Michael Fitzsimmons CPA

San Diego, CA

(619) 757-1500     info@fitz-cpa.com

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 allocations
  • 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 $12,000 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.

After a death, our work for the estate or trust often involves more than just preparing a fiduciary income tax return (IRS Form 1041). Here are some of the items / issues that may be involved:

  • Advice re: personal liability of the fiduciary (trustee / executor / administrator / personal representative) for federal and state tax liabilities of the decedent, the estate, and any applicable trusts, and related penalties and interest. Work will include consideration of actions to mitigate such liabilities through such actions as tax elections, timing transactions, filing requests with the tax authorities to shorten the amount of time they have to audit returns and/or charge the trustee or personal representative (executor/administrator) with personal liability for trust or estate income tax liabilities.
  • Explanation of how trust/estate income taxes are calculated, high tax rates that apply to trust/estate taxable income, and what actions can be taken to minimize tax rates and overall income taxes.
  • Obtain a tax identification number for the trust.
  • Advice re: accounting for transactions, arranging the financial affairs in such a way as to minimize discrepancies between income reported to the tax authorities and income includable on the various tax returns required.
  • Figure out how title to assets was held (form of ownership, i.e., joint vs. community vs. tenancy in common vs. pay on death or totten trust, pre-death irrevocable trust, etc.) to determine who owes taxes on the related income.
  • Advice on determining and adequately documenting cost basis of assets, such as decedent’s home, rental properties, collectibles/coins, investment securities, and other assets.
  • Fiduciary registration with the IRS.
  • How to protect the fiduciary from some claims by beneficiaries re: name, address, and tax identification numbers used on tax returns and distributions.
  • Identification of important dates, such as tax periods, tax election due dates, return filing deadlines and extensions, distribution deadlines, and end of combined estate/trust tax return period.
  • Preparation of IRS forms and other documents to make elections under the Internal Revenue Code.
  • Analysis of will and trust document(s), including creation of CPA’s Trust Summary and/or CPA’s Will Summary to facilitate efficient and effective tax planning and return preparation. Consideration of allocation of receipts and expenditures to principal or income and how that affects who pays the income taxes and what tax rates apply.
  • Review of all possible tax issues and, for those pertinent to the trust/estate, explanation and suggestions on actions to achieve the optimal outcome. CPA’s completion of 7-page Trust/Estate Tax Administration Checklist, Initial.
  • Allocations of income and deductions into periods other than calendar years.
  • Allocations of receipts and expenditures between principal and income pursuant to the appropriate state law, as modified by the trust document (necessary to properly allocate taxable income between the beneficiaries and the fiduciary, and to fulfill fiduciary duty to the income and remainder beneficiaries).
  • Assistance dealing with income or deductions reported to the IRS using the incorrect tax identification number (i.e., income and mortgage interest reported with the decedent’s Social Security number rather than the estate’s or trust’s tax identification number).
  • Assistance creating an action plan to efficiently accomplish tasks necessary to properly handle the trust/estate tax affairs, including a list of due dates.
  • Estate and/or gift tax returns.
  • Decedent’s final personal income tax return.
  • Income tax return for the estate and or decedent’s trust (typically a “will-substitute” trust, commonly referred to as a revocable trust, living trust, family trust, A/B trust, or A/B/C trust).

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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I am a fee-only professional compensated on an hourly or project-fee basis. I maintain my independence and objectivity by refusing to sell insurance, annuities, mutual funds, or software –
I do not earn commissions.