Chapter 20

Estates and Trusts: Their Nature and the Accountant’s Role

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Key terms regarding estates and trusts Decedent - the deceased individual Died testate - decedent has left a will Died intestate - decedent has no will Probate court - determines validity of will Executor or Executrix - the fiduciary

responsible for the administration of a will as named in a will

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Key terms, continued

Administrator - if necessary, a court appointed individual responsible for the administration of a will

Principal or corpus - the assets of an estate Inter vivos trust - a trust formed during one’s

lifetime which passes property to one’s heirs without a will and therefore avoids the probate process

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Probate estate - the decedent’s assets which pass to others by means of a will

Gross estate - the assets of an estate which are considered for federal and/or state estate tax purposes

Property as joint tenants - such property passes in its entirety to the surviving tenant and is excluded from the decedent’s estate

Key terms, continued

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Community property - only the decedent’s interest in such property is included in the estate

Homestead or family allowance - certain assets of the decedent which are exempt from the probate process and are intended to support the family homestead and its members

Key terms, continued

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Identifying claims against the probate estate

Claims are identified, validated, and generally placed in the following order of priority:

1. Claims having a special lien against property, but not to exceed the value of the property

2. Funeral and administrative expenses

3. Taxes: income, estate, and inheritance

4. Debts due the United States and various states

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Identifying claims, continued

5. Judgements of any court of competent jurisdiction

6. Wages due domestic servants for a period of not more than one year prior to date of death and medical claims for the same period

7. All other claims

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Computation of the federal estate taxGross estate XXLess deductions allowed - XXTaxable Estate XXAdd post-1976 taxable gifts +XXUnified tax base XX

Tentative tax on total transfers XXLess tax credits - XXEstate tax due XX

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Allowable deductions Allowable expenses, such as funeral expenses

and costs of administrating the estate Indebtedness against property included in the

gross estate, such as a mortgage and other debts of the decedent

Unpaid property and income taxes of the decedent to date of death

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Allowable deductions, continued Uninsured losses from casualty or theft of

estate assets during the period of settlement Transfers to charity specified by the will Marital deduction, which is unlimited in

amount, for estate property that passes to the surviving spouse if they are a U.S. citizen

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Post-1976 taxable gifts Such gifts are included in the unified tax base For gifts after 1981, taxable gifts result if such

gifts exceed $10,000 ($20,000 for consenting spouse gifts) per donee per year

The Taxpayers Relief Act of 1997 contains provisions to increase the $10,000 annual exclusion for inflation beginning in 1998

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The Unified Credit Excludes a portion of the taxable estate from

taxation The credit amount corresponds with the unified

transfer tax which would be due on the exclusion amount

The applicable exclusion amount and corresponding credit vary by year

The credit may be used to reduce estate or gift taxes

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Credit Shelter Trusts Sometimes referred to as marital deduction

trusts or “A-B” trusts Such trusts shelter a portion of the estate from

estate tax To maximize their benefit, the amount of such

trusts should equal the exclusion amount which corresponds with the unified credit

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Valuation of gross estate assets Assets are valued at fair market value at the

date of death An alternative valuation date may be employed

– if employed, all estate assets must be valued as of six months after the decedent’s death, except for property sold, distributed, or otherwise disposed of during the six month period

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Valuation of gross estate, continued

– such property is valued as of the date of disposition

– the alternative valuation date may be used only if it would reduce the total gross estate and decrease the estate tax liability

The recipient of property acquired from a decedent has a basis in such property at its fair market value on the date of death or alternative valuation date

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Other taxes affecting an estate Most states assess an inheritance tax on the value

of estate assets conveyed to heirs. The tax is levied on the heirs rather than the estate

An estate is viewed as a separate entity Estate income that is distributed currently and

properly to a beneficiary generally is excluded from the taxable income of an estate

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Other taxes affecting an estate, continued

Normally, the beneficiary is taxed on taxable income received, and the estate, as a separate taxable entity, is taxed on any taxable income that it accumulates

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Measurement of estate income The gains or losses on the sale of estate assets

are considered a component of estate principal rather than estate income

When bonds are part of an estate at the time of death, the premium or discount on such bonds is not amortized

If bonds are subsequently purchased by the fiduciary, a premium is amortized whereas a discount is not amortized

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Measurement of income, continued Generally depreciation is not charged against

estate income Depletion on wasting assets is generally

charged against estate income

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Settling a Probate Estate; Distributions of the Property In an intestate distribution, generally only a

spouse or blood relative may receive property

In a testate distribution:– a distribution of real property is a devise to a

devisee

– a distribution of personal property is a legacy to a legatee

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Settling a Probate Estate, continued Types of legacies include

– specific

– demonstrative

– general

– residuary

If assets are not adequate to satisfy legacies, a process called abatement is followed

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The Charge and Discharge Statement The statement is prepared by the fiduciary

in order to report to the probate court the activities during the period of stewardship

The statement reports on estate principal and estate income

The fiduciary is charged for the assets of the estate and discharged or credited for assets distributed or conveyed

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Trusts

A separate entity that receives an individual’s assets for purposes of managing them and distributing them over time

A trust is recognized as a taxable entity

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Trusts are created for a variety of purposes– charitable remainder trusts

– inter vivos trusts

– credit shelter trusts

– Q-TIP trusts

Trusts, continued

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Trusts, continued Trusts which become operative during

one’s lifetime are referred to as inter vivos or living trusts

Trusts which are created through a will are referred to as testamentary trusts

Accounting for a trust is similar to accounting for an estate. A distinction is made between trust principal and income