Tax scenario for Irrevocable trust questions

[silvor]

This scenario has a couple moving parts, and I realize I may need a CPA here, but I thought I would see what the ER community thinks of this one...

My dad had his money & mutual funds in a Revocable Trust which he was the trustee of. Now that he passed, I am the trustee and the money was moved into an Irrevocable trust with its own tax ID.

1) does the cost basis step up when the funds were moved to the Irrevocable Trust? I read something that says it does, but Schwab didn't step up the cost basis. Or does the cost basis only step up when the beneficiaries receive the shares?

2) for whatever reason, my brother has not opened an account where I can transfer the funds to. Why? Who knows. Anyway, if I sell the funds in the Irrevocable trust in 2020, those sales go on a separate tax form correct?

My dad took his $40k IRA distribution and around $14k in Soc Sec in 2020 under his social security number. My concern is reporting under his tax ID will incur more taxes than necessary.

3) if my brother will not open an account and he's due $200k, with a cost basis of $30k, I should have every right to hold back money for taxes on the $170k gain I would think?

 

[Souschef]

I had an Irrevocable trust set up when my wife passed away. It had a separate tax ID. I had to file form 1041 every year along the the CA equivalent.
If there is any distribution, I believe it should be reported on a K-1 form.
As far as withholding for taxes, I would not do that. It is up to the beneficiary to report and pay taxes. I believe there is a stepped up basis when the funds were moved upon death. I had our home appraised at her death to set the stepped up basis.

I hope any CPA's here will check on what I said.

 

[Sunset]

OP - Your brother not opening an account is strange... possibly he thinks he won't have to pay taxes, which is true. Instead the Trust will have to pay taxes and the rates are a LOT higher.

Alternatively, he may be near divorce, and thinking to not claim until after divorce is finalized so he will have all of it. This is somewhat false as inheritance is usually in most States excluded.

It would be good to question him and find out why, he hasn't opened one. I had to convince 2 beneficiaries they needed to open a stock account to get the stocks transferred. They just wanted the money and at first couldn't figure out why not sell and give the cash. Basically it's not how many brokerages work.

As for your Dad, taking his RMD and SS, you will need to do a final tax return, so sure he collected RMD and SS, etc.. and (IMHO) it needs to be claimed under his SSN. Note, the Trust cannot claim it as he was alive at the time. Basically if he hadn't died, who would claim the RMD and SS ?

 

[OldShooter]

Yeah, CPA time. Hire one and pay from the trust as an expense.

None of this sounds terribly hard but there are several moving parts and you are smart enough to ask the questions, so getting the answers shouldn't require more than an hour of CPA time.

IANACPA, but my guess as to the answers is as follows:

1) Basis step-up occurs on date of death. Schwab is not concerned about this; their records reflect purchase cost which has become irrelevant.

2) Don't worry about your brother, except to the extent it is better for him to get his portion in-kind rather than selling the assets in the trust. Trust tax rate on whatever gain has happened since death will be higher than brother's rate. And yes, there will be a trust tax return if the trust makes any money. CPA may be able to help you avoid this.

2a) Dad will pay some taxes. CPA or good tax preparer can help make sure you fill out the forms correctly to minimize them. Don't forget to deal with this, paying his taxes from the estate, before dividing up the balance to heirs.

3) It is not your job to do anything with brother's money or his taxes. Distribute everything except his share, then let it sit there in the trust until he wants it. Dividends and interest accruing to the trust will be taxed unnecessarily high but that will be his choice and he will be paying the tax prep costs.

 

[cathy63]

1) does the cost basis step up when the funds were moved to the Irrevocable Trust? I read something that says it does, but Schwab didn't step up the cost basis. Or does the cost basis only step up when the beneficiaries receive the shares?

You should call Schwab and talk to them about this. They can't know whether you are using the date of death or an alternate valuation date unless you tell them and they probably won't calculate the stepped-up basis until they know. They can also tell you whether the step-up applies to the distribution to the irrevocable trust or not. I think it does.

2) for whatever reason, my brother has not opened an account where I can transfer the funds to. Why? Who knows. Anyway, if I sell the funds in the Irrevocable trust in 2020, those sales go on a separate tax form correct?

Yes, you have to file a form 1041 for the trust. You also have to file a K-1 for any distribution the trust makes to your brother. If you sell the shares, you can have the trust issue a check to him. He doesn't have to have an account to receive the cash. He'd only need a brokerage account if you are trying to distribute shares of stock or mutual funds to him.

My dad took his $40k IRA distribution and around $14k in Soc Sec in 2020 under his social security number. My concern is reporting under his tax ID will incur more taxes than necessary.

You have to file his final tax return (form 1040) and report the income he received during his lifetime under his own SSN. There's no option to report it any other way. If the $40K was not his full RMD, then the beneficiary of the IRA (probably the trust? but maybe it's you and your brother?) need to take the rest of it and report that portion under the SSNs or TIN of the entity that makes the withdrawal.

3) if my brother will not open an account and he's due $200k, with a cost basis of $30k, I should have every right to hold back money for taxes on the $170k gain I would think?

Nope. You sell the stock in the trust, distribute the funds to him, and he's responsible for paying his own taxes. The income the trust receives from the stock sale will be offset by the distribution you make to your brother, so the trust won't owe taxes on the sale.

 

[ERD50]

... for whatever reason, my brother has not opened an account where I can transfer the funds to. Why? Who knows. ...

I'm really curious how this plays out. Is your brother 'crafty' enough to be thinking that the estate will end up paying his taxes because the estate will do the sale and hold the cap gain liability ? Or could it just be mundane, like he doesn't want stocks, doesn't want to deal with a brokerage account, just give me the cash?

Are you the only other beneficiary? 50/50 split? It would not be fair to you or the other beneficiaries to in effect pay taxes for him. And I think it would be complicated to try to "hold back" those taxes, you'd need to separate that out from other taxes due, adjust remaining balances, etc - don't make extra work for yourself that might get questioned later anyhow. It could totally back-fire on you.

I agree with Sunset - time to ask your brother why and explain that it just isn't something you have the flexibility to do as executor/trustee.

I don't know if you can distribute to the other beneficiaries, and then just turn the trust and its content over to your brother and say "There - there's your share of the inheritance, do as you please"?

I just realized - if you pull everything out but his, then even if you do sell the stocks and the 'estate' pays the tax, it would all come out of his share anyhow. Everyone else got theirs already. That could be clean, right? And if something needs to be sold to pay the taxes, no effect on anyone else, it's his stuff being sold.

I just remembered, I was in a somewhat similar situation as co-executor/trustee of MIL/FIL's estate. There were about 10 grandchildren, and I really didn't want to deal with asking them all (spread across the country, and various levels of 'responsible') to set up a brokerage account, wait for them to do that, get all the info, and go through all those transfers. There were some cap gains (and losses in a bond fund that had distributed its divs), as FIL had passed 3 years before MIL, so his stocks were stepped up 3 years earlier.

I was able to sell enough of the losses against the gains to net out near zero cap gains, and raise enough cash so we could just send each grand-kid a check. Much easier. The remaining shares were divided evenly between the three siblings, so a much easier task.

-ERD50

 

[OldShooter]

I'm really curious how this plays out. Is your brother 'crafty' enough to be thinking that the estate will end up paying his taxes because the estate will do the sale and hold the cap gain liability ? Or could it just be mundane, like he doesn't want stocks, doesn't want to deal with a brokerage account, just give me the cash?

Hanlon's Razor: "Never attribute to malice that which is adequately explained by stupidity."

... Are you the only other beneficiary? 50/50 split? It would not be fair to you or the other beneficiaries to in effect pay taxes for him. And I think it would be complicated to try to "hold back" those taxes, you'd need to separate that out from other taxes due, adjust remaining balances, etc - don't make extra work for yourself that might get questioned later anyhow. It could totally back-fire on you.

I agree with Sunset - time to ask your brother why and explain that it just isn't something you have the flexibility to do as executor/trustee.

I don't know if you can distribute to the other beneficiaries, and then just turn the trust and its content over to your brother and say "There - there's your share of the inheritance, do as you please"?

I just realized - if you pull everything out but his, then even if you do sell the stocks and the 'estate' pays the tax, it would all come out of his share anyhow. Everyone else got theirs already. That could be clean, right? And if something needs to be sold to pay the taxes, no effect on anyone else, it's his stuff being sold.

I just remembered, I was in a somewhat similar situation as co-executor/trustee of MIL/FIL's estate. There were about 10 grandchildren, and I really didn't want to deal with asking them all (spread across the country, and various levels of 'responsible') to set up a brokerage account, wait for them to do that, get all the info, and go through all those transfers. There were some cap gains (and losses in a bond fund that had distributed its divs), as FIL had passed 3 years before MIL, so his stocks were stepped up 3 years earlier.

I was able to sell enough of the losses against the gains to net out near zero cap gains, and raise enough cash so we could just send each grand-kid a check. Much easier. The remaining shares were divided evenly between the three siblings, so a much easier task.

-ERD50

Really, really, there are too many moving parts here. If the OP wants to get involved with the brother (Bad Idea, IMO) then it should be done via an attorney as intermediary. Or KISS, get the CPA help, settle the estate and the trust loose ends, paying expenses out of the estate or the trust as appropriate, then send out checks to all beneficiaries including the brother and close the trust.

 

[ERD50]

Hanlon's Razor: "Never attribute to malice that which is adequately explained by stupidity."...

That was in the back of my mind as I wrote it. edit - though in the OP case, it may nor be stupidity at all, he may just not be aware of the implications, which would not be unusual at all. Many people have no awareness of how the tax situation would play out (and they may be happier for it!).

....

Really, really, there are too many moving parts here. If the OP wants to get involved with the brother (Bad Idea, IMO) then it should be done via an attorney as intermediary. Or KISS, get the CPA help, settle the estate and the trust loose ends, paying expenses out of the estate or the trust as appropriate, then send out checks to all beneficiaries including the brother and close the trust.

I have to say, I don't agree with this, and would have felt that I was not doing my duty as executor/trustee to sell the stocks and have the estate pay the tax (which potentially hurts all beneficiaries).

I explained to each of the siblings, that I can transfer the stocks with gains to them instead of all equally including the g-kids. And each sib can hold or sell as much stock in any one year as they want, independent of anyone else, and explained the zero cap gains opportunity and 15% tax on gains beyond that. All agreed, and accepted we were sort of taking on some tax liability from the g-kids, but it was small anyhow, and everyone saw it was easier this way.

Same with the K1's, we told the tax guy to split them among the 3 sibs, skip the g-kids to keep it simple (each g-kid would have had to deal with the higher level tax software, for a small $ amount after all the dividing up). Tax guy just asked for a letter from each sib to put in the record that they accept 1/3rd of the total K1. The IRS doesn't care who pays, as long as the total tax is paid.

-ERD50

 

[OldShooter]

... I have to say, I don't agree with this, and would have felt that I was not doing my duty as executor/trustee to sell the stocks and have the estate pay the tax (which potentially hurts all beneficiaries). ...

I believe that as long as the gains (which probably won't be much due to the step-up anyway) are distributed to the beneficiaries in the same tax year that the trust will owe no taxes.

But SGOTI is not a reliable advisor, which is why I keep saying that the OP should consult experts.

 

[ERD50]

I believe that as long as the gains (which probably won't be much due to the step-up anyway) are distributed to the beneficiaries in the same tax year that the trust will owe no taxes.

But SGOTI is not a reliable advisor, which is why I keep saying that the OP should consult experts.

I think you are correct that the taxes would go to the K1 rather to the estate (but see more later*). But that still leaves the beneficiaries with an unplanned tax bill (I was managing income for Roth conversions). And in those three years, these blue chip type stocks were up about 50%, so it wasn't a tiny gain in relative terms.

So I still wanted to give each beneficiary the ability to manage their tax situation as they saw fit, rather than for me to force those gains on them in one year.

... But SGOTI is not a reliable advisor, which is why I keep saying that the OP should consult experts.

( * here is the 'more later'): Yes, it may be prudent for OP to seek out an expert, if there is any doubt about any of this after doing their own due diligence. But.... while you and I both think that the taxes should have flowed out to the beneficiaries through the K-1 (and I had researched it, as you probably have), my tax guy (decades of experience) had the estate paying taxes in the last year, and he said he checked with a CPA to make sure. Still didn't seem right to me, it makes sense to have final taxes flow to the K1s, or you need to keep the estate open into the next year to have funds to pay the tax bill (which, in a large estate, could maybe trigger another years tax bill? ). We wanted to get it closed, not keep it open into the next year. But it was too small an amount to put any effort into.

I'm really not certain the 'experts' got it right. If there were more $ at stake, I would have challenged it further. IOW, sure, get an expert, but best if you arm yourself with knowledge first.

-ERD50

 

[cathy63]

... I have to say, I don't agree with this, and would have felt that I was not doing my duty as executor/trustee to sell the stocks and have the estate pay the tax (which potentially hurts all beneficiaries)...

I believe that as long as the gains (which probably won't be much due to the step-up anyway) are distributed to the beneficiaries in the same tax year that the trust will owe no taxes.

But SGOTI is not a reliable advisor, which is why I keep saying that the OP should consult experts.

What OldShooter said. The trust doesn't pay the taxes. If the trust sells half the stock and writes a check to the brother, the trust is going to report the gain (very small number if it's soon after death of the grantor) and an equal amount as a deduction on the 1041 for a net of $0. So no tax is due and there's no effect on the other beneficiaries.

As you know from your own experience, it's possible to distribute cash to some beneficiaries and stock to others and it's also possible to distribute the tax consequences from sales unevenly. In this case, one brother takes half the stock, the other takes cash from selling half the stock and owes all of whatever taxes are due as a result of the sale.

edit: ok, I see your estate was open for 3 years. I think if OP can close his sooner, the consequences will be less. Also, I agree that the trust shouldn't have to pay the taxes just because it's the final year. There was probably some extenuating circumstance that's not clear from this discussion, but keeping it open another year after everything had been distributed could have meant a $0 tax bill because there would have been nothing left to earn income?

 

[ERD50]

What OldShooter said. The trust doesn't pay the taxes. If the trust sells half the stock and writes a check to the brother, the trust is going to report the gain (very small number if it's soon after death of the grantor) and an equal amount as a deduction on the 1041 for a net of $0. So no tax is due and there's no effect on the other beneficiaries.

As you know from your own experience, it's possible to distribute cash to some beneficiaries and stock to others and it's also possible to distribute the tax consequences from sales unevenly. In this case, one brother takes half the stock, the other takes cash from selling half the stock and owes all of whatever taxes are due as a result of the sale.

...

OK, it seems you are saying that (assume only 2 heirs) that half the stock could be sold, and ALL the gains associated with that stock could go on the K-1 that goes to the brother? That would seem to take care of it, I was assuming (!) that with equal distributions to both heirs, that the K-1s would be identical with the cap gains split 50-50 as well.

.... edit: ok, I see your estate was open for 3 years. I think if OP can close his sooner, the consequences will be less. Also, I agree that the trust shouldn't have to pay the taxes just because it's the final year. There was probably some extenuating circumstance that's not clear from this discussion, but keeping it open another year after everything had been distributed could have meant a $0 tax bill because there would have been nothing left to earn income?

Yes, the estate was not that large, there would not have been a tax bill for any residual held to pay the final taxes. I was just thinking it was set up that way (the IRS, having the last liabilities all flow through the K-1s to the heirs) to account for those cases.

There may have been some other factor, though it wasn't a complicated trust/holdings, the final tax amount was small, ~ $200 across the two estates, so I just wasn't going to dig deeper. But it also could have complicated things for us if it was larger, if we had distributed to the 13 involved, and then had a tax bill to pay later? Would we have to ask to claw back those funds? What we did was, DW had a JTROS checking account with her Mom, and while legally, DW could have kept it all as hers, we knew it was meant to be split the same as the trust. So we did wait to pay the accountant (and this surprise tax bill), wait a little for any other surprises, and then write one final check to each heir from that checking account, then closed it. That way, the residual in a checking account held in DWs name had no tax consequence on anything.

-ERD50

 

[RetiredAndLovingIt]

Isn't this the brother that moved his son and wife into the home when your dad died?
How did that all pan out, it sounds like he still refusing to co-operate with you and make this whole process as difficult and as costly as he can.

 

[SecondCor521]

I just wanted to point out that the OP has a fiduciary duty to follow the terms of the trust document or will, as well as any applicable state and federal law (and of course IRS rules / regs / IRS code).

This would apply to purchases or sales of trust assets, filing and paying taxes, and distributing the assets to the trust beneficiaries.

There's a lot of talk about the OP taking various courses of action and having various options to do this or that. I don't see it that way - the trustee is obligated and constrained to follow the instructions in the trust or will as well as applicable law.

If they don't? Well, if everyone gets along and agrees to go along (including Schwab and any other financial institutions) and is happy with the result, then probably one can get away with doing otherwise. But if there is any discord or discontent (even long after the fact), then I think OP may open themselves up to liability / lawsuits / bad feelings from the other trust beneficiaries. This could cost OP time, money, and hurt feelings.

Since there is already hints of family discord in the OP, if it were me I'd do everything by the book. It should be possible to do so without getting involved in whatever circus/monkeys the brother might have going on.

 

[silvor]

I just wanted to point out that the OP has a fiduciary duty to follow the terms of the trust document or will, as well as any applicable state and federal law (and of course IRS rules / regs / IRS code).

This would apply to purchases or sales of trust assets, filing and paying taxes, and distributing the assets to the trust beneficiaries.

There's a lot of talk about the OP taking various courses of action and having various options to do this or that. I don't see it that way - the trustee is obligated and constrained to follow the instructions in the trust or will as well as applicable law.

If they don't? Well, if everyone gets along and agrees to go along (including Schwab and any other financial institutions) and is happy with the result, then probably one can get away with doing otherwise. But if there is any discord or discontent (even long after the fact), then I think OP may open themselves up to liability / lawsuits / bad feelings from the other trust beneficiaries. This could cost OP time, money, and hurt feelings.

Since there is already hints of family discord in the OP, if it were me I'd do everything by the book. It should be possible to do so without getting involved in whatever circus/monkeys the brother might have going on.

I'm not really sure what you are getting at here about following courses of action.

I see 2 scenarios:

1) sell the funds and issue a check to him along with a K1. He pays the taxes per the K1.

2) transfer the mutual funds into a brokerage account. He gets the stepped up basis and tax reporting is then his and the brokerage companies issue when he sells.

The trust says split 50/50. It does say the trustee can make the decision on how to split. So the trustee can distribute 1/4 of the stock, cash, a car and whatever else. It does not have to be 1/2 the mutual funds, half the cash, etc.

 

[SecondCor521]

I'm not really sure what you are getting at here about following courses of action.

I see 2 scenarios:

1) sell the funds and issue a check to him along with a K1. He pays the taxes per the K1.

2) transfer the mutual funds into a brokerage account. He gets the stepped up basis and tax reporting is then his and the brokerage companies issue when he sells.

The trust says split 50/50. It does say the trustee can make the decision on how to split. So the trustee can distribute 1/4 of the stock, cash, a car and whatever else. It does not have to be 1/2 the mutual funds, half the cash, etc.

In the simplest terms: you have an obligation as trustee to follow the terms of the trust. If you do not, your brother could sue you, which you might find unpleasant.

But since you understand the terms of the trust and since the trust gives you discretion on how to split, then you're probably fine.

You probably also have an obligation to preserve the assets while they are in the trust, and you might therefore have an obligation (either under the terms of the trust, or under your state's trust laws) to take reasonable steps to minimize taxes. Selling assets and issuing your brother a K1 may or may not meet that obligation. Although it sounds like your brother may not even know about this, so again you're probably fine.

 

[pb4uski]

....does the cost basis step up when the funds were moved to the Irrevocable Trust? I read something that says it does, but Schwab didn't step up the cost basis. ...

FWIW, when I transferred my tIRA assets from Fidelity to Schwab in-kind last year, the basis were not transferred as I recall. While it usually wouldn't matter for a tax-deferred account, I wanted the basis to be able to assess investment performance. gain/loss, etc. IIRC I was able to change the cost basis online.

In your case the basis would be stepped-up basis based on fair value on the date of death, adjusted for any transactions subsequent to death.

 

[pb4uski]

...2) for whatever reason, my brother has not opened an account where I can transfer the funds to. Why? Who knows. Anyway, if I sell the funds in the Irrevocable trust in 2020, those sales go on a separate tax form correct?

My dad took his $40k IRA distribution and around $14k in Soc Sec in 2020 under his social security number. My concern is reporting under his tax ID will incur more taxes than necessary.

3) if my brother will not open an account and he's due $200k, with a cost basis of $30k, I should have every right to hold back money for taxes on the $170k gain I would think?

Your brother isn't going to avoid taxes by not having an account... he is better off to set up an account and do in-kind transfers of securities.

Let him know that if he refuses to set up an account to do an in-kind transfer of securities then you'll have no choice but to sell the securities and give him a check for the proceeds and a K-1 showing the $170k gain that will be taxable income to him in 2021 and that the trust is required to report his gain to the IRS. Do you have his SS#? Ask him what his preference is and that he has 10 days to decide.

I don't think that you have a right or obligation to withhold taxes from the proceeds... but I'm not totally sure on that.

 

[ERD50]

I'm not really sure what you are getting at here about following courses of action.

I see 2 scenarios:

1) sell the funds and issue a check to him along with a K1. He pays the taxes per the K1.

2) transfer the mutual funds into a brokerage account. He gets the stepped up basis and tax reporting is then his and the brokerage companies issue when he sells.

The trust says split 50/50. It does say the trustee can make the decision on how to split. So the trustee can distribute 1/4 of the stock, cash, a car and whatever else. It does not have to be 1/2 the mutual funds, half the cash, etc.

You might want to make him aware of the tax implications of the sale and the K-1. He may be unaware, spend all the money, then have nothing come tax time.


edit ---ooops, cross posted with pb4uski on the above....

I guess I'd be careful about the idea of holding the stocks to spread out sales over several years. If the market tanks, he might blame you!

-ERD50