FIDUCIARY INCOME TAX RETURNS -- FORM 1041 WORKSHOP 1041/14/01-P1

Transcription

1 FIDUCIARY INCOME TAX RETURNS -- FORM 1041 WORKSHOP 1041/14/01-P1

2 Table of Contents Introduction to Fiduciary Returns... 1 Common Trusts... 2 Income Taxation of Estates and Trusts... 3 Income of Estates and Trusts... 4 Deductions of Estates and Trusts... 5 Distributable Net Income (DNI) and Income-Distribution Deduction... 6 Taxation of Beneficiaries... 7 Comprehensive Trust and Estate Case Studies with Filled-In Forms... 8 This product is intended to serve solely as an aid in continuing professional education. Due to the constantly changing nature of the subject of the materials, this product is not appropriate to serve as the sole resource for any tax and accounting opinion or return position, and must be supplemented for such purposes with other current authoritative materials. The information in this manual has been carefully compiled from sources believed to be reliable, but its accuracy is not guaranteed. In addition, Surgent McCoy CPE, LLC, its authors, and instructors are not engaged in rendering legal, accounting, or other professional services and will not be held liable for any actions or suits based on this manual or comments made during any presentation. If legal advice or other expert assistance is required, seek the services of a competent professional. Revised April 2014

3 Introduction to Fiduciary Returns I. Fiduciary returns -- Form A. Fiduciary accounting foundation 1 1. Underlying theory 1 2. Phraseology 2 B. Controlling instrument(s) and state law 3 1. Read and evaluate 3 2. Allocation of receipts and expenditure 3 C. Fiduciary accounting basics 6 1. Effect of governing instrument 6 2. Fiduciary income to income beneficiary 6 3. General cash accounting 6 4. Disclosure of fiduciary accounting income 6 5. Principal and Income Act 6 6. Classification of receipts and expenditures 7 7. Basic summary of components of fiduciary accounting income and principal under RUPIA 7 8. Allocation of income during estate administration Power to adjust Definition of income for estates and trusts 14 II. Reporting income -- Estates 16 A. Estate basics Personal-property income reported by the estate Personal-property income reported by beneficiary Real-property income and expenses -- Reported by estate or beneficiaries? 18 B. Income allocation in year of death between decedent s final Form 1040 and the estate s Form In general Summary of rules 19 III. Miscellaneous 25 A. Community-property basics What is community property? Community-property states Included value of community property Identifying community property Basis -- Community property at death of one spouse Tracing issues Commingling property Use of marital agreements Community-property income reported by estates 26 IV. Other common tax forms 28 V. Case studies 33 A. Classification of receipts and expenditures 33 B. Accounting income -- Simple Form VI. Case studies -- Solutions 37 A. Classification of receipts and expenditures 37 B. Accounting income -- Simple Form i

4 Common Trusts I. Trusts 1 A. Trust basics 1 1. Definitions 1 2. Personal and real property income represented by trusts 2 3. Simple versus complex trusts 2 4. Fluctuating trusts 2 5. Failure to distribute income 3 B. Grantor trusts: revocable and irrevocable 3 1. In general 3 2. Grantor trust reporting requirements 4 3. Grantor trust alternative reporting requirements to filing Form Grantor trust -- Death of grantor 10 C. Revocable living trusts Definitions Revocable trusts -- Benefits Revocable trusts -- Tax disadvantages after death of grantor Merging the revocable trust into the estate New reporting procedure for Making the 645 election 16 II. Pooled income fund 26 A. In general Defined Statutory requirements 26 B. Specific provisions Remainder interest Income interest Commingling of property Prohibition against tax-exempt securities Maintenance of the fund Prohibition against donor or beneficiary serving as trustee Rate of return Allocation of income Taxable year 29 C. Income taxation of the pooled income fund Complex trust Income tax 29 D. Planning considerations Advantages Disadvantages 29 E. Filings Funds Donor 30 III. Sample engagement letter 31 IV. Case study 32 A. Simple versus complex trust 32 B. Simple trust check figures 33 C. Simple versus complex trust -- Solution 34 D. Simple trust check figures -- Solution 35 2-i

5 Income Taxation of Estates and Trusts I. Introduction to Subchapter J -- The overall view 1 A. Background 1 1. Purpose 1 2. Entity 1 3. Distribution deduction 1 4. Undistributed taxable income 2 B. Form 1041 complexity 2 1. Level of difficulty 2 2. Tax-preparation software 2 3. IRS audits of Form Trusts -- Domestic or foreign? 3 II. Filing requirements 4 A. In general 4 1. When Form 1041 must be filed for trusts and estates 4 2. Nonresident alien withholding 4 3. Form 1040NR 4 4. Filing location 4 5. Estate and trust income-tax rates 5 6. Form 1041-V 6 B. Time of filing 7 1. Tax year and due dates 7 2. Extensions of time to file for estates and trusts 8 C. Miscellaneous 8 1. Obtaining a taxpayer identification number (TIN) 8 2. IRS notification of fiduciary relationship 9 3. E-filing 9 D. General aspects of Form Year of form Exemptions -- Form 1041, Line Standard deduction Accounting method Transactions between related taxpayers 11 E. Separate returns for each trust In general Aggregation of trusts Nonaggregation of trusts 12 F. Estimated income-tax payments Form 1041-ES Allocating estimated tax payments to beneficiaries Form 1041, pages 1 and 2 -- General information 17 G. Taxes and credits In general Net investment income tax (NIIT) Alternative minimum tax Domestic employee employment taxes ( nanny tax ) Credits 25 H. Miscellaneous Request for prompt assessment Interest and penalties 26 III. Case study 40 A. Complex trust example 40 B. Complex trust solution 41 3-i

6 Income of Estates and Trusts I. Portfolio income 1 A. Interest and dividend income -- Lines 1 and 2a, and 2b Form In general 1 2. Income in the year of death not reported on the final Form Tax-exempt interest 2 4. Allocation of administrative expenses 2 5. Nominee 3 6. Incorrect information returns 3 B. Capital gain or (loss) -- Line 4, Form New capital gain or loss reporting of an estate or trust 7 2. Tax rates on capital gains -- Estates and trusts 8 3. Net investment income tax 8 4. Capital-gain treatment 8 5. Capital-loss treatment 8 II. Miscellaneous income 16 A. Other portfolio income: Rents, royalties, partnerships, S corporations, other estates and trusts, etc. -- Line 5, Form In general Nonbusiness income Rental and royalty income Real estate professionals Passive activities Reporting passive-activity information to a beneficiary Pass-through income from other estates and trusts Partnership or S corporation interests -- Fiscal years Partnership self-employment income Partnership inside-basis adjustment ( 754 and 732(d)) Partnership interests -- Stub period to date of death Decedent s S corporation interest -- Calendar year Pass-through income without equal cash distribution S corporation recent developments specifically involving estates and trusts Fiduciary accounting income and phantom taxable income QSST -- Qualified Subchapter S trusts 26 B. Other income -- Line 8, Form In general Examples Income in respect of a decedent (IRD) basics 28 III. Active income 29 A. Business and farm income -- Lines 3 and 6, Form In general Sole proprietorship Computing net income Where reported Self-employment tax Operation of business by a trust Net operating losses 30 B. Ordinary gain or (loss) -- Line 7, Form Form Interest in a pass-through entity 33 4-i

7 Deductions of Estates and Trusts I. In general 1 A. Estate and trust deductions -- Introduction 1 1. General principles 1 2. Expenses 2 3. Apportioned deductions and credits 2 4. Deductions in respect of a decedent (DRD) ( 691(b)) 3 B. Estate election to claim administrative expenses as fiduciary income-tax deductions 4 1. In general 4 2. Election 5 3. Excess deductions on termination 5 II. Specific line items 7 A. Interest -- Line In general 7 2. Investment-interest expense 7 3. Qualified residence interest 8 4. Interest on deferred estate-tax payments [Revenue Ruling 92-10] 8 5. Personal interest expense -- Nondeductible 8 B. Taxes -- Line In general 9 2. Taxes deductible for estate-tax or income-tax purposes 9 3. Taxes accrued at death 9 4. Taxes not deductible for income-tax purposes 10 C. Fiduciary fees -- Line In general Fiduciary fees and self-employment tax 10 D. Charitable deductions -- Line In general Deductions allowed Charitable deduction pull-back election Trust accumulation of charitable amounts -- Form 1041-A Compliance Substantiation 14 E. Attorney, accountant, and return-preparer fees -- Line F. Other deductions not subject to the two-percent floor -- Line 15a In general Nonadministrative expenses Deductible administrative expenses Selling expenses as administrative expenses Nonbusiness casualty and theft losses Other casualty and theft losses Depreciation, depletion, and amortization deduction not claimed elsewhere 18 G. New reporting for Net operating loss deduction -- Line 15b In general 18 H. Miscellaneous itemized deductions subject to the two-percent floor -- Line 15c In general Reduction for tax-exempt income allocation Miscellaneous itemized deductions Which expenses are miscellaneous itemized deductions? Proposed regulations Supreme Court decision Bundled investment management and advisory costs Adjusted gross income 26 I. Income-distribution deduction -- Line J. Estate-tax deduction -- Line In general 29 5-i

8 2. Amount of deduction Timing 30 K. Expenses related to tax-exempt income In general Permissible allocation method 34 L. Depreciation, depletion, and amortization Decedent s depreciation, depletion, and amortization in the year of death Depreciation -- Qualified joint interest property by surviving spouse Depreciation apportionment between estate or trust and beneficiaries Depreciation methods Section 179 expense election Depreciation recapture MACRS deduction in short tax year MACRS deduction for a short year 40 III. Case study 42 5-ii

9 Distributable Net Income (DNI) and Income-Distribution Deduction I. Distributable net income (DNI) 1 A. Basics of DNI 1 1. Purposes served by DNI 1 2. Calculating DNI -- Code approach 1 B. Basics of income-distribution deduction and DNI relationship 2 1. Income-distribution deduction 2 2. Distributable net income 2 3. Relation between distribution and DNI 2 4. Exceptions 2 5. Taxation of beneficiaries 2 6. Timing of inclusion of DNI by beneficiary 4 7. Allocation of DNI between entity and beneficiaries 4 8. Character of included DNI 4 C. Calculating DNI 4 1. DNI worksheet (short-cut) approach 4 2. Forms approach 5 D. DNI and entity losses 6 1. In general 6 2. Retained losses 6 E. Capital transactions and DNI 6 1. Capital gains and DNI 6 2. Taxing capital gains to beneficiaries 7 3. Service s position 7 4. Capital losses and DNI 7 F. Advanced trustee power to adjust issues 8 1. Power to adjust/unitrust definitions of income 8 G. Marital claims Spousal allowances Alimony Marital trusts 14 H. Net investment income tax (NIIT) Application to estates and trusts Non-application to certain trusts Computation 16 II. Income-distribution deduction 19 A. Schedule B -- Income-distribution deduction Amount Purpose Schedule to complete 19 III. Schedule B -- Line-by-line explanation 19 A. DNI and the income-distribution deduction Line 1 -- Adjusted total income (from Line 17, page 1, Form 1041) Line 2 -- Adjusted tax-exempt interest (i.e., net tax-exempt income) Lines 3 through 6 -- Capital-gains adjustments Line 7 -- Distributable net income (DNI) Line 8 -- Fiduciary accounting income for the tax year Line 9 -- Income required to be distributed currently Line Other amounts paid, credited, or otherwise required to be distributed Line Total distributions Line Amount of net tax-exempt income included on Line Lines 13 and Tentative income-distribution deduction Line Income-distribution deduction 23 B. Two-tier distribution structure -- Estates and complex trusts 28 6-i

10 1. Required periodic payments Relation to fiduciary accounting income First-tier distributions First-tier distributions in excess of DNI First-tier distributions not in excess of DNI Complex trusts and estates Charitable contributions Allocation of DNI to classes of income Other deductions 30 C. Schedule J Reporting Calculation 30 IV. Case study 31 A. DNI (three methods), the income-distribution deduction, and taxable income Calculate DNI, TAI, and Adjusted Total Income using the Worksheet Method Calculate DNI, income-distribution deduction, and taxable income using the Forms Approach Calculate DNI using the Code Approach 32 B. DNI (three methods), the income-distribution deduction, and taxable income -- Solutions Calculate DNI, TAI, and Adjusted Total Income using the Worksheet Method Calculate DNI, income-distribution deduction, and taxable income using the Forms Approach Calculate DNI using the Code Approach 35 6-ii

11 Taxation of Beneficiaries I. Termination of estates and trusts 1 A. Termination of an estate or trust 1 1. Trust termination 1 2. Estate termination 1 3. IRS position 1 4. Planning for termination 2 5. Taxation of estate or trust 2 II. Special rules 2 A. Election of the 65-day rule ( 663(b)) 2 1. In general 2 2. Limitations 2 3. Simple trusts 2 B. Separate-shares rule 3 1. In general 3 2. Language of the will or trust 3 3. Physical segregation of assets 4 III. Allocations to beneficiaries 7 A. Allocation of deductions to classes of income -- Going from page 1 of Form 1041 to Schedule K In general 7 2. Direct expenses 7 3. Losses 7 B. Gains or losses on transfers of property to beneficiaries In general Recognition of gain/loss on property distributions -- Mandatory Recognition of gain on property distributions -- Elective 643(e)(3) Nonrecognition of loss 11 C. Allocation of net income to beneficiaries Allocation of classes among beneficiaries Amounts within each class DNI limitation 12 IV. Reporting and tax compliance 13 A. Schedule K-1 (Form 1041) -- Beneficiary s share of income, deductions, credits, etc In general 13 B. Schedule K-1 -- Line-by-line explanation Lines 1, 2a, and 2b -- Taxable interest and dividends Lines 3, 4a, 4b, 4c, 12C, and 12D -- Net long-term capital gain Line 5 -- Annuities, royalties, and other nonpassive income Line 6, 7, and 8 -- Trade or business, rental real estate, and other rental income Lines 9A, 9B, and 9C -- Depreciation, depletion, and amortization Line Estate-tax deduction Lines 11A, 11B, 11C, 11D, and 11E -- Deductions in the final year of a trust or decedent s estate Lines 12A, 12B, 12C, 12D, 12E, and 12F -- Adjustments for minimum tax Lines 12G, 12H, 12I, and 12J -- Adjustments and tax-preference items Lines 13A through 13P -- Credits Line 13U -- Recapture of credits Lines 14A through 14H -- Other information 18 7-i

12 Comprehensive Trust and Estate Case Studies with Filled-In Forms I. Comprehensive trust case study 1 A. Edison Watson Trust: Trust Transactions Worksheet 1 1. Case study facts and instructions 1 2. Completed worksheet 4 3. Form Selected filled-in forms 5 II. Comprehensive final Form 1040 and estate Form 1041 case study 10 A. John R. Smith: Final Form 1040 versus Form 1041 Worksheet 10 B. Case study facts Completed worksheet Final Form Filled-in forms Estate Form Filled-in forms 22 8-i