1. Final Form 1040 & 1041 Trusts: More Than Meets the Eye
Raymond T. Rowe, J.D., C.P.A.
Troy, Michigan
(248) Rowelawfirm.com

2. Your Client Died - What Tax Returns are Required
Final Personal Income Tax Return
Income Tax Returns for Estate and/or Trust
Allocating Income between the 1040 and 1041
How are expenses allocated
Distributions
65 day Rule
Are There Still Tax Planning Opportunities

3. AICPA 360 Degrees of Financial Literacy
Available at both AICPA and MICPA website
What is a post-mortem election?
Estate planning technique that can help minimize federal transfer tax or income tax liabilities
Usually made by personal representative
Must be timely made in the required fashion
QTIP election allows treatment of all of part of qualifying assets to pass to spouse free to tax under marital deduction
Selection of tax year allows personal representative to divide income into as many taxable years as possible to prevent bunching of income

4. Income Tax Returns in General
Executor or administrator estate or other person in control of property must file an income tax return for the tax year that ends on date of death. Reg. Sec (b)(1)
The final return is due on the regular return due date Reg Sec (b)
No requirement to make adjustments to reflect a short year. Reg Se (a)(2)
No requirement to continue to make estimated tax payments after date of death Reg. Sec (a)(4)
Surviving spouse still has obligation to continue estimated tax payments

5. Income Tax Returns in General
Executor or administrator must file tax return for estate from date of death until estate is liquidated for each tax year in which gross income is $ or more or beneficiary is nonresident alien. Secs. 6012(a)(3),(5).
Trustee of trust must file tax return for each nonexempt trust where gross income is $ or more, there is any taxable income or beneficiary is nonresident alien Secs. 6012(a)(4),(5).

6. Accrued Income Most individual taxpayers report income on a cash basis
Income received by date of death is reportable on Form 1040
Forms 1099 income may not make this allocation; Payer will change the Payee identity based upon receipt of information
Tax return preparer should make an allocation of income based upon date of death
Many preparers do not make this allocation
Income accrued as of date of death but not received is taxable income to recipient under income in respect of a decedent rules
There is no step up in basis for accrued income

7. Accrued Income - Examples
Dividends declared prior to date of death where taxpayer is alive on stockholders’ of record date
Accrued interest on
Savings accounts and CDs
Bonds
Savings Bonds [but see opportunity below]

8. Opportunities on Final Income Tax Return
Accrued interest on U.S. Savings Bonds
Most taxpayers are on a cash basis for reporting this income
Taxpayer at any time can elect to change to accrual basis for this interest
For year of switch all accrued and untaxed interest is taxable in year of change.
There is no step up in basis for Savings Bond interest. If no change in method beneficiaries are taxable on interest when bonds are cashed in
Election can be made to cover U.S. Savings Bonds held in decedent’s own name and also those held in decedent’s revocable trust Rev. Rul , C.B. 208

9. Opportunities on Final Income Tax Return
Elderly clients may be in lower tax bracket than beneficiaries
Taxpayer may have high itemized deductions
Medical expenses
Carryover of excess charitable contributions
Foreign tax credits carryovers (need foreign income to use)
Investment interest carryover

10. Opportunities on Final Income Tax Return
Decedent’s net operating loss deduction
Rev Rul , C.B. 52
Decedent’s capital and net operating loss sustained in final tax year are deductible only on the final tax return and are available to estate or heirs. See Secs. 165 and 172
Can carryback losses
Surviving spouse may want to consider accelerating income or deferring deductions on final return to take advantage of decedent’s NOL

11. Opportunities on Final Income Tax Return
Capital loss carryovers
No benefit to sell unrecognized capital gain assets in final year since these assets will receive step up in basis upon death
Capital assets with unrecognized loss
Step up in basis rule also affects unrecognized loss assets.
The basis in these assets is stepped down to current FMV
If final Form 1040 year has taxable income taxpayer could sell loss assets before death to lower tax (use $3,000 of loss)

12. Opportunities on Final Income Tax Return
Installment sales during year of death
The election to treat a sale as an installment sale is an election to be made on a sale by sale basis
Installment sale income is income in respect of a decedent and there is no step up in basis. 100% of gain would be reported by the recipient
Compare tax rates of decedent and beneficiaries and taxable income of decedent to determine whether or not to elect installment sale income recognition

13. Opportunities on Final Income Tax Return
Income from partnership and S corporation returns
Income from pass through entities are allocated
For partnerships to whoever was partner at year end
For S corporations to owners on either pro rata basis based on dates of ownership or by interim closing of books
Election to close tax year is made at entity level
Personal representative should work with entities to plan income allocation to final decedent's return
Sec. 754 Election in Partnership
Upon death partner’s outside basis is increased
Partnership can make 754 Election to increase inside basis of partnership assets attributable to deceased partner is increased as to the inherited partnership interest
Other partners do not benefit from basis increase

14. Opportunities on Final Income Tax Return
Sec. 754 Election continued
Election is made on partnership return for year partner died
Return must be filed by extended due date or within 12 months thereafter
Can be revoked only with IRS approval
754 election can also be made if there is a sale of the partnership interest
Suspended Passive Losses
Deductible on final Form 1040
But only to extent that they exceed the amount by which the basis in the asset is stepped up in value. [IRC Sec. 469(g)(2)]

15. Opportunities on Final Income Tax Return
Election to file joint return
Personal Representative and spouse have the right but not the obligation to file a joint return for the year of death
Include only income through date of death on Form1040
If no Personal Representative is appointed spouse has sole right to decide to file a joint return
Joint return is not allowed if
Surviving spouse has remarried prior to end of survivor’s tax year
Either of the spouses is a nonresident alien at any time during the tax year IRC Sec. 6013(a)(1)
By filing joint return estate becomes jointly and severally liable with surviving spouse for taxes and penalties associated with the final tax return IRC Sec. 6013(d)(3)

16. Estate or Trust - Form 1041 Estate and Trust are two separate entities
Estate Decedent's Probate Estate
Exemption $600.00
Can choose any fiscal year ending on end of month not more than 12 months after decedent’s death
Trust
Exemption of $ for simple trust and $ for complex trust
Must use calendar year unless it qualifies for natural business year
Can elect to treat trust income on tax return for estate
Make election on Form 8855
Effective for two years beyond date of decedent’s death

17. Estate or Trust - Form 1041 Taxation of Estate
Administration expenses can be significant
Expenses can be deducted in year paid
Unless Estate elects to report income on accrual basis
Often expenses are paid just before closing of estate thus it may make sense to choose accrual basis
No loss carry forward for excess expenses
Income can carryout to beneficiaries if there are distributions
Excess expenses do not carry out to beneficiaries

18. Estate or Trust - Form 1041 Taxation of Trust
Expenses can reduce taxable income
Consider using accrual method
For simple trusts all income is taxed to beneficiaries even if not distributed
For complex trusts distributions carry out taxable income
Can elect to treat distributions made within 65 days of year end as if they were distributed during prior tax year
Excess expenses
Do not carry forward
In year of trust termination excess expenses carryout to beneficiaries as itemized deduction

19. Estimated Tax In Final Year
On final year for a Form 1041 all income including capital gains is passed out to and taxed to beneficiaries
By filing Form 1041-T Allocation of Estimated Tax Payments to Beneficiaries any estimated tax can be allocated to the beneficiaries
Must file this form within 65 days of end of tax year
Does not apply to withheld taxes such as taxes withheld on retirement plan distributions

20. Estate or Trust - Form 1041: Distributions
Distributions generally carry out a portion of Distributable Net Income
Distributions in excess of DNI are corpus
Distributions made to multiple beneficiaries generally cause DNI to be allocated on pro rata basis.
Exception is specific sum of money and specific property
If paid all at once or in not more than three installments the distribution is treated as coming out of corpus and does not carryout DNI/taxable income IRC Sec., 663(a)1)
The amount of money or identity of specific property must be ascertainable under governing instrument
Transfer of real estate to devisee does not carryout income if title vests immediately

21. Estate or Trust - Form 1041: Distributions
Separate Share Rule
General rule is that DNI is carried out pro rata
Under separate share rule DNI is carried out based upon beneficiaries respective share of DNI IRC Sec. 663(c)
Where governing instrument creates separate economic interests in one beneficiary or a class of beneficiaries where their interests are not affected by economic interests accruing to other beneficiaries. Reg (c)-4
Application of separate share rule is mandatory
Bequests of specific sum of money paid in more than three installments is considered to be a separate share

22. Estate or Trust - Form 1041: Distributions
Income from assets specifically bequeathed to a beneficiary
Beneficiary receiving a bequest of a specific property is entitled to net income of that property during period of administration
Income from specific property is a separate share
If income is not distributed during year and estate/trust pays tax on the income the beneficiary is entitled to receive the net income after tax
Uniform Principal and Income Act [MCL (a)] provides that income from property specifically devised goes to the specific devisee.

23. Estate or Trust - Form 1041 Distributions in kind
Generally estate or trust does not recognize tax on a distribution
Exception is a distribution of capital asset in satisfaction of a pecuniary (money) bequest.
Beneficiary has carryover basis from estate or trust when estate or trust does not recognize income on distribution
643€(3) election estate or trust treats distribution as a sale at fair market value
Beneficiary’s basis is increased by gain recognized
Election is annual election and applies to all property distributed
Benefits of election: Income recognized by estate or trust could offset excess deductions or capital losses
Detriment: If beneficiary is in a lower tax bracket

24. Expenses – Form 706 or Form1041
Form 706 no longer as much of an issue since exemption is $11,400,000.00
Deductions that are allowable on Form 706 as administration expenses under Sec. 2053(a)(2) or losses under Sec are not deductible on Form unless
Election is made waiving right to deduct these items on Form 706
Copy of election is attached to Form 1041

25. Expenses – Form 706 or Form1041
Double deductions for Deductions in Respect of a Decedent Sec. 691(b)
Claims against decedent’s estate accruing prior to date of death that are paid after date of death
Deductible as expenses on Form 1041
Deductible on Form 706 as debts
Examples are interest and property taxes accrued but unpaid at date of death

26. Expenses on Form 706
If there is an estate tax liability a number of expenses are deductible on 706 and as noted above there is generally no double deductions
Requirements for expenses
Must be enforceable
Related party claims & expenses must be bona fide
Underlying transaction must be in ordinary course of business, negotiated at arms length and free from donative intent
Nature of claim or expense must be unrelated to expectation or claim of inheritance
Must originate under agreement between decedent & family, related party or beneficiary & substantiated with contemporaneous evidence (for example family member who provided care prior to death is deemed to have done so for love and affection if there was no written agreement)

27. Expenses on Form 706
Related party expense requirements
Performance by claimant is under terms of agreement and performance can be substantiated
All amounts paid are reported by each party and properly taxed to claimant
If claimant is a beneficiary weigh taxability of payment to tax savings to decedent
Not all payments must be made by due date of Form 706
Reasonably ascertainable claims and expenses
Executor commissions, attorney & CPA fees
Claim or counterclaim that existed as of date of death
Claims not exceeding $500,000 existing at date of death even if contested if there is a qualified appraisal of claim
Recurring payments that are enforceable & non-contingent
Similar claims

28. Expenses Deductible Under IRC Sec. 67(g)
Code Sec. 67(g) suspends the deduction of miscellaneous deductions for the years 2018 to 2025
IRS issued Notice to clarify how this affects trusts and estates.
Expenses paid or incurred in administration of trust or estate that would not have been incurred by individual are deductible
Trustee or Personal Representative fees
Tax return preparation fees
Appraisal fees

29. Expenses Deductible Under IRC Sec. 67(g)
Expenses not deductible include
Investment management fees
Fees and costs for the holding of property including homeowner association fees, insurance and maintenance fees
If fees are grouped (for example trust administration fees) an allocation is required between the deductible and non deductible fees
Excess deductions on termination of trust or estate are being studied to determine if they are deductible by beneficiaries
Limitation does not apply to capital loss or net operating loss carryovers

30. Election related to S Corporations
A non-Grantor trust is not a qualified S corporation shareholder
An estate can hold S Corp stock for as long as necessary for reasonable administration
If no 706 is filed estate can only qualify for 2 years.
Distribution can be made to qualifying individual beneficiary, a Qualified Subchapter S Trust or and Electing Small Business Trust
Either trust must make an affirmative election under Sec. 645

31. IRS Audits Just because the client died doesn’t mean the audit is over
Things you must do
File Form 56 – Notice Concerning Fiduciary Relationship
Filed by the fiduciary, Personal representative, Trustee, guardian, conservator
Terminating entity such as trust or estate can only file when it is still in existence
Needed to be able to represent the fiduciary estate
Often these are not filed

32. IRS Audits Things to Do New Form 2848
CPA previously represented taxpayer who is now dead
CPA now needs to represent the fiduciary

33. References
Post-Mortem Tax and Estate Planning Elections; David L. Johnson, Montana Law Review, September 1981, Article 2
The Power of Post-Mortem Estate Planning (selected issues for 2010 and 2011); Carol A. Cantrell, University of Miami, 45th Annual Heckerling Institute on Estate Planning, January 2011
The 10 most powerful postmortem planning pointers for trusts and estates; Karen S. Cohen, CPA, Journal of Accountancy, May 2012