It is taxed under both the transfer tax system and the income tax system. The deduction is the excess of the decedent's actual federal estate tax over the federal estate tax that would be payable if the IRD were excluded from the decedent's gross estate. It allows deductions for expenses that are accrued before death but are not deductible on the decedent's final income tax return because the decedent used the cash method of accounting. These may also be deductible on the estate tax return. This rule is designed to make the creators of a trust pay a price for not giving up enough control or economic benefits when he or she creates a trust.
Control refers to the administrative powers retained by the grantor.
The grantor is taxed on the income generated by this form of trust. Termination of Estates and Trusts Estates and trusts are not permitted to take a personal exemption on their final return. Unused carryovers are passed through to beneficiaries for use on their individual returns. Estate and trust excess deductions for their final year are passed through to beneficiaries and reported as miscellaneous itemized deductions.