Final answer:
The trust's income distribution deduction is limited to its distributable net income (DNI) of $3,800 for year 2, which consists of qualified dividends, corporate bond interest, and capital gains, minus the investment expenses related to tax-exempt interest.
Step-by-step explanation:
To calculate the trust's income distribution deduction, we need to identify the trust's distributable net income (DNI). Generally, DNI includes income received by the trust (interest, dividends, capital gains) minus deductions (investment expenses). However, tax-exempt income (like municipal bond interest) and expenses related to it are typically excluded. Here's a breakdown:
- Qualified Dividends: $2,000
- Municipal Bond Interest (tax-exempt): $1,000
- Corporate Bond Interest: $1,500
- Capital Gains: $500
- Investment Expenses Relating to Tax-Exempt Interest: $200
The DNI calculation would be as follows:
$2,000 (Qualified Dividends) + $1,500 (Corporate Bond Interest) + $500 (Capital Gains) - $200 (Investment Expenses related to tax-exempt interest) = $3,800
However, since the trust is to distribute $10,000, which exceeds the calculated DNI of $3,800, the income distribution deduction is limited to the DNI of $3,800. Therefore, the trust's income distribution deduction for year 2 would be $3,800.