filing final income tax return for deceased person...

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Filing Final Income Tax Return for Deceased Person:

Mastering Allocations, Understanding IRD and More

WEDNESDAY, AUGUST 12, 2015, 1:00-2:50 pm Eastern

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Aug. 12, 2015

Filing Final Income Tax Return for Deceased Person

Deborah Petrone, CPA, MTax, CGMA,

Principal-Schlabig & Associates

[email protected]

David N. Kass, CPA, JD

Kass & Kass

[email protected]

Linda L. Snelling, JD, LLM- Taxation

Partner- Sachs Sax Caplan

[email protected]

Tereina Walk, JD, LLM- Taxation

Associate- Sachs Sax Caplan

[email protected]





Notice

ANY TAX ADVICE IN THIS COMMUNICATION IS NOT INTENDED OR WRITTEN BY

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any tax opinions, memoranda, or other tax analyses contained in those materials.

The information contained herein is of a general nature and based on authorities that are

subject to change. Applicability of the information to specific situations should be

determined through consultation with your tax adviser.

Filing a Final Income Tax Return

for a Deceased Person

Presented By:

Deborah L. Petrone, CPA, M.Tax, CGMA – Principal, Schlabig & Associates

David Kass, CPA, JD – Kass & Kass

Linda L. Snelling, CPA, JD, LLM- Taxation – Partner, Sachs Sax Caplan

Tereina R. Walk, JD, LLM- Taxation – Associate, Sachs Sax Caplan

I. Filing Requirements-

Filing of the Final Tax Return

Presented by:

Linda L. Snelling, CPA, JD, LLM-Taxation

Partner, Sachs Sax Caplan

Filing Requirements

• If a taxpayer dies before his or her return is filed, his or her personal representative must file the final income tax return (Form 1040) of the decedent for the year of death and for any year returns were not previously filed.

• A personal representative is an executor, administrator, or anyone who is in charge of the decedent’s property. Generally, an executor is named in the will and appointed by the court when the will is admitted to probate to administer the estate. If no will exists, the executor will be appointed for an intestate estate utilizing the priority of appointment set forth under state law.

• The duties of the personal representative are to collect the decedent’s assets, pay any creditors, including taxes, and to distribute the remaining assets to the beneficiaries or heirs (in an intestate estate). Executors need to be careful not to distribute the estate assets prior to satisfying all tax liabilities.

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Filing Requirements, cont.

• The gross income, age, and filing status of a decedent generally determines if a return needs filed.

• A return must be filed if the decedent had self-employment income over $400 or received any advance earned income credit.

• When filing a final return, write DECEASED and the date of death on the top of the return.

• If an individual died after the close of the tax year but before the return for that year was filed, the return for the tax year just ended will not be the final return .

• The final return is due by April 15th of the year following the date of death.

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Filing Status

• Joint return ▫ The estate’s executor or personal representative must consent to

filing a joint return with the surviving spouse. If there has been no personal representative appointed before the due date of the return, the surviving spouse can file the joint return.

▫ A joint return cannot be filed if the surviving spouse remarried before the end of the year. If this happens the filing status of the decedent is typically married filing separately.

▫ A personal representative can revoke a joint return election by filing a separate return. This is an exception to the general rule that the election to file a joint return is irrevocable.

▫ Surviving spouse must sign the return and write in the signature area “filing as surviving spouse” if no executor or personal representative has been appointed. If there is a personal representative, that person should sign along with the surviving spouse.

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II. Income Calculation

Presented by:

Deborah L. Petrone, CPA, M.Tax, CGMA

Principal, Schlabig & Associates

Income to Include in the Final Return

• The final return should include all income and deductions to date of death, based upon the method of accounting used by the decedent while alive.

• Cash method:

▫ Include only those items actually or constructively received before date of death.

▫ Uncashed checks received prior to the decedent’s death are constructively received.

▫ Interest is constructively received when subject to withdrawal as well as interest on bonds that had matured prior to death but were uncashed.

▫ Dividends are considered constructively received if they were available for use without restriction.

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Income to Include in the Final Return, cont.

▫ If the corporation routinely mails its dividend checks, then the dividend is includable when received. Therefore if the individual died between the time the dividend was declared and the time it was received in the mail, the decedent did not constructively receive it before death. Do not include the dividend in the final return.

• Accrual Method: ▫ Income items normally accrued before death are

included on the final return.

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Interest and Dividend Income Reported

on Forms 1099 • 1099 Forms reporting interest and dividends earned by the

decedent before the date of death should be included on the decedent’s final return. Separate 1099 Forms should show the interest and dividends earned after the decedent’s date of death and should be reported by the estate or other recipient and should be reported on its return. You can request corrected 1099 Forms if the original ones were not correct.

• If this is not possible, then you have to allocate the interest

and dividend income between the decedent and the other recipient. Report the entire interest and dividend reported under the TIN of the decedent. Then subtract the amount allocable to the estate or other recipient as “Nominee Distribution” with the TIN of the nominee.

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Partnership Income

• The death of a partner closes the partnership’s tax year for that partner. Generally it does not close the partnership’s tax year for the remaining partners.

• The decedent’s distributive share of partnership items must be computed as if the partnership’s tax year ended on the day the partner dies.

• The partners can agree to estimate the decedent’s distributive share by prorating the amounts the partner would have included for the entire partnership year.

• On the decedent’s final return, include the K-1 income that ends with the decedent’s date of death.

• Depending on the terms of the will, the decedent’s estate will often step-in after the date of death as a partner reporting partnership items from the day after the date of death until the end of the partnership tax year.

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S Corporation Income

• If a shareholder dies during an S corporation’s tax year, his or her prorata share of the corporation’s income, loss, deductions and credits is included on the decedent’s final return.

• Income, loss, deductions and credits are allocated proportionately to the decedent accordingly to the number of days in the corporation’s tax year prior to death, without regard to income or loss actually incurred by the corporation during the tax year.

• If all the shareholders agree, the corporation may elect to allocate income or loss as if the year consisted of two short years – one ending on the date of death and the other ending on the last day of the corporate year.

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Trusts

• The decedent’s method of accounting is controlling. • Cash:

▫ The decedent’s final return will reflect the actual distributions of trust income (DNI) that was received prior to death.

• Accrual: ▫ DNI computed through the date of death is included in

the decedent’s final return, regardless of whether or not it was actually distributed.

• Simple trusts (trust which require the income to be distributed currently): ▫ Income is allocated through the date of death

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Self-employment Income

• Include self-employment income actually or constructively received depending on the decedent’s accounting method.

• This would also include the decedent’s distributive share of a partnership’s income or loss reported on the decedent’s final K-1 from the partnership.

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HSA, Archer MSA or Medicare Advantage MSA

• The treatment of a HSA or MSA at the death of the account holder, depends on who acquires the interest in the account.

• If the decedent’s estate acquires the interest, the fair market value (FMV) of the assets in the account on the date of death is included as income on the decedent’s final return.

• If the decedent’s spouse is the designated beneficiary, it becomes that spouse’s HSA or MSA.

• If a non spousal (or a non-designated spouse) beneficiary acquires the interest, the FMV of the assets in the account at the date of death must be reported on the beneficiary’s tax return. However, the income is reduced by any qualified medical expenses paid for the decedent by the beneficiary within one year of the date of death.

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Sale of a Personal Residence

• If one spouse dies and the home is sold in the year of death, the surviving spouse can file as married filing joint and exclude $500,000 of the gain on sale if either spouse met the two year requirement.

• If the surviving spouse stays single, then that individual can take the $500,00 exclusion up to two years after the date of death.

• If not married, the gain to be excluded is limited to $250,000.

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Losses and Deductions

• All deductible expenses paid before death can be written off on the final tax return.

• All medical bills paid within one one year after death may be treated as having been paid by the decedent at the time the expenses were incurred and included on the final tax return. If the final return was already filed, a 1040X can be prepared to take the additional medical expenses.

• Any insurance reimbursements of previously deducted medical expenses are income to the estate or trust tax returns

• Unamortized points paid in refinancing a personal residence are deductible in full on the final return of the decedent.

• The full standard deduction (if no itemized deductions ) and exemption is available even if the taxpayer died on January 1.

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• Passive activity losses:

▫ On a decedent’s final return, suspended passive losses up to an amount equal to the “step-up” to FMV at date of death becomes nondeductible or permanently disallowed.

▫ Passive losses in excess of the amount of “step-up” to FMV at the date of death are freed up and allowed on the decedent’s final return.

▫ If income in the final year is insufficient to use these passive losses that are allowed, the losses may generate a net operating loss that can be carried back under NOL rules.

▫ Any unused passive losses do not carry forward to the estate or any other beneficiary’s tax return. Lost at death.

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• Capital losses and net operating losses: ▫ Decedent’s losses are only on the decedent’s final

return – no carryover to the estate or other successor in interest is allowed.

▫ No carryover of a decedent’s separate loss is available to the surviving spouse.

• At-risk carryovers: ▫ The treatment of suspended at-risk losses is unclear

▫ Any basis adjustment – “step-up” to FMV at the date

of death and the decedent’s amount at risk will be added to the successor’s amount at risk.

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• Estate tax deduction on the return of the recipient of IRD: ▫ Income that the decedent had a right to receive is included

in the decedent’s gross estate and is subject to estate tax. ▫ This IRD is also taxed when received by the estate or

beneficiary. ▫ An income tax deduction is allowed to the recipient for the

estate tax paid on the income. ▫ Figure the estate tax with and without the IRD and the

difference is the estate tax deduction. • Request for a prompt assessment of income tax:

▫ The executor or personal representative can request this to shorten the three year statute of limitations to assess additional taxes to the eighteen months utilizing Form 4810.

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III. Income in Respect of a

Decedent

Presented by:

David Kass, JD, CPA

Kass & Kass

Definition of IRD

• IRD defined as Income a decedent earned or had a right to receive if he had not died

• IRC 691(a)(1) Provides that gross income that is not reported by decedent in either the period encompassing the date of his death or a prior period is Income In Respect of a Decedent.

25

Common IRD Items Included in Gross

Income 1. Uncollected salaries, vacation pay, or Sick Pay of a

Cash Basis Taxpayer 2. Deferred Compensation and Stock Option Plans 3. Qualified Pension Plans, SEP, Keough Plans and

Traditional IRA’s 4. Accounts Receivable of a Cash Basis sole

proprietor. 5. Accrued Interest and Dividends unpaid at date of

death. 6. Rents and Royalties accrued before death (earned

but not yet paid for a cash basis decedent. 26

On Which Return is IRD Reported?

• It is either reported on Decedent’s estate tax return (Form 1041)

• Or it is reported by Decedent’s beneficiaries on their 1040’s

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More Common IRD Items

7. Gain from the sale of property if sale occurs before death but proceeds not collected until after death.

8. Installment sale gains 9. Interest accrued through date of death of series EE

savings bonds. Unless decedent elected to report annually or all interest earned is reported on Decedent’s final 1040 return.

10. Annuity payments in excess of decedent’s investment in the contract

11. Alimony due but not paid to decedent at death 28

Purpose of IRC 691

The Section’s Purpose in simplest sense is to make sure items earned by decedent but not reported by

him on his returns due to timing differences deferrals etc., is subjected to income tax.

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Reason for IRD Deduction

• Congress aware of fact that IRD included in gross income for income tax purposes

• Could also be subjected to federal estate tax

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When Is IRD Deduction Allowed?

• For Individuals deduction available only if they itemize

• Deduction available as a misc. itemized ded. Not subject to 2% AGI threshold.

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Computation of Deduction

1. Compute the Fed. Estate Tax on the entire taxable estate on form 706

2. Compute the Estate tax on the estate excluding the IRD income items

3. Subtract No. 2 from No. 1

4. The result is the total IRD Deduction

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Apportioning the IRD Deduction

• Divide the IRD included in each beneficiary’s income by the total IRD income

• Multiply resulting percentage by total IRD Deduction as determined in prior 2 slides.

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Important points to keep in mind

• Federal Estate Tax Exclusion is 5.43 million

• The increased exclusion means a lot less people will pay estate tax

• Therefore a lot less will qualify for an IRD Deduction

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Tax Planning Point No. 1

• If Decedent left his or her estate including IRD items to more than 1 heir and the heirs are in different income tax brackets

• Have heirs in lower tax brackets disclaim or refuse their Bequests in favor of more heavily taxed heirs

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Qualified Disclaimer Rules

• Covered in IRC Section 2518

• Basic Rules:

• Must be in writing

• Must be received by Decedent’s

• Executor no later than 9 months after decedent’s death.

• Other Rules: Your local probate court may have its own rules.

• For example in NYS a Qualified Disclaimer must be recorded in Surrogates Court

• The disclaiming heir may not accept any part of bequest.

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Effect of a Qualified Disclaimer

• Disclaimed bequest passes to nondisclaiming heirs as if Decedent’s will had left it to him or her.

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Tax Planning Idea No. 2

• At the start of this presentation on IRD • We noted IRD income could be reported on the

Estate’s fiduciary Income tax Return or A Beneficiary’s Income Tax return.

• Income earned by a Fiduciary (Estate or trust) is taxed at 39.6% rate for each dollar over $12,150.00

• Suggestions : 1) Have Executor execute a qualified disclaimer in favor of lower taxed bene’s.

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Tax Planning Idea No. 2, Cont.

• Have attorney who draft’s will or trust documents provide that all income earned by fiduciary must be distributed each calendar quarter

• This makes the estate or trust a simple estate or trust and has the effect of passing the income tax on the estate or trust income to the beneficiaries

• If either idea is not possible, suggest that the Executor or Trustee invest the trust or estate corpus in Tax Free Municipal Bonds

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Inherited IRAs

• Inherited IRAs ▫ If a beneficiary receives a lump-sum distributions from a

traditional IRA it is taxed to that heir up to the taxable balance of the decedent that includes unrealized appreciation and income accrued to the date of death minus any basis (nondeductible contributions).

▫ If the beneficiary of a traditional IRA is the decedent’s surviving spouse who properly rolls over the distribution into another traditional IRA , a qualified plan or 403 annuity the distribution is not currently taxed.

▫ If the beneficiary is not a spouse, the inherited IRA cannot be rolled over to their own IRA. The beneficiary can make a trustee-to-trustee transfer to a newly created “inherited IRA” .

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Roth IRAs & Employer Sponsored

Retirement Accounts • Roth IRAs

▫ Qualified distributions from a Roth IRA are not subject to tax as long as the account has been open at least five years at the time of the owner’s death.

▫ If the original owner of the Roth IRA dies before the five year period has been lapsed, the beneficiary can satisfy the holding period by rolling the account over into an “inherited Roth IRA” and waiting until the holding period has passed.

• Employer Sponsored Retirement Accounts: ▫ 401(k) and 403(b) accounts and annuities are taxed to

the beneficiary. 41

Retirement Accounts, cont.

▫ As with traditional IRAs, a spouse who inherits an employer sponsored 401(k), 401(b) or annuity can roll the distribution over to an “inherited IRA” that enables them to spread out their distributions over their lifetimes.

▫ As of 2007, non-spousal beneficiaries can do the same by rolling the distribution from the employer sponsored retirement plan into an “inherited IRA”, although the rules are not exactly the same as spouses.

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IV. Special Income Issues:

a. Stock Options

b. Basis Adjustments

c. Refunds

Presented by:

Deborah L. Petrone, CPA, M.Tax, CGMA

Principal, Schlabig & Associates

Compensatory Stock Options

• Determine whether the option is an incentive stock option or a non-qualified stock option:

• An incentive stock option (ISO) is an option granted to an individual for any reason connected with employment to purchase stock of the corporation. Even though the ISO is compensatory in nature, it is taxed at capital gain rates not ordinary income rates when the stock is sold as long as IRS requirements are met.

▫ Two of the ISO requirements are: the option must not be exercisable more than 10 years of the grant date and the ISO cannot be transferred other than by will or laws of distribution and may be exercised by only one optionee.

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Compensatory Stock Options, cont.

▫ The optionee must be employee of the granting corporation all times during the period from the grant date to three months before the exercise date.

▫ Failure to meet any qualification of the ISO results in a disqualifying disposition and causes the optionee to recognize ordinary income and short-term capital gain after the exercise date instead of the more favorable long-term capital gain rates.

▫ Some plans forfeit unvested options at death – so read the plan!

▫ A decedent must have been an employee within three months before the date of death.

▫ If an employee dies while holding an ISO, the normal holding period requirement no longer applies.

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• A non-qualified stock option (NSO) is granted to an employee or independent contractor, such as a director, in connection with performance of services.

▫ They do not qualify as ISOs and can be transferred to others if the option agreement permits.

▫ There is no taxable event to the employee or contractor upon issuance as the NSO has no readily ascertainable value.

▫ The taxable event is deferred until the NSO is exercised and upon the exercise, the optionee recognizes ordinary compensation income.

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▫ Upon the death of the employee or contractor, the NSO is considered IRD.

▫ The decedent earned a right to collect before death but had not yet reported for tax purposes. There will be no “stepped-up basis” to FMV at the decedent’s date of death as the ISO had.

▫ The beneficiary will realize taxable income upon exercise of the option.

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▫ The executor or personal representative may sell the underlying stock after exercising an ISO without the adverse consequences of a disqualifying distribution.

▫ The basis of the option is “stepped-up” to the fair market value (FMV) as of the date of death. Property passing from a decedent is deemed to have a long-term holding period, so the option has met the long-term gain/loss requirement.

▫ However, the holding period of stock acquired by the executor or personal representative exercise of the option begins on the date of exercise because the stock was acquired by purchase, not by passing from the decedent.

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Basis Differential on Covered Securities

• Covered securities are those securities purchased after January 1, 2011, that brokerage firms are required to report not only gross proceeds from the sale, but also the cost basis, acquisition date, and whether any gain or loss with respect to such securities is long-term or short-term.

• This information is then reported on the “covered” section of Form 8949 the total of which flows to Schedule D.

• As with interest and dividend 1099 reporting, separate Form 1099Bs should show the capital gain activity before and after death. You can request a corrected 1099 Form if the original ones were not reported correctly.

49

Basis Differential on Covered Securities, cont.

• If this is not possible, then you have to allocate the covered security information between the decedent, the estate or other recipient. Report the entire covered information under the TIN of the decedent. Then subtract the amount allocable to the estate or other recipient as “Nominee Distribution” with the TIN of the estate or other recipient.

• Unlike the interest and dividend allocation, the cost basis, date of acquisition and gain/loss reporting will be different after the date of death.

50

Basis Differential on Covered Securities, cont.

• The cost will be the “stepped-up basis” to FMV at the date of death (or the alternative valuation date). The acquisition date will be the date of death. Property acquired from a decedent is treated as held for more than one year making the gain long-term.

• The whole point of reporting the entire amount of either 1099 Int, Div or B under the decedent’s final return and subtracting out the portion that happened after the date of death is to preclude letters from the IRS that cannot match the TIN and the amounts reported!

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Refunds

• Must actually file the return to receive the refund even if otherwise not required to file!

• If a surviving spouse files a joint return, there is no special requirement to receive a refund.

• When and executor or administrator files the return on behalf of the decedent, a refund will be paid as long as a copy of the court order is attached.

• If a personal representative files the return on behalf of the decedent, a Form 1310, Statement of Person Claiming Refund Due a Deceased Taxpayer must be filed with the return to obtain the refund.

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V. Tax Elections and Coordination

with the Fiduciary Return

Presented by:

Tereina R. Walk, JD, LLM - Taxation

Associate - Sachs Sax Caplan

Various Tax Elections

• Section 213 (Decedent’s Medical Expenses)

• Section 444 (Fiscal Year Election)

• Section 454 (U.S. Savings Bond Interest)

• Section 645 (Form 8855)

• Section 754 (Partnership elections)

• Section 1362 (Small Business Corporation)

• Section 2053 and 2054 (Administration Expenses)

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Elections with respect to Decedent’s

Medical Expenses

• Medical expenses not paid before death are liabilities of the estate and are shown on the federal estate tax return (Form 706). However, if medical expenses for the decedent are paid out of the estate during the 1-year period beginning with the day after death, you can elect to treat all or part of the expenses as paid by the decedent at the time they were incurred.

• If you make the election, you can claim all or part of the expenses on the decedent's income tax return (if deductions are itemized) rather than on the federal estate tax return (Form 706). You can deduct expenses incurred in the year of death on the final income tax return. You should file an amended return (Form 1040X) for medical expenses incurred in an earlier year, unless the statutory period for filing a claim for that year has expired.

• The amount you can deduct on the income tax return is the amount above 10% of adjusted gross income (or 7.5% of adjusted gross income if the decedent or the decedent's spouse was born before January 2, 1950). Amounts not deductible because of this percentage cannot be claimed on the federal estate tax return.

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How election made-

• A statement is attached in duplicate, to the decedent's income tax return or amended return. The statement must state that the amounts have not been claimed as estate tax deductions; the statement will also indicate that the estate waives the right to claim the amount as a deduction. This election applies only to expenses incurred for the decedent, not to expenses incurred to provide medical care for dependents.

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Section 444 (Fiscal Year Election)

(a) General rule • Except as otherwise provided in this section, a partnership, S corporation, or personal service corporation may

elect to have a taxable year other than the required taxable year. (b) Limitations on taxable years which may be elected • (1) In general • Except as provided in paragraphs (2) and (3), an election may be made under subsection (a) only if the deferral

period of the taxable year elected is not longer than 3 months. • (2) Changes in taxable year • Except as provided in paragraph (3), in the case of an entity changing a taxable year, an election may be made

under subsection (a) only if the deferral period of the taxable year elected is not longer than the shorter of— • (A) 3 months, or • (B) the deferral period of the taxable year which is being changed. • (3) Special rule for entities retaining 1986 taxable years • In the case of an entity’s 1st taxable year beginning after December 31, 1986, an entity may elect a taxable year

under subsection (a) which is the same as the entity’s last taxable year beginning in 1986. • (4) Deferral period • For purposes of this subsection, except as provided in regulations, the term “deferral period” means, with respect

to any taxable year of the entity, the months between— • (A) the beginning of such year, and • (B) the close of the 1st required taxable year ending within such year. (c) Effect of election • If an entity makes an election under subsection (a), then— • (1) in the case of a partnership or S corporation, such entity shall make the payments required by section 7519, and • (2) in the case of a personal service corporation, such corporation shall be subject to the deduction limitations of

section 280H.

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Section 645 Election to treat a Qualified

Revocable Trust as Part of an Estate

• Complete the Form 8855 and file it together with the Form 1041 on the due date (including any extension).

• This allows the Trustee of a Qualified Revocable Trust and the Executor to treat the Trust as part of the Estate.

• The Trust and Estate will have the same fiscal year end.

• Election is irrevocable.

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Section 754 (Partnership elections)

• Regs. Sec. 1.754-1(b)(1) provides that an election under Sec. 754 to adjust the basis of partnership property under Secs. 734(b) and 743(b) shall be made in a written statement filed with the partnership return for the tax year during which the distribution or transfer occurs. For the election to be valid, the return must be filed no later than the time prescribed for filing the return (including extensions) for the tax year. Further, a valid Sec. 754 election must (1) set forth the name and address of the partnership making the election, (2) be signed by any one of the partners, and (3) contain a declaration that the partnership elects under Sec. 754 to apply the provisions of Secs. 734(b) and 743(b).

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Sample NOTIFICATION TO PARTNERSHIP BY TRANSFEREE PARTNER OF TRANSFER OF A

PARTNERSHIP INTERST ON DEATH UNDER REG. 1.743-1(k)(2)(ii)

Transferee Information: Deceased Partner Information:

EIN: EIN:

Relationship to Deceased Partner Relationship to Transferee

DOD: ____________

Date of Ownership: DOD FMV: $___________

Under penalties of perjury, I declare that I have examined this statement and to the best of my

knowledge and belief, it is true, correct, and complete.

Signed:

_____________________________ ________________

____________, Transferee Partner Date 61

Further Information 754 Election • If the taxpayer fails to timely file a valid Sec. 754 election, automatic relief may be

available under Regs. Sec. 301.9100-2. Under this regulation, a taxpayer is granted an automatic extension of 12 months from the due date for making certain regulatory elections. To obtain relief under these provisions, the regulation mandates that the taxpayer take the steps required to correctly file the election in accordance with the statute or the applicable regulation. Required steps include filing an original or amended return for the year in which the taxpayer intended the election to be effective. This original or amended return must include the correctly completed Sec. 754 election.

• Any return, statement of election, or other form of filing made to obtain an automatic extension must provide the following statement at the top of the document: "FILED PURSUANT TO §301.9100-2."

• The regulations also provide that taxpayers making an election under an automatic extension (and all taxpayers whose tax liability would be affected by the election) must file their return(s) in a manner that is consistent with the election and must comply with all other requirements for making the election for the year the election should have been made and for all affected years; otherwise, the IRS may invalidate the election.

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Section 1362 Election

• (a) Election • (1) In general • Except as provided in subsection (g), a small

business corporation may elect, in accordance with the provisions of this section, to be an S corporation.

• (2) All shareholders must consent to election • An election under this subsection shall be valid only

if all persons who are shareholders in such corporation on the day on which such election is made consent to such election.

• Sections (b)-(e) provide detail with respect to making election

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QUALIFIED SMALL BUSINESS TRUST

Subchapter S Elections- Sample Language • SPECIAL BUSINESS PROVISIONS

• The following provisions apply to any closely-held stock or other business interests held in this Trust.

• 1. Subchapter S Stock. Despite any other provisions of this Trust, if a trust created in this instrument is to become the owner

of, or already owns, stock in a corporation that has an election in effect (or one that proposes to make an election) under IRC §1362

(an “S Corporation”), and that trust would not otherwise be permitted to be an S Corporation shareholder, the following provisions

will apply:

• (a) Electing Small Business Trust. The Trustee in its discretion may elect for the trust to become an Electing Small Business

Trust (“ESBT”), as defined in the Internal Revenue Code.

• (b) Qualified Subchapter S Trust. If the Trustee does not cause the trust to become an ESBT, the Trustee shall set aside the S

Corporation stock in a separate trust for the current income beneficiary of such trust, so that a Qualified Subchapter S Trust

(“QSST”) election under IRC §1361 can be filed with respect to that trust. If a trust has more than one permissible current income

beneficiary, the Trustee shall divide that S Corporation stock into shares so that there is an equal share for the spouse and each child

who are then living. The Trustee shall hold each share as a separate QSST for the persons described above, and each such person

will be the sole beneficiary of his or her QSST. To the greatest extent possible, the Trustee shall administer each QSST under the

terms of the trust from which it was derived, but subject to the following overriding provisions:

• (i) Consent. The Trustee shall notify the beneficiary of each separate trust promptly that a QSST election must be filed with

the IRS. Thereafter, each beneficiary shall file a timely and proper QSST election with the IRS. If a beneficiary fails or refuses to

make the QSST election, the Trustee shall make an ESBT election for that trust.

• (ii) Income Payments. During the beneficiary’s life, the Trustee shall pay all net income of the trust to the beneficiary (and

only to that beneficiary) in quarterly or more frequent installments. The beneficiary’s income interest in the trust will terminate on

the earlier of his or her death or the termination of the trust under its terms.

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Subchapter S Elections- Sample

Language- con’t • (iii) Principal Invasions. If the beneficiary is otherwise entitled to receive principal distributions, the Trustee

may distribute all remaining principal from that separate trust during the beneficiary’s life only to or for the benefit of that beneficiary (and no one else).

• (iv) Final Distribution. If the QSST is terminated during the beneficiary’s life, the Trustee shall distribute all remaining assets of that separate trust to that beneficiary. If the beneficiary dies before that trust’s termination, all remaining assets of the QSST are to be distributed as provided in the original trust.

• (v) Termination of QSST Status. If a separate trust would cease to qualify as an S Corporation shareholder, the Trustee, in its discretion, may: 1) make an ESBT election for that separate trust, or 2) distribute all S Corporation stock to the beneficiary. The Trustee, in its discretion, also may convert a QSST to an ESBT, whether or not the beneficiary has consented to QSST treatment and, if the beneficiary consents, may convert an ESBT to a QSST.

• 2. Retention of Stock. Settlor authorizes the Trustee to retain the assets that it receives, including shares of stock or other interests in CLIENT COMPANY, INC. or CLIENT COMPANY, LLC, its successors in interest, or any other company or entity carrying on or directly or indirectly controlling the whole or any part of its present business (collectively referred to as “CLIENT COMPANY USA”), for as long as the Trustee deems best, and to dispose of those assets when it deems advisable.

• Settlor prefers that the Trustee not sell shares of stock or other interests in CLIENT COMPANY USA because he believes that the best interests of the beneficiaries will be served by retention of those interests in the Trust’s portfolio. Settlor intentionally excuses the Trustee from the duty to diversify investments by the sale or other disposition of interests in CLIENT COMPANY USA that ordinarily would apply under the prudent investor rule, and Settlor directs that the Trustee not be held liable for any loss or risk (even so-called “uncompensated risk”) incurred as a result of this failure to diversify. Settlor realizes, however, that circumstances may change, and that the Trustee may determine it to be advisable to sell some or all of the interests in CLIENT COMPANY USA, and nothing in this paragraph shall be interpreted in any manner to limit that Trustee’s authority to do so.

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Section 2053 and 2054 Elections-

coordination with 642(g) • (g) Disallowance of double deductions • Amounts allowable under section 2053 or 2054 as a deduction in

computing the taxable estate of a decedent shall not be allowed as a deduction (or as an offset against the sales price of property in determining gain or loss) in computing the taxable income of the estate or of any other person, unless there is filed, within the time and in the manner and form prescribed by the Secretary, a statement that the amounts have not been allowed as deductions under section 2053 or 2054 and a waiver of the right to have such amounts allowed at any time as deductions under section 2053 or 2054. Rules similar to the rules of the preceding sentence shall apply to amounts which may be taken into account under section 2621(a)(2) or 2622(b). This subsection shall not apply with respect to deductions allowed under part II (relating to income in respect of decedents).

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Coordination with the Executor or Personal

Representative of the Decedent

• When the estate tax year begins:

▫ There is some question as to whether the estate is created on the date of the decedent’s death or the day after.

▫ According to the regulations, the decedent’s final income tax return includes his or her income received (actually or constructively) up to and including the date of death implying that the taxpayers are presumed to have lived the entire day of their death.

▫ Therefore it stands to reason that the first day of the estate is the day after the date of death. So if a taxpayer died on July 13, the estate year begins on July 14 and ends no later than June 30.

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Representative of the Decedent, cont. • When the estate tax year ends:

▫ The executor or administrator of a decedent’s estate can choose any tax year which provides an opportunity to defer the beneficiary’s recognition of income received by the estate or to maximize deductions of the estate.

▫ The estate’s taxable year must end on a month end and cannot have more than 12 months.

▫ The election to use the desired fiscal year is made by filing the estate’s initial Form 1041 with the selected year end.

▫ As a practical matter, calendar year filing may be more convenient.

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Representative of the Decedent, cont.

• IRS consent required to change a tax year:

▫ Once a tax year has been chosen, the tax year cannot be changed without IRS approval using Form 1128. There must be a business purpose.

▫ The tax year specified on an extension request in the initial year does not determine taxable year. The taxable year is established by the initial return that is filed.

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• Accounting methods: ▫ The fiduciary may compute taxable income under any

combination of methods, including the cash method, the accrual method, or any other permissible method allowed.

▫ Under certain circumstances the accrual method must be chosen.

• Year end of Trusts: ▫ Trusts are required to use a calendar year-end. The

only exceptions to this rule are charitable trusts and those trusts that are exempt from taxes and grantor trusts wholly owned by the grantor.

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▫ However, a trustee of a qualified revocable trusts (QRT) and the executor of an estate can elect to treat the trust as a part of an estate. Only one Form 1041 (for the estate) is required if this Section 645 election is made, even though the trust rather than the estate holds the assets. This Section 645 election allows the trust to use the same fiscal year-end as the estate.

▫ The election once made is irrevocable.

▫ This election must be made on Form 8855 in the estate’s initial year.

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• Basis of inherited property:

▫ The basis is generally “stepped-up” to FMV at the date of death or on the alternate valuation date if chosen by the personal representative.

▫ If the property is held jointly then only one-half is included in the estate and is “stepped-up”.

▫ This “stepped- up” property does not include IRD!

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filing final income tax return for deceased person...

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