A trust document gives a beneficiary the noncumulative annual right to withdraw the greater of $5,000 or 5% of the value of trust corpus in any calendar year. The existence of a "5 by 5" power will cause which of the following tax implications?

A trust document gives a beneficiary the noncumulative annual right to withdraw the greater of $5,000 or 5% of the value of trust corpus in any calendar year. The existence of a "5 by 5" power will cause which of the following tax implications?

• A. No tax implications, since the power is deemed de minimis.
• B. No tax implications, if the value of the power is less than $10,000.
• C. The beneficiary will be taxed on the withdrawal portion only if the power is exercised.
• D. The beneficiary will be taxed on the income from the withdrawal portion of the trust, whether or not the power is exercised.

Answer: (D)

Having a 5 by 5 withdrawal power creates a presently exercisable right for the beneficiary to demand a portion of the trust’s income each year. For tax purposes, that means the income tied to the withdrawal portion is treated as distributed to the beneficiary, so the beneficiary is taxed on it even if the power isn’t actually exercised. The rule applies regardless of whether the power is exercised in a given year, and it doesn’t depend on any de minimis thresholds or on taxation only when a withdrawal occurs.

Having a 5 by 5 withdrawal power creates a presently exercisable right for the beneficiary to demand a portion of the trust’s income each year. For tax purposes, that means the income tied to the withdrawal portion is treated as distributed to the beneficiary, so the beneficiary is taxed on it even if the power isn’t actually exercised. The rule applies regardless of whether the power is exercised in a given year, and it doesn’t depend on any de minimis thresholds or on taxation only when a withdrawal occurs.