Question

In: Accounting

On January 1, 2019 , Jerry Fallen transfers publicly traded debt securities with a fair market...

On January 1, 2019 , Jerry Fallen transfers publicly traded debt securities with a fair market value of

$570,000 to a newly established inter vivos trust for which his 22 year old son, James, is the only

beneficiary. The cost of these securities to Jerry was $520,000. During 2019 , the securities earn and

receive interest of $32,000, all of which is distributed to James.

On January 1, 2020, the securities are transferred to James in satisfaction of his capital interest in the

trust. At this time, the fair market value of the securities has increased to $615,000. James sells all of

the securities for $615,000 on January 3, 2020.

Indicate the tax consequences for Jerry, James, and the trust, in each of the years 2019 and 2020

Expert Solution

Taxable Event 1 :

On 1st January'2019, when Jerry Fallen transfers debt securities to the trust, it consitutes to be a capital gain in his hands, irresepctive of who the beneficiary is. Since it is a transfer, it comes within the scope of taxable event under head capital gains. The capital gain will be FMV ($570000) less acquisition cost of securities ($520000) = $50000

Taxable Event 2 :

Interest received by trust on securities of $32000, it shall be first taxable in hands of trust being income.

Taxable Event 3 :

When interest is trasnferred to the beneficiary James, it shall be taxable in hands of James as income from other sources. The transfer shall be allowed as expense to the trust off setting the taxability in the hands of trust in taxable event 2.

Taxable Event 4 :

On 1st January'2020 when securities are transferred to James in satisfaction of his capital interest, it shall be a taxable event in the hands of trust. Capital Gain shall be $615000-$570000 = $45000

Taxable Event 4 :

Transfer of securities by James at $615000 is a taxable capital gain, but since cost of acquisition is equal to FMV of transfer, there will be no taxability, and James will ultimately enjoy proceeds of $615000 being the beneficiary.

Note : In event of computation of capital gain, FMV is taken deemed sales consideration.

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