Decedent’s Final and Fiduciary Returns

Summer 2014

Developed by Kathy Hubbard, EA

Presented by XXXX

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.

The following presenters from the Texas Society of Enrolled Agents are involved with the 2013 Regional Practitioner Meetings:

Anna Dunson EA

Kathy Hubbard EA

Ricardo V. Rivas EA

John M. Stanley EA

This presentation is made courtesy of The Texas Society of Enrolled Agents.

Material is covered by copyright law and is used with the permission of the author.

Table of Contents

The Final 1040

Who Signs the Return? The Personal Representative!

Decedent’s and Successor’s Income

Income Documents

Income In Respect of a Decedent (IRD) §691

Expenses In Respect of Decedents (DIRD)

Fiduciary Returns

Form 1041 Due Dates

1041 Filing Requirements IRC §6012:

Gross Income

Beneficiaries

Taxes

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

Expenses in Respect of a Decedent

The Fiduciary's Expenses

Expenses Subject to 2% AGI Reduction

Estate vs Trust Recap

Distributable Net Income (DNI) IRC §643 and the Distribution Deduction IRC §651

Fiduciary Tax Rates for 2013

Exemption Amounts for Alternative Minimum Tax

Net Investment Income Tax (NIIT)

What Estates and Trusts are subject to the Net Investment Income Tax?

What is included in Net Investment Income?

What kinds of gains are included in Net Investment Income?

What are some common types of income that are not Net Investment Income?

What investment expenses are deductible in computing NII?

APPENDIX

The Final 1040

The date of death generally establishes the last day of income attributing to the decedent. It closes the decedent's tax year, but not the 1040 filing year. No matter when one dies in a tax year, a 1040 return, if due, is due on April 15 of the following year. It may be extended.

The standard deduction (if not itemizing), additional standard deductions for being over age 64 and/or blind, plus the exemption for oneself, are claimed in full. They are not prorated. If the decedent was a dependent, the full exemption amount is used.

  • 1040 Filing Requirements Depend Upon:
  • Gross Income
  • Age
  • Filing Status
  • Other Tax or Filing Obligations
  • Gross Income
  • Gross Income in an amount sufficient to require return filing is itself a function of age and status variables. In general, for 2012, it ranged from a low of $950 for a dependent under age 65 to a high of $21,800 for a married couple filing jointly when both are age 65 or older.
  • Income is measured from the January 1 up to midnightof the date of death.
  • Age
  • One is considered to have reached age 65 on the day before one’s 65th birthday.
  • Filing Status
  • There are exceptions to the customary status and income filing rules. 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. 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.
  • So too where one filed head of household, but passed away less than 181 days into the year. The qualifying relatives were not in the decedent’s care for over half the year.
  • 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.
  • Other Filing Situations
  • Special Taxes with Form 1040:
  • AMT,
  • Social Security and Medicare tax on unreported tips, or on wages from a non-withholding employer,
  • Uncollected Social Security, Medicare or RRTA on reported tips, or on group term life insurance,
  • Recapture taxes, such as first-time home buyer tax, forgiven to decedent; spouse continues paying his or her half.
  • Self-employment tax, if net self-employment earnings were $400 or more, or,
  • Wages from services performed as a church employee were $108.25 or more.
  • Special Taxes on a Stand-Alone Form if the 1040 not otherwise required:
  • Additional tax on a qualified plan reported on Form 5329
  • Household employment taxes reported on Schedule H
  • Non-deductible IRA contributions can be reported on a standalone Form 8606 if the Form 1040 is not required.
  • Refundable Credits, Payments of Tax or to a non-deductible IRA
  • Earned Income, child, prior year minimum tax, education and fuel credits
  • Withholdings and estimated tax payments,
  • Never Overlook:
  • 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 have special tax forgiveness provisions. Carefully review 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.
  • Similarly, certain death benefits paid to survivors of public safety officers killed due to traumatic injuries sustained in the line of duty after September 10, 2001are excluded from both income and estate taxes. Public safety officers include police, fire, rescue, and medical emergency staff, and chaplains responding to emergencies as a member of the police or fire crew.

Who Signs the Return? The Personal Representative!

A personal representative is an executor, administrator, or anyone in charge of the decedents’ property. An executor or executrix is some named in the decedent’s will to administer the estate and distribute properties as the decedent directed. An administrator is someone usually appointed by the court if the decedent was intestate (died without a will,) or if no executor was named in the will, or if no named executor can or will serve. Once appointed, the representative files form 56, Notice Concerning Fiduciary Relationship with the IRS.

Sometimes, no will exists, or the existing will bequeaths all to trust set up in the will, or to a preexisting trust which had been a revocable trust when the decedent lived. When the trustor dies, revocable trusts become irrevocable. (Remember, powers of attorney expire on death.) Now it is the trustee who is the personal representative.

On a joint return, if no representative has been appointed, the surviving spouse can file and sign. Note--a court-appointed personal representative may revoke an election to file a joint return previously made by the surviving spouse alone. This is done by filing a separate return for the decedent within one year from the due date of the return including extensions.

Decedent’s and Successor’s Income

Revenue received prior to and including death belong on the decedent’s final return. Income received afterwards (unless the taxpayer was using the accrual method) belongs on the return of the next legal owner. Ownership is first determined based on how an asset is “styled,” that is “titled” or “named.” Common types of ownership are separate property, joint property, joint property with right of survivorship, payable on death property, life estates, revocable or “living” trusts, community property, and community with rights of survivorship. At this point the practitioner pulls out Pub559’s Table B: Worksheet to Reconcile Amounts Reported In Name of Decedent on Information Returns.

Joint ownership does not automatically go to the survivor, whereas joint ownership with right of survivorship does transfer. JTROS is a written agreement between (among) the two (several) owners. It must be created at the inception of the ownership. Disposition of assets owned solely by the decedent is determined according to the last will and testament. If the will says “give my TI stock to Joe,” then Joe has a specific gift and specific, post mortem income from its dividends. If the will says “after paying (special gifts and expenses) give everything to Joe,” then the fiduciary income return reports the income on its form 1041, if it isn't distributed. More detail on that process comes a bit later in this paper. If no will exists or is probated (filed in the court for the purpose of transferring title,) property passes according the state probate code. The attorney for the estate should be consulted for resolving any title uncertainties.

In cases where a married couple’s income producing assets are owned jointly with community and /or survivorship rights, or have wills bequeathing all to the other spouse, the final joint return typically has no breakout of premortem and postmortem income. In other cases, the practitioner will need to allocate the income.

Income Documents

Interest, dividends and other proceeds payers may be convinced to issue 1099s showing only the decedents portion, and issuing a second 1099 to the beneficiary for the remaining portion. Most often it falls to the personal representative to file nominee 1099s. Practitioners often receive the tax information well after the 1099 filing due dates.

Retirement income payments are sometimes predictable. Social Security “prepays” a person for the month ahead; when they die during that month, the payment is taken back by the administration. The 1099-SSA will only include the amount taxable to the decedent. Many other state and private retirement pensions pay “after” the month in question, and some pay two or more months after death, so that these decedent’s estates will have at least one post postmortem payment.

Partnerships have the burden of figuring the distributive share of income and expense reportable on the date of the partner’s death, and reporting the remainder share on a separate K-1. S Corporation income is also reportable through the date of death on the shareholder’s final return.

Capital gains and losses reported to the decedent but occurring post mortem should still be reported on the final 1040 (unless the reporting party agrees to revise their 1099) for income document matching purposes. However, an adjustment will need to be made on the form 8949 with an amount (column g) sufficient to produce no gain or loss (column h;) use adjustment code N (for Nominee.)

Losses, both net operating and capital, if not absorbed on the decedent’s final return, do not carry over to the estate. A net operating loss incurred by the decedent can be carried back to prior years. Capital losses on the decedent’s final 1040, if married filing jointly, may carry forward to the spouse’s subsequent returns for her portion only for her separate property; for community property s/he carries forward half of the loss.

Passive activity losses accumulated and unused prior to death are allowed against the decedent’s income on the final return to the extent that they are greater than the difference between the beneficiary’s’ basis and the decedent’s adjusted basis. Thus, a rent house with a depreciated basis of $30,000 in the decedent’s hands, and a fair market value of $40,000 provides a $10,000 maximum of passive activity losses deductible on the decedent’s final return. If the decedent had $12,000 in unused passive losses, the remaining $2,000 is not deductible.

Credits come with their own parameters. For instance, unused business tax credits are carried back one year and forward for 20 years (15 years if arising before 1998). Any such unused credits available in the year of death are deductible on the final return.

Basis in excess of the return in an annuity can be claimed on the final return of the decedent §72(b)(3)(A) or the beneficiary §72(b)(3)(B). The same holds true claiming the loss on a ROTH or a non-deductible IRA which is under basis when the account is closed.

With an Archer MSA or its successor, the HSA, if the spouse is the designated beneficiary, is "rolls over" and is treated as the spouse's. Otherwise, the fair market value of the account on the DOD becomes taxable to the beneficiary. Unless the beneficiary is the estate, taxability is reduced by any qualified medical expenses for the decedent that are paid by the beneficiary within 1 year of the date of death.

Withheld and estimated tax payments are reported and claimed on the decedent’s final return. So, if Tim’s retirement check was $1,000 per month, and had $200 withheld, and if Tim died on March 1, and the retirement checks were paid on March, April and May 3, Tim personal representative would report the 1099R income total of $5,000 on the “pension income” line of Tim’s final return and the five months of $200 withheld tax, or $1,000 on the “federal income tax withheld” line of the return. Then, on line 21 of form 1040, a line item of “post postmortem income” in the amount of ($3,000) is reported.

Income In Respect of a Decedent (IRD) §691

IRD is that part of postmortem income on which, had the decedent lived, s/he would have collected and paid income tax. Tim’s pension payments from March to May in the example above is IRD These are income assets on which, if the estate exceeds certain dollar limits, will be subject to both estate income and inheritance tax. This character of income is determined by reference to the decedent. (With today’s generous estate exclusions -- $5.12 million for 2012-- most families will no longer pay the inheritance tax.) The IRD assets do not receive the “stepped up” basis under IRC §1014. The income retains the same character in the beneficiary’s hands. A partial list includes:

  • Interest, dividends, rents and royalties accrued pre mortem but paid post mortem,
  • Uncollected salaries, wages, bonuses, vacation and sick pay,
  • Certain deferred compensation and stock option plans,
  • Annuity payments in excess of the decedent’s investment in the contract,
  • Qualified pension plans, profit sharing plans, SEP, Keogh and IRA accounts – save for nondeductible amounts, like ROTHs,
  • Accounts receivable in the hands of a sole proprietor,
  • Gain on the sale of property sold pre-postmortem but collected post postmortem,
  • Structured settlements and structured attorney payment plans,
  • Difference between the face amount and the decedent’s basis in an installment sales obligation,
  • Interest accrued through the date of death on Series EE bonds, unless either the decedent elected to report interest annually or the interest was reported on the decedent’s final form 1040.

Perhaps the most frequent complaint a practitioner hears from the beneficiary who cashed in an inherited IRA is “but I thought inheritances were tax free!” Another frequent surprise for beneficiaries comes when they learn that funeral expenses are not deductible against either the decedent’s or the estate’s income. (They are only deductible from the estate’s balance sheet -- that is on the inheritance return, form 706. Inheritance tax is an excise, or transaction, tax.)

Expenses In Respect of Decedents (DIRD)

Expenses paid by the decedent go on the final return; these include itemized expenses, business and investment expenses, along with interest and taxes.

Expenses of the fiduciary go on its’ form 1041 return, such as administration expenses, interest and taxes, along with business, rental and royalty expenses. Persons who acquire an interest in the property subject to obligations which the estate is not required to pay must pay the obligations. An example here would be a non-recourse mortgage, one secured only by the property itself, and not by the decedent.

Many expense types have unique reporting regimes and schemes for the decedent and/or the successor. The practitioner should carefully review these transition requirements by asset or expense type, such as with royalty income and depletion. The same holds true for the transfer of a right to income. For instance, review the particulars around installment sales, should these be sold by the estate.

Income and deductions in respect of a decedent play a big role in completing inheritance Form 706. Communication with and between the estate’s attorneys and the tax practitioner is vital for accurate returns with the correct interplay of elections and other matters. For example, medical and dental expenses of a decedent paid post-postmortem for a year following the date of death may be deducted either on the 706 or on the final 1040.

Fiduciary Returns

The practitioner has now sorted the income and expenses to the date of death, then from the day after to the end of the year, and reconciled it to the forms 1099. Furthermore, the postmortem income has been allocated to its postmortem owners or to the estate, completing Table B’s Worksheet.

The most common estate planning the small tax practitioner encounters is the Last Will and Testament (LWT). Next in frequency is the revocable trust where the decedent was the trustor and the trustee. On death it becomes irrevocable, and a successor trustee takes over. The third type usually arises from language in the LWT or the trust, and it establishes a trust for the surviving spouse, who receives income and support; the children are the remainder beneficiaries.