Trust & Estate Taxes & Accounting
What distinguishes a good Estate & Trust CPA?
- Knows what tax elections are available and when and how they must be made.
- Understands the difference between taxable income, generally accepted accounting principals (GAAP) income, and fiduciary accounting income.
- Understands his role as support professional to the attorney.
- Understands the effect of state laws on both federal and state trust and estate tax returns, i.e., community property, situs of beneficiaries and fiduciaries, assets subject to probate, etc.
What can a good Trust & Estate CPA do?
- Timely, accurate preparation of tax returns
- Coordination of tax returns – returns for individual income tax, trust/estate income tax, & estate tax
- Tax elections and forms
- Proper fiduciary accounting to protect the trustee and report to the beneficiaries
- Annual update when doing each year’s personal or trust income tax return – identify issues that may require additional estate planning work
Coordination of Tax Returns
Since there is a close relationship between the financial affairs of the decedent, his or her estate, the various trusts, and gift strategies, and the tax returns for surviving family members and business entities (corporations, partnerships, LLC's), what is done on one tax return affects others. Consideration of the ramifications and communication among the interested parties is critical to achieving an optimal result and reducing potential for conflict. Coordination should include consideration of:
- Income allocatoins
- Deductions
- Elections
- Carry-overs
- Credits
- Estimated tax payments
- Tax refunds
Trust Income Tax Return / Estate Income Tax Return
Trusts and estates file IRS Form 1041 for income taxes. The executor, trustee, administrator, or personal representative is referred to as the fiduciary – the responsible party.
Income tax rules for trusts and estates are similar to those for personal (individual) income taxes. However, some important differences exist.
- A trust or estate needs only about $11,000 of taxable income to be in the top ordinary income tax bracket, compared to hundreds of thousands of dollars of taxable income for an individual. Because of this, it is often better to have the income taxed to the beneficiaries, not the trust. However, circumstances may require the trust to pay some or all of the tax, or it may be better overall when nontax reasons are factored in. Understanding the rules, combined with planning and follow-through, can optimally match income and deductions, including the use of distribution timing and related trust tax elections, to minimize tax liabilities.
- Fiduciary accounting income influences how much taxable income may be allocated to beneficiaries through the income distribution deduction.
- Capital gains and losses, while subject to the same preferential rates as on personal tax returns, are generally allocated to principal and the trust or estate, not the beneficiaries, pays the capital gains income tax.
Estate Tax Return
- Schedule of Property
- Timely, accurate preparation of tax returns
- Tax elections and reporting compliance optimized
- Make it audit-ready, since most estate tax returns get audited:
- Documentation: thorough, well-organized, and cross-referenced
- Accuracy of calculations and illustrations thereof
- Appraisals & expert opinions as appropriate
- Types of valuation discounts, calculation methodologies, and assumptions that have stood up in court recently
Gift Tax Return
Only required for gifts greater than the annual exclusion ($13,000 in 2009 & 2010) or gifts that are not present interest.
- Form 709.
- Due April 15.
- May be appropriate to file a gift tax return to start the running of the 3-year statute of limitations, even if no gift tax return is required.
Fiduciary Accounting
Charge and Discharge Statement – The fiduciary’s financial statement
- Fiduciary accounting is NOT accounting under business Generally Accepted Accounting Principles (GAAP).
- Fiduciary accounting is "responsibility" accounting.
- Accounting for assets via charges & credits to principal & income.
- Generally cash basis, except for amortization, depletion, and depreciation.
- According to the trust document or will, trustee’s discretion where granted, then state law. If no rule and discretion not granted, allocate to principal.
- Accountant must be impartial, not favoring either income or principal/remainder beneficiaries.
Fiduciary accounting income, while different from taxable income, affects the tax liabilities of the trust or estate and its beneficiaries because it affects the “Income Distribution Deduction” on the tax return.
Trust Tax Consulting / Estate Tax Consulting
Minimizing income taxes in the context of an estate or trust involves coordination of actions by the estate or trust and the beneficiaries. Choice of assets to liquidate or distribute, and what to distribute to whom, are powerful ways to minimize overall taxes. Also important are investment choices, estimated tax payments, and maximizing deductions. Tax-exempt income should be considered for its effect on limiting the amount of deductions otherwise allocable to taxable income. As in other areas, Alternative Minimum Tax is an important consideration. The complexity involved means that often one must use tax projection software to get an accurate estimate of income taxes under a given scenario, and to compare alternative scenarios.
Planning to minimize estate taxes is complex and typically done by an attorney as part of an overall estate plan, which considers much more than just estate tax savings.
Many tax elections are available in the trust tax and estate tax arena. Planning to make the appropriate elections at the right time will optimize results.
Tax Elections and Forms
- Estate / Trust Tax Elections – Administrative
- Discharge of executor, administrator, or trustee from personal liability for taxes
- Required IRS notification of fiduciary relationship
- Estimated tax payments
- Estate / Trust Tax Elections – Timing & Allocation
- Alternate Valuation Date
- Medical expenses
- Charitable contributions – where and how to claim them for maximum benefit
- Distributions
- In cash or in kind?
- Timing
- Payment of income taxes by trust or beneficiary?
- Estate / Trust Tax Elections – Entity
- Gain on Property Distributions
- Qualified Subchapter S Trust or Electing Small Business Trust
- Combined estate & trust income tax return
- QTIP
- QDOT
- Estate / Trust Tax Elections – Other
- Gift Splitting
- Special Use Valuation
- Nonqualifying Distribution Right
- Electing Tax Treatment of Qualified Payments
- Treatment of Standing Timber Growing on Qualified Woodlands as an Interest in Real Property
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