1 Fiduciary Income Tax – Tips and Tricks for Filing Trust and Estate Income Tax Returns Colorado Bar Association, Trusts & Estates Section January 21, 2016 Klaralee Charlton, an Associate Attorney with Katz, Look & Onorato, P.C., presents an overview of the fiduciary income tax filing requirements and discusses some of the nuances of reporting income and deductions related to estate and trust administration. Klaralee also touches on the tax benefits that can be achieved by making certain elections, allocations, and timing decisions. Form 1041 What it is: Form 1041 is an Income tax return for a trust or estate reporting income earned by the estate’s or trust’s assets. Income earned prior to a decedent’s date of death or prior to the creation of the trust is not reported on Form 1041. Income earned by assets owned jointly with rights of survivorship or with pay on death designations are not reported on Form 1041. Also, Form 1041 should not be confused with Form 706 which is the estate tax return. Difference from Individual Income Tax Return: Individual income tax is calculated by taking income minus deductions, minus standard deduction = taxable income. Estate or Trust income tax is calculated by taking income, minus deductions, minus standard deduction, minus distributions = taxable income. Obtain an EIN: Income generated after date of death should no longer be attributed to an individual’s social security number. The estate or previously revocable trust should obtain an EIN and have all income generated after date of death reported under the EIN. A perfect transition from SSN to EIN is usually impossible, so examination of monthly statements and 1099s will be necessary to split out income reportable on the Form 1041. Coordination with Estate Plan: It is imperative the attorney or CPA preparing the fiduciary income tax return understand the estate plan, especially in first spouse to die situations.
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Fiduciary Income Tax – Tips and Tricks for Filing Trust and Estate Income Tax Returns Colorado Bar Association, Trusts & Estates Section
January 21, 2016
Klaralee Charlton, an Associate Attorney with Katz, Look & Onorato, P.C., presents an overview
of the fiduciary income tax filing requirements and discusses some of the nuances of reporting
income and deductions related to estate and trust administration. Klaralee also touches on the
tax benefits that can be achieved by making certain elections, allocations, and timing
decisions.
Form 1041 What it is: Form 1041 is an Income tax return for a trust or estate reporting income earned by the
estate’s or trust’s assets. Income earned prior to a decedent’s date of death or prior to the
creation of the trust is not reported on Form 1041. Income earned by assets owned jointly with
rights of survivorship or with pay on death designations are not reported on Form 1041. Also, Form
1041 should not be confused with Form 706 which is the estate tax return.
Difference from Individual Income Tax Return: Individual income tax is calculated by taking
income minus deductions, minus standard deduction = taxable income. Estate or Trust income
tax is calculated by taking income, minus deductions, minus standard deduction, minus
distributions = taxable income.
Obtain an EIN: Income generated after date of death should no longer be attributed to an
individual’s social security number. The estate or previously revocable trust should obtain an EIN
and have all income generated after date of death reported under the EIN. A perfect transition
from SSN to EIN is usually impossible, so examination of monthly statements and 1099s will be
necessary to split out income reportable on the Form 1041.
Coordination with Estate Plan: It is imperative the attorney or CPA preparing the fiduciary income
tax return understand the estate plan, especially in first spouse to die situations.
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Filing Requirements Estates: Gross Income > $600.00 or Nonresident Alien Beneficiary.
Trusts: Any Taxable Income or Gross Income > $600.00 or Nonresident Alien Beneficiary
Simple Trust: Trust agreement requires all income to be distributed currently (i.e. Marital Trust); No
charitable distributions; No distributions of corpus.
Complex Trust: All other trusts that do not qualify as Simple Trusts. Majority of trusts will be
Complex.
Significant Administration Expenses: Consider filing a 1041 even if the estate or trust has no
income in order to pass the administration expenses out to the beneficiaries.
Calendar vs. Fiscal Year Estates: Option to file based on Calendar year starting on the decedent’s date of death through
December 31 (i.e. Date of Death: July 25, 2014, Calendar year is July 25, 2014 – December 31,
2014) or based on Fiscal year starting on the decedent’s date of death through the last day of
the month preceding the month of death (i.e. Date of death: July 25, 2014, Fiscal year is July 25,
2014 – June 30, 2015. Following fiscal year runs July 1, 2015 – June 30, 2016).
Trusts: Calendar Year, unless coupled with an Estate, if applicable, via a § 645 election (see
below).
Benefits of Fiscal Year: Fewer tax returns, delay taxation to beneficiaries, maximize benefit of
deductions (See Examples 1 & 2).
Burdens of Fiscal Year: Cannot rely on 1099, K-1 etc reporting to determine income for the fiscal
year.
Initial Return vs. Final Return Initial Return: First return filed for the entity.
Final Return: Last return filed for the entity.
Return may be both initial and final if estate or trust is fully administered within one tax
year.
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Final return is the only return on which losses may pass out to beneficiaries. This concept
should impact the calendar vs. fiscal year filing decisions and the timing of payment of
expenses (See Example 3).
645 Election IRC § 645, Treas. Reg. § 1.645-1
Making the Election: The 645 Election is made on the first, timely filed Form 1041 using Form 8855
and allows the income and expenses for both a trust and estate to be reported on a single 1041.
Usually, the election is made on the estate’s first fiscal year return. The Trust should file a timely
Form 1041 on the calendar year if it is unknown whether the 645 election will be made. The
election is irrevocable. (See Example 4)
Time Limit: For estates that DO NOT file a Form 706, the election is only effective for 2 years from
date of death. For estates that DO file a Form 706, the election is effective for 6 months after a
final determination is entered.***
Benefits: The 645 Election simplifies income and expense reporting during the estate
administration process, allows the use of the fiscal year for a trust, and provides better income
and expense matching opportunities.
Ending the Election: If both the trust and estate are terminating, then the trust must file a blank
1041 to notify the IRS of its termination. All income and expenses are reported on the combined
return. If the trust is continuing, then the trust will file a short year return reporting income and
expenses earned and incurred after the combined 1041 filing. If the estate is continuing, the
estate files on the same schedule as before.
Income Interest/Dividends
Pre-Date of Death: Report on decedent’s Final 1040
Post-Date of Death: Report on Form 1041
Until an EIN is obtained and accounts are retitled, financial institutions will continue to
report both pre- and post-death income under the decedent’s social security
number. Obtain copies of monthly statements in order to separate pre- and post-
death income.
Allocate post-death income to Form 1041. The tax preparer should include
explanatory remarks on both the Final 1040 and Form 1041 regarding the allocation of
the pre- and post-death income.
Capital Gains
I.R.C. § 1014 - Basis of property owned by a decedent or in a revocable living trust (and in other
entities not described herein) is adjusted to fair market value as of date of death. For the
majority of decedents, this will include the real property and stocks and bonds. It does not
include many retirement accounts such as pensions, IRAs, and annuities, discussed below.
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Sale of Decedent’s Residence
o If owned solely by decedent, adjust basis of entire property to fair market value
as of decedent’s date of death.
o If owned as Joint Tenants or Tenants in Common, adjust the decedent’s interest in
the property (typically 50%) to fair market value as of decedent’s date of death.
Surviving owner retains original basis.
o If community property, then the entire basis is adjusted to the fair market value as
of decedent’s date of death.
Sale by Estate or Trust
o Report the sale on Schedule D and calculate the gain or loss. Since the basis is
adjusted, little gain or loss should be reported if sold shortly after the decedent’s
death.
o Example: House owned solely by decedent. Purchased in 2000 for $300,000. Date
of death value $450,000. Sell shortly after date of death for $450,000. Basis is
$450,000 under I.R.C. § 1014. Proceeds $450,000. No gain.
o Losses are only permitted if the property has been converted to an income
producing property or is being held for investment purposes. I.R.C. § 165(c)
I.R.S Publication 559: If the estate is the legal owner of a decedent's
residence and the personal representative sells it in the course of
administration, the tax treatment of gain or loss depends on how the
estate holds or uses the former residence. For example, if, as the personal
representative, you intend to realize the value of the house through sale,
the residence is a capital asset held for investment and gain or loss is
capital gain or loss (which may be deductible). This is the case even
though it was the decedent's personal residence and even if you did not
rent it out. If, however, the house is not held for business or investment use
(for example, if you intend to permit a beneficiary to live in the residence
rent-free and then distribute it to the beneficiary to live in), and you later
decide to sell the residence without first converting it to business or
investment use, any gain is capital gain, but a loss is not deductible.
Sale by surviving spouse owner
o If sold within 2 years of decedent’s date of death, surviving spouse may exclude
$500,000 of gain under I.R.C. § 121 if the 2 out of 5 year rule for use and ownership
was met as of decedent’s date of death.
o Example: House owned as JT. Purchased in 1985 for $150,000. Used as primary
residence until decedent’s death. Date of death value $700,000. Sold for
$800,000. Total Basis ($350,000 + $75,000 = $425,000), Gain ($800,000 - $425,000 =
$375,000). Exclude up to $500,000 of gain if sold within 2 years of decedent’s date
of death. If sold after, then only exclude $250,000 of gain, pay tax on $125,000 of
gain.
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Stocks and Bonds
o Adjust basis to the fair market value as of date of death in accordance with
Treas. Reg. § 20.2031-2. For stocks and bonds, the fair market value is the average
of the day’s high and low selling price. If only closing prices are available, then
use the average of the date of death closing price and the closing price on the
trading day before the date of death.
Weekend deaths require more work to calculate the date of death value.
Calculate the average of the high and low selling price on the first trading
day before the date of death and the first trading day after the date of
death (i.e. Friday and Monday). Then prorate the difference between the
two days and add or subtract the prorated difference to the nearest
trading day to find the date of death value.
Mutual Funds do not use the Friday/Monday calculation for weekend
deaths. Instead, mutual funds use only public redemption price on the
trading day prior to the date of death (i.e. Friday).
The brokerage company should provide a summary of the date of death
values; however, these are frequently calculated incorrectly. Advisable to
spot check the calculations, especially when preparing a Form 706. If the
number of stocks are significant, request these valuations as soon as
possible to avoid delays during the tax season.
Joint Assets and Joint Trusts – Special Considerations
o Joint assets will not receive a full basis adjustment. Jointly held investment
accounts should have one-half of all assets adjusted to fair market value by the
financial institution. Even if the financial institution says they’ve adjusted them, the
taxpayer should still spot check the Form 1099 to ensure accurate adjustment.
o Assets held in joint trusts (trusts with two settlors) must be analyzed to determine
whether the asset is wholly one settlors or wholly another or partially both.
Sometimes the terms of the trust will control, but oftentimes, the trust agreement
will not delineate which assets are allocated to each settlor.
ABC Stock XYZ Stock
Date of Death High: $11.00 Trading Day Before Date of Death Close:
$9.00
Date of Death Low: $10.00 Date of Death Close: $11.00
27 Tax due. If line 25 is smaller than the total of lines 23 and 26, enter amount owed . . . . . 27
28 Overpayment. If line 25 is larger than the total of lines 23 and 26, enter amount overpaid . . 28
29 Amount of line 28 to be: a Credited to 2015 estimated tax ; b Refunded 29
Sign
Here
Under penalties of perjury, I declare that I have examined this return, including accompanying schedules and statements, and to the best of my knowledge and belief, it is true, correct, and complete. Declaration of preparer (other than taxpayer) is based on all information of which preparer has any knowledge.
Signature of fiduciary or officer representing fiduciary Date EIN of fiduciary if a financial institution
May the IRS discuss this return with the preparer shown below (see instr.)? Yes No
Paid Preparer Use Only
Print/Type preparer's name Preparer's signature DateCheck if self-employed
PTIN
Firm's name
Firm's address
Firm's EIN
Phone no.
For Paperwork Reduction Act Notice, see the separate instructions. Cat. No. 11370H Form 1041 (2014)
Trust TIN
Form 1041 (2014) Page 2
Schedule A Charitable Deduction. Do not complete for a simple trust or a pooled income fund. 1 Amounts paid or permanently set aside for charitable purposes from gross income (see instructions) . 1
2 Tax-exempt income allocable to charitable contributions (see instructions) . . . . . . . . 2
7 Total tax. Add lines 3 through 6. Enter here and on page 1, line 23 . . . . . . . . . . 7
Other Information Yes No
1 Did the estate or trust receive tax-exempt income? If “Yes,” attach a computation of the allocation of expenses. Enter the amount of tax-exempt interest income and exempt-interest dividends $
2 Did the estate or trust receive all or any part of the earnings (salary, wages, and other compensation) of any individual by reason of a contract assignment or similar arrangement? . . . . . . . . . . . . . . .
3 At any time during calendar year 2014, did the estate or trust have an interest in or a signature or other authority over a bank, securities, or other financial account in a foreign country? . . . . . . . . . . . . . .See the instructions for exceptions and filing requirements for FinCEN Form 114. If “Yes,” enter the name of the foreign country
4 During the tax year, did the estate or trust receive a distribution from, or was it the grantor of, or transferor to, a foreign trust? If “Yes,” the estate or trust may have to file Form 3520. See instructions . . . . . . . . .
5 Did the estate or trust receive, or pay, any qualified residence interest on seller-provided financing? If “Yes,” see the instructions for required attachment . . . . . . . . . . . . . . . . . . . . . . . . .
6 If this is an estate or a complex trust making the section 663(b) election, check here (see instructions) . .7 To make a section 643(e)(3) election, attach Schedule D (Form 1041), and check here (see instructions) . .8 If the decedent’s estate has been open for more than 2 years, attach an explanation for the delay in closing the estate, and check here 9 Are any present or future trust beneficiaries skip persons? See instructions . . . . . . . . . . . . .