Trusts and Estates from IRS View Issues, Errors and Mistakes. Scott Emerson

Transcription

1 Trusts and Estates from IRS View Issues, Errors and Mistakes Scott Emerson

2 The ultimate in estate planning is when all of your assets are liquidated, all of your bills are paid and the check to the undertaker bounces.

3 Time Line Concepts of Estate (Form 706) and Estate (Form 1041) Beneficiary Form 1040 Form 1040 Date of Death Estate Form 1041 Estate Form 1041 Form 1040 Form 1040 Form 1040 FINAL Form 1040 Form 1041 Form 1041 Form 1041 Form 706 (Assets Valued at DOD) Testamentary Trust

4 Form 56 The EIN or SSN of the person for whom the fiduciary is acting, along with the address of that person and the fiduciary. The authority for the fiduciary relationship. If the authority is a trust instrument or will, copies of the instrument per Reg Notice of revocation or termination of the relationship or the substitution of fiduciaries. All co-trustees should sign the form unless the trust document allows for one to act.

5 Time Line Concepts of Estate (Form 706) and Estate (Form 1041) Form 1040 Form 1040 Date of Death FINAL Form 1040 Form 706 (Assets Valued at DOD)

6 Final Form 1040 Medical and Funeral Expenses Medical may be claimed on final 1040 assuming that they meet all of the AGI, etc. criteria. Funeral Expenses can not be claimed on the final Funeral expenses are only allowed to be claimed on the Form 706

7 Final Form 1040 Passive Activity Losses (PAL) On the final Form 1040 of a decedent, the taxpayer is allowed to claim suspended passive activity losses (PALs). However, these suspended PALs are reduced by any step-up in basis that is received by the beneficiary. The amount by which the suspended PALs are reduced is lost. See IRC 469(g)(2).

8 Final Form 1040 Example 1: Suspended loss at death was $50,000. Decedent s basis of the asset was $150,000. FMV at the time of death was $185,000. Since asset was stepped up in value by $35,000, the PAL that is allowed to be deducted is reduced to $15,000. $35,000 of PAL that was not able to be claimed is lost

9 Final Form 1040 Example 2: Suspended loss at death was $50,000. Decedent s basis in the asset was $150,000. FMV at the date of death was $225,000. In this instance there would be no deduction allowed for the PAL because the amount of the step up ($75,000) is greater than the PAL ($50,000). The ($50,000) PAL is not deductible by anyone.

10 Form 706 Final Medical expenses may be claimed on 706 if they are not claimed on Final Can t claim the AGI limitation percentage that was limited on the 1040 Funeral expenses are allowed only to be claimed on Form 706 (Schedule J)

11 Valuation of Assets Except 2010 Valuation at the date of death Alternative Valuation Date Must reduce estate tax due Must revalue ALL assets Basis claimed on Form 706 goes to estate (Form 1041) or heirs

12 Decedents in 2010 Amount of assets that can be stepped up in basis is limited to $1.3 Million. Any assets above $1.3 will retain the decedent s basis. Maybe hard to determine basis. When heirs sell they will have to report as capital gains on their returns

13 State of Tennessee Gift tax limits for 2009 thru 2011 are $13,000 and $3,000 Gift tax repealed starting 1/1/2012 Estate tax exemption is $1,000,000

14 Form 706 Charitable Gifts Specific bequests are deductible on Form 706 I give $5,000 to local church. These would be paid out of the assets of the estate No Estate Tax Return, no deduction for the donation

15 Form 706 All Estate Tax Returns are classified by IRS All previously filed gift tax returns are associated All publicly traded stock values are checked prior to classification

16 Time Line Concepts of Estate (Form 706) and Estate (Form 1041) Date of Death Estate Form 1041 Estate Form 1041 FINAL Form 1040 Form 706 (Assets Valued at DOD)

17 Estate Form 1041 This entity is in place during the period of administration of the estate. Usually lasts for 2 to 3 years Attach a statement to the return if it is open longer to explain why IRS can shut the estate down as unduly prolonged

18 Estate Form 1041 If the decedent was active in his rental real estate activity, the estate will be considered to be active for the first two years of its existence. Thus, the $25,000 PAL that is allowed to an individual is allowed to the estate for the first two years. See IRC 469(i).

19 Estate Form 1041 Charitable gifts Must be authorized by the will and be paid from income Can t be charitable bequest Can t be in-kind contribution Allocation must be made to tax-exempt income

20 Estate Form 1041 Income in respect of a decedent (IRD) Person who receives the income is taxed on the income Estate may distribute and include in Income Distribution Deduction if set out in will Whoever receives the income also is allowed the Estate Tax Deduction associated with it

21 Estate Form 1041 Estate tax deduction Line 19 The estate tax is computed with and without the IRD. This difference is the tax attributable to the IRD items. Then as the items are included in income the estate tax associated with each one is allowed as a deduction Schedule should be attached to the return showing the computation

22 Estate Form 1041 Example decedent had $300,000 in a non-roth IRA and accumulated salary of $50,000 at the date of death. Estate tax attributable to these items is $105,000. Heir A received ½ of IRA and all the salary. Heir includes the $200,000 in income and would be allowed an estate tax deduction of $60,000. Estate kept ½ of the IRA so it would include the $150,000 in income and receive an estate tax deduction of $45,000.

23 Passive Activity Losses Estate Form 1041 Receive ($25,000) passive loss deduction for the first 2 years of the estate If active before death, then will be considered active for the first 2 years of the estate Distribution of the passive activity to the heirs does not allow the estate to claim any suspended passive losses Any suspended passive losses increase the basis in the hands of the heir receiving it

24 Trust Issues Form 1041

25 Qualified Disability Trust Beneficiary must meet Social Security s definition of 100% disabled Trust acts like a grantor trust except that it receives a $3,650 exemption for 2009 Medical and personal expenses paid for beneficiary are not deductible by the trust

26 Basis of Assets in the Trust During life, basis is donor s basis plus any gift tax paid Death, basis is FMV at date of death (or alternate valuation date on Form 706*)

27 Passive Activity Losses (PAL) No ($25,000) passive loss Active participation is based upon the trustee s participation in the entity in his role as trustee. Beneficiary participation doesn t count. A trust can never be a real estate professional. Distribution of the asset or entity to the beneficiary does not allow the suspended loss to be claimed. Remember all expenses from the activity are subject to the PAL rules.

28 Charitable Contributions Code Section 642(c) states, "In the case of an estate or trust, there shall be allowed as a deduction in computing its taxable income any amount of the gross income, without limitation, which pursuant to the terms of the governing instrument is, during the taxable year, paid for a purpose specified in 170(c)."

29 Charitable Contributions Must be authorized in the trust document Deduction is up to 100% of gross income Must be PAID from income (No in-kind contributions) Revenue Ruling Partnership contribution to charity Must be paid from income of the partnership S-Corporation contributions are not included in this ruling Allocation must be made to tax-exempt income

30 Business or Farm in a Trust Oil and gas working interest are required to be reported on a Schedule C Trust is a passive investor Active businesses should not be in a trust Can elect to be taxed as a corporation Farm rentals should be reported on Schedule E

31 Net Operating Losses/Negative Income Distribution Deductions Trusts can only distribute losses in the final year. NOLs are distributed and beneficiary can claim on their Form Not subject to carryback provisions but can be carried forward. Beneficiary steps into the shoes of the trust as to the years left on the NOL carry forward.

32 Final Year Issues Excess deductions are distributed in the final year and are deductible on the Form 1040 of the beneficiary on Schedule A subject to the 2% limitation Prepayment credits are distributed by filing a Form 1041-T and including the amounts on Form K-1

33 Allocation of Expenses it Tax-exempt Income Treasury Regulation (c), If an expense or amount otherwise allowable is indirectly allocable to both a class of nonexempt income and a class of exempt income, a reasonable proportion thereof determined in the light of all facts and circumstances in each case shall be allocated to each

34

35 Trust Distributions Income and corpus distributions are controlled by the will or trust document. Income distributions would be reflected on Form K-1 and sent to beneficiary. Trustee or executor can allocate expenses to income prior to distribution, thereby taking advantage of favorable tax treatments. For a simple trust the income is taxable to the beneficiary whether or not it is actually received.

36 Trust Distributions The trustee or executor may make an election to treat distributions made after the close of the taxable year and within the first 65 days of the subsequent year as being paid in the prior year. Losses are not allowed to be distributed except in the year of termination. This applies to capital and ordinary losses. Depreciation is a separately stated item on the K-1 and may create a loss at the beneficiary level. Trust is not allowed a 179 expense.

37 Trust Distributions Basis of assets distributed 1. Basis would be the same as in the hands of the trust for most assets. 2. Distribution of a passive activity to the beneficiary doesn t trigger the suspended loss to be deductable. The suspended loss would be added to the basis. 3. The sale of an asset received from an estate (except IRD) would be given long term capital gain treatment.

38 Other Deductions Line 15a deductions not subject to 2% limitations. Includes those expenses that would not have been incurred had the assets not been in the trust or estate. Line 15b deductions subject to the 2% limitations. Both 15a and 15b should be allocated to taxexempt income

39 Miscellaneous Itemized Deductions Line 15b of the Form 1041 will include any investment advisory fees paid by the trust or estate. (Knight v Comm. 552 U S 181 (2008)) The Supreme Court used the standard of whether or not the cost would have been incurred if the money or asset had not been held in an estate or trust.

40 Miscellaneous Itemized Deductions Proposed Regulation (c) the taxpayer must use a reasonable method to allocate the single fee, commission or expense between the costs unique to estates and trusts and other costs. Out of pocket costs billed to the trust or estate are treated as separate from the bundled fee.

41 S-Corporations In order to be a valid shareholder a trust must be either: Grantor Trust Qualified Sub-chapter S Trust (QSST) Electing Small Business Trust (ESBT)

42 S-Corporation QSST 1 beneficiary. All income must flow intact to them and be reported on their individual income tax return ESBT Taxed at the trust at the highest marginal rate for each category of income (i.e. ordinary, capital gains). Usually only shows up on the tax computation section on the Form 1041