SPPTChap019

Advanced Accounting by Hoyle et al, 6th Edition

Learning Objective 19-1Understand the proper methods of accounting forand administering an estate and the corresponding legal terminology.19-2Understand the proper methods of accounting forand administering an estate and the corresponding legal terminology.

Learning Objective 19-2Describe the types of estatedistributions and identify theprocess of asset allocations anddistributions from an estate.19-7Describe the types of estatedistributions and identify theprocess of asset allocations anddistributions from an estate.Accounting for an EstateThe term estate refers to the property (assets) owned by an individual.More specifically defined as aseparate legal entity holding title to the real and personal assets of a deceased person.Estate accounting focuses on the recording and reporting of financial events from the time of a persons death until the ultimate distribution of all property held by the estate.19-3The term estate simply refers to the property owned by an individual. However, in this chapter, estate is more specifically defined as aseparate legal entity holding title to the real and personal assets of a deceased person. Thus, estate accounting refers to the recording and reporting of financial events from the time of a persons death until the ultimate distribution of all property the estate holds. as a separate legal entity holding title to the real and personal assets of a deceased person.Thus, estate accounting refers to the recording and reporting of financial events from thetime of a persons death until the ultimate distribution of all property the estate holds. Estate AccountingA valid will ensures that asset disposition occurs as intended and avoids disputes when a person dies. A will is a persons declaration of how s/he desires the property they own to be disposed of after death.When someone dies: With a valid will, they die testate.A will serves as the blueprint for settling the estate.Without a valid will, they die intestate.State laws control the administration of the estate.Real property is conveyed based on laws of descent.Personal property transfers based on laws of distribution.19-4 To ensure that this disposition is as intended and to avoid disputes, each individual should prepare a will, a persons declaration of how he desires his property to be disposed of after his death. If an individual dies testate (having written a valid will), this document serves as the blueprint for settling the estate, disbursing all remaining assets, making various tax elections, and appointing fiduciaries to accomplish these tasks. When a person dies intestate (without a legal will), state laws control the administration of his or her estate. Although these legal rules vary from state to state, they normally correspond with the most common patterns of distribution. When intestacy laws rather than a will apply, real property is conveyed based on the laws of descent whereas personal property transfers are made according to the laws of distribution. When a person dies intestate (without a legal will), state laws control the administrationof his or her estate. Although these legal rules vary from state to state, they normallycorrespond with the most common patterns of distribution. When intestacy lawsrather than a will apply, real property is conveyed based on the laws of descent whereaspersonal property transfers are made according to the laws of distribution.

Laws governing wills and estates are called probate laws.Each state establishes its own laws of descent and laws of distribution.Almost half of the states have adopted the Uniform Probate Code.Estate AccountingProbate Laws -- Three general purposes:Gather and preserve all of the property.Carry out orderly and fair settlement debts.Discover and implement the decedents intentions for remaining property. 19-5Each individual state establishes laws governing wills and estates known as probatelaws. The National Conference of Commissioners on Uniform State Laws developed theUniform Probate Code in hopes of creating consistent treatment in this area. To date,almost half of the states have officially adopted the Uniform Probate Code. In many ofthe other states, the rules and regulations applied are somewhat similar to those of theUniform Probate Code. In practice, however, an accountant must become familiar withthe specific laws of the state having jurisdiction over the estate of the specific decedent. Regardless of the locale, probate laws generally are designed to achieve three goals:1. Gather, preserve, and account for all of the decedents property.2. Administer an orderly and fair settlement of all debts.3. Discover and implement the decedents intent for the remaining property held at death.

Probate Process The will is presented to the court.An executor (administrator) is assigned.Court appoints a representative as administrator.Terms of will are carried out.Entitled to compensation.Administration of the EstateCourt rules on wills validity.No will has been discovered.ORState laws control administration of estate.19-6This process usually begins by filing a will with the probate court or indicating that no will has been discovered. If a will is presented, the probate court must rule on the documents validity. A will must meet specific legal requirements to be accepted. These requirements may vary from state to state. All of the decedents property must be located, debts paid, and distributions appropriately conveyed. Whether a will is present or not, an estate administrator must be chosen to serve in a stewardship capacity. This individual serves in a fiduciary position and is responsible for (1) satisfying all applicable laws and (2) making certain that the decedents wishes are achieved (if known and if possible). If a specific person is named in the will to hold this position, the individual is referred to as the executor (executrix if female; this text will generically use the term executor) of the estate. If the will does not designate an executor or if the named person is unwilling or unable to serve in this capacity (or if the decedent dies without a will), the courts must select a representative. A court-appointed representative is known legally as the administrator (female: administratrix) of the estate. An executor/administrator is not forced to serve in this role for free; that person is legally entitled to reasonable compensation for all services rendered.

If funds are insufficient to satisfy all of the legacies, the reduction of these gifts is called the process of abatement.Estate DistributionsPriority:Specific legaciesDemonstrative legaciesGeneral legaciesResidual legaciesDebts and expenses of the administration of the estate are paid first.19-8The debts and expenses of the administration are paid first in settling an estate. If theestate has insufficient available resources to satisfy these claims, the process of abatementis again utilized. Each of the following categories is exhausted completely to pay alldebts and expenses before money is taken from the next category:Residual legacies (first to suffer abatement is the last to receive inheritance).General legacies.Demonstrative legacies.Specific legacies and devises (last to suffer abatement).Learning Objective 19-3Understand the federal estatetax and state inheritance taxsystems, the correspondingexemptions, and tax planningopportunities.19-9Understand the federal estatetax and state inheritance taxsystems, the correspondingexemptions, and tax planningopportunities.Estate and Inheritance TaxesThe federal estate tax is an excise tax assessed on the right to convey property. The computation begins by determining the fair value of all property held at death.Real property transferred immediately to a beneficiary and not subject to probate must be included for federal estate tax purposes.

An alternative evaluation date, six months after death, may be used to determine fair value if it reduces the amount of estate taxes to be paid.19-10The federal estate tax is an excise tax assessed on the right to convey property. The computationbegins by determining the fair value of all property held at death. Even if real property is transferred immediately to the beneficiary and is not subject to probate, the value must still be included for federal estate tax purposes. In establishingfair value, the executor may choose an alternate valuation date if that tax election willreduce the amount of estate taxes to be paid. This date is six months after death (or thedate of disposition for any property disposed of within six months after death). Thus,the federal estate tax process starts by determining all asset values at death or this alternatedate. Note that a piecemeal valuation cannot be made; one of these dates must beused for all properties.State Inheritance TaxesSome wills specify that inheritance taxes are to be paid from any residual cash amounts the estate holds.Often, recipients of property must contribute cash to the estate to cover the taxes.If the will makes no provisions for state inheritance taxes (or if the decedent dies intestate), the amount conveyed to each party must be reduced proportionately based on the fair value received. Other Estate Issues19-11States assess inheritance taxes on the right to receive property with the levy and all other regulations varying, as discussed earlier, based on state laws. However, the specifications of a will determine the actual impact on the individual beneficiaries. Manywills dictate that all inheritance tax payments are to be made from any residual cash amounts that the estate holds. Consequently, individuals receiving residual legacies are forced to bear the entire burden of this taxalthough, presumably, that was thetestators desire. If the will makes no provisions for state inheritance taxes (or if the decedent dies intestate), the amounts conveyed to each party must be reduced proportionately based on the fair value received. Thus, the recipient of land valued at $200,000 would haveto contribute twice as much for inheritance taxes as a beneficiary collecting cash of $100,000. Decreasing a cash legacy to cover the cost of inheritance taxes creates little problem for the executor. However, a direct reduction of an estate asset such as land,buildings, or corporate stocks might be virtually impossible. Normally, the beneficiary in such cases is required to pay enough cash to satisfy the applicable inheritance tax. The estate planning process often establishes life insurance policies to provide cash for such payments. However, the ownership of such insurance may in turn result in the proceeds being subjected to the federal estate tax. Thus, the need for estate professionals such as CPAs is essential for planning.Learning Objective 19-4Understand and account forthe distinction between principal and income in the context of estate and trust accounting.19-12Understand the federal estatetax and state inheritance taxsystems, the correspondingexemptions, and tax planningopportunities.The recipient of estate income is called the income beneficiary.The recipient of the estate principal (also called corpus) is called the remainderman.How income is to be determined should be defined by the decedent in the will to avoid confusion.Principal of the estate includes assets that existed at the date of death, which became assets of the estate.

Distinction Between Income and Principal19-13In many estates, the executor faces the problem of differentiating between income and principal transactions. For example, a will might state all income earned on my estate for five years after death is to go to my sister, with the estate then being conveyed tomy children. The recipient of the income is known as an income beneficiary whereas the party who ultimately receives the principal (also known as the corpus ) is called a remainderman. As the fiduciary for the estate, the executor must ensure that all parties are treated fairly. Thus, if amounts are distributed incorrectly, the court can hold the executor legally liable.

Learning Objective 19-5Describe the financial statementsand journal entries utilized to account for estate and trust transactions.19-14Describe the financial statementsand journal entries utilizedto account for estate andtrust transactions.Periodic Charge and Discharge statements report disclose progress in settling the estate.Separate statements are required for income and principal.Each statement reports:Assets under the control of the executor.Disbursements made to date.Any property still remaining.Charge and Discharge Statement19-15As necessary, the executor files periodic reports with the probate court to disclose the progress being made in settling the estate. This report, which may vary from state to state, is generally referred to as a charge and discharge statement. If income and principal must be accounted for separately, the statement is prepared in two parts. For both principaland income, the statement should indicate the following:1. The assets under the executors control.2. Disbursements made to date.3. Any property still remaining.Learning Objective 19-6Describe various trusts, their proper use, and accounting for activities.19-16Describe various trusts, theirproper use, and accounting foractivities.TrustsA TRUST is created by conveying assets to a fiduciary (or trustee) Trusts are often established: - from the provisions of a will, specified by the decedent to guide distribution of estate property. - to reduce the size of a taxable estate and estate taxes that must be paid. - to protect assets and ensure that the eventual use of these assets is as intended. A trustee may be an individual or an organization

19-17TrustsA TRUST is created by the conveyance of assets to a fiduciary (or trustee) who manages the assets according to the stipulated instructions. Trusts are often established to reduce the size of a persons taxable estate and the estate taxes that must be paid. A trustee may be an Individual or an organization.People form trust funds to protect assets and ensure that the eventual use of these assets is as intended. Trustscan also result from the provisions of a will, specified by the decedent as a means of guidingthe distribution of estate property. In legal terms, an inter vivos trust is one started bya living individual, whereas a testamentary trust is created by a will.A testamentary trust is established by the will after the trustors death.TrustsThe person who funds the trust is called the grantor, trustor, or settlor.An inter vivos trust is established while a person is still alive.The person who funds the trust appoints a trustee to manage the investments of the trust.19-18In legal terms, an inter vivos trust is one started by a living individual, whereas a testamentary trust is created by a will. In legal terms, an inter vivos trust is one started by a living individual, whereas a testamentary trust is created by a will.Frequently, the trustor or settlor or grantor (the person who funds the trust) will believe that a chosen trustee is simply better suited to manage complicated investments than is the beneficiary. A young child, for example, is not capable of directing the use ofa large sum of money. The trustor may have the same opinion of an individual who possesses little business expertise. Likewise, the creation of a trust for the benefit of a person with a mental or severe physical handicap might be considered a wise decision.. Different Types of TrustsCredit Shelter TrustQualified Terminable Interest Property Trust (QTIP Trust) Charitable Remainder TrustCharitable Lead TrustGrantor Retained Annuity Trust (GRAT)Minors Section 2503(c) TrustSpendthrift TrustIrrevocable Life Insurance TrustQualified Personal Resident Trust (QPRT)19-19Other Types of TrustsCredit Shelter TrustDesigned for couples, where each spouse agrees to transfer at death an amount up to the tax-free exclusion ($5 million in 2011) to the otherReduces the estate of surviving spouseQualified Terminable Interest Property Trust (QTIP Trust)Property is conveyed to a trust; distributions are paid to the beneficiary (usually spouse)At a specified time, the remainder is conveyed to a designated partyAllows steady income for one beneficiary, while protecting principal for another.Charitable Remainder TrustTrust income is paid to a beneficiary for a period of time (or death of the beneficiary). Then the principal is given to a stated charityRenders appreciated property requiring liquidation nontaxableCharitable Lead TrustTrust income paid to a specified charity for a period of time, then the remaining principal is transferred to a different beneficiaryGrantor Retained Annuity Trust (GRAT)Trustor collects fixed payments from the trustPrincipal given to beneficiary after a specified time or at the death of the trustorAllows for reduction of gift taxMinors Section 2503(c) TrustEligible to receive a tax-free gift of $13,000 ($26,000 if from a couple) each yearSpendthrift TrustBeneficiary cannot transfer or assign any payments not yet receivedIrrevocable Life Insurance TrustMoney is contributed to purchase life insurance on the donor, so that proceeds can be used to pay estate and inheritance taxesQualified Personal Resident Trust (QPRT)Donors home is given, but the donor retains the right to live there for a period rent free

Usually, the cash basis of accounting is used to record trust fund transactions.Adjustments to the Trusts Principal:Investing costs and commissions.Income taxes on gains added to the principal.Costs of preparing property for sale.Extraordinary repairs.

Record-Keeping for a Trust Fund19-20In the same manner as an estate, the trust agreement should specify the distinction between transactions to be recorded as income and those to be recorded as principal. If the agreement is silent or if a transaction that is not covered by the agreement is incurred, state laws apply to delineate the accounting. Generally accepted accounting principles usually are not considered appropriate. For example, trusts utilize the cash method rather than accrual accounting in recording most transactions. Although a definitive set of rules is not possible, the following list indicates the typical division of principal and income transactions:Adjustments to the Trusts PrincipalInvestment costs and commissions.Income taxes on gains added to the principal.Costs of preparing property for rent or sale.Extraordinary repairs (improvements).

Adjustments to the Trusts Income:Rent expenseLease cancellation feesInterest expenseInsurance expenseIncome taxes on trust incomeProperty taxesTrustee fees and periodic reporting costs (accountant and legal fees) must be allocated between trust income and principal based on the value of the assets. Record-Keeping for a Trust Fund19-21Adjustments to the Trusts IncomeRent expense.Lease cancellation fees.Interest expense.Insurance expense.Income taxes on trust income.Property taxes.Trustee fees and the cost of periodic reporting (accountant and legal fees) must be allocatedbetween trust income and principal. This allocation is often based on the value ofassets within each (principal/income) category.