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I am so Confused about this one. Can someone please care to elaborate on the answer? Thank you
On January 1, Year 3, Dix transferred certain assets into a trust. The assets consisted of Lux Corp. bonds with a face amount of $500,000 and an interest rate of 12%. The trust instrument named Dix as trustee, Dix’s child as life beneficiary, and Dix’s grandchild as remainderman. Interest on the bonds is payable semiannually on May 1 and November 1. Dix had purchased the bonds at their face amount. As of January 1, Year 3, the bonds had a fair market value of $600,000. The accounting period selected for the trust is a calendar year. The trust instrument is silent as to whether Dix may revoke the trust. Assuming that the trust is valid, how should the amount of interest received in Year 3 be allocated between principal and income if the trust instrument is otherwise silent?
C. Principal: $10,000; Income $50,000
The correct answer is C.
The initial principal placed in the trust is $500,000. The fair market value of the principal has grown to $600,000. The interest received by the trust in Year 3 is $60,000 (($500,000 × 12% × 1/2 year) × 2). The principal has grown $100,000 since the inception of the trust. Therefore, 1/6 ($100,000 ÷ $600,000) of the interest ($10,000 = 1/6 × $60,000) would be allocated to the principal and the remainder of the interest would be allocated to the income ($50,000 = 5/6 × $60,000).
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