insurance on the life of the grantor. Such part of the income of the trust for the benefit of the grantor shall be included in computing the taxable income of the grantor.'' Employee's Trust Income tax shall not apply to employee's trust which forms part of a pension, stock bonus, or profit-sharing plan of an employer for the benefit of some or all of his employees.'? Requisites or Conditions For Exemption of Employee's Trust (1) The employee’s trust must form part of a pension, stock bonus, or profit-sharin, ploy PI is plan of an employer for the benefit of some or all of his employees; (2) Contributions are made to the trust by such employer, or employees, or both; (3) The contributions are made for the purpose of distributing to such employees the earnings and principal of the fund accumulated by the trust in accordance with such plan; (4) Under the trust instrument, it is impossible, at any time prior to the satisfaction of all liabilities with respect to employees under the trust, for any part of the corpus or income to be (within the taxable year or thereafter) used for, or diverted to, purposes other than for the exclusive benefit of his employees. Any amount actually distributed to any employee or distribute shall be taxable to him in the year in which so distributed to the extent that it exceeds the amount contributed by such employee or distribute."" '" Sec. 64(A), NIRC. " Sec. 60(B), NIRC. ” Sec. 60(B), NIRC,May 2020 TAXABILITY OF INCOME OF TRUSTS The income of a trust may be taxable to the trustee, or to the beneficiaries, or to the grantor. (A) Income of Trust Taxed to the Trustee" (1) The income of a trust which is to be accumulated or held for future distribution, whether consisting of ordinary income or gain from the sale of assets included in the corpus of the trust, must be returned by and will be taxed to the trustee. (2) The income of a trust, whether created by will or deed, for accumulation of income, whether for an unascertained person or persons with contingent interests or otherwise, shall be taxed to the trustee. (3) The income of a trust, where under the terms of a will or deed, the trustee may, in his discretion, distribute the income or accumulate it, the income is taxed to the trustee, irrespective of the exercise of his discretion. (B) Income of Trust Taxed to Beneficiaries The income ofa trust for the taxable year which is to be distributed to the beneficiaries must be returned (i.e. included in the ITR) by and will be taxed to the respective beneficiaries. Note: Income distributed to beneficiaries of a trust is subject toa CWT of 15% to be withheld by the trust. (C) Income of Trust Taxed Directly to the Grantor!’ (1) Incase of a revocable trust, income from such part of the trust estate title to which may be revoked by the grantor or revested in the grantor. ‘The income should be included in the grantor’s return. (2) In the case of a trust the income of which, in whole or in part, may be held or distributed for the benefit of the grantor. That part of the income which may be held or distributed for the benefit of the grantor should be included in the income tax return of the grantor. (3) Such part of the income of the trust which may be applied to the payment of premiums upon policies of insuranee on the life of the grantor. Such part of the income shall be included in computing the taxable income of the grantor. Sec, 207, Rev. Reg. No. 2-40. "* Sec. 64(A), NIRC.May 2020 Determination of the Tax The tax shall be computed upon the taxable income of the trust and shalll be paid by the fiduciary.'6 Taxable Income of Trusts The taxable income of the trust shall be computed in the same manner and on the same basis as in the case of an individual.” Gross Income of Trusts The items of gross income taxable to individuals are also the same items of gross income which are taxable to trusts. Deduction of Trusts A trust can take up the same items of deduction authorized under Section 34 of the Tax Code and allowed an individual taxpayer.'* Special Deduction of Trusts” ‘A trust can also deduct, in addition to the deductions authorized under Section 34, the following: (1) The amount of the income of the trust for the taxable year which is to be distributed currently to the beneficiaries; 2) The amount of income collected by a guardian of an infant which is to be held or distributed as the court may direct; and 3) The amount of the income of the trust for the taxable year which is properly paid or credited to any beneficiary. Note: The amount so allowed as a deduction shall be included in computing the taxable income of the beneficiaries, whether distributed to them or not. 6 Sec, 60(C\(1), NIRC. "7 Sec, 61, NIRC. "Sec. 61, NIRC. '? Sec, 61(A) and (B), NIRC.May 2020 Rates of Tax The rates of tax under Section 24(A)(2) of the Tax Code, which are prescribed for individuals earning purely self-employment or professional income, shall be used in computing the income tax of trusts. A trust shall thus have the following tax rates: A) If the trust’s gross sales/receipts plus other non-operating income exceeds the VAT threshold of P3,000,000 as provided in Section 109(BB) of the Tax Code, it shall be taxed on its net taxable income using the graduated rates under Section 24(A)(2)(a) of the Tax Code. (B) If such trust’s gross sales/receipts plus other non-operating income does not exceed the VAT threshold of P3,000,000, the trustee shall have the option for the trust to be taxed at: (1) Eight percent (8%) of gross sales or gross receipts, plus other non- operating income in excess of Two Hundred Fifty Thousand Pesos (P250,000); Note: This 8% tax on gross sales/receipts plus other non-operating income shall be in lieu of (a) the progressive income tax rates under Section 24(A)(2)(a) of the Tax Code, and (b) the 3% Other Percentage Tax (“OPT”) under Section 116 of the Tax Code. OR (2) The graduated (progressive) rates under Section 24(A)(2)(a) of the Tax Code. Computation of Income Tax of Trusts Accounting Period - ~—Callendar year Tax Base - (a) Taxable net income or (b) Gross sales/receipts + non-operating income, if 8% income tax rate is availed of. Rate of Tax - (a) Graduated rates or (b) 8% Income tax rate (if qualified and elected) Consolidation of Income of Two or More Trusts” Where two or more trusts are created by the same trustor or grantor, and in each instance the beneficiary is the same person, the taxable income of all the trusts shall be consolidated, and the tax computed on such consolidated income. Such proportion of said tax shall be assessed and collected from each trustee which the taxable income of the trust administered by him bears to the consolidated income of the several trusts. % Sec. 60(C)(2), NIRC.May 2020 Formula The formula to determine the allocation of tax to be paid by each trustee shall be as follows: Taxable income of trust Tak on cobgelidaied 4.023. “Tee atousted ~tomiactientie |X table he = ortobepald asolidated Taxable axable income eee income Author's Note: Under Section 116 of R.A. No. 11232 (the Revised Corporation Code of the Philippines), an estate or trust may form a corporation with a single stockholder called a One Person Corporation. It may therefore be argued that an estate or trust which is constituted as a One Person Corporation should be taxed like a corporation. However, Section 60(A) of the Tax Code provides that the tax imposed upon individuals shall apply to the income of estates or trusts. The same section| does not make any qualification or distinction as to the juridical personality of an estate or trust. The author therefore submits that until Section 60(A) of the Tax Code is otherwise repealed or amended by new legislation, or until the BIR issues regulations/rulings subjecting estates and trusts constituted as One Person Corporations to the corporate income tax, the income tax imposed upon individuals should still apply to the income of estates and trusts.