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How to resolve Lacerte diagnostic ref 10901: Deductions reducing distributable income on Form 1041

by Intuit• Updated 3 months ago

When preparing a Fiduciary return, you may encounter the following informational diagnostic:

Deductions not attributable to one class of income have reduced the distributable income in one or more classes of income. Please see the DNI Diagnostic for further details. (ref. #10901)

This informational diagnostic generates when deductions have reduced more than one class of income. The class (or classes) of income being reduced are based on the K-1 Deductions method selected.

Available deduction methods:

Tier Allocation - This method applies the deductions to different classes of income ahead of others until the deductions are used in full. After making an appropriate allocation to tax-exempt income, deductions are first allocated to interest, dividends, and other income, then to the extent that any remain, to passive income. Using tier allocation preserves the amount of passive income passed through to the beneficiaries so that it can be used to offset passive losses from other sources.

Pro-Rata Allocation - This method allocates a percentage of the total deductions to a particular class of income equal to the same percentage that the particular class of income bears to the total income. For example, if interest income is 10% of the total income of the trust, then 10% of the total deductions are allocated to interest for Schedule K-1 allocations.

To change the K-1 deduction method for a specific client:

Go to Screen 44, Deduction Allocation for DNI.
Locate the DNI Allocation Options section.
Enter a 1 or 2 in Automatic allocation: 1 = tier, 2 = pro-rata [O].

To view or change which method is selected for all clients:

From the Settings menu, select Options.
Select the Tax Return tab.
Scroll down to the K-1 Distribution Options section.
Locate the K-1 Deductions option.
Select the applicable option from the dropdown menu:
1. Tier allocation
2. Pro-rata allocation
Select OK.

To view the DNI Diagnostic Schedule:

Select the Forms tab.
Select DNI Diagnostic.

This will show where the deductions are being applied and which class/classes of income are being reduced. The Total column should reflect the same amounts on the 1041, page 1.

Additional options available on Screen 44:

Allocate charitable deductions to capital gains - This reduces the capital gains distributed to beneficiaries by virtue of an allocable portion of charitable deductions.
Allocate non-charitable deductions to capital gains - This reduces the capital gains distributed to beneficiaries by virtue of an allocable share of deductions. If you leave this field blank, the program does not allocate any deductions to capital gains.
Optimize qualified dividends (only use with tier allocation) - When this option is selected, the qualified dividends have deductions allocated to them after all other types of income (e.g. interest) except for capital gains. If this option is not selected (or pro-rata deduction allocation is used) then expenses are allocated to the qualified dividends by the proportion of qualified dividends to total dividends.

Lacerte Tax 2023

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