What Is the 663(b) Election 65-Day Rule?

The 663(b) election, often called the 65-day rule, is a provision in the Internal Revenue Code for fiduciaries of estates and certain trusts. It allows a trustee or executor to make a distribution to a beneficiary within the first 65 days after the close of the entity’s tax year and treat that payment as if it were made on the last day of the preceding year. This look-back capability allows fiduciaries to make more informed decisions about distributions after the exact income for the year has been calculated.

Purpose of the 65-Day Rule

The 65-day rule provides flexibility because trusts and estates are subject to their own income tax, with tax brackets that are highly compressed compared to individual taxpayers. For instance, in 2024, a trust or estate hits the top 37% federal tax rate on ordinary income over $15,200. This structure can lead to a significant tax burden on income that is retained by the trust rather than distributed to beneficiaries.

Distributable Net Income (DNI) determines the maximum amount of a distribution that is taxable to the beneficiaries and deductible by the trust. When a trust or estate distributes income to a beneficiary, it can take a deduction for that amount, and the beneficiary then reports the income on their personal tax return.

For example, a trust that earned $50,000 in income during the year and made no distributions by December 31st would have to pay tax on that income, likely at the highest marginal rate. By making a distribution to a beneficiary in a lower tax bracket within the first 65 days of the next year and applying the 663(b) election, the tax liability is shifted from the trust to the beneficiary, often resulting in a lower overall tax paid.

The election can also help in managing the Net Investment Income Tax (NIIT). This additional 3.8% tax applies to the undistributed net investment income of trusts and estates with income above a certain threshold. By distributing income to beneficiaries, a trustee can potentially lower the trust’s income below the NIIT threshold, avoiding this extra tax.

Eligibility for the Election

The election under Internal Revenue Code Section 663(b) is available to decedent’s estates and complex trusts. A complex trust is one that is not required to distribute all of its income annually, is permitted to make distributions to charities, or makes distributions from its principal. This is a distinction from simple trusts, which are mandated to distribute all their income each year and are therefore ineligible for this election.

To qualify, the distribution must be made within the first 65 days following the close of the entity’s tax year. For entities that use a calendar year, this deadline is March 6th, or March 5th in a leap year. The fiduciary must affirmatively choose to apply the rule; it is not an automatic process. The election provides the discretion to treat all, part, or none of the distributions made within this 65-day window as having occurred in the prior year.

The amount of the distribution that can be treated as paid in the preceding year is also subject to limits. The elected amount cannot exceed the greater of the trust’s accounting income or its DNI for the year, reduced by any amounts that were already paid, credited, or required to be distributed during that prior year.

How to Make the Election

The fiduciary makes the election on a timely filed Form 1041, U.S. Income Tax Return for Estates and Trusts. The election is made by checking the designated box under the “Other Information” section, which is found on Question 6 of Schedule G on the 2023 version of the form.

This election must be made annually; a choice made in one year does not carry over to subsequent years. The deadline for making the election coincides with the due date for the Form 1041, including any approved extensions.

Once the election is made for a specific tax year by checking the box on Form 1041, it is irrevocable for that year. This makes it important for the trustee or executor to carefully consider the tax implications for both the trust and the beneficiaries before finalizing the return.