Case Study of a Complex Fiduciary Income
Tax Return Form 1041
John R. Anzivino, CPA
Claudia M. Bendana, CPA
Kaufman Rossin
November 19, 2015
1
Facts:
•
•
•
•
Date of death: April, 2013
Decedent was survived by five adult children
Decedent created several revocable trusts during life
S-Corp revocable trust required to pay debts of decedent, administration
expenses and estate tax
DOD Value
Cash
2,000,000
Closely held S Corp stock – 12/31 year end
Marketable Securities
156,000,000
36,000,000
Annuities
7,000,000
Miscellaneous & tangible personal property
Gross Estate
Section 2053 and 2054 deductions
Adjusted gross estate
10,000,000
211,000,000
(3,000,000)
208,000,000
2
Section 6166: Extension of
Time to Pay Estate Tax
•
To qualify, the aggregate value of the decedent’s ownership
interests in each closely held business of 20% or more must
exceed 35% of the adjusted gross estate
•
The estate tax attributable to the value of the closely held
business interests may be deferred for five (5) years (interest
only) and ten (10) years (principal and interest)
•
The estate qualifies because about 75% of the decedent’s
adjusted gross estate is comprised of closely-held business
interests.
•
$62 million of the $83 million estate tax due qualifies for
deferral.
3
Trust as S Corp Shareholder
• The estate of a deceased shareholder is a permitted
shareholder of an S corporation (IRC § 1361(b)(1)(B)).
• A trust is generally not a permitted S corporation
shareholder. Certain trusts may be S Corp shareholders for
a period of time. (IRC § 1361(c)(2))
• A “qualified revocable trust” joining an estate income tax
return through a §645 election is a permitted S-corp
shareholder as long as a §645 election is in place.
4
Section 645 Election
- A “qualified revocable trust” is any trust (or portion thereof)
that on the date of death of the decedent was treated as owned
by the decedent under IRC Section 676 – Power to Revoke.
- Section 645 election allows a “qualified revocable trust” to
file a combined Form 1041 with the estate. Benefits of the
election include:
• Income tax deferral by using fiscal year end
• Combined income and deductions
• Delay making ESBT/QSST elections
5
Section 645 Election Period
– Election applies from date of death to the “applicable date”,
which is the later of the following:
• two years from date of death or
• six (6) months after the date of the final determination of
the estate tax liability, even though payment may be
deferred under §6166.
– When the §645 election terminates and if the S Corp stock will
continue to be owned by the trust, ESBT or QSST elections need
to be made.
6
Section 645 Combined Form 1041
Estate
Revocable
Trust #1
S-Corp
Revocable
Trust
• Chose fiscal year-end 11/30; S-Corp K-1 for 12/31 not reported
until following tax reporting period
• Eleven (11) month deferral of $10,000,000 of income tax on
$25,000,000 business income
• Estate and revocable trust income and expenses are combined
• What about distributable net income (DNI)?
7
§ 663(c) - Separate share rule
•
A separate share exists if the economic interests of the
beneficiary or class of beneficiaries neither affect nor are
affected by the economic interests accruing to another
beneficiary or class of beneficiaries (Reg 1.663(c)-4)
•
A share may be considered as separate even though more
than one beneficiary has an interest in it.
•
The same person may be a beneficiary of more than one
separate share.
•
An estate and qualified revocable trusts for which an election
is made under §645 are always a separate shares for purposes
of allocating DNI and those shares may contain two or more
separate shares.
8
Specific Bequests in Trust – Separate shares?
•
A beneficiary’s interest in a specific bequest in trust is a separate
economic interest, thus a separate share
•
Florida Statute 738.202 states that each beneficiary described in
738.201(4) is entitled to receive a portion of the net fiduciary
accounting income
•
Florida Statutes 738.201(4) states that the fiduciary shall
distribute the net fiduciary accounting income … to all other
beneficiaries, including a beneficiary who receives a pecuniary
amount in trust
•
Each beneficiary’s share of fiduciary accounting income is equal to
the beneficiary’s share of undistributed principal assets on date of
distribution
9
Separate Shares
Specific
bequest
Trust 1
Estate
Specific
bequest
Trust 2
Revocable
Trust #1
Specific
bequest
Trust 3
S-Corp
Revocable
Trust
Specific
bequest
Trust 4
Residue
Residue
Trust share 1
Trust share 1
Trust share 2
Trust share 2
Trust share 3
Trust share 3
Trust share 4
Trust share 4
Trust share 5
Trust share 5
10
Fiduciary Accounting Income and Distributable Net Income
Flow – Year 1
Estate
No distributions
Revocable
Trust #1
Partial funding of
specific bequests in
trust
S-Corp
Revocable
Trust
No income
No distributions
Revocable Trust #1 partial funding of the specific bequests
in trust causes a portion of DNI of the Revocable Trust #1
only to be allocated to those specific devisee trusts
11
Allocation of Fiduciary Accounting Income to Specific
Devisees in Trust -Year 1
Revocable Trust #1 Assets
DOD Value
Marketable Securities
Retirement Account payable to Trust
Annuities payable to Trust
36,000,000.00
200,000.00
3,500,000.00
Total Assets
39,700,000.00
Specific Bequests in Trust
Trust #1
Trust #2
Trust #3
Trust #4
Residue
FAI Allocation Denominator
2,000,000.00
2,000,000.00
500,000.00
500,000.00
34,700,000.00
39,700,000.00
12
5.04%
5.04%
1.26%
1.26%
87.41%
100.00%
Fiduciary Accounting Income and
Distributable Net Income Flow – Year 2
$21,000,000 loan
to pay estate tax
$2,400,000 Loan Payment
$2,400,000 residuary distributions
$2,500,000 specific bequests in trust
•
•
4 Specific bequest trusts receive
DNI based on their share of
Fiduciary Accounting Income
Residuary beneficiaries receive
balance of DNI in equal shares
13
Distribution
$2,400,000
S Corp Revocable
Trust
Estate and
Revocable Trust #1
Income 1,000,000
S Corp
Business income
$25,000,000
$0 distributions
•
DNI remains in the trust
•
Business income not subject
to Net Investment Income
Tax due material participation
by the fiduciary
Material Participation and Net Investment
Income Tax
• Section 469(h) states that material participation requires
“regular continuous and substantial” involvement in the
operations of the business.
• The sole fiduciary of S-Corp Revocable Trust is involved in
the operations of the business on a regular, continuous and
substantial basis.
• What if the Trust makes distributions to beneficiaries who
do not materially participate?
– Reg 1.1411-3(e)
14
§691 Income in Respect of Decedent
• Income in respect of a decedent (“IRD”) is gross income a
decedent was entitled to receive at the time of death but not
included on the final Form 1040
Examples: unpaid wages, installment sales, annuities, IRAs
• IRD is subject to estate tax and income tax.
• An income tax deduction for the estate tax paid on the IRD is
allowed (§691(c))
• The IRD deduction is a miscellaneous itemized deduction not
subject to the 2% AGI limitation.
15
S-Corp Trust - Fiduciary Accounting Issues
• S-Corp trust is required to pay debts of decedent,
administration expenses and estate tax
• S Corp Trust lacks liquidity
• S-Corp distributions are income (Fla. Stat §738.401(2))
• Estate, inheritance and other transfer taxes are
disbursements from principal (Fla. Stat. 738.702(f))
• What to do? Fla. Stat. § 738.704?
16
Contact us
John R. Anzivino, CPA
Estate & Trust Principal
Kaufman Rossin
305.857.6706
janzivino@kaufmanrossin.com
Claudia Bendana, CPA
Estate & Trust Manager
Kaufman Rossin
305.646.6101
cbendana@kaufmanrossin.com