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A.
Federal taxation of transfer of
pet and caretaking funds to caretaker or trustee
1. Federal income taxation
In
general, the receipt of funds and other property
(i.e., pet animal) by gift, bequest, devise, or
inheritance is not subject to federal income
taxation. In other words, there is no income taxable
event merely because the pet and/or certain caretaking
funds pass to a caretaker or a trust for the care of
an animal. What happens when
the caretaking funds earn interest or dividends within
the trust is an entirely different question (discussed below).
2. Federal estate and gift taxation
Under
current federal uniform transfer tax law, a decedent
may, through a combination of taxable gifts made
during the decedent’s lifetime or passing at death
through the decedent’s “gross estate”, transfer up
to a certain amount to nonspouse/noncharitable
beneficiaries without incurring federal estate or
gift taxes. Under the current statute, for
gift tax purposes, this "exemption" amount is $1
million. For estate tax purposes, the
exemption amount is currently $2 million, but will rise
to $3.5 million
in 2009; and in 2010, the estate tax is repealed, only
to return again with a $1 million exemption in 2011. Most estate planners posit
that there will be some change in the law prior to
2010.
Within
this general framework, it should be noted that any
amount passing to a pet trust by reason of the
settlor’s death will generally be included in the
gross estate. Under
Revenue Ruling 78-105, 1978-1 CB 295, the IRS has
ruled that no portion of the amount passing to a valid
trust for the lifetime benefit of a pet qualifies for
the charitable estate tax deduction, even if the
remainder beneficiary is a qualifying charity.
That said, the relatively wealthy pet owner should
consider how the taxes attributable to such a
trust should be paid under the federal and state
apportionment rules.
B. Federal income taxation of trust for pet
Revenue Ruling 76-486,
1976-2 CB 192 provides that if a trust for
the benefit of an animal is valid under state law,
then the trust itself will be subject to income
taxation – not the caretaker-trustee or the pet
animal. If the net taxable income from the pet trust
exceeds $100, the trustee is generally required to
file a fiduciary income tax return (IRS Form 1041) and
pay any income taxes.
1.
Who pays the income taxes
Under the
federal income tax law, if the caretaker is
considered the beneficiary of the trust (which is
the case with a traditional legal trust for pets),
then under IRC §661, the trust is entitled to deduct
the amount of “distributable net income” paid out to
the caretaker, and the caretaker is required to
recognize this taxable income
on his or her own income tax return. When all is
said and done, either the trustee or the caretaker pay
the income taxes, depending on whether the taxable income is
accumulated or distributed each year. As a
result, any trust provisions intending to make the
caretaker whole should also take into account
potential tax consequences.
Of
course, a pet animal is not required to file or pay
income taxes. Thus, Revenue Ruling 76-486 provides
that if the pet is considered the beneficiary of the
trust (which appears to be an implicit assumption
under the pet trust statutes), the trust receives no
income distribution deduction for such distributions
and would be required to pay income taxes with respect
to any taxable income. Nor would
the trust qualify as a charitable trust, even if the
remainder beneficiary is a qualifying charitable
organization.
2.
Deductibility of payments for the care of the pet
If the
pet is considered property of the trust, an
argument could be made that any expenditures made for
care of a pet represent deductible trust
administration expenses – reducing the amount of
taxable income to either the trust or the
caretaker-beneficiary. IRC §212 allows a deduction
for ordinary and necessary expenses incurred: (a) for
the production of income; (b) for the management,
conservation, or maintenance of property held for the
production of income; or (c) in connection with the
determination, collection, or refund of any tax. The
accompanying regulations also state that a trustee may
deduct expenses incurred “in connection with the
performance of the duties of administration.”
In practice, trustee fees and professional fees
(e.g., attorneys, accountants, tax return
preparation) are clearly deductible; but
expenditures incurred for the care of a pet, which
is not an income-producing asset and is not
inextricably related to the normal business of
administering a trust, are probably not
deductible.
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