Posts Tagged ‘accountant’

Income Taxation of Trusts — Not Just Special Needs Trusts

APRIL 6, 2015 VOLUME 22 NUMBER 13

We have previously explained the income taxation of self-settled special needs trusts and third-party special needs trusts. We focused on special needs trusts because, well, that’s what we do — and also because there seems to be so much confusion about special needs trusts. But that is not the only confusion out there. We find a lot of confusion about taxation of trusts, generally. Let’s see if we can clarify some of the issues.

The income tax issues are actually the same for trusts that are not “special needs” trusts. But the generalizations are a little harder to keep straight, since there is a much broader variety of trusts out in the world. So let’s see if we can lay out some questions and answers to help you understand the issues.

The first question: is the trust a “grantor” trust?

Why is this question the first (and probably the most important)? Because if the trust is a grantor trust it (a) does not need to have a separate taxpayer identification number (what is called an EIN, or Employer Identification Number, in tax language) and (b) should not file a separate tax return. If the trust is a grantor trust, you can (and usually should, if only for convenience purposes) use the grantor’s Social Security Number and report income on the grantor’s personal income tax return.

So how do you know if your trust is a grantor trust? Let’s ask a few qualifying questions:

  • Did you create the trust, or did the money in the trust once belong to you?
  • Is the trust revocable (by you)?
  • Are you the trustee?
  • Are you a beneficiary of the trust?

If you answer the first question “yes” and any one or more of the following questions “yes,” your trust is almost certainly a grantor trust. There are some exceptions, but they are relatively rare. Talk to your attorney and your tax preparer — and we recommend you talk with both. Why? There is a lot of misunderstanding out there, and neither lawyers nor accountants always get the answer right on this question.

What are the most common misunderstandings? You will sometimes hear accountants, bankers, stockbrokers and lawyers assure you that an irrevocable trust that names someone other than the grantor as trustee must have a separate EIN (and, presumably, file a separate tax return). That’s simply not true. It’s also not relevant to whether or not the trust is a grantor trust.

There are also some “magic” provisions in irrevocable trusts that are usually used precisely to make them grantor trusts. If, for instance, your irrevocable trust includes a provision that says the person who set it up retains the right to trade (“substitute”) property in the trust for their own property, it’s pretty likely that was included precisely to make sure the trust is a grantor trust.

What if the trust is not a grantor trust?

Then the trust will need an EIN, and it will file a separate income tax return. That does not necessarily mean it will pay any income tax, but it will need a return filed.

Depending on the language of the trust and the nature of its distributions, some or all (or, rarely, none) of its distributions will be taxed to the recipient — or to the person who benefited from the distribution. So, for instance, if a non-grantor trust sends cash to its beneficiary, the beneficiary will probably pay some income tax on the distribution. Same answer if, instead, the trust pays the beneficiary’s rent, college tuition and car payments directly — all of those distributions are for the benefit of the beneficiary.

Note that not all of the trust’s distributions will be treated as income to the beneficiary. Only the portion of the distributions that would have been taxed to the trust (that is, the trust’s income) will be subject to being passed through to the beneficiary. So, for instance, if a trust has $1,000 of interest income, and pays $15,000 in rent and tuition bills for the beneficiary, no more than that $1,000 figure will be taxable income to the beneficiary. At least some of the administrative costs will probably be deductible before calculating the tax effect.

How does the non-grantor trust report its income for tax purposes?

The federal tax form used by trusts is called the 1041 (it’s similar to, but different from, the individual’s 1040 income tax form). It actually looks a little simpler than the personal income tax return, but that’s misleading — some of the accounting and tax concepts are more complicated and less understood. We recommend that trustees get a professional to prepare the trust’s tax return.

What about state income tax returns?

The trustee will likely need to file state income tax returns that mirror the federal return. But for which state(s)? That’s a hard question to answer, and impossible to generalize about. Some states want trust income tax returns for any trust that has a trustee or co-trustee living in their state. Others look primarily to where any one beneficiary lives. Other states do not have income tax at all, and so do not require a trust to file an income tax return. Your professional tax preparer will want to consider at least: (a) the language of the trust, (b) the residence of all beneficiaries, and (c) the residence of all trustees.

Can any tax preparer handle a trust’s income tax return?

Yes. Probably. Maybe. Wait — let us ask you a question: have you asked the tax preparer how often he or she prepares trust income tax returns? If not, we suggest you might want to ask. The returns are not bewilderingly complicated, but they are unfamiliar to people — even professionals — who are not used to working with them. Your best bet: get a professional (probably a CPA, perhaps a lawyer or law firm) who does this kind of tax return on a regular basis.

Good luck getting through this tax season. We hope this helps. Be careful, though — there are exceptions and qualifications to the general rules we’ve outlined. Check with your experienced tax preparer or attorney before actually preparing returns. Better yet: let the professionals do it.

Exploitation of Vulnerable Senior Leads to Disinheritance

JANUARY 27, 2014 VOLUME 21 NUMBER 4

Arizona has a relatively strong statute dealing with exploitation of vulnerable adults. An exploiter can be charged criminally, and might receive a longer sentence or larger fine because of the victim’s vulnerability. But the strongest part of the Arizona law is probably the provision that lets the victim — or the victim’s heirs — pursue a civil judgment against the exploiter.

That was what Hazel Kaplan (not her real name) did. Her uncle Paul was a widower, living alone in Lake Havasu City, Arizona. Paul’s estate plan included a trust naming Hazel as successor trustee, and leaving his estate to her and two other nieces. Hazel regularly visited with uncle Paul, and helped him to pay his bills. When Paul’s wife had died, it was Hazel who had been there to help make funeral arrangements and help Paul with the transition.

Then, in 2001, Karen moved in as a caretaker. Paul, an immigrant, had located her through the immigrant community in the eastern U.S., and she moved to Arizona to live with him, oversee his medications, drive him to appointments, feed and bathe him — even monitor his care, change his catheter and clean up after he suffered a heart attack in 2006. Karen was his only caretaker (other than one nurse who visited after his heart attack) from her arrival in 2001 until Paul’s death in 2008.

Paul’s accountant prepared four amendments to Paul’s trust between 2006 and 2008. Over the course of those amendments, Hazel’s share of the estate and her appointment as successor trustee were both removed — caretaker Karen and her son were named as trustees and Karen as the beneficiary of Paul’s entire estate.

Three months before his death, Paul visited his bank in the company of Karen and her son. He withdrew $200,000 and opened two accounts with the proceeds. One account was in Karen’s name with her son as co-owner; the other account named Paul himself and Karen’s son as co-owners. Two months later Karen closed out the account her name was on, and used the proceeds to buy a house in Delaware, where she had lived before moving in with Paul. The house had been a bank foreclosure, and Karen’s daughter was the real estate agent in the transaction. She did not put Paul’s name — or his trust’s — on the title. She sold the property immediately after Paul’s death for a significant gain, and kept the proceeds.

After Paul’s death, niece Hazel started a probate proceeding and a lawsuit against Karen and her son. She alleged that both had violated Arizona’s vulnerable adult statute, and asked for the return of everything either of them had received from Paul or his estate.

After a two-day trial, the probate judge ruled that Karen and her son had, indeed, exploited a vulnerable adult. He ruled that the trust amendments were invalid, and that Karen and her son forfeited any right to inherit any portion of Paul’s estate or trust as a result of their exploitation.

The Arizona Court of Appeals considered the evidence and arguments, and upheld the probate judge’s ruling. One key question: was Paul a vulnerable adult?

Several witnesses (including the accountant who prepared trust changes, the bankers who handled the transfer of money from Paul’s name to his exploiters’ names, and Karen and her son) all testified that he was mentally alert. His doctor testified that he was very passive and suggestible, and niece Hazel testified that Paul was very susceptible to others — particularly to women. The appellate court noted that the probate judge had been in a better position to judge the believability of each witness, but noted that the accountant and the bankers had a vested interest in testifying that Paul had been able to give them direction. Besides, said the appellate judges, mental impairment is not required for an adult to be “vulnerable” under Arizona law — physical disabilities and resultant reliance on caretakers can make the patient vulnerable to manipulation.

The result? Paul was a vulnerable adult, Karen and her son owed him a duty not to take advantage of him, and their acts exploited him — especially when they were involved in getting $200,000 transferred to them before Paul’s death. Oh, and Karen was ordered to pay Hazel’s legal fees for the appeal, too. Kousoulas v. Marinis, January 7, 2014.

Does Hazel’s lawsuit stand for the proposition that any caretaker who receives the estate of the person they cared for is necessarily an exploiter? No, but the relationship inherent in a caretaker/patient relationship is certainly subject to exploitation, and gifts to caretakers will always be suspect. The evidence that Karen kept Hazel from visiting her uncle, and that she and her son were involved in changing his estate plan (though they did not go into the room with the accountant when Paul signed trust changes) both weighed heavily against them.

If Paul had hired an attorney to handle his estate planning, rather than entrusting it to his accountant, would things have been different? Possibly — an attorney would likely have been more attuned to the importance of separating out the possibility of exploitation and (if it was clear that Paul genuinely wanted to leave his estate to his caretaker) documenting the evidence of Paul’s wishes. But the probate judge noted, and experienced lawyers usually realize, that it is difficult to assure that a client’s choices are not being changed by suggestions from caretakers — especially full-time, live-in caretakers, who have such a strong opportunity to develop a relationship based on dependency. That is, in fact, why there can be a presumption of undue influence when a change is made in favor of someone who has a fiduciary relationship with a vulnerable adult.

How to Leave Your IRA to a Trust — And Why You Might

OCTOBER 4, 2010 VOLUME 17 NUMBER 31
Last week we wrote about how you can go about leaving your IRA (or 401(k), 403(b), etc.) to a child with a disability. In passing we mentioned that the discussion about how to leave your IRA to any trust could wait for another day. Today is that day. Let’s tackle this as a Q&A session (or, if you prefer, we can call it a FAQ list).

Can I name a trust as beneficiary of my IRA?
Yes. That was easy.

Are the rules the same for 401(k), 403(b) and other retirement accounts?
Generally, yes. If you have more esoteric retirement accounts, talk to someone to make sure you are doing the right thing. What the heck — talk to an expert in any case. Our purpose here is just to give you some background and introduce the language and issues, not to give you direct legal advice.

Before you tell me how to do it, why would I want to name a trust as beneficiary of my IRA?
There are several reasons you might:

  • If you have a child who is a spendthrift, or married to a spendthrift, or who is involved in tax issues or legal proceedings, you might want the retirement account to be protected against creditors.
  • If you worry that your child might get divorced and want to keep your retirement account out of the divorce calculations and proceedings, a trust might help protect the account (and, for that matter, other assets you are considering leaving to that child).
  • You might just want to delay the withdrawal of your retirement account as long as possible. Of course, you could name your child as beneficiary and trust him or her to withdraw the money as slowly as is permissible. With a trust you can help assure that “stretch-out” of the IRA.

Why is my banker/broker/accountant telling me I can’t name a trust as beneficiary?
That used to be the rule, and lots of professionals are not yet caught up. There are also a couple of special rules that apply when you name a trust as beneficiary — though they are not at all hard to comply with, so it’s not clear why advisers get hung up on those rules. Finally, even though the rules permit naming a trust as beneficiary they do not require all account custodians to go along — so your broker might be telling you that, while the rules permit naming a trust, your account can not take advantage of those rules.

If I want to name a trust as beneficiary, what must I do?
There are a handful of requirements. The important ones: give the IRA custodian a copy of the trust (that, by the way, can be taken care of later — but you can do it now if you want), name only one income beneficiary for the trust, and make sure your beneficiary designation comports with the trust set-up and your larger plans. That probably means you should get competent professional assistance, but that’s usually a good idea for your estate planning anyway.

Are there bad things that happen if I name a trust as beneficiary?
Yes, but not very bad. Depending on the ages of all the beneficiaries and potential beneficiaries, you might have shortened the stretch-out time to a period less than the life expectancy of the primary beneficiary.

Uh, could you please repeat that — in English?
Of course. Let’s use an illustration.

Suppose you have three children: Abigail, Ben and Candy. You are OK with Abbie and Ben getting their shares of your IRA in their names — you trust them to make sound judgments about how quickly to withdraw the money, and you don’t want to bother with a trust for them. Candy is a different story. The details of that story don’t matter: you just want to put Abigail in charge of deciding whether to withdraw more than the minimum amount each year from Candy’s share of the IRA.

You can name a trust for the benefit of Candy as beneficiary of 1/3 of your IRA (naming Abbey and Ben as the other two beneficiaries outright). But what will happen if Candy dies before the IRA is closed out?

As it happens, Candy does not have children. You decide to have the trust say that upon Candy’s death the remaining trust interest in “her” share of your IRA will go to Abigail and Ben. Abigail is ten years older than Candy. That all means that Candy will have to make her IRA withdrawals using Abigail’s age and life expectancy.

But wait. Candy does have children?
Well, why didn’t you say so? That makes it even easier. You can have the trust provide that if Candy dies before the last IRA withdrawal her children become the beneficiaries of the trust (and, indirectly, the IRA). As before, we use the oldest potential beneficiary as the determining age — and we are going to assume for the sake of this piece that Candy is older than all of her children. No effect on Candy’s withdrawal rate. But note that if Candy does die, her children will still have to withdraw from the IRA at Candy’s rate, not their own.

What about estate taxes?
Now you’re talking about a whole different kettle of fish (or something). As you know, the estate tax situation is in flux right now, and some states have their own estate tax rules. That makes it very hard to generalize, and unnecessarily complicates this discussion. Suffice it to say that your IRA will be part of your estate for estate tax purposes, and just because there is income tax due on it does not mean that there won’t also be an estate tax liability attached to it. But if your entire estate is worth less than $1 million, you probably are not going to care very much. Stay tuned for a new number to be inserted in that sentence sometime before the end of 2010.

That sounds pretty simple. Could you please make it more complicated?
We’d be happy to, but it’s not required. We could give you information about what lawyers call “conduit” trusts and “accumulation” trusts. We could explain why you can’t have the money go to a charity upon Candy’s death. We could even try to give you some better names for your imaginary children (while still adhering to the A, B and C convention). But for most of our clients, those complications are unnecessary.

The bottom line: it is not that hard to name a trust as beneficiary of your IRA, 401(k) or other qualified retirement plan. You just need to review the rules, and understand why you might want to do such a thing.

It is also permissible to consider all that, try to get the rules straight, and then decide not to bother. One thing that we don’t want to allow you to do, though: ignore the issue, prepare a will that seems to handle all of your assets, and then have an IRA beneficiary designation that doesn’t agree with the rest of your estate plan, imposes an undue burden on your children and beneficiaries, or fails to address your child’s disability, money problems or legal or financial situation.

We hope this has helped demystify a subject that lawyers and accountants often seem to enjoy complicating. Your life, however, tends to be complicated. Please get good legal, financial and investment advice before you decide what you should do.

To Our Favorite Estate Planning Client: Please Help Us Help You

JUNE 1, 2009  VOLUME 16, NUMBER 42

Dear client:

It has been wonderful working with you. We are pleased that your estate plan is completed, and simultaneously saddened that we will not be seeing much of you for a couple years. Please remember to get in touch with us if there are major life changes. In any event, you should probably make an appointment in five or six years just to check on what is new — either in your life or in the  world of estate planning.

In the meantime, we would very much like it if you would help us out. It will make things much easier for us (and for your family) if you will take these additional steps:

Please talk with your family. The best way to minimize disappointment and disputes after your death is to let everyone know what to expect in advance. Be prepared to discuss issues with your family, too. You may even make changes to your estate plan based on those conversations — we will be happy to have follow-up discussions as needed. There is no legal requirement that you either share or withhold copies, but there are good practical reasons to let them in on the plans.

Recently we had a client who carefully prepared her advance medical directives. She told the son she named as her agent what she wanted, and she completed all the documents correctly. When she fell ill, her daughter (who had not maintained much contact) could not believe her mother would want to refuse medical care. She initiated legal proceedings to force continued aggressive treatment. She was not successful, but the cost and heartache were both considerable — and brother and sister no longer speak to one another. Mom could have avoided that outcome, we think, if she had discussed her wishes with both children.

Coordinate your beneficiary designations. If your will leaves everything to your children equally, but your life insurance names only your oldest daughter as beneficiary, your daughter gets the proceeds regardless of your will. Is that what you intend? If so, make it clear. If not, change the beneficiary designation to match your will. Different considerations are involved with life insurance, IRAs, and other kinds of policies; please ask us for assistance in getting your beneficiary designations arranged.

In a recent case in our office, a mother told her three children that they and her long-time companion were named as equal beneficiaries on her IRA account. When she died it turned out that the companion was the only beneficiary. Did mom intend that result, or was it an oversight? An excellent relationship with the grieving companion is endangered by this outcome. If, in fact, mom wanted to split the account among the four people most important in her life, that will not be the result.

In our recent example, even if all four beneficiaries were to agree that the account should have been split, it is not as easy as just doing that. Income tax consequences mean that the children would receive considerably less than their mother apparently intended. Even if everything can be worked out harmoniously, there will be legal expenses, not to mention a period of uncertainty and unease.Please talk with your family, and even show them the documentation. Don’t leave them uncertain about whether you really intended the result your documents indicate.

Don’t tinker with your beneficiary designations, documents or titles. If someone at your bank says you should make all your accounts into “Payable on Death” (POD) accounts, please talk to us first. If we have helped you name a trust as beneficiary on your IRA and your accountant tells you that’s a mistake, please talk to us before you change it back.

Please do not put your children’s name on your house, or your bank account, “just in case.” We prepared your documents to take care of “just in case,” and your changes may undo the value and effect of the documents we prepared for you. We are happy to discuss the effect of the change in title; if your banker tells you that we “just don’t know how banks work,” remind him that he is not the expert on how the law works. There is nothing that prevents us from meeting with you, your insurance agent and/or your broker all at once; we can then discuss and reach agreement on what should happen to effect your wishes.

Prepare a personal property list. Almost every will we prepare includes a provision that allows you to designate individual items of personal property (like family heirlooms, antique furniture, favorite paintings, etc.) that should be left to specific individuals. We encourage you to complete that list, even if it remains a work in progress. It need not list every item in your house, but time and again we have seen the outright joy on the faces of friends and family members (and particularly, we might note, on the faces of grandchildren) who received an individual item from such a list. It can convey a special message to your loved ones.

Some years ago we handled the estate of a woman whose personal property list ran to more than fifty pages. She felt strongly about each item on the list; you probably do not have that many specific bequests you wish to make. If your list is only three items long, that is fine. And once again, we urge you to show it to your family; your son may surprise you by telling you that he doesn’t actually have any interest in grandma’s antique cedar chest, and you should know that now so that you can leave it to your granddaughter instead.

Prepare a list of assets and directions. It really helps if you have left a roadmap for the person who handles your estate. You know perfectly well where the life insurance policy you bought in 1955 is located, and how often the statement from that little bank in Ohio arrives. Your daughter does not, and if she is handling your estate she will spend countless hours looking for those kinds of information. You can make her job much easier if you give her some clues and direction. She also will need to make decisions about your funeral, your obituary and even what (if any) music will be played. If you have told her what you want, her job will be so much less stressful, and the other family members can hardly criticize her for following your directions.

When you signed your estate planning documents, we gave you a form called “What My Family Should Know.” It is not the only way to gather this information, but it can be a useful starting point. If you can not locate the form, do not hesitate to contact us for a new copy; even if you have partly completed it and just want to start over or make a few changes, we will be happy to give you another blank copy. Just ask.

Incidentally, we would really like it if your online login and password information was available somewhere. Whoever handles your estate (whether after your death or after you have become incapacitated) will be able to check (and close) your e-mail account, get up-to-date information from your online bank and brokerage services, and complete many steps that take much longer if they must be done solely by mail. There is a balance to be struck, of course; you need to keep that information confidential while you are still alive and capable, but available to the one person who needs it when you are not able to pass it along in person. Let us know if you need help with this project; we might have some ideas about how to manage the competing interests.

Feel free to update our information. Many of our clients send us periodic updates of their assets, titles and information. We do not charge to glance at those forms as they arrive, and that means there is at least one other place your family might look for roughly current information. We will simply hold the information in your file, to be updated again when we next hear from you.

We hope you enjoy perfect health, and that your estate plan turns out not to have been needed. This is one instance in which it is good if it turns out you didn’t need to expend the funds. But please help us so that if something should happen, we can make your estate plan work the way you intended. And we’re looking forward to seeing you in five years (or sooner) to update.

©2017 Fleming & Curti, PLC