The Expert in Tax Education

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Decedent’s Final and Fiduciary Returns

The Expert in Tax Education

The Expert in Tax Education

Developed by Kathy Hubbard, EA

Presented by XXXX

Summer 2014

Decedent’s Final and Fiduciary Returns

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Objectives•To address common scenarios that small tax practitioners encounter with decedents' final and fiduciary returns,•To provide a quality fact base with ample references, worksheets and examples for the tax professional•To provide information specific to Texas.

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The Final 1040

•Final Tax Year is January 1 - DOD•Final 1040 Year ends December 31•NO ES 2210 penalties, but full pay 4/15•Return due 4/15, extendable to 10/15•Full amount, no proration for

standard, over age 65 and/or blind deductions

exemption, incl if decedent was a dependent

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1040 Filing RequirementsDepend Upon

Gross IncomeAgeFiling StatusOther Tax or Filing Obligations

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Gross Income

•Controlled by both age and filing status,•Ranges from

$950 (dependent under age 65) to

$21,800 (married couple, both over age 65)

•Measured from January 1 to midnight on DOD

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Age

For tax purposes, one reaches age 65 on the day before one’s 65th birthday

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Filing Status

There are exceptions tothe customary status

and incomefiling rules.

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Filing Status

If a married couple normally files jointly,even though they live apart, and one of them dies, a return must be filed if gross income is at least $3,800.

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Filing Status

Where a couple files jointly, and one dies, and the surviving spouse remarries,

the decedent must file married separately!

This is a post-mortem impact on filing status.

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Filing Status

If the decedent normally filed head of household,

but passed away less than 181 days into the year,

Status reverts to single (or mfs): The qualifying relatives were not in the decedent’s care for over half the year.

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Filing Status

If Decedent is a Qualifying Child:

If the decedent is a child, s/he qualified the relative with whom she spent the majority of her days that final year for HOH.

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Other Tax or Filing Obligations

•Taxes!•AMT•Uncollected SS, Medicare, RRTA•Recapture taxes•Self employment or church wages

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Other Tax or Filing Obligations

•If 1040 not otherwise required, can file standalone:

Form 5329 additional tax on a qualified plan

Schedule H, household employment taxes

Form 8606 for non-deductible IRA contributions.

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Other Tax or Filing Obligations

•Credits Require Filed ClaimEarned Income, child, prior year minimum tax, education and fuel credits

Withholdings and estimated tax payments.

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Never OverlookSpecial Tax Forgiveness

Provisions

Mortally wounded warriors or civilians serving in combat zones,

injured and/or deceased victims and families of victims harmed by

terrorist attacks, and astronauts who perish in the line of duty.

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Never Overlook

The particulars surrounding the passing of these military and civilian persons, and

The discreet types of tax relief applicable to their tax accounts and sometimes those of their families.

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Never Overlook

Certain death benefits paid to survivors of public safety officers IF

Killed due to traumatic injuries sustained in the line of duty

After September 10, 2001Which are excluded from both income and estate taxes.

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Who Signs the Return?The Personal

Representative!

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Who is a Personal Representative?

Executor named in the will* Administrator appointed by the

court* Trustee of decedent’s trust* Surviving spouse Successor in possession of

property*

* File form 56, required, § 6903

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Decedent’s and Successor's IncomePassed Without Probate

Ownership stylesCommunityJointJoint with surv’ship rightsLife estateBeneficiary designationsPay on DeathRemainderTrust property

Pass Under LWT

Testamentary transferSpecific bequestsResidual bequestsWill can “pour over” to a “living” trustWill can create trusts

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Income Documents

W2s & 1099s issued through end of year or end of account:

Request reissued 1099, orIssue 1099 for nominee’s share

Review monthly detail on bank and brokerage statements

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Income Documents con’tOn Decedent’s Return

Sch B Interest and Dividends in full, less nominee portion reduction Sch C,E,F Income and Expense to DOD (may need to report full 1099 and deduct nominee portion)Sch D True or 1099B gross, code N-nominee Pension/IRA/Other Reported portion on correct return line, “Post Mortem Income” is subtracted on Line 21.

On Beneficiary’s Return

Sch B Nominee portion

Schs C,E,F Post mortem income and expensesSch D Nominee portion, long term usually DOD cost basis § 1014Report on correct return line, if known, or line 21.

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Income In Respect of a Decedent

IRD Arises From Certain Assets or Rights, and

Retains the Decedent’s“Tax Character”

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§691 IRD Earned Before, Paid After

Interest, Dividends, Rents and Royalties,

Uncollected salaries, wages, vacation, bonus and sick pay,

Certain deferred compensation and stock option plans,

Annuity and retirement plans in excess of basis (ROTH IRA’s excepted,)

Difference between the face amount and decedent’s basis in an installment plan

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Expenses in Respect of a Decedent

Mortgage InterestInvestment InterestProperty & state income taxesMedical Expenses paid within a year of deathBusiness and Investment Expenses

Review rules for depreciation, depletion and installment sales

Beware the HSA

Pre MortemContributions

DeductibleDistributions for

Medical Expenses not Taxable

Post MortemUnless spouse is

beneficiary,FMV of Accounts

Subject to Income TaxLess amounts used to

pay decedent’s medical expenses within 1 year of death.

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The Fiduciary's Expenses

•Attorney Fees•Fiduciary and Estate Return Fees•Court Costs•Fiduciary Fees•Fiduciary Premium Bond Fees•Certain investment management fees and other costs incurred because of the entity’s status as an estate or trust § 67(e)(1).•Miscellaneous expenses which exceed 2% of the estate adjusted gross income.

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Expenses Subject to 2% AGI Reduction

Preparation fees for forms 709 (gift) or 1040,Maintenance, utilities and insurance to protect the value of the non-trade or business property,Non unique portfolio management and advisory fees.

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Pub 559: Table BSource  A 

  

Enter total from 1099

B  Enter portion reportable on

decedent's final return

C Amount

reportable on estate's or

beneficiary's return

D  

Part of column C

that is IRD*

Interest:

Bank XYZ 500 350 150 12

Credit Union 300 200 100 10

Gross Proceeds

ETC Stock 20,000 9,000 11,000

* Required for Form 706

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Form 1041 Returns:Due Dates

On the 15th day of the 4th month after the tax year ends

Extend for 5 months on Form 7004

FYE established by initial return filed

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Fiduciary Returns:Filing Requirements §6012

Gross IncomeAny Taxable IncomeBeneficiariesOther Tax or Filing Obligations

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Gross Income

At least $600, orAny taxable income;Generally, uses same rules as individual income

determination §641(b)

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Beneficiaries

Income notwithstanding, filing required if any beneficiaries are non resident aliens [Reg. 1.641(a)(2) and 1.61-1(a).]

For an estate (or trust) to claim a “distribution deduction” for funds paid to a beneficiary, Forms K1 must be attached to the return

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Other Tax or Filing Situations

Claiming and having refunded income taxes withheld by payersDistributing final year excess deductions and losses to beneficiaries Owing taxes on wages paid to the decedents domestic employees by the estate

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Post Mortem Planning

Claiming accrued interest income from Series EE Bonds on the decedent’s final lower tax bracket return,

Selecting fiscal or cash accounting method,

Selecting a fiscal year,Redeeming income and paying

expenses within a fiscal year.

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Estimated Tax PaymentsNo ES payments due on decedent’s

final return or estate’s tax years ending before 2 years following DOD

No ES payments due if tax for current year <$1,000

No ES payments due if prior year tax on a full 12 month year was $0

Otherwise, follow the 100/110% individual safe harbor regime under §6654(I)

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Estate vs. Trust

Estate

Special ES rules

Standard Deduction $600*

S-Corps are qualified shareholders

TrustOnly §6654(I) rules for ES

Standard Deduction either $300 or $100*

S-Corps are only allowable partners for 2 years

* No standard deduction allowed in the fiduciary return’s final year

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Estate vs. Trust con’t

EstateCan select fiscal year end,

May allocate ES payments to beneficiaries in final year by filing form 1041-T by the 65th day of the calendar tax year.

Trust

Must use calendar year,

May allocate ES payments to beneficiaries any year by filing form 1041-T

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Active Rental Participation

EstatesFor 2 years post DOD, if the decedent qualified for active participation, the estate qualifies, § 469(i)(4)After 2 years, same rules as trust

TrustsOnly active if the trust is actively participating --IRS says this means the trustee, butsome courts have said this means the beneficiaries …!

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Qualified Revocable Trusts can Elect to be Taxed as Estates §645

Treats QRT as an estate, or QRT and Estate as the estate,File Form 8855 – review election due date variables, andCheck the “estate” and “645 election” boxes on 1041

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The 65 Day Rule §663(b)

Available to both trusts and estates:Allows 65 days after the close of the tax year to determine and distribute income to beneficiaries

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Example 1Estate Inflows & Outflows Total On Final 1041

IRA $ 5,000 $ 5,000Checking acct cash $ 30,000 0Reportable Income $ 5,000

Inflows marshaled $ 35,000

Court and Attorney Fees -$ 4,000 -$ 4,000Taxable Income $ 1,000

Net cash on hand $ 31,000

Estate Distributes All -$ 31,000

Form K-1 Box 5 Income $ 1,000

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Example 2Estate Inflows & Outflows Total On Final 1041

IRA $ 5,000 $ 5,000Checking acct cash $ 30,000 0Reportable Income $ 5,000

Inflows marshaled $ 35,000

Court and Attorney Fees -$ 8,000 -$ 8,000Taxable Income - $ 3,000

Net cash on hand $ 28,000

Estate Distributes All -$ 28,000

Form K-1 Box 11 A - $ 3,000

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The Decedent’s Home

The personal residence gets the step up in basis § 1014, andIf sold, closing expenses would generate

a loss -- non deductible for a personalloss, thus not deductible;

If occupied by one or more beneficiary,-that use is considered a distribution.

The Decedent’s Stuff

•If will says the kids (people) get the rest, and•If the executor/ heirs donate the stuff to a charity,•Then each heir donated a 1/X undivided interest in the stuff, and• The rules for individual non-cash donation documentation apply.

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Distributable Net Income

(DNI) §643 & the

Distribution Deduction § 651

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What is DNI?

Amount of income of the estate or trust for the taxable year determined under:

the terms of the governing instrument, andapplicable local law §643(b), but NOTThe Internal Revenue Code

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Terms of the Governing Instrument

How many wills or trusts say that the executor or trustee should use the Internal Revenue Code and not local UPIA for preparing the 1041 returns and determining principal and income?!!

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Now What?

READ THE ENTIRE WILL AND / OR TRUST!Be familiar with the Uniform Principal and

Income Act and the Uniform Prudent Investor Act.

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Trust vs Estate?

Trusts have extended lifetimes and more conditional beneficiary structures; the UPIAswere designed to govern their asset preservation and management.

Decedent’s estates are generally short lived & designed to distribute all assets, but still come under § 643(b).

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Fiduciary IncomeDerived from each states’ adoption of some form of the Uniform Principal and Income Act;Classifies receipts as “principal” and “income” (without regard to the IRC), for instance:Municipal interest and corporate bond interest are interest incomeEquities are principal; when stock is sold, the type of principal is exchanged from equity to cash, and remains classified as principal.

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Net Exempt IncomeIf an estate has $8,000 in taxable interest income,

And $2,000 in municipal interest income,

Thus total income of $10,000, of which 20% is tax exempt,And it has $1,000 in administration expenses,Then it cannot deduct 20% of the administration expense from taxable income;Its NEI is $1,800 ($2,000 - $200);Similar perorations of expense required where some beneficiaries are exempt organizations.

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DNI Formula § 643

Starts with taxable income,Adds back the exemption amountRemoves capital gain, andAdds in Net Exempt Income.

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The Distribution Deduction

The lower of the amount distributed § 661(a)(2)

or The amount deductible under the DNI

rules, § 651(b),

andIncome is carried out first.

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Texas Property CodeTitle 9, Trusts

Chapter 116, Uniform Principal and Income Act

116.005 Allocation Powers: Trustee may allocate between principal and income Chapter 117, Uniform Prudent Investor Act

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Fiduciary Tax Rates for 2013If Taxable Income Is: The Tax Is:Not over $2,450 15% of the taxable income

Over $2,450 but not over $5,700 $367.50 plus 25% of the excess over $2,450

Over $5,700 but not over $8,750 $1,180 plus 28% of the excess over $5,700

Over $8,750 but not over $11,950 $2,034 plus 33% of the excess over $8,750

Over $11,950 $3,090 plus 39.6% of the excess over $11,950

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2013 Exemption Amounts for AMT

Under § 55(b)(1) the excess taxable income above which the 28% tax rate applies is $179,500The amounts used under § 55(d)(3) to

determine the phase out of the exemption amounts is $ 76,950

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Net Investment Income Tax

Beginning 2013:

NIIT is 3.8% on the lesser ofNet investment income, orThe excess of the MAGI over

the threshold amount

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When are Trusts and Estates Liable for NIIT?

When they have undistributed Net Investment Income, and

Have AGI over the dollar amount at which the highest tax bracket for an estate or trust begins for such taxable year (for tax year 2013, $11,950).

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Any Special Circumstances?

There are special computational rules for certain unique types of trusts, such as Charitable Remainder Trusts and Electing Small Business Trusts, which can be found in the proposedregulations.

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Any Exceptions?

Grantor Trusts Charitable Trusts Retirement Trusts Real Estate Investment Trusts Common Trust Funds

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NII IncludesInterest,Dividends, Capital gains, Rental and royalty income,Non-qualified annuities,Income from businesses involved in trading of financial instruments or commodities,And businesses that are passive activities to the taxpayer (within the meaning of IRC § 469).

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What Type of Gains?

To the extent that gains are not otherwise offsetby capital losses, the following gains arecommon examples of items taken into accountin computing Net Investment Income:Gains from the sale of stocks, bonds, and

mutual funds, andCapital gain distributions from mutual funds.

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And NON Investment Income Is?

Wages,Unemployment compensation; Operating income from a non-passive business,Social Security Benefits,Alimony, tax-exempt interest,Self-employment income,Alaska Permanent Fund Dividends (see Rev. Rul. 90-56, 1990-2 CB 102), and distributions from certain Qualified Plans (those described in IRC §§ 401(a), 403(a), 403(b), 408, 408A, or 457(b)).

What Expenses Reduce NII?

Deductions that are properly allocable to items ofGross Investment Income, such as:

• Investment interest expense, • Investment advisory and brokerage fees, • Expenses related to rental and royalty income, • And state and local income taxes properly

allocable to items included in Net Investment Income.

NIIT Thresholds for 1040 and 1041

• 1040

• MFJ, QW $250,000• HoH, S $200,000• MFS $125,000

• NOT indexed • for inflation

• 1041

• Dollar amount of the• highest income tax • bracket for such taxable• year, for 2013 =

$11,950

• THUS, indexed• for inflation

A New Form for NIIT?

• One New Form for both Forms 1040 & 1041

• Computes the NII Base in the first section,

• Carries to different tax computation sections for individuals and fiduciaries.

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They Moved The Cheese!

The inheritance tax was the main estate planning obstacle for the middle class, before the indexed $5M exemption & the portable spousal exemption became law.

The challenge now is the NIIT!!!

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Net Investment Income Tax Avoidance

Distribute IncomeDecant AssetsDisclaim Assets within 9 months, if possible and practical

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Appendix

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Documents Needed to Prepare 1041 Will and Order Admitting Will to ProbateLetters Testamentary / of AdministrationInventory of Property (If from the probate records, will not include non-probate property nor liabilities)Bank and brokerage statements with detail -- mandatory for determining pre and post mortem transactions (including those passing outside probate)

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Documents Needed to Prepare 1041 con't

Roster of Name, address and SSN (or EIN) of

each named beneficiary, with amounts, dates & descriptions of all distributions to each

Copy of Form 706 if filedAll income forms (W2, 1099)Prepare: A DOD Balance Sheet at FMV, unless a 706 is filed with alternate date is elected)Prepare: Table B

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Workpapers to Prepare for Form1041

A DOD Balance Sheet at FMV, (unless a 706 is filed with alternate date is elected)

Table B or Equivalent

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Governing Documents Analysis

N/A No Yes

Personal Representative?

Alternative Representative?

Independent?

Bonded?

Fee or Payment Allowed to Fiduciary?

Specific Bequests?

--Name Each

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Governing Documents Analysis N/A No Yes

Establishment of Trusts?

-- Name Each Trust, Trustee & Beneficiary

--Distributions required? Otherwise allowed? For?

--Dissolution Determined by?

Methods for Determining Income & Principal Named?

Charitable Beneficiaries?

Remainder & Income Beneficiaries?

Residual Beneficiaries?

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