Chapter 4 Co-Ownership, Estates and Trusts CO-OWNERSHIP , There is co-ownership when two or more heirs or beneficiaries inherit an undivided roperty from a decedent, or when a donor makes a gift of an undivided property in favor of two or more donees. Inheritance is subject to “Estate Tax” while Donation is subject to “Donor’s Tax”. Both taxes are not income taxes but classified as “Transfer Taxes” which are discussed in Volume 2 (Transfer and Business Taxation). Nonetheless, incomes from such properties are subject to income tax. Co-owners are taxed individually on their distributive share in the income of the co-ownership. Meaning, co-ownership itself is not taxable for the reason that the activities of co-ownership are generally limited to the preservation of the common property and the collection of the income therefrom. Should the co-owners invest the income in business for profit, they would be constituting themselves into a partnership and such shall be taxable as a corporation as discussed in Chapter 6 - Income Tax of a Partnership. When inherited property remained undivided for more than ten (10) years and no attempt was ever made to divide the same among the co-heirs, nor was the property under administration proceedings nor held in trust ‘the property should be considered as owned by an unregistered partnership, consequently, taxable as corporation. 191Co -oqner a Estates and. Trusts [ILLUSTRATION 1: CASE A: ; ; Ana, Loma and Fe “bought” a parcel of land for the purpose of improving the same before leasing it out to interested tenants, Question 1: sa co-ownership created? - et . SUE property may be undivided, it was acquired by the owners not through gratuitous transfer (inheritance or: donation) but by purchase. ‘Ana, Loma and Fe formed a partnership, instead of co-ownership. Partnership is generally taxable as a corporation. Consequently, Ana, Loma and Fe shall be considered “shareholders” for income tax purposes. Income tax of a partnership as well as the partners are discussed in Chapter 6. CASE B: On January 1, 2017, Noy, a resident citizen taxpayer died leaving an undivided parcel of land to his heirs Allan, Mar and Pacquito valued at P60,000,000. The property is an income producing property primarily through rentals. In 2018, the property earned gross rentals amounting to P-15,000,000 while expenditures necessary to carry out the operations was R3,000,000. On the other hand, the heirs, who are all engaged in businesses in their own individual capacity, provided the following data for 2018 taxable year: Allan Mar Pacquito Gross business income 6,000,000 P5,000,000 8,000,000 Business expenses 3,000,000 2,500,000 + 6,000,000 Income subject to final taxes (net) 200,000 320,000 500,000 Question 1: Is a co-ownership created? * Answer: Yes. "Since the property is undivided, the heirs are considered co-owners. = The estate of Noy valued at P60M is not ‘Subject to income tax but to estate tax (a transfer tax discussed in Volume 2). Question 2: Assuming Noy was able to ition i : Secure a partition and three separate land titles were issued by the government before his death, naming his fa as the rightful owners in his last wil is i Seed will and testament, is a co-ownership created? The property involved is not. an undivided property. 192Co-conership, Estates eek Trusts Question 3: What j of the property from Noy to his heirs? * Answer: Estate Tax Question 3: How much is ** Answer: none A CO-ownership capacity. ** Answer: R7,000,000 Solution: Gross income of Allan ~ ** Answer: P2,090,000 Taxable income. 4! P2,000,000 Income Tax Payable In excess of P2M; (PSM x 32%) is the applicable tax for the gratuitous transfer (inheritance) Estate tax and Donor's tax (transfer taxes) are discussed in volume 2. the taxable income of the co-ownership? oe is not a taxable person or entity. Its income, however, is listributed or shared by the heirs/donees, thus, taxable to them in their individual Question 4: How much is the taxable income of Allan in 2018? 6,000,000 Allowable business expenses of Allan (3,000,000) Share in net income of the co-ownership 4,000,000 (P12Mi3) Taxable income _P7,000,000 Question 5: How much is the income tax payable of Allan in 2018? 7,000,000, TAX DUE (using the graduated tax rates): 490,000 46 0 2,090,000 INCOME TAX OF AN ESTATE Income tax of an estate refers to the tax on income received by the estate during the period of administration or settlement. An “estate” is a mass of all the property, rights, and obligations of a deceased person which are not extinguished by his death, including those which have accrued thereto since the Opening of succession. For instance, the parcel of land worth - 60,000,000 in illustration 1, CASE B above is the estate of Noy. The passage of his property to his heirs upon his death is subject to Estate Tax (Refer to Volume 2 - Business and Transfer Taxes). - 193 ‘A transfer tax is a tax on gratuitous transfer of property either through gift/donation (subject to donor's tax) or through inheritance (subject to estate tax). A transfer tax is not an income tax because there is “no taxable income tealized from the passage of property to the heirs upon the death of the decedent.Co-oanershi Estates ch Trasts “Administration or Settlement Period” refers to the period when title to the properties left by a decedent is not yet finally transferred to the heirs/beneficiaries. At this period, the executor named by the deceased in his “last will or testament”, if any, or the administrator appointed by the court, as the case may be, is temporarily in-charge of the administration of the estate until such time that the estate is finally distributed to the rightful heirs. While under administration, the estate may earn income, thus, the corresponding income tax should be paid. ILLUSTRATION 2: ‘A decedent died leaving the following to his lawful heirs: Cash P5,000,000 House and lot 15,000,000 | Vacant parcel of land 5,000,000 Commercial building 30,000,000 Vehicles 0. Total (@ FMVs upon death) ~The properties to be received by his lawful heirs upon his death are not part of their gross income for purposes of computing the heirs’ taxable income because it does not come within the definition of income. The estate of a decedent may be settled judicially or extrajudicially. Judicial settlement pertains to settlement of an estate in a court proceeding while in extrajudicial settlement, the heirs or beneficiaries settle for themselves the distribution of the estate or their inheritance. Caassification of Estates under settlement or administration = Estate under ‘judicial” Fiduciary/trustee administration (administrator/executor) files the ITR * and pays the tax due thereon. * Estates not under “judicial” Heirs and beneficiaries file the ITR of administration (ie, the estate and pay the tax due thereon. extrajudicial settlement} 194Co ~oanership Estates oe Trusts Applicable tax The taxable income of the estate is cor in the same manner as an individual taxpayer. Consequently, aoa acto computed using the graduated income tax rates for individuals under Section 24(A) of the Tax Code (as amended under RA 10963 otherwise known as the TRAIN Law Likewise, an estate is required to adopt the calendar year as its accounting Period. 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 place upon it at the decedent's death, the excess is income taxable to the estate. Where the heir sells the property after the settlement, the heir is taxable individually on any profit derived. ee LUC Cee mie PRIOR to 2018 INCOME, TAX TRAIN LAW ~ TAXABLE YEAR 2018-2022 2023 onwards INCOME, TAX TAK Not over P250,000 Not over 10,000 Exempt Exempt Over P10,000 500 + 10% in Over P250,000 but 20% of excess over | 15% of excess over but not over ‘excess of P10,000 not over P400,000 250,000 250,000 . 30,000 Over P30,000 P2,500 + 15% in ‘Over P400,000 but —-P30,000 + 25% in P22,500 + 20% in but not over ‘excess of P30,000 not over P800,000 excess of P400,000 ‘excess of P400,000 P70,000 \ Over P70,000 PB,500 + 20% in ‘Over P800,000 but —_P130,000 + 30% in P102,500 + 25% in butnot over excess of P70,000 not over ‘excess of P800,000 excess of P800,000 140,000 P 2,000,000 Over P140,000. 22,500 + 25% in Over P2,000,000 490,000 + 32% in 402,500 + 30% in butnotover _excess of P140,000 but not over: excess of excess of P2,000,000 250,000 8,000,000 2,000,000 Over P250,000 P50,000 + 30% in Over P8,000,000 —-P2,410,000 + 35% 2,202,500 + 35% in but not over excess of P250,000 in excess of excess of P8,000,000 500,000 8,000,000 Over P500,000 125,000 + 32% in excess of P500,000 195Vas = Com wonershify Estates a) Trusts ILLUSTRATION 3: . On November 1, 2017, Juan Dela Cruz died leaving various property worth 30,000,000. The properties are income producing properties deriving renta| income. The net income from rentals for 2017 amounted to P2,500,000. a “last will and testament” was executed by the decedent prior to his death assigning GJ as the executor. In 2018, (while under administration), the estate earned P4,750,000 (net of 5% creditable withholding tax on rent) and incurred operating expenses of P2,000,000. Question 1; How much is the taxable income of the Estate of Juan Del Cruz in 2017? “Answer: None (CQ Under the Tax Code, when an individual taxpayer dies during the year, it shall be assumed that as if he died at the close of such year (Chapter 1), Consequently, the taxpayer identified in the income tax return for 2017 taxable year shall still be "Juan Dela Cruz’, instead of “Estate of Juan Dela Cruz’. Question 2: How much is income tax payable of the Estate of Juan Dela Cruz in 2018? “Answer: P560,000 Solution: “Gross" rental income (4.75M/95%) 5,000,000 Allowable deductions (2, 10) : 4 Taxable income P3,000,000 TAX DUE (using the graduated tax rate): 15'P2,000,000 P490,000 In excess of PIM @ 32% 320,000 Income Tax Due ~ P810,000 _ Less: CWTax on rentals ____(250,000) Income Tax Payable 560,000. Deduction from estate’s gross income | Deductions from the estate's gross income are the same items of deductions (business expenses) allowed for individual taxpayers under Section 34 of the Tax Code. However, in addition to the usual allowable business expenses, the amount of income of the estate for the taxable year which is properly paid or credited during such year to any legatee, heir, or beneficiary should be deducted (also known as special deduction) in the determination of the estate's taxable income. However, such amount of income distributed shall be included in the determination of the taxable income of the legatee/heir/beneficiary. 196Co-cunechst Estates and, Trusts Shown below is the pro-form ‘a Com taxable income of ~ the estate and the heirs/benefi putation of the iciaries: Taxable income of the Estate Gross income Less: Deductions Business expenses pecial Deduction: Distribution of estate’s income to beneficiaries ._ xxx Taxable income of the Estate Tax Due [Graduated Tax Rate] Pxxx Taxable Income of the Beneficial Compensation income, if any Net income of the beneficiary from business. PXXX and/or practice of profession Add: Amt. received from the income of the estate Taxable income Tax Due [Graduated Tax Rate] ILLUSTRATION 4: On November 1, 2017, Juan Dela Cruz died leaving various property worth 30,000,000 to his heirs; Pedro, Ana and Lorna. The properties are income producing properties deriving rental income. The net income from rentals for 2017 amounted to 2,500,000. A “last will and testament’ was executed by the decedent prior to his death assigning GJ as the executor. In 2048, (while under administration), the estate earned P4,750,000 (net of 5% creditable withholding tax on rent) and incurred operating expenses of P2,000,000. During 2018, Pedro (one of the lawful heirs) received P200,000 from the income of the estate. Pedro's other income and expenses were as follows: Compensation income P800,000 Business income = 1,500,000 Business expenses 600,000 197GE aenersh py Estates and Tus, _ inistration, how much ig the F di Question 1: Assume that the estate 'S still under 4! taxable income of the estate in 2018? + Answer: P2,800,000 Solution: “Gross” rental income (4.75M + .25M) eae Allowable business expenses | ,000, Distribution of income to Pedro (heir) Eh Lob Taxable income Question 2: How much is the taxable income of Pedro? | | i | Compensation income enon | * ; ted as follows: Answer: P1,900,000 compu! 800,000 Business income Business expenses (600,000) Amt. received from the income oftheestate _ _200,000< Taxable income 1,900,000 Termination of Judicial/Extrajudicial Settlement After termination of judicial/extrajudicial settlement of the estate where the heirs still do not divide the property but instead contribute to the estate money, property, or industry with intention to divide the profits between/among themselves, an unregistered partnership is created and the estate becomes liable for the payment of corporate income tax. (Evangelista vs. Collector, GR No. L-9996, October 15, 1957; Ofia vs. Commissioner, GR No. L-19342, May 25, 1972). On the other hand, if the heirs, without contributing money, property or industry to improve the estate, simply divide the fruits thereof between/among themselves, a co-ownership is created, and individual income: tax Pes on the income received by each of the heirs, payable in their separate and individual capaci us Commissioner, GR No. L-78133, October a eee VS. Commissioner, GR No. L-68118, October 29, 1985), , 198fo oe Comcsonershit Estates and, Trasts TAXATION OF TRUSTs Trust is a Tight on Property, real or Personal, held by one Party for i Bae ae It may be arranged inter-vivos or created by will ul tons Oa Property is Passed to another for conservation or investment wi the 'ncome therefrom and ultimately the Corpus (principal) to be distributed in accordance with the directions of the creator as expressed in the 9Overning instrument, Trust agreement all indivi, i an individecn erm a individuals to create Sustained benef property or other types of fi , may place a sum of money, F . such as equity and debt instruments in the hands of a trustee for the benefit of an incapacitated or minor child. PARTIES to a TRUST: * Trustor— Person who establishes a trust, * Trustee — One in whom Confidence is reposed as regards Property for the benefit of another person, . Beneficiary — Person for whose benefit trust is created. . Fiduciary- any person or Corporation that holds in trust an estate of another person or Persons. A fiduciary may exist only if a legal trust is created. Taxability of Income of Trusts The income of a trust may be taxable to the trustee, beneficiary or grantor, as the case may be. Taxable to the “Trustee” if: anette to the “Trustee” if: The income of the trust is taxable to the “trustee” i accumulated or held for future distribution, whether Ordinary income or gain from sale of assets incl luded in the corpus of the trust. The imposition Of the tax is not affected by the fact that the ultimate beneficiary may be a Person exempt from tax. Likewise, the income of a trust administered in a foreign country is taxable to the trustee. if the income is to be 199Co -owne hey Lstales and. Trasts Taxable to the “Grantor/Trustor” if. * Under the term of the trust, the principal of the trust may be reveste: The income of the corpus or princip: shall be taxable to the grantor. = The income of the trust may be held or distributed for th ana . inder the term of the trus' the benefit of the grantor. title to any part of the corpus or d to the grantor (Revocable Trust), al that may be revested to grantor e benefit of the t, the income of the trust shall be applied for Taxable to the Beneficiaries The income of the trust is taxable to the beneficiaries if the income is to be cial Deductions: 1. Distribution of the distributed to the beneficiaries. In such a vaar's income 10.00 case, the beneficiaries include in their Meir or beneficiary; return their distributive share in the net ‘and income of the trust. The distribution of 2, Amount collected by the year's income to an heir or a guardian of an beneficiary is a special item of deduction infant which is to be for the trust. At the same time, the held or distributed income distributed (actual = OF ame court may constructive) shall be treated as a special item of income to the heir/beneficiary. Special deductions are not allowed in case of a trust ad foreign country [Sec.61(C)-NIRC]. ministered in a Computation of Taxable Income The principles applied in computing the taxable income of an estate, plicable in the determination of the as previously discussed, is also ap| taxable income of a trust. Hence, the Trust's taxable income is likewise computed in the same manner as an individual taxpayer, except that the basic personal exemption allowed is limited only to P20,000 (Section 62- NIRC). The tax due is also based on the graduated rates provided under Section 24(A) of the Tax Code as shown in Table 2-2 of Chapter 2. Moreover, calendar period shall beused as accounting period for tax purposes. A trust is required to adopt the calendar year as its accounting period. 200Co-vnershi Estates Pek Trusts Shown below is the pro-forma Fi income of a Trust and a Beneficiary: computation of the taxable in: Taxable income of the Trust Gross income Less: Deductions Business expenses ‘Special Deduction: Distribution of trust's income to beneficiaries Taxable income of the Trust Prox Compensation income, if any Net income of the beneficiary from business and/or practice of profession Add: Amt. received from the income of the trust Taxable income of the Beneficiary Tax Due [Graduated Tax Rate] Classification of Trust 1, 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. Under the Tax Code, ordinary trust is any of the following trusts: = A trust where the income is accumulated or held for future distribution under the terms of a will trust. = A trust where the income is to be distributed currently by the fiduciary to the beneficiaries. » A trust where the income is accumulated for the benefit of unborn or unascertained person or persons with contingent interest." = A trust where the income collected by a guardian of a infant is held or distributed as the court may direct; and * A trust where the income, is at the discretion of fiduciary, may be either distributed to the beneficiaries or accumulated 2012. Revocable Trust (Section 63-NIRC)— Co -oconershipy Estates Ps Tras ls power to revest in the grantor, title to any is vested: » In the grantor either alone or in conjunction with any person not having a substantial adverse interest in the disposition of such part of the corpus of the income therefrom; or = In any person not having a substantial adverse interest in the disposition of such part of the corpus or the income therefrom. a trust where at any time, the part of the corpus of the trust The income of such part of the trust shall be included ry computing the taxable income of the grantor [Sec. 63, NIRC]. 3. Employees’ Trust - income tax shall not apply to employee’s trust which forms part of pension, stock bonus, or profit-sharing plan of an employer for the benefit of some or all of his employees [Section 60(B)-NIRC]. The income of an employees’ trust is likewise exempt from the payment of final taxes as well as income derived from the sale of real property whose funds are sourced from the employees’ trust fund [Miguel J. Ossorio Pension Foundation, Inc. vs. CA and CIR(G.R. No. 162175, June 28, 2010)]. Requisites or Conditions for Exemption of Employee's Trust = The employee's trust must form part of a pension, stock bonus, or profit-sharing plan of an employer for the benefit of some or all of his employees; = Contributions are made to the trust by such employer, or employees, or both; = 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; = 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. 202 Any amount actually distributed to any employee or distributee shall be taxable to him in the year of distribution, to the extent that it exceeds the amount contributed by such employee or distributee.Co-vonershit Estates cA Trusts 0 or oar ern (Two or more trusts) and the beneficiary isth rusts is created by the same trustor or grantor © Same person, the following rules shall apply: The taxable i uU ey Brae of all the trusts shall be consolidated and the tax consolidated i Consolidated income. The tax computed on the income shall be apportioned to the different trusts, such that each tri : . : income. ust shall have a share in the income tax on consolidated Consolidated Income Where twi The format of computation follows (Tax Apportionment): Tax Apportioned = ees Taxable income of the trust x Consolidated —taxable income of the trust MS Taxable income of alll trusts income tax 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. Each trust shall pay an income tax still due or payable computed as follows: Income Tax apportioned to a trust PXXX Less: Income tax already paid (xxx) Income tax payable PXxx ILLUSTRATION 5: _ -_ _ In 2018, George created three (3) trusts for his minor daughter. The following data were furnished by the trusts during 2018: | Trust Gross Income: Expenses Net Income Income Tax Paid 1 P5,000,000 P2,500,000 2,500,000 500,000 2 10,000,000 5,000,000 5,000,000 1,200,000 3 15,000,000 7,500,000 7,500,000 2,000,000 Required: Compute the income tax payable of Trust 1, 2 and 3 = Consolidated Tax Due Consolidated Gross Income 30,000,000 Consolidated expenses ___(15,000,000)_ Consolidated taxable income __ P15,000,000_ ue [Section 24(A)] ae a p6,000,000 2,410,000 In excess over P8M @ 35% ——4,450,000_ Consolidated Income Tax Due ____ P4,860,000_ 203L_ Estates and Tiny, Oe ceonership) Income Tax Still Due/Payable of Trust 1 aon Tax Apportionment to ee ‘ ; (2,500/15,000 x P4,860,000) Pa Less: Income tax already paid a Income tax still due/payable __ #310,000_ Income Tax Still Due/Payable of Trust 2 Tax Apportionment to Trust 2 P1,620,000 0 x P-4,860,000, (6,000/15,000 x ) “(1200000) Less: Income tax already paid Income tax still due/payable ,000 Income Tax Still Due/Payable of Trust 3 Tax Apportionment to Trust 3 P2,430,000 (7,500/15,000 x P4,860,000) 2,000,000) Less: Income tax already paid Income tax still due/payable P430,000 _ Filing of Income Tax Returns The following persons acting in any fiduciary capacity shall file the income tax return for an estate or trust (Section 65-NIRC): Guardians Trustees Executors/administrators Receivers Conservators All other persons or corporations acting in any fiduciary capacity In case of two or more joint fiduciari " € d ies, retu shall be a sufficient compliance with the er me ee ocose The return may be filed in ents of the i os Authorized agent banks; Revenue District Officer; Collection agent; , Duly authorized city or muni has his legal residence or oe Treasurer in which the taxpaye! rincipal place of business. 204PROBLEMS. p4.1. (Estate) pedro died two (2) years ago leaving an undivided property deriving income from rentals. His heirs were Louie and Floyd. The property is under administration through the decedent’s executor. The following data were provided in 2018: Rental income of the estate (gross of 5% tax) P800,000 Deductible operating expenses — estate 420,000 ‘Personal Income/Expenses of the heirs: Louie Floyd Gross business income P 325,000 P 380,000 Deductible business expenses 117,000 105,000 Dividend from domestic corporation 25,000 30,000 Dividend from foreign corporation 12,000 8,250 Prize, supermarket raffle 15,000 7,500 Royalty, books 10,000 18,000 Additional Information: Louie is married with 2 dependent children while Floyd is single without dependent children. Required: Determine the following: ‘1. Income tax payable of the estate 2., Income tax payable of Louie 3. Income tax payable of Floyd P4.2, (Estate) Pedro died two (2) years ago leaving an undivided property deriving income from rentals. His heirs were Louie and Floyd. The property is under administration through the decedent's executor. The following data were provided in 2018: Rental income of the estate P1,000,000 Deductible operating expenses (estate) . 500,000 Income distributed to Louie 50,000 Income distributed to Floyd 50,000 Dividend income from domestic corporation 100,000 Interest income from U.S. $ deposits 200,000 Interest income from peso deposits 100,000 205a A a" Apes rv Cuercises Co ea Estates and, T, rests Personal Income/Expenses of the heirs: Louie Gross Income P 325,000 pat Deductible expenses 117,000 105." Dividend from domestic corporation 25,000 301 Dividend from foreign corporation 12,000 ee Prize, supermarket raffle 15,000 Pa Royalty, books 10,000 18008 Additional Information: Louie’ is married with 2 dependent children while Floyd is single without dependent children. F Required: Determine the following: 1. Income tax payable of the estate 2. Income tax payable of Louie 3. Income tax payable of Floyd P4.3. (Trust) Mr. Masigasig created a trust in favor of Pedro. A large sum of money was entrusted to BDO (Trustee), the income of which is accumulated in favor of Pedro. The following data were provided: Gross income of the trust P3,000,000 Deductible business expenses of the trust 1,800,000 Income distributed to Pedro during the year 200,000 Dividend income from domestic corporation 100,000 Dividend income from resident foreign corporation 100,000 Interest income from U.S. $ deposits 200,000 100,000 Interest income from peso deposits Personal Income and Expenses of Pedro 800,000 Compensation income Rental income (net) 475,000 Rental expenses 80,000 Royalty income, books 300,000 120,000 Other royalty income , Dividend from domestic corporation 30,000 Dividend from foreign corporation 8,250 Prize, S&R raffle 15,000 Lotto winnings 10,000,000 Tax payments (Quarter 1-3) 120,000 abe wit ) 206— ‘ er Cterasles = u Co -oanershipy Estates age Trusts Required: Determine the following: 1. Income tax payable of the trust 2. Income tax payable of Pedro.