Estate Planning Articles

Article / Updated 10-06-2022

As of January 1, 2013, an additional 3.8 percent tax was added to investment income in estates and trusts, thanks to provisions in the Health Care and Education Reconciliation Act of 2010. It's not an additional tax on every dollar, but only on the lesser of undistributed net investment income or any amount of adjusted gross income in excess of the highest tax bracket in any year. What sorts of investment income are included? Here’s a list: Annuities Capital gains (including the taxable portion of the gain on the sale of a personal residence) Dividends Interest Passive activity income from partnerships and Subchapter S corporations Rents and royalties You may have noticed that excluded from the list are tax-exempt interest, wages, and distributions from qualified pension, profit-sharing, and stock bonus plans — although you may still be tagged with this tax (or a portion of it) if the trust or estate’s overall income is too high. In addition, it’s important to note that the tax is on net investment income, not gross investment income. As a result, you can allocate portions of all your deductible expenses against the total income, and only pay the tax on the portion that remains that’s over the limit. All irrevocable trusts that are required to file Form 1041 are subject to this tax. However, the following trusts are apparently excluded: Grantor trusts (all income is reported by the grantor on his/her individual income tax return) Charitable foundations Charitable remainder trusts The rules surrounding how investment versus non-investment income are treated in Electing Small Business Trusts (ESBTs) are quite complex. If you’re the trustee of an ESBT, you should check with a competent tax advisor for assistance in this calculation. How to calculate the tax The UIMC tax was only intended to apply to high-income individuals, but the basic inequity in the size of the tax brackets for trusts and estates versus individuals created an unfriendly environment for estates and trusts, one where only quite small entities are exempt from paying it. The tax is imposed as an additional tax, after all other income taxes are levied. How to lessen the tax’s impact The UIMC tax is only imposed on taxable income in the trust or the estate over certain limits; if the income doesn’t reach those limits, there’s no additional tax. So, your job as executor, administrator, or trustee is to try to reduce the taxable income in the trust, while still behaving in a responsible way. You could, for example: Keep track of capital gains and plan to offset gains with some losses, if necessary. As executor, you should be aware of the size of the estate’s capital gains before the end of the year. If your gains are large but you own something that’s a less-than-sterling performer, sell it before the end of the tax year. The loss from that sale will reduce the total gains year-to-date. Invest in tax-exempt bonds and funds. Remember, tax-exempt income isn’t included in the threshold calculation, so it isn’t subject to the tax. Increase distributions to beneficiaries, but only if the trust instrument allows, and the distribution otherwise makes sense. You still have to follow the terms of the trust instrument and pay attention to the intentions of the settlor. But if you manage to pass out income to beneficiaries, that income will be included in their threshold calculation for this additional tax, not the trust or estate’s. Plan deductions to fall into years when income is higher and pay fewer deductible expenses in years the trust doesn’t perform as well or when more is distributed to the beneficiary. That’s assuming you can predict these things, which you may not be able to precisely. But if you normally pay a trustee fee in January, and your income for the prior year is high enough to trigger this tax, you may want to take the January fee in December of the prior year. There is no perfect solution here because the techniques that might enable the trust or estate to pay taxes at a lower rate may not be consistent with either the intent of the donor or what’s in the best interest of the beneficiary. It’s up to you to weigh all these possibilities and arrive at the most equitable solution. Whatever you do, be sure to jot down your reasoning and put it in the file. That way, should anyone ever question your decision, you’ll be able to remind yourself why; and next year, when faced with the same questions and the same dilemmas, you’ll be able to see what you did in the past and judge for yourself how well it worked.

Cheat Sheet / Updated 03-09-2022

An estate plan, including a last will and testament, protects your family and finances after you die. Your first step in estate planning is to write a comprehensive will that moves smoothly through the probate process. Make sure you're aware of current estate taxes that may influence your planning and how insurance factors into your estate plan. Various types of trusts are available; do some research to find out whether setting up a trust is the way to go and consider some special circumstances that may arise and how they can affect your estate planning.

Cheat Sheet / Updated 02-25-2022

As the fiduciary of an estate or trust, you have many duties, beginning immediately upon the decedent’s (deceased person’s) passing. You’re also guaranteed to become intimately familiar with a host of tax forms you may not have known existed.

Article / Updated 12-22-2021

If you're preparing taxes for an estate or trust, be aware that the Income Distribution Deduction (Schedule B) is unique to these assets. When trusts and estates give income payments to beneficiaries, those payments carry income tax consequences for the trust or estate and for the beneficiaries. The trust or estate receives a deduction, and the beneficiaries must include the amount deducted from the Form 1041 on their individual Form 1040. Form 1041, Schedule B synthesizes all the important information into the all-important income distribution deduction. To complete Schedule B, follow these steps (unless the trust or estate is in its final year): Take the total from line 17 on the front of Form 1041 (line 1). Add that total to the adjusted tax-exempt interest, which is nothing more than total tax-exempt interest less fiduciary and other fees allocated to it (also known as the contents of line 2). Enter the net capital gain (flip your tax return to its front, and place the number you see on line 4 onto Schedule B, line 6 on the back). Subtract that number from your total of Schedule B, lines 1 and 2, to arrive at the distributable net income (DNI), or the total amount that could possibly be taxed to the beneficiary. If you’re preparing the return for an estate or simple trust, you can ignore Schedule B, line 8. If yours is a complex trust and you’re either not required to distribute all income or you distributed more than just income, you need to calculate trust accounting income (TAI). To calculate TAI, add lines 1 through 8 from the front of Form 1041 and the tax-exempt income from line 1 of “Other Information” on the back of Form 1041. Subtract capital gains or losses (line 4, Form 1041) and all fees and expenses that you charged against the income earned in the trust. Exclude fees and expenses charged against principal (including whatever fees you paid from the capital gains) when calculating TAI. Also, don’t allocate any of the income fees you’ve paid between taxable and tax-exempt income. On Schedule B, line 11, you put the total amount of distributions made from the estate or trust to beneficiaries during the tax year. These amounts may be mandatory. For example, in the case of a simple trust, all income must be distributed in the tax year that you’re preparing the return for. In this case, one of three scenarios may apply: If you’re required to distribute all, or any part, of the trust’s income, place the amount you’re required to pay to the beneficiary (even if you didn’t actually pay it) on line 9. Any amounts of income you paid to the beneficiary at your discretion, but that weren’t mandated by the trust instrument, belong on line 10. The total of lines 9 and 10 belongs on line 11. On line 12, calculate what portion of that total distribution came from tax-exempt income. If you distributed 100 percent of the income, place the number you have on Schedule B, line 2. If you distributed less than 100 percent, calculate the percentage of income you did distribute, and then multiply that percentage by the amount on Schedule B, line 2. Subtract line 12 from line 11 to arrive at line 13, Schedule B. Now that you’ve calculated line 13, you need to also arrive at line 14. Just subtract line 2 of Schedule B from line 7 and place your answer on line 14. Compare lines 13 and 14. The smaller of the two is the income distribution deduction. Place your answer on line 15, Schedule B, and then carry the result to line 18 on page 1 of Form 1041.

Article / Updated 12-22-2021

Simply put, probate is the legal process related to a deceased person's will, property and finances that takes place after they die. It can be long and costly, so to spare their families the hassle, many people opt to meet their estate planning goals through the proper use of beneficiary designations. You're likely familiar with beneficiary designations on life insurance policies, 401(k) plan assets, and IRA accounts, but you may not be aware that you can designate beneficiaries on other types of assets as well. You may establish a transfer on death (TOD) or payable on death (POD) beneficiary designation on your bank accounts. This same type of beneficiary designation is also available with many brokerage accounts. Contact your brokerage company to establish a beneficiary designation on your personal account. In a few states, you can have a beneficiary designation on your personal property and real estate. Contact your county's registrar of deeds office to find out whether this option is allowable and to figure out the process to register your beneficiary designation on personal property and real estate. If you own assets titled joint tenants with right of survivorship, that account already has the equivalent of a beneficiary designation. Your joint owner will automatically inherit 100 percent of the asset balance upon your death. Assets that transfer to your heirs automatically upon your death aren't subject to the terms of your will. The ownership of the account (joint tenants with right of survivorship) or the beneficiary designation takes precedence over your will. Those assets will be transferred directly to recipients without going through a long, tedious, and expensive probate process. Your will actually doesn't become effective until it has been entered into probate. The probate process typically takes 9 to 24 months to complete. By structuring your assets to minimize the number of items and total dollar value of assets that have to go through probate, you will save your executor (the one who you assign in your will to do this time-consuming, thankless job) a lot of time and your estate a lot of money.

Article / Updated 12-21-2021

In addition to making payments to the beneficiaries, as trustee, you’re also responsible for paying the expenses you incur in administering the trust. The primary expenses include trustee’s fees, investment advice, accounting fees, and taxes. Trustees’ fees A trustee’s fee is the amount the trust pays to compensate the trustee for his or her time. There is no set trustee’s fee. You can choose to base it on a small percentage of the market value of the assets plus a percentage of the income earned by the trust. You may opt to calculate the number of hours you spend and bill by the hour. You may even charge a flat fee, which is more like an honorarium. What you may not do is overcharge. Trustee fees are an income tax deduction for the trust but taxable income to you. You must declare these fees on your Form 1040, where you place them on line 21, Other Income. If you’re a professional trustee, this income is also subject to Self-Employment Tax. Otherwise, it’s income taxable only. Trustee fees are typically paid both from principal and income so as not to burden either side unduly. Investment advice in a trust Investment advice is deductible to the trust minus the 2 percent haircut to which miscellaneous itemized deductions are subject. Trust's accounting fees Unless you’re preparing Form 1041 by yourself, you also have to pay accounting or tax preparation fees. You may choose to pay these from income or principal, or a combination of the two. Accounting fees in a trust are usually charged on an hourly basis or on the complexity of the returns being prepared, and are fully deductible. Taxes in a trust State and local income taxes, real estate taxes, and personal property taxes are all deductible if paid by the trust on trust obligations. So, if the trust owns real estate, it gets to deduct those taxes. If, on the other hand, the trust pays the real estate taxes on property owned by the income beneficiary, the trust has actually made a distribution to the beneficiary. If the trust is only paying a capital gains tax, you pay that from principal. If the trust is accumulating income, you pay the entire tax from principal because the accumulated income is transferred to principal at the end of each year and becomes part of the principal. On occasion, when you don’t transfer accumulated income to principal, you pay taxes on the ordinary income of the trust from the income side, and the capital gains taxes from the principal side. To the extent that income is available in the trust to pass out to a beneficiary, that tax payment becomes an income distribution, and the beneficiary will receive a Schedule K-1 from the trust. Unlike individuals, who may deduct state sales taxes rather than state income taxes, state sales tax deductions aren’t available for trusts. After all, trusts don’t buy anything except for services, and those services typically aren’t subject to sales tax.

Article / Updated 12-21-2021

An estate or trust’s income retains its character, and so beneficiaries must be informed of this character. The Schedule K-1 (Form 1041) gives the beneficiary the specific allocation between all items of income, allowing easy transfer from the K-1 to the beneficiary’s Form 1040. When there is one income beneficiary, the total amount of the income distribution deduction (IDD) is shown on a single Schedule K-1, with allocations made between the different types of income. When there are multiple beneficiaries, you’re required to prepare a separate K-1 for each, with the total IDD divided among the beneficiaries on their K-1s in the same proportion as the distributions were made. Schedule K-1 allows your beneficiary to separate his or her income distribution into all the sorts of income received by the trust or estate. Because it is an attachment to Form 1041, you must distribute a copy of it to the income beneficiaries no later than the due date for Form 1041, as extended. Remember, the beneficiaries can’t prepare their 1040s until they receive their K-1s from you. Part I: Information about the estate or trust In Part I, fill out the tax identification number (the TIN), the name of the estate or trust, and the fiduciary’s name and address. You also have the opportunity to check a box to indicate whether and when you filed Form 1041-T, Allocation of Estimated Tax Payments to Beneficiaries (Under Code Section 643(g)). By checking Part I, Box D of Schedule K-1, you tell the beneficiary that he or she now has credit for additional tax payments, even though the trustee originally paid them on behalf of the trust. Code Section 643(g) allows you to assign estimated taxes paid by the trust or estate to individual beneficiaries in the final year of the trust or estate. Because the trust won’t owe any tax in its final year, it doesn’t need the estimated tax payments. Form 1041-T may only be filed in the final year of the trust or estate, is irrevocable, and must be made on or before the 65th day of the year following the end of the trust or estate’s tax year. If you’ve made a Code Section 643(g) election and allocated the estimated taxes, you have to check Box E to indicate it’s the final year of the trust or estate. Part II: Information about the beneficiary Schedule K-1, Part II is about as simple as it gets. On line F, put in the beneficiary’s TIN, and on line G, fill in the beneficiary’s name and address. In Box H, choose between a domestic or foreign beneficiary, whichever applies. If the beneficiary lives in the U.S., no further information is necessary. If the beneficiary resides in a foreign country, you may want to consult with a tax advisor who can check the foreign tax treaties involved and make sure you’re not required to withhold U.S. income taxes on distributions to this beneficiary.

Article / Updated 12-13-2021

Estate planning is all about what you want to have happen to you, your dependents, and your stuff when you’re gone. Estate planning also covers what happens if you’re alive but can’t make decisions for yourself. You may think that you don’t care what happens after you’re gone, but what about the family, friends, and stuff you leave behind? Do you care if the most important person in your life receives anything you may have of value, or are you okay with having the state decide how to divvy up your stuff? Who’s going to go through your underwear drawer? Who will care for your beloved cat or, more importantly, your dependent children? The first thing you need to do when planning your estate is to calculate your gross estate. Then you can employ different estate planning strategies based on the size and composition of your estate. Begin by entering your Net Worth total in Step 1 of the Calculating Your Gross Estate worksheet (shown in figure below), which you can download and print here. If you haven't yet determined your net worth, the Statement of Financial Net Worth Worksheet can help you figure it out. Download here. The number you came up with for your gross estate is probably bigger than you were expecting. That number represents, for most people, the stuff you need to figure out what to do with, and your estate plan tells the world what you want to happen to your stuff when you die.

Cheat Sheet / Updated 09-24-2021

Taking the time and attention to write a will and set up a trust — or a couple of trusts — are acts of generosity that your heirs and loved ones will appreciate in their time of grief. To do it right, you need to keep track of the people and papers involved, plan for incapacity, and know what you need from an estate plan, then review your plan regularly and especially after significant life changes.

Article / Updated 07-06-2021

Administering a trust is similar to organizing your own finances. However, a trustee must create a trust account for every year of the trust’s existence. This account traces all the activity in the trust from the ending balances of last year’s account to the closing balances at this year’s end. This information will be communicated to the trust’s beneficiaries and the probate court. Assembling trust administration info yearly Trusts divide transactions between principal and income. Although you can format them in a variety of ways, this figure shows a sample account in a form commonly used by most trust accountants. Schedule A minus Schedule B must equal Schedule C, and Schedule D minus Schedule E must equal Schedule F. If all your trust’s assets are held by one bank, brokerage, or law firm fiduciary department, they should send you annual trust accounts. If you’ve scattered the trust’s assets among a variety of financial institutions, the responsibility of compiling all the information into one account becomes yours. Although annual account preparation may seem like a lot of work for little benefit, it’s important for a trustee to do every year. Not only do you pick up any inconsistencies in your recordkeeping this way, but you also create a permanent record of set points in the trust’s timeline. Sample annual account for the XYZ Trust Click here to view this form. Obtaining assents of beneficiaries Once you’ve created an annual account, sign it and provide copies to all the beneficiaries for their assent, or approval. Prepare a summary cover sheet for the account, sign it as trustee, attach it to the six schedules, and provide a copy of the complete packet to the beneficiary. Include a photocopy of that cover sheet, which the beneficiaries then sign and return to you. Signed, these photocopies become the beneficiary’s assent to the account. After obtaining assents from all the beneficiaries, attach these signed documents to the front of your account, and keep the whole everything together in a permanent file. This figure shows a sample cover page, with the assent line included, for the annual account shown in the previous figure. Sample cover page for XYZ Trust annual account Click here to view this sample. Filing with the probate court If your trust is governed by an instrument contained within the Last Will of the trust’s grantor, you may file annual accounts with the probate court. In most cases, the annual account format shown in the first figure should be adequate, but obtain the court’s specific guidelines. Instead of using the cover sheet in the second figure, use the court’s cover. Even if you don't get pressure from the probate court to file the annual account, you are still required to file. Prepare and file accounts in a timely fashion; finding all the financial records you need years after the fact can be difficult.