Case Study of a Complex Fiduciary Income Tax Return Form 1041 John R. Anzivino, CPA Claudia M. Bendana, CPA Kaufman Rossin November 19,

Facts: Date of death: April, 2013 Decedent was survived by five adult children Decedent created several revocable trusts during life S-Corp revocable trust required to pay debts of decedent, administration expenses and estate tax DOD Value Cash 2,000,000 Closely held S Corp stock – 12/31 year end 156,000,000 Marketable Securities 36,000,000 Annuities 7,000,000 Miscellaneous & tangible personal property 10,000,000 Gross Estate 211,000,000 Section 2053 and 2054 deductions (3,000,000) Adjusted gross estate 208,000,000 2

Section 6166: Extension of Time to Pay Estate Tax To qualify, the aggregate value of the decedent’s ownership interests in each closely held business of 20% or more must exceed 35% of the adjusted gross estate The estate tax attributable to the value of the closely held business interests may be deferred for five (5) years (interest only) and ten (10) years (principal and interest) The estate qualifies because about 75% of the decedent’s adjusted gross estate is comprised of closely-held business interests. $62 million of the $83 million estate tax due qualifies for deferral. 3

Trust as S Corp Shareholder The estate of a deceased shareholder is a permitted shareholder of an S corporation (IRC § 1361(b)(1)(B)). A trust is generally not a permitted S corporation shareholder. Certain trusts may be S Corp shareholders for a period of time. (IRC § 1361(c)(2)) A “qualified revocable trust” joining an estate income tax return through a §645 election is a permitted S-corp shareholder as long as a §645 election is in place. 4

Section 645 Election -A “qualified revocable trust” is any trust (or portion thereof) that on the date of death of the decedent was treated as owned by the decedent under IRC Section 676 – Power to Revoke. -Section 645 election allows a “qualified revocable trust” to file a combined Form 1041 with the estate. Benefits of the election include: Income tax deferral by using fiscal year end Combined income and deductions Delay making ESBT/QSST elections 5

Section 645 Election Period – Election applies from date of death to the “applicable date”, which is the later of the following: two years from date of death or six (6) months after the date of the final determination of the estate tax liability, even though payment may be deferred under §6166. – When the §645 election terminates and if the S Corp stock will continue to be owned by the trust, ESBT or QSST elections need to be made. 6

Section 645 Combined Form 1041 Estate Revocable Trust #1 S-Corp Revocable Trust Chose fiscal year-end 11/30; S-Corp K-1 for 12/31 not reported until following tax reporting period Eleven (11) month deferral of $10,000,000 of income tax on $25,000,000 business income Estate and revocable trust income and expenses are combined What about distributable net income (DNI)? 7

§ 663(c) - Separate share rule A separate share exists if the economic interests of the beneficiary or class of beneficiaries neither affect nor are affected by the economic interests accruing to another beneficiary or class of beneficiaries (Reg 1.663(c)-4) A share may be considered as separate even though more than one beneficiary has an interest in it. The same person may be a beneficiary of more than one separate share. An estate and qualified revocable trusts for which an election is made under §645 are always a separate shares for purposes of allocating DNI and those shares may contain two or more separate shares. 8

Specific Bequests in Trust – Separate shares? A beneficiary’s interest in a specific bequest in trust is a separate economic interest, thus a separate share Florida Statute states that each beneficiary described in (4) is entitled to receive a portion of the net fiduciary accounting income Florida Statutes (4) states that the fiduciary shall distribute the net fiduciary accounting income … to all other beneficiaries, including a beneficiary who receives a pecuniary amount in trust Each beneficiary’s share of fiduciary accounting income is equal to the beneficiary’s share of undistributed principal assets on date of distribution 9

Separate Shares Estate Revocable Trust #1 S-Corp Revocable Trust Specific bequest Trust 1 Specific bequest Trust 2 Specific bequest Trust 3 Specific bequest Trust 4 Residue Trust share 1Trust share 2Trust share 3Trust share 4Trust share 5Trust share 1Trust share 2Trust share 3Trust share 4Trust share 5 Residue 10

Fiduciary Accounting Income and Distributable Net Income Flow – Year 1 Estate No distributions Revocable Trust #1 Partial funding of specific bequests in trust S-Corp Revocable Trust No income No distributions Revocable Trust #1 partial funding of the specific bequests in trust causes a portion of DNI of the Revocable Trust #1 only to be allocated to those specific devisee trusts 11

Allocation of Fiduciary Accounting Income to Specific Devisees in Trust - Year 1 12 Revocable Trust #1 Assets DOD Value Marketable Securities 36,000, Retirement Account payable to Trust 200, Annuities payable to Trust 3,500, Total Assets 39,700, Specific Bequests in Trust Trust #1 2,000, % Trust #2 2,000, % Trust #3 500, % Trust #4 500, % Residue 34,700, % FAI Allocation Denominator 39,700, %

Fiduciary Accounting Income and Distributable Net Income Flow – Year 2 4 Specific bequest trusts receive DNI based on their share of Fiduciary Accounting Income Residuary beneficiaries receive balance of DNI in equal shares DNI remains in the trust Business income not subject to Net Investment Income Tax due material participation by the fiduciary Estate and Revocable Trust #1 Income 1,000,000 S Corp Revocable Trust Business income $25,000,000 $21,000,000 loan to pay estate tax S Corp Distribution $2,400,000 $2,400,000 Loan Payment $2,400,000 residuary distributions $2,500,000 specific bequests in trust $0 distributions 13

Material Participation and Net Investment Income Tax Section 469(h) states that material participation requires “regular continuous and substantial” involvement in the operations of the business. The sole fiduciary of S-Corp Revocable Trust is involved in the operations of the business on a regular, continuous and substantial basis. What if the Trust makes distributions to beneficiaries who do not materially participate? – Reg (e) 14

§691 Income in Respect of Decedent Income in respect of a decedent (“IRD”) is gross income a decedent was entitled to receive at the time of death but not included on the final Form 1040 Examples: unpaid wages, installment sales, annuities, IRAs IRD is subject to estate tax and income tax. An income tax deduction for the estate tax paid on the IRD is allowed (§691(c)) The IRD deduction is a miscellaneous itemized deduction not subject to the 2% AGI limitation. 15

S-Corp Trust - Fiduciary Accounting Issues S-Corp trust is required to pay debts of decedent, administration expenses and estate tax S Corp Trust lacks liquidity S-Corp distributions are income (Fla. Stat § (2)) Estate, inheritance and other transfer taxes are disbursements from principal (Fla. Stat (f)) What to do? Fla. Stat. § ? 16

Estate & Trust Principal Kaufman Rossin Estate & Trust Manager Kaufman Rossin John R. Anzivino, CPA Claudia Bendana, CPA Contact us