Each year, individuals file their annual federal and state income tax returns reporting all the income earned during the year and paying any taxes that may be due. The same income tax reporting holds true upon an individual’s death. Upon death, a final individual income tax return (Form 1040) for the individual (Decedent) will be filed covering the period of January 1st through the date of death. Thereafter, all the income earned post death for a Decedent is required to be reported and filed on a fiduciary income tax return. At Kennedy & Ruhsam law, we are well equipped to handle all the income taxes for estates and trusts with professional, experienced, and a trusted legal team.
When a Fiduciary Income Tax Return is required for an Estate or Trust
When you are nominated and appointed as the Personal Representative and/or Trustee under a Decedent’s Will, you become the fiduciary of that estate or trust and are held responsible for overseeing the estate and trust administration. The administration includes ensuring all federal and state taxes are paid before the estate or trust is passed to the heirs. Just as individuals must file income taxes each year, an estate or trust also holds that responsibility. This is because every estate and trust will own property, received from the Decedent, that receives income. If an estate or trust receives any taxable income, gross income of $600 or more, or if there is a beneficiary who is a non-resident alien, then a fiduciary income tax return must be filed. The Internal Revenue Service requires the filing of the fiduciary income tax returns for estates and trusts on Form 1041 – U.S. Income Tax Return for Estates and Trusts. One of the first responsibilities under the fiduciary role is to obtain a new taxpayer identification number for the estate or trust. Essentially the estate and trust become “new” entities, filling the shoes of the Decedent. All the income earned will be reported under the new “employer identification number” (EIN) obtained for the estate or trust, rather than under the Decedent’s social security number.
The Tax Year and Filing Deadlines
The benefit of an estate is that the fiduciary may select either a calendar year for the filing of the fiduciary income tax return, or a fiscal period that begins with the date of death through the month preceding the date of death (12 month period), at the latest. In some instances, a fiscal period may be less than 12 months depending on the details and circumstances of the administration. Our legal team at Kennedy and Ruhsam law will assist the fiduciary with selecting a fiscal year that best minimizes the income tax liability for the estate.
A trust is most commonly on a calendar year filing basis. There is one exception, however, that allows a trust to “combine” with an estate’s fiduciary income tax return so that only one return is filed for “both” the estate and the trust. This is completed by the 645 Election that is filed with the IRS Form 8855 “Election to Treat Qualified Revocable Trust as part of Estate.”
When distributions are made from the estate or trust to the beneficiaries, which is commonly completed when closing the estate or trust administration, the fiduciary income tax return will issue a Schedule K-1 for each beneficiary reporting the income earned from the trust or estate, as allocated between each of the beneficiaries. Note that if the Schedule K-1 is the final schedule, it will also report all excess carryover deductions from the estate or trust to the beneficiaries as well. Each beneficiary of an estate or trust will be required to report the income and/or the excess deductions carried over from the estate or trust on their individual income tax returns.
The filing deadline for a fiduciary income tax return will either be on April 15th if the estate or trust is filed on a calendar basis, or if the return is filed on a fiscal year period, then the return must be filed by the 15th day of the fourth month from the end of the fiscal period. It is also important to remember that a fiduciary is allowed an automatic six-month extension of time to file the return, but like a majority of tax rules, a fiduciary must pay any estimated taxes due by the original due date.
Income and Deductions
The income reported on the fiduciary income tax returns for estates and trust includes income reported on Form 1099’s or Schedule K-1’s under the estate or trust’s EIN number. It is important to remember that many assets, such as stock and investments, have a step-up in basis as of the Decedent’s date of death. Reviewing the Inventory filed with a probate court or the Decedent’s Estate Tax Return (Form 706) will provide you with the step-up cost basis information. Also, the amount of income available for distribution from an estate or trust is called the “Distributable Net Income” (DNI). The estate or trust will claim a deduction for any portion of the DNI that is distributed to a beneficiary during the tax period on a Schedule K-1, as previously discussed, which the beneficiary must report the income on his or her own personal income tax return.
Another consideration under a trust’s fiduciary income tax return is whether the trust is a simple trust or a complex trust and that is based on the terms and provisions within the trust and governed under the Internal Revenue Code (26 U.S. Code § 642). The difference between a simple trust and a complex trust relates to distributions of income, and whether income is “required” to be paid (simple trust) or the distribution of income is discretionary (complex trust). The deduction for personal exemption amounts on a fiduciary income tax return are as follows: (a) for estates the exemption is $600; (b) for trusts, in general, the exemption is $100; or (c) for simple trusts that are required to distribute all of it income, the exemption amount is $300.
The deductions allowed on a fiduciary income tax return include professional fees such as legal and accounting fees, taxes (income and real estate), fiduciary fees, charitable deductions, and other administrative expenses of the estate that are reasonable and that were necessary to be incurred during the collection, management and preservation of the estate or trust. Oftentimes, investment brokerage statements will report all the income and gains/losses and expenses during the calendar year on a Form 1099. A fiduciary will need to properly allocate income and expenses based on the date of death so income earned pre-death is reported on the Decedent’s Final Individual Income Tax Return (Form 1040) and any post-death income is reported on the Fiduciary Income Tax Return (Form 1041).
Another key election to remember is the 65-day distribution rule under 26 U.S. Code § 663(b). The 663(b) election allows distributions to beneficiaries of estates and trusts within 65 days of year end to be counted as prior-year distributions. If the final distributions from an estate or trust occur within the first 65 days of a new year, then the 65-day rule allows the distribution to be reported on the tax return as having been completed in the prior taxable year.
Dealing with Death
Holding the fiduciary role for an estate or trust may surprise you in many ways, from the estate and trust administration duties, such as preparing an Inventory, Accounting, and making final distributions to heirs/beneficiaries, etc., to the tax implications and liabilities for each estate or trust. The legal team at Kennedy & Ruhsam law will help you successfully hold the role as fiduciary and assist you with the estate and trust administrations and preparation of the individual and fiduciary income tax returns, and will do so with compassion, competence, and expertise.
For more information on income taxes and death, please contact Tina M. Johnson, RP® at Kennedy & Ruhsam Law Offices, P.A., at (651) 262-2080 or tina.johnson@mpkennedylaw.com.