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

The Section 663(b) election, often called the “65-day rule,” is a provision in the U.S. tax code that applies to estates and certain types of trusts. This rule provides fiduciaries, such as trustees or estate executors, with a degree of flexibility after a tax year has concluded. It allows them to treat financial distributions made to beneficiaries within the first 65 days of a new year as if they were made on the final day of the preceding tax year.

This look-back capability is a tool for managing the tax obligations of the entity. By making this election, a fiduciary can better align the trust’s or estate’s distributions with the income it earned during the prior year. This adjustment can influence which party—the trust or the beneficiary—is responsible for paying income tax on that amount.

Purpose and Function of the Election

The main purpose of the 65-day rule is to address the tax consequences of income earned by a trust or estate that is not distributed by the end of the tax year. This is tied to the concept of Distributable Net Income (DNI), which defines the amount of taxable income passed from a trust to its beneficiaries. The trust or estate can take a deduction for the amount of income it distributes, and the beneficiaries then report that same amount as their own income.

A problem arises when a trust or estate earns income but does not distribute it to beneficiaries before December 31. This “trapped” income becomes taxable to the trust or estate itself, which can lead to a higher tax bill because the income tax brackets for trusts and estates are highly compressed. For instance, the top federal tax rate of 37% applies to ordinary income above just $15,650, and an additional 3.8% Net Investment Income Tax may also apply.

Beneficiaries, on the other hand, often have much lower individual income tax rates, making it more efficient for them to receive the income and pay the associated tax. The Section 663(b) election provides a solution to this timing issue. It gives the fiduciary a 65-day grace period after the year ends to make distributions. By making a distribution in January or February and electing to treat it as a prior-year event, the fiduciary can push out the income that would have been trapped, shifting the tax liability from the high-tax-rate trust to the lower-tax-rate beneficiary.

Eligibility and Requirements

The ability to use the 65-day rule is not available to all entities. The election under Section 663(b) is available to decedent’s estates and to complex trusts. Simple trusts, which are required to distribute all of their income annually, are not eligible to make this election because they do not accumulate income that would need to be distributed after year-end.

The primary requirement is the timing of the distribution itself. To qualify for the election, the payment to the beneficiary must be paid or credited within the first 65 days of the trust’s or estate’s tax year. For entities that use a standard calendar year, this deadline is March 6 (or March 5 in a leap year).

A limitation governs the amount of the distribution that can be applied to the prior year. The election is limited to the greater of the trust’s fiduciary accounting income for the year or its Distributable Net Income (DNI) for that same year. This ceiling prevents a fiduciary from distributing amounts far in excess of the income actually earned in the prior period. The fiduciary can also elect to treat only a portion of the distributions made within the 65-day window as belonging to the prior year.

Making the Election

The process for making the Section 663(b) election is integrated into the annual income tax filing for the trust or estate. The fiduciary makes the election on Form 1041, the U.S. Income Tax Return for Estates and Trusts.

To make the election, the fiduciary must check a specific box on Page 3 of the Form 1041, under the “Other Information” section. By checking this box, the fiduciary formally notifies the IRS that they are applying the 65-day rule for that specific tax year. The election must be made for each year the fiduciary wishes to use it; it does not automatically carry over.

The deadline for making the election is the same as the due date for filing the Form 1041, including any approved extensions. This provides the fiduciary with time to assess the prior year’s income, calculate the DNI, and determine whether making the election is beneficial.

Revoking the Election

The Section 663(b) election is binding once the deadline for filing the associated Form 1041 has passed. After the due date, including any extensions, the election becomes irrevocable for that tax year. A fiduciary cannot file an amended return later to undo the election simply because of a change in strategy or a later realization that it was not the most optimal choice.

There is, however, a window of opportunity to change one’s mind before the election becomes permanent. If a fiduciary reconsiders before filing the tax return, they can reverse the decision by filing a timely Form 1041 without checking the election box on Page 3.

The decision to make the election should be made after an analysis of the trust’s or estate’s income, its DNI, and the respective tax situations of both the entity and its beneficiaries. While the IRS may grant relief for a late election under specific circumstances where the fiduciary acted reasonably and in good faith, revoking a timely made election after the filing deadline is not permitted.