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Useful Tips for Preparing Fiduciary Tax Returns

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Useful Tips for FederalFiduciary Income Tax Returns
Paul C. Hayes, Esq.Kelly L. Caissie, Esq.Howard Mobley Hayes & Gontarek, PLLCPhone: [email protected]
Form 1041 – What is it?Form 1041 is anincometax return for a trust or estate reporting income earned by the trust’s or estate’s assetsIncome earned prior to a decedent’s date of death or prior to the creation of the trust is not reported on Form 1041Income earned by assets owned jointly with rights of survivorship or with pay on death designations are not reported on Form 1041Form 1041 should not be confused with Form 706, which is the federal estate tax return
Filing Requirements
Estates:Gross Income > $600, orNonresident Alien BeneficiaryTrusts:Any taxable income, orGross income > $600, orNonresident Alien Beneficiary
Types of Returns and When to File
During the taxpayer’s lifetime:Form 1040(income tax return) – final individual income tax return due April 15 of the year following the taxpayer’s date of deathFollowing the taxpayer’s death:The taxpayer’s estate comes into existence when the taxpayer diesForm 706(estate tax return) is due 9 months after the taxpayer’s date of death (can request an automatic extension for an additional 6 months)Form 1041(estate/trustincometax return)For calendar year estates and trusts, due date is April 15 of the year following the taxpayer’s date of deathFor fiscal year estates, due date is the 15thday of the 4thmonth following the close of the fiscal tax year
Calendar Year vs. Fiscal Year
Estates:Option to file Form 1041 based on calendar year end or fiscal year endIf the calendar year is chosen, first taxable year is decedent’s date of death through December 31 (Example:Date of death: June 10, 2016; First calendar year is June 10, 2016 – December 31, 2016)An estate’s first fiscal year can be any period that ends on the last day of a month and does not exceed 12 months (Example:Date of death: June 10, 2016, Fiscal year: June 10, 2016 – May 31, 2017. Following fiscal year runs June 1, 2017 – May 31, 2018.)Trusts:Trusts are generally required to use the calendar year end – exception if trust coupled with estate via § 645 election
Section 645 Election
The 645 election allows the income and expenses for a decedent’s revocable trust and estate to be reported on a single Form 1041The election is made on the first timely-filed Form 1041 using Form 8855The election is irrevocable once madeMaking the election can simplify the income and expense reporting requirements during the estate administration process, allow the decedent’s revocable trust to use the estate’s fiscal year, and provide better income and expense matching opportunities
Obtaining an EIN
Income generated after a decedent’s date of death should no longer be attributed to the decedent’s social security numberThe decedent’s estate should obtain an EIN and all income generated after death should be reported under the EINIf the decedent had a revocable living trust that became irrevocable at death, an EIN may need to be obtained for the trust as wellAn EIN can be obtained online at the IRS website or by fax
Federal Tax Rates
Capital gains and qualified dividends:Income Tax Bracket Rate0 – 15%then 0%25% –33% then 15%39.6%then 20%Ordinary income:Taxable income:$0 to $2,550 – Rate of 15%$2,551 to $5,950 – Rate of 25%$5,951 to $9,050 – Rate of 28%$9,051 to $12,400– Rate of33%$12,401 and greater– Rate of39.6%Trust may elect to qualify distributions to beneficiaries within first 65 days following end of prior tax year as a deduction from taxable incomeCompare marginal tax rate of recipient beneficiaries to marginal tax rate of trust
Interest/DividendsPre-date of death: report on decedent’s Final 1040Post-date of death: report on Form 1041Capital GainsThe basis of property owned by a decedent or in a revocable living trust is adjusted to fair market value as of date of death, unlessIRDproperty - accordingly, if property is sold shortly after the decedent’s death, there should be little gain or loss on the saleJointly-held assets will not receive a full basis adjustment, but the decedent’s half of such assets will be adjusted to fair market valueIncome in Respect of a Decedent (IRD)Common examples: Retirement accounts such as IRAs, annuitiesIf the decedent’s estate/trust is named as the beneficiary of an IRD asset, distributions to the estate/trust are taxable as ordinary income in the year receivedLife InsuranceThe proceeds from life insurance on the decedent’s life are excluded from gross income, with certain exceptions for transfers for value during insured’s lifetime. However, if a life insurance policy is payable to an estate or trust and there is interest paid on the proceeds, the interest portion must be reported on the estate/trust’s Form 1041
Unlike individuals, estates and trusts are not allowed a standard deductionEstates receive an exemption of $600; simple trusts receive a $300 exemption; and complex trusts receive a $100 exemptionMost expenditures made by an estate or trust are deductible on Form 1041, including the following:InterestTaxesState and local income taxes OR state and local general sales taxes, but not bothState, local, and foreign real property taxesState and local personal property taxesCan’t deduct: federal income taxes, estate/gift taxes, or excise taxesFiduciary feesCharitablededuction– must be provided for under terms of will or trust agreement and payment must be made from gross income to be deductibleAttorney/accountantfeesIncomeDistributionDeduction– if an estate or trust makes distributions to beneficiaries during the tax year, the income earned by the estate or trust can be distributed to the beneficiaries on a Schedule K-1 to claim on their personal income tax returns to the extent of the distributions made, and the estate/trust can deduct the amount of such distributionsSome expenditures are subject to a 2% ofAGIfloor
Non-deductible expenditures include:Any expense already deducted on Form 706Funeral expenses (these may only be deducted on Form 706, if filing)Medical expenses incurred by the decedent prior to death but paid by the estate or trust after the date of death (these may be deducted on the Form 706, if filing, or on the decedent’s final individual Form 1040)Expenses allocable to tax exempt income
Simple vs. Complex Trusts
Simple TrustTrust that is required to distribute all of its accounting income. Actual distribution of income not relevantMakes no charitable contributionsNo distributions out of corpusComplex TrustAny trust that is not a simple trust (i.e., distribution of income is discretionary, charity is a beneficiary, or principal distributions are made)
Grantor Trust
Grantor trusts – intervivostrusts treated as owned by the grantor for income tax purposesExamples:Revocable living trustIntentionally defective grantor trust (IDGT)Grantor trust may obtain its ownEINor provide the Grantor’s social security numberIfEINobtained, Form 1041 is filed with a “grantor trust letter” issued that allocates all income to the grantorAll trust income is reported on the grantor’s income tax return (regardless of whether the income is distributed to the grantor or whether the grantor is even a beneficiary of the trust)
Net Investment Income Tax(Medicare Surtax)
The tax went into effect in 20133.8% tax on the lesser of (1) undistributed “net investment income” for the tax year, or (2) the excess of adjusted gross income for the tax year, over the dollar amount at which the highest tax bracket begins for the tax year ($12,400 for 2016)“Net investment income” includes interest, dividends, rents, royalties, net capital gain derived from the disposition of property (other than property held in a trade or business), and income from passive trade or business activitiesThe threshold for payment of the net investment income tax is much lower for estate/trusts than it is for individuals – whereas estates/trusts owe the tax on net investment income over $12,400 (in 2016), the individual threshold is $200,000 for individuals, $250,000 for married couples filing jointly, and $125,000 for married couples filing separatelyThe net investment income tax is computed using Form 8960 and the tax is reported on Form 1041, Schedule G, line 4
Estimated Tax Payments
Estates:Estimated tax payments are not required for first two tax yearsQuarterly estimated tax payments due beginning with the third tax year, unless no tax due for prior tax year that was 12 monthsTrusts:Quarterly estimated tax payments due quarterly, unless not tax due for prior tax year that was 12 monthsAmount:Smallerof:90% of the tax shown on thecurrent year taxreturn, orThetax shown on theprior year taxreturn (110% of that amount if the estate’s or trust’s adjusted gross income (AGI) on that return is more than $150,000





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Useful Tips for Preparing Fiduciary Tax Returns