Liquidating trust and taxable event
Pension plans are quickly disappearing in both the public and private sectors.
As a result, traditional Individual Retirement Accounts (IRAs) and defined contribution plans under Section 401(k) of the Internal Revenue Code (401ks) will most likely become the most significant assets in many estate plans.
At the time a bankruptcy petition is filed, all of the debtor’s assets become property of a “bankruptcy estate.” The transfer of assets by the debtor to the bankruptcy estate is not treated as a taxable disposition.
After the bankruptcy case has been initiated, income generated from assets included in a bankruptcy estate is included in the bankruptcy estate's income.
By this rule will not apply to transfers to a revocable living trust, or most types of transfers of a trust, in the case of some common estate planning techniques – like gifting an annuity to an Intentionally Defective Grantor Trust (IDGT) – the situation remains unclear, and clients and their advisors must be cautious not to accidentally create an unfavorable taxable event!
because they’re tax-deferred, but because they date of annuitization is deferred to the future; i.e., they have not yet been “annuitized”).
Companies experiencing financial distress sometimes use a Chapter 11 bankruptcy case to liquidate substantially all their assets.
The liquidation may be through asset sales that are approved by the bankruptcy court through a motion to sell under Section 363 of the Bankruptcy Code. Ed.2d 203 (2008) (Section 1146 of the Bankruptcy Code is inapplicable to asset sales outside of a confirmed plan). Therefore, the debtor's tax attribute carryovers from prior tax periods become available to offset the federal income tax liability of the bankruptcy estate during the bankruptcy case.
(For more insight, see our recent blog post - In any of these liquidation scenarios, the bankruptcy estate may realize substantial capital gains income after considering the debtor's adjusted basis in the property. One disadvantage of an asset sale, as opposed to a transfer of assets under a confirmed plan of reorganization, is the lack of any exemption from stamp taxes or similar taxes under Section 1146 of the Bankruptcy Code. In this scenario, the placement of the retirement assets into the trust would be a “lump sum distribution” to the trust, meaning that the full value of the assets transferred would be taxed all at once – as ordinary income to the trust at the trust tax rate.For example, for the tax year ending December 31, 2012, trust income over ,650 will be taxed at a rate of 35%.A debtor may also seek confirmation of a liquidating plan. The Supreme Court overruled cases holding that the exemption set forth in Section 1146 of the Bankruptcy Code could apply absent any plan of reorganization., No. In considering asset sale transactions in liquidating Chapter 11 bankruptcy cases outside of a plan of reorganization, bankruptcy professionals need to determine whether or not there are capital gains, and whether or not there are enough net operating losses or other tax attributes to offset taxable income generated by the bankruptcy estate, such that there is no federal or state income tax liability owed by the bankruptcy estate.The liquidating plan may provide for the sale of the debtor’s assets to a third party.
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Income may be generated for the bankruptcy estate because the debtor’s property was either sold or there was a taxable transfer to a third party.