Form 1041 Reporting of Pecuniary Property-in-Kind Distributions: Tax - - PowerPoint PPT Presentation

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Form 1041 Reporting of Pecuniary Property-in-Kind Distributions: Tax Impact on Trusts and Estates

WEDNESDAY , MAY 3, 2017, 1:00-2:50 pm Eastern

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FOR LIVE PROGRAM ONLY

May 3, 2017

Form 1041 Reporting of Pecuniary Property-in-Kind Distributions

Lawrence H. McNamara, Jr., CPA, FVS, TEP Bend, Ore. larry@lhmcpa.com Klaralee R. Charlton, J.D., LL.M. Katz Look & Onorato, Denver kcharlton@thedenverlawyers.com

Notice

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You (and your employees, representatives, or agents) may disclose to any and all persons, without limitation, the tax treatment or tax structure, or both, of any transaction described in the associated materials we provide to you, including, but not limited to, any tax opinions, memoranda, or other tax analyses contained in those materials. The information contained herein is of a general nature and based on authorities that are subject to change. Applicability of the information to specific situations should be determined through consultation with your tax adviser.

S T R A F F O R D P U B L I C A T I O N S , I N C M A Y 3 , 2 0 1 7 K L A R A L E E R . C H A R L T O N , J . D . L L . M . K A T Z , L O O K & O N O R A T O , P . C .

D E N V E R , C O L O R A D O K C H A R L T O N @ T H E D E N V E R L A W Y E R S . C O M 3 0 3 - 8 3 2 - 1 9 0 0

Form 1041 Reporting of Pecuniary Property-in-Kind Distributions

Klaralee R. Charlton | Katz, Look & Onorato, P.C.

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Taxation of Trusts and Estates

Klaralee R. Charlton | Katz, Look & Onorato, P.C.

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Taxation of Trusts and Estates

Total Income Minus Deductions = Adjusted Total Income Minus Income Distribution Deduction Minus Exemption = Taxable Income

Klaralee R. Charlton | Katz, Look & Onorato, P.C.

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Income Distribution Deduction

Klaralee R. Charlton | Katz, Look & Onorato, P.C.

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Income Distribution Deduction

Klaralee R. Charlton | Katz, Look & Onorato, P.C.

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Taxation of Trusts and Estates

Trust

$300 Dividends ($50 Attorney Fees) Adjusted Total Income $250 Distributions to Beneficiaries $500

Beneficiary 1 K-1 for $125 Dividend Income Beneficiary 2 K-1 for $125 Dividend Income

Klaralee R. Charlton | Katz, Look & Onorato, P.C.

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Income Taxation of a Pecuniary Bequest

Klaralee R. Charlton | Katz, Look & Onorato, P.C.

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Pecuniary Bequest Factors

1.

Bequest must be provided for in the Document

• 2. Identify a sum of money (or property)

3.

Paid in 3 installments or less

I.R.C. § 663; C.F.R. § 1.663-1

Klaralee R. Charlton | Katz, Look & Onorato, P.C.

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Example Language

Standard Pecuniary Bequest Language “Upon my death, my Trustee shall distribute the sum

• f Ten Thousand and 00/100 Dollars ($10,000) to

each of my then living grandchildren, outright and free

• f trust.”

OR “Upon my death, my Personal Representative shall distribute the sum of Ten Thousand and 00/100 Dollars ($10,000) to my neighbor, Fred Rodgers.”

Klaralee R. Charlton | Katz, Look & Onorato, P.C.

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Example Language

“Upon my death, my Personal Representative shall distribute my house to my son and a sum of money equal to the value of my house to my daughter.” Both the distribution of the house and of the money qualify for treatment under I.R.C. § 663.

Klaralee R. Charlton | Katz, Look & Onorato, P.C.

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Bequests that Will Not Qualify

1.

The amount of money or identity of the specific property is not ascertainable under the terms of the governing document as of the date of death;

• 2. An amount which can be paid or credited only from

the income of an estate or trust;

3.

An annuity;

• 4. A residuary estate or the corpus of a trust; or

5.

A bequest paid in a lump sum, if the gift or bequest is required to be paid in more than three installments under the governing instrument.

Klaralee R. Charlton | Katz, Look & Onorato, P.C.

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Example Language (not a pecuniary bequest)

“Upon my death, my Trustee shall distribute the sum

• f Ten Thousand and 00/100 Dollars ($10,000) to

each of my then living grandchildren, outright and free

• f trust each year for 5 years.” >3 Installments

OR “Upon my death, my Personal Representative shall distribute the remainder of my estate to my neighbor, Fred Rodgers.” Residuary

Klaralee R. Charlton | Katz, Look & Onorato, P.C.

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Example Language (not a pecuniary bequest)

“Upon my death, my Personal Representative shall distribute to my spouse money or property equal to 50% of my adjusted gross estate.” Identity at DoD “My Trustee shall distribute the sum of Ten Thousand and 00/100 Dollars ($10,000) from income to each of my grandchildren when they reach age 25.” Payable Solely from Income

Klaralee R. Charlton | Katz, Look & Onorato, P.C.

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Basics of Distributable Net Income (DNI)

Trust

$300 Dividends ($50 Attorney Fees) Adjusted Total Income $250 Distributions to Beneficiaries $500

Beneficiary 1 K-1 for $125 Dividend Income Beneficiary 2 K-1 for $125 Dividend Income

Klaralee R. Charlton | Katz, Look & Onorato, P.C.

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DNI and Specific Pecuniary Bequest

 Simple Will distributes $10,000 to Friend and

divides remainder 50/50 between Son and Daughter

 Estate assets on date of death include:

 Savings Account $50,000  House $220,000  IRA Payable to Estate $10,000

Klaralee R. Charlton | Katz, Look & Onorato, P.C.

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DNI and Specific Pecuniary Bequest

 During administration the house is sold for

$250,000, the $10,000 IRA is cashed in, and the $50,000 savings account earns $100 interest.

 Administration expenses totaled $3,000.  The administration is completed in one year.

$10,000 cash is distributed to Friend. $297,100 cash is distributed between Son and Daughter.

Klaralee R. Charlton | Katz, Look & Onorato, P.C.

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DNI and Specific Pecuniary Bequest

On the Estate’s Form 1041, the following will be reported:

 Line 1, Interest Income $100  Line 4, Capital Gain/Loss $30,000  Line 8, Other Income (1099R) $10,000  Line 14, Attorney Fees ($3,000)  Line 17, Adjusted Total Income $37,100

Klaralee R. Charlton | Katz, Look & Onorato, P.C.

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DNI and Specific Pecuniary Bequest

The Estate will take an income distribution deduction of $37,100 on account of the distributions made to Son and

• Daughter. The estate will have a zero tax liability. IRC § 661.

The Adjusted Total Income of $37,100 will be divided equally between Son and Daughter on the Final Schedule K-1 resulting in each reporting $18,550 of income on their personal returns. IRC § 662. The Friend who received the $10,000 specific pecuniary bequest will not receive a Schedule K-1 and will report NO income on his personal return. IRC § 663.

Klaralee R. Charlton | Katz, Look & Onorato, P.C.

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Basics of Distributable Net Income (DNI)

Friend $10,000 No Schedule K-1 Trust Adjusted Total Income $37,100 Distributions to Residuary Beneficiaries $297,100 Son K-1 for $18,550 Income (Ordinary, Cap Gain, Int) Daughter K-1 for $18,550 Income (Ordinary, Cap Gain, Int)

Klaralee R. Charlton | Katz, Look & Onorato, P.C.

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Interest Income on a Pecuniary Bequest

Klaralee R. Charlton | Katz, Look & Onorato, P.C.

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 Under local law, the estate/trust may have to pay

interest to the recipient of a pecuniary bequest if the bequest is not paid within a designated time period.

 No Income Distribution Deduction may be taken by

the entity on account of the interest paid. Rev. Rul. 73-322.

 Beneficiary must report interest portion as Income

• n its own income tax return.

Basics of Distributable Net Income (DNI)

Friend $10,000 No Schedule K-1 Interest income to Friend if Paid under Local Law Trust Adjusted Total Income $37,100 Line 10 Interest Deduction??? Distributions to Residuary Beneficiaries $297,100 Son K-1 for $18,550 Income (Ordinary, Cap Gain, Int) Daughter K-1 for $18,550 Income (Ordinary, Cap Gain, Int)

Klaralee R. Charlton | Katz, Look & Onorato, P.C.

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Distribution of Substitute Property

If a pecuniary bequest would otherwise qualify under I.R.C. § 663 and property is distributed to the beneficiary in lieu of cash, then:

1.

Distribution is not taxable to the beneficiary;

• 2. Gain or Loss is recognized by the trust or estate;

3.

Beneficiary’s tax basis = FMV at Distribution;

• 4. Beneficiary’s holding period starts over.

Klaralee R. Charlton | Katz, Look & Onorato, P.C.

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Example Distribution of Substitute Property

 Simple Will distributes $250,000 to Friend and

divides remainder 50/50 between Son and Daughter

 Estate assets on date of death include:

 Savings Account $50,000  House $220,000  IRA Payable to Estate $10,000

Klaralee R. Charlton | Katz, Look & Onorato, P.C.

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DNI and Distribution of Substitute Property

 During administration the house appreciates in value

to $250,000, the $10,000 IRA is cashed in, and the $50,000 savings account earns $100 interest.

 Administration expenses totaled $3,000.  Executor decides to distribute the house to Friend in

satisfaction of the specific bequest. $57,100 cash is distributed between Son and Daughter.

Klaralee R. Charlton | Katz, Look & Onorato, P.C.

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DNI and Distribution of Substitute Property

On the Estate’s Form 1041, the following will be reported:

 Line 1, Interest Income $100  Line 4, Capital Gain/Loss Deemed Sale of House $30,000  Line 8, Other Income (1099R) $10,000  Line 14, Attorney Fees ($3,000)  Line 17, Adjusted Total Income $37,100

Klaralee R. Charlton | Katz, Look & Onorato, P.C.

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DNI and Distribution of Substitute Property

The Estate may not take an income distribution deduction

• n account of the distribution of the house to Friend and

will pay tax on gain from deemed sale. Friend who received the House in satisfaction of the specific pecuniary bequest will not receive a Schedule K-1 and will report NO income on his personal return. IRC § 663. Friend’s tax basis will be the fair market value of the House at the time of distribution ($250,000) and his holding period will begin at the date of distribution.

Klaralee R. Charlton | Katz, Look & Onorato, P.C.

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Distribution of Substitute Property

CONTRAST with: If a pecuniary bequest is payable in >3 installments and property is distributed to the beneficiary in lieu the entire bequest, then:

 Distribution is taxable income to the beneficiary to the

extent of the FMV of the property;

 Gain or Loss is recognized by the trust or estate and can

be passed through to the beneficiary of the property;

 The beneficiary’s tax basis in the property is the fair

market value of the asset as of date of distribution;

 The beneficiary’s holding period begins as of the date of

distribution.

Klaralee R. Charlton | Katz, Look & Onorato, P.C.

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Distribution of Substitute Property >3 Inst.

 Simple Will distributes $50,000 to Friend each year

for 5 years and divides remainder 50/50 between Son and Daughter

 Estate assets on date of death include:

 Savings Account $50,000  House $220,000  IRA Payable to Estate $10,000

Klaralee R. Charlton | Katz, Look & Onorato, P.C.

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DNI and Distribution of Substitute Property

 During administration the house appreciates in value

to $250,000, the $10,000 IRA is cashed in, and the $50,000 savings account earns $100 interest.

 Administration expenses totaled $3,000.  Executor decides to distribute the house to Friend in

full satisfaction of the annual specific bequests. The $57,100 cash is distributed to Son and Daughter.

Klaralee R. Charlton | Katz, Look & Onorato, P.C.

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DNI and Distribution of Substitute Property

On the Estate’s Form 1041, the following will be reported:

 Line 1, Interest Income $100  Line 4, Capital Gain/Loss Deemed Sale of House $30,000  Line 8, Other Income (1099R) $10,000  Line 14, Attorney Fees ($3,000)  Line 17, Adjusted Total Income $37,100

Klaralee R. Charlton | Katz, Look & Onorato, P.C.

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DNI and Distribution of Substitute Property

The Estate will take an income distribution deduction

• f $37,100 on account of the distributions made to

Friend, Son, and Daughter. The estate will have a zero tax liability. IRC § 661. The Adjusted Total Income of $37,100 will allocated among Friend, Son and Daughter on the Schedule K-1. IRC § 662.

Klaralee R. Charlton | Katz, Look & Onorato, P.C.

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DNI and Distribution of Substitute Property

The Friend who received the House in satisfaction of the specific pecuniary bequest will have a tax basis of the fair market value of the House at the time of distribution ($250,000) and his holding period will begin at the date of distribution.

Klaralee R. Charlton | Katz, Look & Onorato, P.C.

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Brief Recap

If a Pecuniary Bequest is:

Provided for in the Document Identifies a sum of money (or property) Payable in 3 installments or less

Then, the trust/estate may not take an income distribution deduction for the bequest and the distribution will not be taxable to the beneficiary. Furthermore, if property is distributed in satisfaction of the pecuniary bequest, the trust/estate will recognize this as a deemed sale to the beneficiary.

Klaralee R. Charlton | Katz, Look & Onorato, P.C.

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Formula Pecuniary Bequests

 Not all pecuniary bequests will be as straightforward

as “$10,000 to my Friend” or “the value equal to the devise made to my Son.”

 If a formula pecuniary bequest meets the 3 specific

bequest factors, then the beneficiary will not share in entity DNI and entity may not take income distribution deduction.

 Gain/Loss may be recognized at entity level to the

extent bequest is funded with assets.

Klaralee R. Charlton | Katz, Look & Onorato, P.C.

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Formula Pecuniary Bequests

Estate

Total Assets $6,000,000 Estate Tax Exemption $5,490,000

Bypass Trust $5,490,000 Marital Trust $510,000

Klaralee R. Charlton | Katz, Look & Onorato, P.C.

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Formula Pecuniary Bequest

Sample Pecuniary Marital Language: “I give to the Trustee of the Marital Trust the smallest pecuniary amount that, if allowed as a federal estate tax marital deduction, would result in the least possible federal estate tax being payable by reason of my death.”

Klaralee R. Charlton | Katz, Look & Onorato, P.C.

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Formula Pecuniary Bequest

Sample Pecuniary Bypass Language: “I give to the Trustee of the Bypass Trust the largest pecuniary amount that can pass without payment of estate tax, after taking into account the applicable exclusion amount, and which will result in the least possible federal estate tax being payable by reason of my death.”

Klaralee R. Charlton | Katz, Look & Onorato, P.C.

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Formula Pecuniary Bequest

1.

Residuary beneficiaries benefit or suffer from Appreciation or Depreciation.

• 2. Gain/Loss from Funding with Assets or from the

sale of assets to fund the share is borne by the residuary.

3.

Pecuniary Share does not recognize gain or loss on assets distributed to it in satisfaction of its pecuniary bequest.

Klaralee R. Charlton | Katz, Look & Onorato, P.C.

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Formula Pecuniary Bequest

Marital VS Bypass Pecuniary Bequest Formula if Estate Appreciates to $7,000,000 before funding:

Estate

Marital Formula

Bypass Trust $6,490,000 Marital Trust $510,000

Estate

Bypass Formula

Bypass Trust $5,490,000 Marital Trust $1,510,000

Klaralee R. Charlton | Katz, Look & Onorato, P.C.

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Formula Pecuniary Bequest

Marital VS Family Pecuniary Bequest Formula if Estate Depreciates to $5,000,000 before funding:

Estate

Marital Formula

Bypass Trust $4,490,000 Marital Trust $510,000

Estate

Bypass Formula

Bypass Trust $5,000,000 Marital Trust $0

Klaralee R. Charlton | Katz, Look & Onorato, P.C.

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Funding a Formula Pecuniary Bequest

Three Funding Alternatives Rev. Proc. 64-19:

1.

True Worth

• 2. Fairly Representative

3.

Minimum Worth

Klaralee R. Charlton | Katz, Look & Onorato, P.C.

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True Worth Funding Language

“My Trustee shall have discretion to select the assets to be allocated to the Marital Trust and the Bypass Trust; provided, however, that the assets allocated to each Trust shall be valued at their respective fair market values on the date of each allocation.” “My Executor shall select and distribute to the Trustee the cash, securities and other property that will constitute the trust, employing for that purpose values current at the time of distribution.”

Klaralee R. Charlton | Katz, Look & Onorato, P.C.

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True Worth Funding Marital Pecuniary Bequest

Marital Trust Funded with House Worth $510,000 DOD Value was $460,000 Trust Recognizes gain of $50,000 on Funding of Marital Trust

Bypass Trust K-1 for $50,000 Gain on House Funded to Marital Trust

Klaralee R. Charlton | Katz, Look & Onorato, P.C.

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Fairly Representative Funding Language

“My Trustee shall have discretion to select the assets to be allocated to the Marital Trust and the Bypass Trust; provided, however, that the assets allocated to each Trust be fairly representative of the proportional share of the appreciation or depreciation in value, to the date or dates or distribution, of all property when available for distribution.”

Klaralee R. Charlton | Katz, Look & Onorato, P.C.

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Fairly Representative Funding

Estate Plan Leaves $4,000,000 pecuniary bequest to the Marital Trust.

Klaralee R. Charlton | Katz, Look & Onorato, P.C.

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Trust Assets Death Trust Assets Funding House $2,000,000 House $2,500,000 Land $2,000,000 Land $1,500,000 Stocks $3,000,000 Stocks $2,500,000 Bonds $1,000,000 Bonds $1,500,000

Fairly Representative Funding Pecuniary Bequest

Marital Trust $4,000,000 Assets Basis = Date of Death Value Transferred Holding Period Trust No gain / loss recognized on funding spouse’s pecuniary bequest. No deemed sale transaction at the trust level.

Bypass Trust No Schedule K-1 because no gain/loss recognized at Trust level

Klaralee R. Charlton | Katz, Look & Onorato, P.C.

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Minimum Worth Funding Language

“My personal representative shall select and distribute the cash, securities, and other property, including real estate and interests therein, that will constitute the marital bequest, employing for the purpose of valuation the lesser of (a) the federal estate tax value of any asset, or the replacements of or the proceeds of any asset, included in my gross estate or (b) the current value of the asset at the time of distribution.”

Klaralee R. Charlton | Katz, Look & Onorato, P.C.

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Minimum Worth Funding

Klaralee R. Charlton | Katz, Look & Onorato, P.C.

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Davis, Wright & Tremaine LLP http://www.dwt.com/files/Uploads/Documents/Presentations/10-09_AdvisingTaxableEstate_1.pdf

Minimum Worth Funding Pecuniary Bequest

Marital Trust Basis = Date of Death Value Transferred Holding Period Trust No gain / loss recognized on funding spouse’s pecuniary bequest. No deemed sale transaction at the trust level.

Bypass Trust No Schedule K-1 because no gain/loss recognized at Trust level

Klaralee R. Charlton | Katz, Look & Onorato, P.C.

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Contrast with Fractional Share Funding

 “I give a fractional share of my residuary estate of

which (a) the numerator is the smallest amount that, if allowed as a federal estate tax marital deduction, would result in the least possible federal estate tax being payable by reason of my death, and (b) the denominator is the value of my residuary estate as finally determined for federal estate tax purposes.”

Klaralee R. Charlton | Katz, Look & Onorato, P.C.

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Fractional Share Funding

Main Trust No recognition of gain/loss on distribution of assets.

Marital Trust Tax Basis Carries Over Transferred Holding Period Bypass Trust Tax Basis Carries Over Transferred Holding Period

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