Inheritance and Tax question - form K-1?

[BOBOT]

DW has gotten partial distribution from her grandmother's estate (gran passed in 2009 but there have been complications). We have been told by the executor that we will have to file form K1 and pay tax on some of the earnings the estate had in TY2010.
I don't understand why we have to pay tax on undistributed portion of the estate. Anyone have a similar experience or tax expertise?

Yeah, I know- nice problem to have.

Thanks==

[LOL!]

I think this is pretty typical. I am not a tax person, but someone is responsible for the investment gains (dividends, realized cap gains) that the estate has received. That someone is the folks who get distributions from the estate. You GET a form K-1 from the estate, so when they say "file form K-1", it is not a big deal to include it with your Form 1040. All the tax software packages know what to do with a K-1.

The alternative would be that the estate pays the taxes, but I suspect that the tax rate for the estate would be much higher than your tax rate. So getting the K-1 saves on taxes.

[kaneohe]

Agree w/ LOL that this is probably not a big deal and that the term
"filing a K1" was either misused or misunderstood. I don't know anything
about TurboTax or any of the other software packages but basically the usual
things you would find on an estate K1 would be interest, and perhaps
dividends/capital gains. They would end up where they normally end up if they
were your personal returns....Sch B for interest/dividends; Sch D for cap gains ...so you aren't really filing a K1 but just receiving one. Of course,, K1s can also be pretty complicated if you have other income categories.

As LOL noted, if the estate can pass the earning on to you, that usually is a good thing if there is any significant amount of earnings since the estate tax brackets are much more compressed than personal brackets and reach their max much sooner. Occasionally if the estate earnings are very small,,
it may be cheaper to retain the earnings in the estate (if allowed) if the beneficiaries have significant amounts of other earnings.

[BOBOT]

Thanks to both.

[meierlde]

For an estate K-1 turbotax deluxe at least has a copy of the form, you just type the numbers into the right boxes and the numbers get populated in the right places. Now also the business version of turbotax generates the form 1041 that supplies the k-1. So getting a K-1 is not a big deal, assuming you are also not the executor and have to fill it out, its not a big deal either in that case, but you do need to buy more software. (The K-1 is filed by the executor, so you don't file it with the IRS if you get 1 but rather a schedule E which shows the amounts)

[Trawler]

When my grandmother passed I recieved a K-1 as well. Looked into it and found this was my share of gain/loss/income of the estate the from date of death until estate distributed. In my case I got a loss on the K-1 as the market dropped at the time the estate was being handled. The loss was treated like any capital gain/ loss on my persanl returns.

[Aeowyn]

I was the executor of my mother's estate. Her estate was big enough that I hired an attorney to help me put a bow on everything. The attorney advised me (since there were several heirs) that it may not be considered responsible to keep or put probated assets invested in anything other than guaranteed accounts (cash). So within a month of her death, I converted everything to cash. The only income her estate generated during the time it took to close her estate was then interest on the cash accounts.

The estate is treated like a business. We filed taxes for the estate. If we had owed taxes, we would have paid them out of the estate. But the interested earned by the estate accounts were less than the attorney fees (considered a “business” expense for the estate) and other fees (like probate court and filing tax returns) needed to process the estate. The tax return for the estate had capital loss carryovers. These loss carryovers got transferred to the heirs in proportion to their percentage of the probated assets of estate they inherited.

[LOL!]

Quote:

Originally Posted by Aeowyn .... These loss carryovers got transferred to the heirs in proportion to their percentage of the probated assets of estate they inherited.

via K-1s, right?

[BOBOT]

Quote:

Originally Posted by Aeowyn I was the executor of my mother's estate. Her estate was big enough that I hired an attorney to help me put a bow on everything. The attorney advised me (since there were several heirs) that it may not be considered responsible to keep or put probated assets invested in anything other than guaranteed accounts (cash). So within a month of her death, I converted everything to cash. The only income her estate generated during the time it took to close her estate was then interest on the cash accounts. <snip>

This raises another point I've wondered about (maybe this should be a different thread): when my mother's estate was distributed the executor distributed her portfolio as equal shares of each holding to me and my siblings. If there was a holding that could not be divided equally, the difference was made up with cash. So we were able to decide for ourselves which shares to keep or sell. It also avoided what could have been (back in the bad old days of high commissions) sizable transaction costs to the estate.
But I can see the wisdom of converting to cash, especially if the estate will take a long time to settle, to avoid short term risks.
I'll need to think about this for our own estate planning.

[LOL!]

I have often seen that the estate assets should be converted to cash as soon as possible as that is prudent and removes all risk for the executor and is part of the fiduciary responsibilities. However, when my MIL died, her estate went up by 45% in the year that it took to settle the estate. Nevertheless, there were still complaints about that because the attorney kept saying "No one will have to pay taxes" at least 3 times. Some folks were surprised by the taxes they had to pay. Then the attorney said, "I meant no one will have to pay estate taxes. I didn't say anything about income taxes."

[clifp]

As a future executor a couple of questions come to mind.

Who is responsible for taxes on income an estate earned before it is distributed?
Is there limitation for how long an estate can earn income?
If somebody dies in say Dec 1 do you have file two income taxes one for the deceased and one for the estate?

[meierlde]

Quote:

Originally Posted by clifp As a future executor a couple of questions come to mind. Who is responsible for taxes on income an estate earned before it is distributed? Is there limitation for how long an estate can earn income? If somebody dies in say Dec 1 do you have file two income taxes one for the deceased and one for the estate?

To answer the question for the year of the persons death you file a final regular income tax and then 1 year and 4 months after the end of the month before the persons death you file the first 1041.
As to the taxes, thats the estate that is responsible, unless you are distributing, in which case you can use the K-1 route (check with attorney on this for more details)
Some estates are still earning income 40 years after the death depending for example performers estates where somehow it is not possible to transfer the income to the beneficiaries. (Or if an annuity pays out but had no beneficiary (a fixed term annunity for example) , and the company refuses to change the payment method).

[sheehs1]

As of the Date of Death...all assets and amounts are "fixed" and considered "principle assets". Some assets get a stepped up basis depending on the assets. Annuities do not. Stocks do. That sort of thing. The principle assets can be considered one bucket. Interest and income earned is another bucket.

If you are getting a K1, that means the executor distributed to you "earned income" generated by the estate. I will assume you actually received "the money". This K1 does not included any of the "principle assets"....as those are your right to receive by inheritance...etc. However...the distribution you received may have included some of the principle cash assets. Don't know ..you would have to ask the executor. (i.e, did he or she distributed to you some of the principle cash plus some interest income or was it just interest income..?)

The "principle assets" once distributed to the beneficiaries will be included as "distributions to beneficiaries" in the final tax return for the estate.

If the value of the estate is over the Unified Tax Credit amount which currently is either 3 million or 3.5 million or maybe even the 5 million Congress approved at the end of last year...then the estate will owe around 45% tax on the amount that exceeds this Credit. The estate owes this not the beneficiaries.

By law you are entitled to the preliminary accounting filed by the executor and a yearly accounting...of everything done by the executor including copies of the final estate tax return and income tax return of the decedent.
Hope this helps....

[Aeowyn]

Yes – the capital loss carryover was on a K1 (at least I’m 99% sure – not home right now to check).

When I made my post, I mentioned that the assets that were “probated” were liquidated. The house was one of these assets (fortunately it was already under contract to be sold when my mother passed so it didn’t take very long to liquidate).

The majority of her estate (probably ~2/3 of it) did not need to be probated since it was either listed as joint or TOD/POD (transfer on death/payable on death) to my brother and me. This included some mutual funds that I helped her set up. Since I didn’t need to probate these, the shares were split and given to the to TOD recipients.

There were other heirs of her estate besides my brother and myself, but TOD supersedes the will. Legally those assets went to the TOD recipients directly. To honor the spirit of my mother’s will, my brother and I took the money we received outside of probate and gave it to the other heirs in proportion to what our mother wished (we gave cash to the other heirs). This had the added benefit that we were able to claim a charitable donation on the amounts that we “personally” wrote a check to her church for (one of the other heirs).

Anyway – listing TOD recipients won’t save you anything on federal estate taxes or state inheritance tax (if any of these apply), but it will speed things up by passing the money outside of probate. It took about 1 month to get the joint/TOD/POD accounts distributed (and only that long because I had to fill out Indiana inheritance tax forms to document DOD values of all the accounts and have it signed off by the county before any funds could be released). But it took over a year to probate the rest of the estate.

[Aeowyn]

Quote:

Originally Posted by clifp As a future executor a couple of questions come to mind. Who is responsible for taxes on income an estate earned before it is distributed? Is there limitation for how long an estate can earn income? If somebody dies in say Dec 1 do you have file two income taxes one for the deceased and one for the estate?

Since we were probating my mother’s estate – we obtained a tax number for her estate (just like you would set up a business tax number). All of the estate accounts were listed under the estate tax ID. Any time there was a bill owed by the estate (like a final electric bill - final credit card bills – burial costs – attorney fees – personal taxes for the decedent – Indiana Inheritance tax), as the executor I wrote a check out of the estate account to pay for it. Likewise when I received funds that needed to be probated – they went into an estate account (including things like refunds of car home/medical insurance that were paid in advance as well as liquidated assets).

As the executor, you are responsible to make sure the final income tax gets filed for the decedent as well as the appropriate tax returns for the estate.

Just like a business, the estate account does not need to follow a calendar year for taxes. According to my attorney, the “fiscal” year for the estate has to end no latter the end of the month preceding the one year anniversary of the date of death. I think you then have 3 ½ months to get the taxes filed after the end of the “fiscal” year. (Just like we have 3 ½ months to file personal taxes after the end of the calendar year).

As the executor, you are also responsible for making sure all accounts get closed (even if there is no balance). I contacted all of her credit cards and let them know the accounts needed to be closed due to death. I of course contacted all of the places she had assets to get those assets released. I also contacted places like utilities, phone, and insurance companies. You are also responsible for publishing a call for anyone who might have a claim on the estate – like creditors you don’t know about (my attorney did this for me). You have to give enough time after you publish this (I believe this 3 months) before you can finalize the estate. Of course legitimate claims to the estate need to be paid before any money goes to the heirs. By the way – if the estate has a negative net worth you’ll need to let the creditors know they aren’t going to paid in full as debt does not get inherited. You’ll need to get a few official copies of the death certificate and then make lots of copies. Most of the places that needed death certificates were willing to take copies – some needed official copies. I carried death certificates and a copy of the letter from the court appointing me as an executor for quite a while as I needed them when ever I did anything with her estate.