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Advanced Issues in Probate for the Paralegal
Prepared by J. Randolph Robida,
Attorney at Law
© December, 2000
J. Randolph Robida all rights reserved.
The following materials were presented at a seminar held in Denver, Colorado, on July 26, 2000, sponsored by Institute
for Paralegal Education, a division of National Business Institute ("NBI"). The program, "Advanced Issues in Probate for
the Paralegal" was presented by attorneys, Randolph Robida and Robert L. Sagrillo, of Sagrillo, Hammond & Dineen,
LLC. The materials contained in this page are from the portion of the program delivered by Randy Robida. If you would
like additional information about the issues discussed herein, related legal issues, or other seminars presented by Randy
Robida or NBI, please contact our office, or NBI.
Please Note: These materials should not be used as a substitute for professional advice where questions of
interpretation should be addressed by a professional advisor. Please read the DISCLAIMER before continuing on this
Advanced Issues in Probate for the Paralegal
TABLE OF CONTENTS
Examining the Guidelines of Fiduciary Responsibilities and Liabilities
ADVANCED ISSUES IN PROBATE FOR THE PARALEGAL
EXAMINING THE GUIDELINES OF
FIDUCIARY RESPONSIBILITIES AND LIABILITIES
- ELECTING ALTERNATIVE VALUATION DATES
- A GENERAL RULE. For purposes of the estate tax, the value of the property included in the gross estate is
generally determined as of the date of death. Internal Revenue Code Section 2031.
- ALTERNATE VALUATION DATE. As a result of the 1929 stock market crash, Congress realized that there
could be instances where the value of estate assets decreased so rapidly that the imposition of a tax based on the
date of death value was a substantial hardship. Internal Revenue Code Section 2032 allows the personal
representative to choose to value the estate's property on the day six months following the date of death, instead
of on the date of death.
- Example: Captain Ricard passes away December 31, 2000, one day before the US Supreme Court rules
that the Microfluff Minnows operating system constitutes a public nuisance, and shall be banned. Virtually
all of Captain Ricard's estate consists of Microfluff stock which was worth $10,000,000 on the date of his
death, but is worth only $1,000,000 the day after his death. If not for Section 2032A, Captain Ricard's
estate would have to pay an estate tax based on the date of death value of $10,000,000. The estate tax
would be roughly $5,000,000, more than the total value of the estate available for payment of tax the day
following Captain Ricard's death. Section 2032 allows the personal representative to value the estate six
months after the date of death, so that the amount of tax due is based on the value of the assets available to
pay the tax.
- REQUIREMENTS. The election to use the alternate valuation date can be made only when it will decrease both
the value of the gross estate and the amount of estate tax payable. In addition, it must reduce the amount of any
generation skipping tax. I.R.C. § 2032(c). These rules were designed to prevent an estate with no estate tax
liability from making use of the alternate valuation date to increase the income tax basis in estate assets. (Note the
basis of estate assets is increased to the date of death fair market value under Code Section 1014.)
- Example: Decedent dies January 1, 1999. His only asset is an investment portfolio worth $400,000 at the
date of death. Because the value of the estate is less than the estate tax exemption equivalent, there is no
estate tax due. Six months later the value of the investment portfolio is $600,000, an amount which is still
less than the estate tax exemption equivalent.
Under these circumstances, without the restrictions listed above, the Personal Representative could choose the alternate
valuation date to get an increased income tax basis in the investment portfolio without incurring any estate taxes as a result
- TIMING. The election must be made on the estate tax return. A valid election may be made on a return filed up to
one year after the return due date, including extensions. Once the election is made, it cannot be revoked, even if
the attempted revocation is made prior to the return due date. If the election is not made on the return, the
personal representative may make the election on a subsequent return if filed by the due date including
extensions. It may be possible to make a protective election which can be withdrawn later or to file a return
without making an election and file a subsequent amended return by the regular due date, including extensions.
The IRS is authorized to allow an election after the time specified above and generally will do so if it determined that the
failure to file an election was reasonable and in good faith and that allowing a subsequent election would not adversely
affect the government's interest.
- CONSIDERATION IN DECIDING WHETHER TO MAKE THE SECTION 2032 ELECTION. Though a
reduction in the estate tax clearly benefits the estate, there are other considerations which should be taken into
account in determining whether to make a Section 2032 election.
- Non-Tax Consequences of Alternate Valuation Date. The election may have unintended consequences
with respect to the administration of the estate. For example, depending on the language in the will, the
selection of the alternate valuation date may affect calculation of values for purposes of making
distributions to beneficiaries.
- Lower Income Tax Basis to the Heirs. If the alternate valuation date is selected for estate tax purposes, the
lower values are also used in calculating the income tax basis of estate assets. Consequently, the
beneficiaries receive a reduced income tax basis.
- Effect of Alternate Valuation Date on Other Estate Tax Provisions. In addition, the use of the alternate
valuation date could affect the application of other estate tax provisions, such as the use of the Section
- Practical Issues. In order to determine whether the Section 2032 election is appropriate, the personal
representative must know the value of estate assets both as of the date of death and at the alternate
valuation date. In many cases, it is clear that the value of the gross estate has not decreased during the
relevant period. In such cases, the alternate valuation election is not available, and a precise valuation as of
the alternate valuation date is not required. However, where the estate consists of multiple assets with
fluctuating values, and the value of the estate at the alternate valuation date may be less than its value at
the date of death, the personal representative is well advised to get an accurate valuation on both dates date
to avoid liability for failure to elect the alternate valuation date when appropriate.
- Coordination With Non-Tax Issues. The personal representative must consider non tax issues in the course
of evaluating the alternate valuation election. The alternate valuation may impact the estate tax
apportionment and the dispositive provisions of a will.
- Tax Apportionment. The estate tax due and, consequently, the apportionment of estate tax is clearly
affected by the alternate valuation election. If the will calls for estate taxes to be allocated among the
assets causing the tax, the selection of the alternate valuation date can have a significant impact
when the value of some assets has increased, while the value of others has decreased. Many wills
contain a provision authorizing the personal representative to make adjustments to the estate tax
allocation when an election has caused a significant change. In any event, the personal
representative should be prepared for questions from beneficiaries any time the alternate valuation
date is elected.
- TRACKING VALUATION. Where it appears that the alternate valuation may be appropriate, the personal
representative should anticipate the issue and provide for the appropriate date of the death and alternate
valuations to be available in time to make the election. Though the 27-month rule should provide adequate time,
the estate beneficiaries may want the issue to be resolved as quickly as possible so that they can receive
- IMPACT OF ALTERNATE VALUATION ELECTION ON DISTRIBUTIONS. Generally, under Colorado law,
where distributions are based on the value of estate assets, the value used is the value at the date of death;
however, many wills contain a provision specifying that the value used for purposes of calculating distributions
should be the value as finally determined for estate tax purposes. The personal representative should review and
take into account any such provisions in the will when it appears that election of the alternate valuation date may
be appropriate. The personal representative should understand how the alternate valuation election will affect the
distribution of assets any time the alternate valuation date is used.
- BACKGROUND. In general terms, the estate tax marital deduction is available to the first spouse to die only
when the value of the assets to be deducted will be includible in the surviving spouse's taxable estate. Again,
generally, this requires that the surviving spouse have the ability to dispose of the assets as he or she pleases. On
the other hand, especially in situations involving children from a prior marriage, both spouses often want to insure
that their assets eventually pass to their children from the prior marriage. These conflicting interests often result in
a situation where one or both spouses want to take advantage of the marital deduction, without giving the
surviving spouse the power to change the ultimate disposition of the assets. The QTIP election allows the
taxpayer to leave assets to a surviving spouse in a trust or other arrangement which does not give the surviving
spouse the power to change the ultimate disposition of the assets, but still take advantage of the marital deduction.
- Example: H and W are married. H has children from a prior marriage and an estate valued at
approximately $2,000,000. If H dies first, he would like to take advantage of the marital deduction to delay
payment of any estate taxes on his assets, but he does not want to give W the power to redirect the ultimate
disposition of his property to anyone other his children. In general terms, H cannot take advantage of the
marital deduction unless he gives W the power to redirect the ultimate distribution of his assets. The QTIP
rules allow H to take advantage of the marital deduction without giving W the right to redirect his assets.
- GENERAL. Internal Revenue Code Section 2056(a) provides for an unlimited marital deduction for the value of
property passing to a surviving spouse. Certain property interests which would not be includible in the surviving
spouse's estate do not qualify for the marital deduction under Code Section 2056(b)(1). However, pursuant to
Code Section 2056(b)(7)(A), certain transfers which would not otherwise qualify for the deduction will be treated
as Qualified Terminable Interest Property (QTIP) and will qualify for the deduction. On the death of the surviving
spouse, the value of the qualified terminable interest property is brought into the surviving spouse's gross estate
under Section 2044(a). The property included under Section 2044(a) is valued at the surviving spouse's date of
death or the alternate valuation date if elected.
- THE ELECTION. Many wills allow the personal representative to elect whether to treat certain qualified property
passing to a surviving spouse as QTIP property. To the extent the QTIP election is not made the marital deduction
will not be available, and the property will be subject to the estate tax in the estate of the first spouse to die. If the
QTIP election is made, the marital deduction will be available in the estate of the first spouse, but the property
will be subject to estate tax in the estate of the second spouse.
- FIRST SPOUSE'S ESTATE NOT SUBJECT TO ESTATE TAX. If the value of the first spouse's estate is such
that no estate tax will be due, then it is generally appropriate not to make the QTIP election. Since there is no
estate tax liability, use of the marital deduction is not necessary, and the QTIP election is inappropriate. If the
QTIP election is made anyway, the property which otherwise would not have been included in the second
spouse's gross estate will be so included, and may be subjected to estate tax.
- SECOND ESTATE NOT SUBJECT TO ESTATE TAX. Where the first estate will be subject to estate tax, but
the estate of the surviving spouse will not, it is appropriate to make the QTIP election so that the value of the
QTIP property will be included in the estate of the spouse who will not have to pay estate tax.
- BOTH ESTATES MAY BE SUBJECT TO ESTATE TAX. Where both estates will or may be subject to estate
tax, the personal representative of the first estate must attempt to determine which option will result in the lowest
overall estate tax. By its nature, this calculation must be based on numerous assumptions, including the ultimate
value of the surviving spouse's estate, the estate tax rates in effect at the time of the surviving spouse's death, and
the projected date of the surviving spouse's death (in order to calculate the present value of any estate tax due).
Clearly, it is impossible to guaranty an accurate calculation; however, unless the surviving spouse's estate will be
in a higher estate tax bracket, it is generally appropriate to make the QTIP election so that the estate tax on the
QTIP property is delayed.
- PARTIAL QTIP ELECTION. Many wills give the personal representative authority to make the QTIP election
with respect to a portion of the qualifying property passing to the surviving spouse. A partial election may be
appropriate in a number of situations. For example, where the use of a partial election is sufficient to reduce the
value of the first spouse's estate to an amount not subject to the estate tax, there is generally no point in making
the election for the full value of the property. Or, if it appears that the surviving spouse will not survive for a long
period, a partial election may be used to equalize the value of the estates to take full advantage of the graduated
estate tax rates.
- PRACTICAL ISSUES. Where the determination of whether to make a QTIP election or how much of a QTIP
election to make is dependent on assumptions about the estate of the surviving spouse, the personal representative
should document its analysis of the issue and, if at all possible, get the written approval of the beneficiaries
regarding its decision. This may reduce the potential for a lawsuit by disgruntled beneficiaries if the assumptions
turn out to be incorrect.
- BACKGROUND. A stock redemption occurs when a shareholder redeems (turns in) his/her stock in return for a
distribution from the corporation. Under the regular income tax rules, a stock redemption may be treated as either
a sale or exchange of the redeemed stock or as a dividend. If the transaction is treated as a sale or exchange, the
shareholder recognizes income only to the extent the value of the distribution exceeds his/her basis in the stock,
and such income is generally qualified for capital gains treatment. On the other hand, if the transaction is treated
as a dividend, the entire value of the property distributed is taxed as ordinary income. In general, a redemption is
treated as a dividend unless the redeeming shareholder loses his/her proportionate interest in the corporation.
- Example: Tom and Joe each own 50% of the "Tom and Joe Corporation." They would like to withdraw
cash from the Corporation, but do not want the withdrawal to be taxed as a dividend to them. Without
advise from a competent tax advisor, they conclude that, if they each redeem 10% of their stock, they will
be able to treat the transaction as sale of stock to the Corporation. However, because they are making a
proportionate redemption, and each of them will still own 50% of the Corporation once the transaction is
complete, the Internal Revenue Code provides that, in spite of the return of stock, the whole transaction
will be treated as a dividend distribution. I.R.C. §§ 301(a); 302; 316; and 317.
When an individual owns 100% of a corporation, any transfer of stock back to the corporation still leaves the shareholder
with 100% ownership and, consequently, results in dividend as opposed to sale or exchange treatment. As a result, under
the regular rules, it would be impossible for the estate of a decedent who owned 100% of stock in a corporation to redeem a
portion of the stock to pay the estate tax on the value of the corporation. Section 303 of the Internal Revenue Code was
adopted to make it easier for the owners of small corporations to use corporate assets to pay estate taxes and administrative
- REQUIREMENTS. Section 303 imposes two requirements. First, the stock to be redeemed must be eligible
stock; and second, the amount and timing of the distribution must be consistent with Section 303 requirements.
To qualify for Section 303 treatment, the stock to be redeemed must be included in the gross estate. Section
303(a). Stock included in the gross estate but not owned by the decedent at death meets this requirement.
- Example: Prior to death, Taxpayer transferred his stock in X Corporation to his children but retained a
right to revoke the transfer up until the date of death. Though Taxpayer does not own the stock on the date
of death, it will be included in his gross estate for estate tax purposes, and will meet the requirement that
the stock be included in taxpayer's gross estate.
If there is a reorganization of a closely held corporation following the death of a shareholder, the new stock created by the
reorganization will qualify for Section 303 treatment if its basis is determined by reference to the basis of the old stock, the
old stock was included in the gross estate of the taxpayer, and the old stock would have qualified for Section 303 treatment.
- 35% REQUIREMENT. To qualify for Section 303 treatment, the value of the Section 303 stock included in the
estate must be greater than 35% of the value of the gross estate, less expenses, debts, taxes, and losses. This rule
is intended to limit the application of Section 303 to those cases where the value of the corporation constitutes a
substantial portion of the gross estate.
- More than One Corporation. If the decedent owned at least 20% of a corporation, it may be combined with
other corporations in which the decedent owned at least 20% for purposes of meeting the 35%
requirement. For purposes of the 20% test, generally, only stock directly owned by the decedent is counted.
- REQUIREMENT THAT STOCKHOLDER BE LIABLE FOR PAYMENT OF ESTATE TAXES. Where stock
which would otherwise qualify as Section 303 stock is held by a distributee (beneficiary) who does not share
liability for the payment of estate taxes, that stock does not qualify for Section 303 treatment.
- Example: Prior to death, decedent gave his stock in XYZ Corporation to his daughter, but retained the right
to revoke the gift. Decedent's will specifically provides that the corporate stock held by daughter is not to
be used to pay estate taxes unless no other assets are available. If there are other assets available to pay the
estate taxes, the stock transferred to decedent's daughter does not qualify for a Section 303 redemption,
because neither the stock, nor the daughter are liable for the payment of any estate tax.
- TIME LIMITATIONS. Generally, the redemption must occur within 90 days after the third anniversary of the due
date of the estate tax return. If there is a redetermination of the estate tax by the Tax Court, the redemption may
occur at any time before the 61st day after the Tax Court decision becomes final. If the estate has elected to make
estate tax payments in installments under Section 6166, a redemption may occur at anytime during the Section
6166 payment period. Even so, there are limitations on the amount that can qualify if a distribution is made more
than four years after the date of the decedent's death.
- GENERATION SKIPPING TAX. Section 303 contains provisions making it applicable to the Generation
Skipping Tax as well.
- PRACTICAL ISSUES. Because the decedent's estate receives a stepped-up basis in any stock included in the
estate for tax purposes, the sale or exchange treatment afforded by Section 303 generally results in little or no
taxable income, especially where the redemption is made shortly after death. Section 303 can be extremely
valuable where the major asset of an estate is stock in a wholly-owned corporation of the decedent. Before taking
advantage of a Section 303 redemption, the personal representative must insure that the redemption will not
violate any provisions in the bylaws, shareholder agreements, buy/sell agreements, or other corporate documents.
- PARTNERSHIP BASIS ADJUSTMENTS
- BACKGROUND. General partnership income tax rules provide for a partnership to have a basis in its assets and
for the partners to have a separate basis in their partnership interests. The partnership's basis in its assets is often
referred to as "inside basis," while the partners' basis in their partnership interest is often referred to as "outside
basis." The partnership tax rules are arranged so that, in most cases, the partnership's inside basis is equal to the
total outside basis of the partners.
- Example: A and B form a partnership. A contributes $50, and B contributes an asset with a fair market
value of $50. B's tax basis in the asset was $25. The partnership's total inside basis is equal to $75. This is
the sum of a $50 basis in the cash provided by A, and a $25 carryover basis in the asset contributed by B.
A's outside basis is $50, while B's outside basis is $25 (his basis in the asset contributed to the partnership),
for a total outside basis of $75, which is equal to the partnership's inside basis.
- EFFECT OF PARTNER'S DEATH ON BASIS. When a partner dies, his/her estate receives a stepped-up basis in
the decedent's partnership interest. However, without a corresponding adjustment to the partnership's inside basis,
there will be a discrepancy in the new outside basis of the estate, and the partnership's inside basis in its assets.
- Example: Assume that in the previous example, partner B dies. Since B owned 50% of the partnership, and
the fair market value of the partnership assets is $100, the fair market value of B's interest is $50 (even
though his basis was only $25), and the estate will receive a stepped-up basis of $50 in B's partnership
interest. Meanwhile, without an adjustment to the partnership's inside basis, it will remain at $75 so that
total outside basis ($100) will exceed the partnership's inside basis.
Adjustment of the partnership's inside basis is not required; however, failure to equalize outside and inside basis can have
adverse tax consequences and generally complicates partnership tax accounting to such an extent that it is beneficial to
make the election in most instances.
- MECHANICS OF BASIS ADJUSTMENT. There are two provisions in the Internal Revenue Code regarding
partnership basis adjustments, Section 734 and Section 743. Section 743 is the provision which applies to
decedents' estates. The election to make a Section 743 or 734 basis adjustment is made by the partnership, and,
once made, cannot be revoked. Code Section 754 contains the rules for making the election.
If a Section 754 election is in place, a Section 743 basis adjustment is made when a partner dies. The rules regarding
Section 743 basis adjustments are extremely complex and were revised on December 15, 1999. In short, they provide that
the new partners' (the beneficiaries of the partner who passed away) inside basis in partnership assets will adjusted to reflect
the stepped-up outside basis in the partnership interest.
- Example: D owns a 25% interest in a business partnership. D dies July 31, 2000, and leaves his 25%
interest to N, his nephew. On the date of D's death, the fair market value of his partnership interest was
$100,000, while his inside and outside basis in the basis in the partnership was $25,000. N will receive a
stepped-up outside basis of $100,000 in D's partnership, while the inside basis will remain unchanged at
$25,000 absent a Section 754 election. If a Section 754 election is in place, the inside basis of N's
partnership interest will be adjusted to $100,000 to reflect his stepped-up outside basis. The basis
adjustment will apply only to N's interest in the partnership, and will have no effect on the inside or outside
of the other partners.
- IMPACT OF BASIS ADJUSTMENT. The Section 743 basis adjustment will have a number of complex tax
implications. However, in short, it will increase N's basis in his share of the partnership assets, and most likely
decrease N's overall tax liability over time.
- SPECIAL NOTE. Due to the complexity of the partnership basis adjustment provisions, I have limited the
discussion in this outline to the bare essentials. If an estate includes a partnership interest of any significant value,
it is important that the personal representative retain the services of a competent tax advisor to review the
implications of a Section 754 election before determining whether making such an election is appropriate.
- MAKING THE ELECTION. If a Section 754 election is not already in place, it must be made with the
partnership return for the taxable year during which the applicable distribution or transfer takes place. The return
must be filed by the applicable due date including extensions.
- THE OPTION OF DEFERRING ESTATE TAXES.
- BACKGROUND. There are a number of provisions in the Internal Revenue Code allowing for an extension of
time to pay the estate tax. Section 6161 contains two such provisions. Section 6161(a)(1) provides for a twelve
month extension to pay for reasonable cause; and Section 6161(a)(2) provides for an extension as long as ten
years if there would otherwise be a hardship resulting from the payment of estate taxes. Section 6163 provides an
extension where the taxable estate includes a remainder or reversionary interest. Section 6163 allows for the
payment of the estate tax resulting from such an interest to be made six months after the interest terminates.
Finally, Section 6166 provides an extension for estates where a closely-held business interest constitutes a
substantial portion of the value. This provision was intended to provide for the payment of estate taxes without
the necessity of selling a closely-held business where that asset constitutes a substantial portion of that estate's
- THE SECTION 6166 ELECTION. Section 6166 of the Internal Revenue Code provides that an executor may
extend the payment of estate taxes where a closely held business interest constitutes 35% or more of the value of
the gross estate. The Section 6166 election must be filed with a timely filed Estate Tax return and must contain
- the decedent's name and taxpayer ID number;
- the amount of tax to be paid in installments;
- the selected date of the first payment for the installment;
- the number of annual installments;
- a description of the property listed on the estate tax return that qualifies as a closely-held business interest;
- the facts on which the personal representative relies in concluding that the estate qualifies under Section
The personal representative may elect to make the first installment up to five years after the date on which the estate tax
would normally be due, resulting in a total of 15 years of deferral. Payments of interest are generally required during any
years preceding the payment of the first installment.
- AMOUNT AVAILABLE FOR DEFERRAL. The amount of tax which may be deferred is generally calculated by
determining the percentage of the adjusted gross estate which is attributable to the value of a closely-held
business interest and applying that percentage to the estate tax liability.
- DEFINITION OF CLOSELY-HELD BUSINESS. Ownership of a business as a sole proprietor qualifies as a
closely-held business, as does an interest in a partnership or corporation carrying on a trade or business if the
decedent owned 20% or more of the value of such partnership or corporation. Note that for tax purposes, limited
liability companies are treated as partnerships.
- SUBSEQUENT ADJUSTMENTS TO THE ESTATE TAX RETURN. Where the estate has made a Section 6166
election and the return is subsequently adjusted by the Service or the Tax Court, the Section 6166 election is
applicable to the adjusted amounts assuming they would otherwise qualify.
- Example: Decedent died in 1997 owning among other things a small ski repair business. Based on the
values used by the personal representative in preparing the estate tax return, the ski repair business
qualified as a Section 6166 closely-held business, and the estate elected to defer the taxes resulting from
the inclusion of that business in the taxable estate. Subsequently, the Internal Revenue Service challenged
the value used by the personal representative for the business and, ultimately, it was agreed that the value
of the business should be increased by $300,000. The original Section 6166 election is still valid assuming
the other requirements are met and the additional tax resulting from the increase in the value of the
business may be paid pursuant to the Section 6166 installment agreement. Note that if the value of the had
been adjusted so that the total value of the small business no longer met the 35% requirement, the Section
6166 election would not be available.
- COLORADO ESTATE TAX PAYMENT EXTENSIONS. The State of Colorado has a provision which says, in
effect, that the election Section 6166 installment payments for federal estate tax purposes will apply to Colorado
estate taxes as well.
- CHOICE OF FISCAL YEAR.
- INTRODUCTION. Income taxes are determined annually based on the taxpayer's tax year. Most individuals use
the calendar year as their tax year. That is they pay taxes based on the taxable income earned from January 1st to
December 31st each year. Most business entities are severely limited in their choice of tax year, with the calendar
year being the default option. In situations involving "pass through entities" (a pass through entity is a tax entity
whose income may be reported on the return of another entity or individual), such as estates, choice of a tax year
can have significant consequences. This is a result of the fact that the recipient entity reports income from the
pass through entity in the recipient entity's tax year within which the pass through entity's tax year ended.
- Example: Estate selects a calendar year as its tax year. Bob, its only beneficiary, also has a calendar year
tax year. Estate's income for the year 2000 is $10,000, and is reported as such on its year 2000 tax return.
Assuming the Estate actually distributed the $10,000 to Bob at some time during the year, it would be
taxable to Bob for the year 2000, because Estate's tax year ended on December 31, 2000, the same date on
which Bob's tax year ended. If Estate had elected a January 31st year end for tax purposes, the $10,000 in
income would have been reported by Bob on his 2001 tax return, because 2001 would have been Bob's tax
year, during which the Estate's tax year ended. This could result in a tax deferral of one year for Bob.
With respect to estates, which often have expenses in excess of income, it is important to note that the same deferral would
apply to any expense deduction passed through from the estate to the beneficiary. It should also be noted that generally
excess deductions from an estate cannot be passed through to its beneficiaries until the final tax year of the estate.
- PROCEDURAL MATTERS. Estates are authorized to select a taxable year other than a calendar year pursuant to
Internal Revenue Code Section 441(a). An estate's initial tax year must end on the last day of a month, and cannot
exceed twelve months in length.
- Example: Decedent died March 15, 2000. Decedent's estate's first tax year may end at the end of any month
beginning March, 2000 and ending February, 2001. An initial year ending March 2001 would be more than
twelve months long and is not authorized. Section 6071(a). The selection of the estate's tax year is made on
the estate's first income tax return.
- Practice Tip. The form used to request a taxpayer ID number for the estate contains a question regarding
the proposed tax year end for the estate. Completing that question does not constitute a valid election of the
estate's tax year. An entry made on the request for taxpayer ID number does not bind the estate to the date
- TIME CONSTRAINTS. An estate income tax return is due on the 15th day of the fourth month following the
close of the estate's taxable year. Section 6072(a). Consequently, the decision to use a particular year end may
generally be made up to three and a half months after the year end of choice. The election is valid if made on a
properly extended return, though the filing of the extension request will set the tax year.
- Example: In early May of 2000, Personal Representative determines that the best tax year end for the estate
is January 31. A return for a tax year ended January 31, 2000 would be due on May 15, 2000. If Personal
Representative cannot prepare a complete return by May 15th, she may file a proper extension by May 15th
and preserve the choice of January 31st as the Estate's tax year end. If Personal Representative fails to make
a proper election, the default tax year for the estate is the calendar year.
- Estates With Net Income. If the estate has sufficient income earning assets to generate income in excess of
expenses, it is generally better to delay the reporting of income by the beneficiaries as long as possible.
Since most beneficiaries are usually on a calendar year tax year, this means that an appropriate tax year for
the estate will end on January 31st.
- Example: The XYZ Estate has substantial investment assets, and it is expected that the Estate will
generate more than enough income to pay its expenses. The Decedent died July 1, 2000, by selecting
January 31, 2001 as its first tax year, the estate will delay the reporting of all income earned from
the date of death through January 31, 2001, until the beneficiaries' 2001 tax year. For individual
beneficiaries this means that tax on such income will not be due until April 15, 2002. In addition, all
income earned by the XYZ Estate after January 31, 2001 will be reported on its January 31, 2002
return, meaning that the individual beneficiaries will not report the income until they file their 2002
returns on April 15, 2003.
- Estates With Projected Losses. Where it is anticipated that the estate's expenses will exceed its income, the
analysis is somewhat different. This is a result of the fact that an estate cannot pass excess deductions
through to its beneficiaries until the estate's final tax year; nor can the estate carry expenses from one year
to the next, unless such excess expenses qualify as net operating losses. Consequently, where an estate is
expected to generate expenses in excess of its income it is important to try to bunch those expenses into the
estate's final year as much as possible. Generally, this can be accomplished by keeping the administration
period short and waiting to pay expenses until the estate's final year.
- Example: Mr. Jones passes away on August 1, 2000. Mr. Jones' estate does not contain significant
income producing assets, and, as the result of some apparent family conflicts, it seems clear that the
estate will incur significant legal and accounting expenses. If the estate were to select June 30th as
the close of its tax year, and were to pay most of its legal and accounting expenses before June 30,
2001, those expenses could be used to offset estate income, but could not be passed through to
estate beneficiaries unless the estate was closed by June 30, 2001. If the administration process takes
a year and a half, the estate will not be closed by June 30, 2001, and the expenses in excess of the
estate's income for that year will be lost as a deduction. If the estate instead selected a calendar year
end (December 31st) and delayed making payment of its legal and accounting fees until the
following year, those expenses could be passed through to the estate beneficiaries on its final return
for the year ending December 31, 2001.
- Estates With Excess Expenses Filing an Estate Tax Return. Generally, the expenses deductible by an estate
on its income tax return may also be deducted on the Estate Tax return if one is required. Where an Estate
Tax return is required, it is often most beneficial to deduct those expenses on that return, instead of on the
income tax return. If this is the case, the timing considerations discussed above are irrelevant or, at least,
- Practical Considerations. In may small estates, the potential tax savings of selecting a tax year other than
the calendar year may easily be offset by the additional administrative expenses associated with selection
of a fiscal year. For example, financial institutions and brokerage companies prepare their reports of
interest and dividend income on an annual basis. Choosing a different tax year often requires additional
calculations and computations in preparing the estate's income tax returns.
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