Matching Taxes to Their Source
Trust tax is not a single line item. In a simple trust, complex trust, or grantor trust, different receipts can be classified differently. Some go to income, such as interest, dividends, or rent from real estate. Others go to principal, such as capital gains from asset sales. This statute creates a straightforward rule: the tax follows the receipt. Whatever generated the taxable income is the fund that pays it.
A tax required to be paid by a trustee based on receipts allocated to income must be paid from income.
A.R.S. § 14-7429(A)This principle keeps things fair for each trust beneficiary. Income beneficiaries bear the tax cost of income they receive. Remainder beneficiaries bear the tax cost of gains that build principal. Neither side subsidizes the other.
Entity Income and Mixed Allocations
Trusts often hold interests in entities like partnerships or S corporations. Those entities produce taxable income that may be allocated partly to income and partly to principal. The trust pays the tax from each fund in the same ratio that receipts were allocated. If the tax exceeds the total receipts from the entity, the excess comes from principal.
A tax required to be paid by a trustee on the trust's share of an entity's taxable income must be paid proportionately from principal and income to the extent that receipts from the entity are allocated to both income and principal.
A.R.S. § 14-7429(C)(3)The statute requires one more adjustment. After the initial allocation, the trustee must account for any tax deduction from distributions. If a distribution lowers the overall tax bill shown on the trust's tax returns, the trustee adjusts income or principal receipts to reflect that benefit.