Chapter 12 Tax Considerations In Estate Administration

Wills, Trusts, and Estates Administration, 3e Herskowitz © 2011, 2007, 2001 Pearson Higher Education, Upper Saddle River, NJ All Rights Reserved. 2 Learning Objectives  Understand what responsibility the personal representative has concerning the decedent’s taxes  Understand how to complete the decedent’s final income tax return  Learn how to complete the estate’s federal tax return  Learn how the decedent’s estate is valued  Learn what may be done legally to minimize the estate’s tax burden  Learn how recent changes in federal tax laws affect estate administration  Learn a few post-mortem estate planning techniques

Wills, Trusts, and Estates Administration, 3e Herskowitz © 2011, 2007, 2001 Pearson Higher Education, Upper Saddle River, NJ All Rights Reserved. 3 Who Is Responsible For The Estate’s IRS Obligations?  The executor or administrator is responsible  If the correct forms aren’t timely filed, the representative will be personally liable for all penalties and back interest  But—there is IRS Publication 559!  Pub. 559 details what forms need to be filed on the decedent’s behalf  Pub. 559 provides sample forms  Pub. 559 has instructions on completing the forms

Wills, Trusts, and Estates Administration, 3e Herskowitz © 2011, 2007, 2001 Pearson Higher Education, Upper Saddle River, NJ All Rights Reserved. 4 Important IRS Forms To Be Filed First  Form 56: Notice Concerning Fiduciary Relationship  identifies the decedent and the personal representative  not required by the IRS, but filing this form makes things easier; insures IRS knows who to contact  Form SS-4: Application for Employer Identification Number  the estate, as a non-human entity, needs a tax ID number  the tax ID number needs to be used on all later IRS documents and correspondence

Wills, Trusts, and Estates Administration, 3e Herskowitz © 2011, 2007, 2001 Pearson Higher Education, Upper Saddle River, NJ All Rights Reserved. 5 The Decedent’s Final Income Tax Return  Form 1040 is filed by the personal representative  The 1040 form for a decedent has two distinguishing features  It should be marked “final return”  the tax year should only include the time the decedent was alive  If a refund is due, file a Form 1310  If the estate pays the decedent’s medical expenses, they may be deducted on the decedent’s income tax return  Remember—state and local tax returns need to be filed also (where there are state taxes)

Wills, Trusts, and Estates Administration, 3e Herskowitz © 2011, 2007, 2001 Pearson Higher Education, Upper Saddle River, NJ All Rights Reserved. 6 The Estate’s Federal Income Tax Return  Income of the decedent accrued during life but not paid before death flows to the estate  So, the estate must file a tax return to account for that income  IRS Form 1041

Wills, Trusts, and Estates Administration, 3e Herskowitz © 2011, 2007, 2001 Pearson Higher Education, Upper Saddle River, NJ All Rights Reserved. 7 The Estate Tax Return  Federal and state estate tax returns must be filed  IRS Form 706 must be filed within nine months of the decedent’s death  Five parts of Form 706 1) Information on decedent and personal representative 2) Tax computation, which requires 19 schedules to be completed 3) Alternative valuation election 4) “General information,” including decedent’s occupation, marital status, etc. 5) “Recapitulation,” a summary of the totals on the 19 schedules

Wills, Trusts, and Estates Administration, 3e Herskowitz © 2011, 2007, 2001 Pearson Higher Education, Upper Saddle River, NJ All Rights Reserved. 8 How Ugly Is The Gross Estate?  The gross estate is the value of the property and interest of the decedent, at death, including jointly held property, pensions, and life insurance  Usually fair market value (FMV) is used to value the estate’s assets  But…the representative can elect to value the property six month after decedent’s death (alternate valuation)  The alternate valuation must be used for all property if chosen  This could lead to a reduction in value if some of the properties’ value are falling  The taxable estate (adjusted gross estate) is calculated after exemptions and deduction offset the gross estate

Wills, Trusts, and Estates Administration, 3e Herskowitz © 2011, 2007, 2001 Pearson Higher Education, Upper Saddle River, NJ All Rights Reserved. 9 Form 706 Schedules Relating to Assets A: Real Estate A-1: Real Estate Used in Farming or Closely Held Business B: Stocks and Bonds C: Mortgages, Notes and Cash D: Insurance on Decedent’s Life E: Jointly Held Property F: Other Miscellaneous Property G: Transfers During Decedent’s Life H: Powers of Appointment I: Annuities Schedules Relating to Deductions K: Debts of the Decedent, and Mortgages and Liens L: Net Losses During Administration and Expenses Incurred in Administering Property Not Subject to Claims M: Bequests and the like to Surviving Spouse N: Qualified ESOP Sales (this schedule is repealed!) O: Charitable, Public, and Similar Gifts and Bequests

Wills, Trusts, and Estates Administration, 3e Herskowitz © 2011, 2007, 2001 Pearson Higher Education, Upper Saddle River, NJ All Rights Reserved. 10 Form 706 (continued) Schedules Relating to Credits  Credits directly reduce the amount of taxes that are due by the decedent’s estate P: Credit for Foreign Death Taxes Q: Credit for Tax on Prior Transfers repealed – do not use R: Generation-Skipping Transfer Tax U: Qualified Conservation Easement Exclusion

Wills, Trusts, and Estates Administration, 3e Herskowitz © 2011, 2007, 2001 Pearson Higher Education, Upper Saddle River, NJ All Rights Reserved. 11 Unified Tax Credit  Formerly, persons were entitled to a credit of $600,000 against their estate’s value, or 1.2 million for spouses, but it included gift and estate credits together  That changed in 2001 when federal tax laws were changed  Under the present law, the gift and estate tax schedules are separate  The new law’s tax credit increases each year until January 1, 2010 when it becomes unlimited and someone can die without any estate tax. But…  January 1, 2011 the old unified credit system is scheduled to go into effect again and if you die then your credit is only $1 million each.  As of December 2010 Congress had not fixed this predicament

Wills, Trusts, and Estates Administration, 3e Herskowitz © 2011, 2007, 2001 Pearson Higher Education, Upper Saddle River, NJ All Rights Reserved. 12 Estate Valuation Exemptions Under The EGTRRA of 2001 Exclusion Amounts for Estate Transfers 2001$ 675, $1,000, $1,500, $2,000, $3,500, the law is repealed 2011$1,000,000 If EGTRRA isn’t made permanent, living past December 31, 2010 could be costly

Wills, Trusts, and Estates Administration, 3e Herskowitz © 2011, 2007, 2001 Pearson Higher Education, Upper Saddle River, NJ All Rights Reserved. 13 Top Gift and Estate Tax Rates for Years 2003 Through 2011 YearBracket % % % % % % % % (Gift Tax Only) %

Wills, Trusts, and Estates Administration, 3e Herskowitz © 2011, 2007, 2001 Pearson Higher Education, Upper Saddle River, NJ All Rights Reserved. 14 The Paralegal And Estate Valuation  Paralegals working in this area should have or learn accounting, computation, and considerable organization skills  Learning how to maneuver through IRS Form 706 and its 19 schedules is paramount  Learning how to organize and complete the various federal and state tax forms is also critical  Working with accountants, appraisers, tax experts, and financial institutions (not to mention the personal representative) is standard in this area of paralegal practice