by Fiduciary Accounting
Beneficiaries under a will or trust have a right to be kept informed at all times about the management of the estate or trust and the fiduciary has a duty to so inform them. Managing and maintaining records for an estate or trust requires understanding the principles of fiduciary accounting. Receipts and expenditures are classified as either income or principal. For example, dividends, interest and rents (income) must be accounted for separately from the trusts assets (principal). This characteristic distinguishes fiduciary accounting from any other type of account recordkeeping. The allocation between income and principal is significant for estates but has greater importance in trust administration. A trust has two classes of beneficiaries the current beneficiaries and the remaindermen. The current beneficiaries have a beneficial interest in income or principal, or both, during the life of the trust. The remaindermen inherit the trust principal when the trust terminates. The classification of receipts and expenditures between income and principal has a direct impact on what each class of beneficiary receives.
The fiduciary of a domestic decedent’s estate, trust, or bankruptcy estate files Form 1041 to report:
- The income, deductions, gains, losses, etc. of the estate or trust.
- The income that is either accumulated or held for future distribution or distributed currently to the beneficiaries.
- Any income tax liability of the estate or trust.
- Employment taxes on wages paid to household employees.
Form 1041 (fiduciary tax return) is the income tax form used for estates and trusts. It is used to report INCOME in the estate or trust, including sales of property. The estate or trust exists until final distribution of its assets.
The tax year for an estate can be a calendar year or a fiscal year; the type of year is chosen when the first Form 1041 is filed for the estate. Once chosen, the tax year can only be changed with IRS permission. A calendar year is required for trust returns.
INCOME Filing Requirement: A return must be filed if the estate or trust has gross income of $600 or more. However, if one or more beneficiaries are a non-resident alien, Form 1041 must be filed even if the gross income is less than $600, regardless of taxable income.
A form K-1 is filed with the Form 1041 for each beneficiary. A copy of the K-1 must be furnished to each beneficiary. The K-1 shows the allocation of the beneficiary’s share of the estate-trust income and losses that the beneficiary will need to report on his or her individual income tax return.
Tax on the VALUE OF ASSETS in the Estate: A Form 706 is required if the gross estate is greater than the taxpayer’s estate tax exemption. Unless reduced because of pre-death gifts, the federal estate tax exemption for 2018 is $11,200,000 for individuals and $22,400,000 for married couples, up significantly from 2017 rates of $5,490,000 and $10,980,000 respectively. The exemption amounts are scheduled to increase for inflation until 2025. On January 1, 2026 they revert back to the 2017 exemption amounts. The highest marginal estate and gift tax rate remains at 40% of the net value of the estate.
Preparing and Filing Tax Returns
Executors and trustees are responsible for filing a variety of tax returns for the estates and trusts they manage. If accountants practice in this area of taxation, they can provide this service; if they dont, they can advise clients on what is required and refer them to a specialist. Obviously, CPAs need to understand the basic requirements and tax planning issues before advising a client.
Decedents final income tax returns. Under Internal Revenue Code section 6012(b)(1), the executor or trustee is responsible for filing any tax returns the decedent would have been required to file if still living, including the decedents final income tax returns, and for paying any taxes due. However, section 6013(a) says the surviving spouse shares this responsibility if a joint return is filed. Filing a joint return with the surviving spouse is an election the fiduciary must make after considering income splitting to possibly lower the tax bracket, using the decedents deductions, avoiding joint and several liability, increasing the availability of medical deductions and casualty losses. Tax planning considerations are important here, and the individual fiduciary needs competent advice.
Fiduciary income tax returns. An executor or trustee is responsible under IRC section 6012(b)(4) for filing a fiduciary income tax return and paying any taxes due for each year an estate or trust exists. In general, the beneficiaries are taxed on the income paid out or required to be distributed under the terms of a trust. Retained income is taxed to the estate or trust. Estate or trust income that exceeds $7,900 is taxed at the maximum federal rate of 39.6%. Since any estate income not needed to pay estate expenses will be distributed to the beneficiaries when estate administration is completed, the executor or trustee must consider whether to distribute income to the beneficiaries before the estate is closed.
Federal estate tax return. The executor of an estate generally is responsible for filing the estate tax return (Form 706, United States Estate Tax Return ), if one is required. If the value of the gross estate exceeds $600,000, the executor must file a federal estate tax return no later than nine months from the date of death, with a possible six-month filing extension under IRC section 6018(a). If the court has not appointed an executor because there is no probate estate, IRC section 2203 says the executor for purposes of filing the return is “any person in actual or constructive possession of any property of the decedent.” The trustee of the decedents trust is required to file the return under this circumstance. The executor or the trustee is personally liable for filing the estate tax return and paying any tax due. To protect himself or herself, the executor or trustee should make a request for early determination of the tax and discharge from personal liability under IRC section 2204. This request should be made at the time the return is filed.
