Concept Summary 20.1 Subchapter K (Partnerships,LLC) Subchapter S (S Corporation
ID: 2468145 • Letter: C
Question
Concept Summary 20.1
Subchapter K
(Partnerships,LLC)
Subchapter S
(S Corporations)
Subchapter J
(Trusts, Estates)
How is the notion of income taxation of estates and trusts different from the estate and gift tax? Are they the same type of tax? If not, how are they different? ,
After reviewing Concept Summary 20.1 in your textbook, pick one of the principles of fiduciary taxation and explain it using an example. See chart above for the concept summary 20.1
Tax TreatmentSubchapter K
(Partnerships,LLC)
Subchapter S
(S Corporations)
Subchapter J
(Trusts, Estates)
Taxing structure Pure pass-through, only one level of federal income tax Chiefly pass-through, usually one level of Federal income tax Modified pass-through, Federal income tax falls on the recipient of entity accounting Entity-level Federal income tax? Never Rarely Yes, if the entity retains any net taxable income amounts Form for reporting income and expense pass-through Schedules K and K-1, Form 1065 Schedules K and K-1, Form 1120S Schedules K and K-1, Form 1041Explanation / Answer
Answer
The notion of income taxation of estates and trusts is different from the estate and gift tax in following manner. They are not the same type of tax.
Trusts and estates taxed for income tax purposes in following manner
A trust is created when the grantor transfer property to a trustee for the benefit of a third person (the beneficiary). An estate is the assets and liabilities left by a person at death. Both a trust and an estate are separate, legal, taxpaying entities, just like any individual. Income earned by the trust or estate property (e.g., rents collected from real estate) is income earned by the trust or estate.
Who is liable for taxes on income earned by a trust depends on who receives or retains benefits from the trust (i.e., the trust entity, the beneficiaries, the grantor, or the power holder).
Who is liable for taxes on income received by an estate depends on how the income is classified (i.e., income earned by the decedent, income earned by the estate, income in respect of the decedent, or income distributed to beneficiaries).
In general, trusts and estates are taxed like individuals. General tax principles that apply to individuals also apply to trusts and estates. A trust or estate may earn taxexempt income and may deduct certain expenses. Each is allowed a small exemption ($300 for a simple trust, $100 for a complex trust, $600 for an estate). However, neither is allowed a standard deduction. The tax brackets for income taxable to a trust or estate are much more compressed and can result in higher taxes than for individuals.
Income tax returns for trusts and estates are known as fiduciary tax returns (Form 1041). That is because the fiduciary (the trustee or estate representative) is generally responsible for filing the return and paying any taxes owed. Trusts and estates may also be required to file a state income tax return.
The general income tax rules for trusts
Generally, income is taxable to trust entity or trust beneficiaries
Trust income retained by the trust is taxed to the trust, while distributed income is taxed to the beneficiary who receives it. Thus, trust income is taxable to the trust or to the beneficiary but not to both. This result is obtained though the use of the distributable net income (DNI) concept.
Except grantortype trusts or charitable remainder trusts
There are two exceptions to the general rule. First, if the grantor has retained an interest in the trust (e.g., right of revocation) or if some other person is given a general power of appointment over the trust income or principal, trust income is taxable to the grantor or powerholder. These are known as grantortype trustsan example is the revocable trust where all income is taxed to the grantor. Second, if the trust is a charitable remainder trust because the charity is tax exempt, retained trust income is generally not taxable to the trust, but any distributions are taxed to the beneficiaries.
The general income tax rules for estates
Reporting of Income of the decedent: If a decedent was a cash method taxpayer, income received (actually or constructively) by the decedent prior to death is reported on the decedent's final 1040. If the decedent was an accrual taxpayer, income accrued prior to death is reported on the final 1040.
Reporting of Income of the estate: Income earned by the decedent but not paid before death is reported on the income tax return of the recipient of the income. This income is called income in respect of the decedent (IRD). Examples of IRD include uncollected wages, accrued interest on bank accounts, and dividends declared but not collected. If the recipient of IRD is the decedent's estate, it is reported on Federal Form 1041 (the fiduciary tax return) by the estate representative. If the recipient is an estate beneficiary, it is deducted on Schedule B and reported to the beneficiary on Schedule K1 for inclusion on the beneficiary's personal return. Other income (nonIRD) earned by estate property after death and retained by the estate is reported on the estate's tax return (Form 1041). Other income (nonIRD) earned by estate property after death and distributed by the estate to a beneficiary is deducted on Schedule B and reported to the beneficiary on Schedule K1 for inclusion on the beneficiary's personal return.
• Income of the beneficiary: The beneficiary may receive income (or incomeproducing property) directly from the decedent at the time of death. The beneficiary must include this income on his or her individual tax return.
What deductions are allowed
Generally, the same deductions allowed for individuals are allowed for estates.
Some expenses for administering an estate can be deducted on either the estate tax return (Form 706) or the fiduciary return but not both. The personal representative may also elect to split an expense and deduct a portion on each return. The following deductions are allowed on Form 1041:
• Probate expenses, such as court costs, bonds, and professional fees
• Expenses for selling estate property
• Uninsured casualty losses
Estate Tax
The Estate Tax is a tax on your right to transfer property at your death. It consists of an accounting of everything you own or have certain interests in at the date of death. The fair market value of these items is used, not necessarily what you paid for them or what their values were when you acquired them. The total of all of these items is your "Gross Estate." The includible property may consist of cash and securities, real estate, insurance, trusts, annuities, business interests and other assets.
Once you have accounted for the Gross Estate, certain deductions (and in special circumstances, reductions to value) are allowed in arriving at your "Taxable Estate." These deductions may include mortgages and other debts, estate administration expenses, property that passes to surviving spouses and qualified charities. The value of some operating business interests or farms may be reduced for estates that qualify.
After the net amount is computed, the value of lifetime taxable gifts (beginning with gifts made in 1977) is added to this number and the tax is computed. The tax is then reduced by the available unified credit.
Most relatively simple estates (cash, publicly traded securities, small amounts of other easily valued assets, and no special deductions or elections, or jointly held property) do not require the filing of an estate tax return.
A filing is required for estates with combined gross assets and prior taxable gifts exceeding $1,500,000 in 2004 - 2005; $2,000,000 in 2006 - 2008; $3,500,000 for decedents dying in 2009; and $5,000,000 or more for decedent's dying in 2010 and 2011 (note: there are special rules for decedents dying in 2010); $5,120,000 in 2012, $5,250,000 in 2013, $5,340,000 in 2014, $5,430,000 in 2015, and $5,450,000 in 2016.
Gift Tax
The gift tax is a tax on the transfer of property by one individual to another while receiving nothing, or less than full value, in return. The tax applies whether the donor intends the transfer to be a gift or not.
The gift tax applies to the transfer by gift of any property. You make a gift if you give property (including money), or the use of or income from property, without expecting to receive something of at least equal value in return. If you sell something at less than its full value or if you make an interest-free or reduced-interest loan, you may be making a gift.
Related Questions
drjack9650@gmail.com
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.