How to Compute Taxes for a Decedent, Estate, or Trust

To prepare the decedent’s personal tax return or one for an estate or trust, you must calculate the tax after you determine the income and deductions. If you’re completing a Form 1041 and need to complete Schedule G, you may need to perform several different types of tax computations. These include computations of ordinary tax, capital gains and qualified dividends, tax on lump-sum distributions, and alternative minimum tax.

If you’re completing the decedent’s personal return, determine the tax liability the same way as you would your own.

How to determine ordinary tax

You can find tax rate tables for estates and trusts, which change every year, in the Form 1041 instructions for that year.

Many executors, administrators, and trustees choose to make distributions to beneficiaries to lower the tax on ordinary income. By making distributions, you pass that taxable income to the beneficiaries, who are, likely, in a lower tax bracket.

How to compute capital gains and qualified dividends

Whether you’re filing a tax return for an individual, trust, or estate, capital gains and qualified dividends are taxed at fixed rates. Calculate these taxes on the worksheets attached to Schedule D.

The Schedule D worksheet lists the various types of capital gains property and applies the correct tax rate to those gains. If you have entries on Schedule D, or you have qualified dividends, completing this worksheet can save you money. You pay far lower rates on most capital gains and qualified dividends than on other income.

Whether you calculate your tax by using the worksheet on the back of Schedule D or the tax rate table, place the total tax on taxable income on line 1a of Schedule G, Form 1041.

How to handle tax on lump-sum distributions

Sometimes the estate you’re administering has received the payout of an employer’s qualified retirement account. This greatly increases the estate’s income tax liability.

If the decedent was born prior to January 2, 1936, the estate may be eligible to use either of the following tax-lowering strategies:

1. Ten-year averaging

2. 20 percent capital gains rules

Prepare these special calculations on Form 4972, Tax on Lump-Sum Distributions. Instructions are included under “Forms and Instructions.” After you finish Form 4972, you place the taxes on lump sum distributions on line 1b of Schedule G, Form 1041.

How to calculate alternative minimum tax

Since 1986, all trusts and estates are required to do the alternative minimum tax (AMT) calculation, even if they aren’t subject to the AMT. The AMT is a flat tax designed to prevent certain high-income individuals, estates, and trusts from not paying any, or enough, income tax.

The AMT schedule (all 4 parts and 76 lines) for trusts and estates is on pages 3 and 4 of Form 1041, under Schedule I. Line-by-line directions are in the Form 1041 instructions. The following gives you the basics about each part.

Part I: Estate or trust’s share of alternative minimum taxable income

Here's how to get rolling with your calculations:

1. Take your adjusted total income from page 1, line 17 and add back any interest, taxes, or miscellaneous itemized deductions subject to the 2 percent (Form 1041, line 15a) you’ve previously deducted. Subtract any income tax refunds included as income on line 8.

   Among other frequent AMT add-back items are interest from private activity bonds, net operating losses, and AMT adjustments from other estates or trusts.

2. Add the beginning adjusted total income to your adjustments. Put the total on line 25, adjusted alternative minimum taxable income.

3. Finally, subtract the income distribution deduction from Schedule I, Part II, line 44, and the estate tax deduction (Form 1041, line 19).

   If your total comes to less than the exemption amount (which you’ll find on line 29 of Schedule I), you’re finished! This estate isn’t subject to the AMT this year. If your total is more than the exemption, continue.

Part II: Income Distribution Deduction on a minimum tax basis

If you made distributions to income beneficiaries during the year, you need to complete this part, whether or not the trust or estate is subject to the AMT.

Redo the Income Distribution Deduction (Schedule B) calculation. Remember that your starting point is different and that you may have less tax-exempt interest, in which case your adjusted tax-exempt interest may be different.

Remember, private activity bond interest is taxable for AMT purposes.

Part III: Alternative minimum tax:

Use lines 45 through 56 to calculate the additional tax, if any, that the trust or estate has to pay due to the AMT. The instructions for the calculation are printed on Schedule I.

Part IV: Computation using maximum capital gains rates

Lines 57 through 76 mirror the calculations you already made on the back of Schedule D so that capital gains continue to receive preferential tax treatment. Follow the instructions on the return carefully.

If you have a number on line 56 of Schedule I, the trust or estate owes this additional tax. Copy the amount on line 56 onto line 1c of Schedule G, Form 1041.