August 08, 2013
The important thing to remember about the IRS' Form 1041 is that the form is a way to report income earned by the estate, rather than that income earned by the beneficiaries. Therefore, only things like estate interest or dividends, business income, or estate income from sources like property sales, should be reported on this form. Generally, there is a pretty extensive list of the types of income that need to be reported on the Form 1041 document. This includes the following:
- Dividends and interest from investments
- Rents from property named in the estate
- Royalties from business and intellectual property contained within the estate
- Any gain from the sale or auction of the estate's property,
- Any income gained from business practices within the estate
- Any income from partnerships or trusts within the estate
The area of estate-based dividends and interest earned from investments tend to be a bit murky for most CPAs who are filing the form for the first time in their careers. In order to fully clarify which investment income sources qualify, and which ones are eligible for exclusion from Form 1041, the Internal Revenue Service has drafted Publication 550. This document explains in detail how to calculate and report income from dividends and interest, and it contains a long list of included and excluded sources of this income within an estate's annual income.
It's important that CPAs filing a Form 1041 remember one clear truth about filing this type of tax return: Just like personal property and assets, it is entirely possible that the estate's assets and sources of income have actually decreased over time. While most people think of this tax form in terms of the gains experienced by an estate, many find that estates can actually lose value over time. This is especially true in terms capital assets like property, where values fluctuate on an annual basis and the trend in recent years has been more downward than upward.
For this reason, the Internal Revenue Service has made available the Schedule D inclusion that can be filed along with the Form 1041 tax return. Schedule D is used by the accountant to report a gain or loss in net income as it pertains to the capital assets within an estate. The income schedule is titled Capital Gains and Losses, and it relies heavily on the character of the assets listed and detailed to determine gains or losses. CPAs will recall that the character of assets refers to their annual gain or loss, based on how the estate holds or uses that asset when taxes are filed each year.
Generally, accountants use Schedule D to determine the gain or loss from a property in three key ways:
1. Gain or Loss From a Property Subject to Special Use Valuation
This is probably the most common way to report a gain or loss pertaining to property contained within an estate, and it generally refers to any farm or other business facility used for doing business. If the property is sold to a qualified heir, any potential gain from that sale would be calculated if the valuation of the property at the time of sale was greater than the valuation of the property at the time of the decedent's death. If the inverse is true, the property is termed a loss.
It should be noted that, in this case, a "qualified heir" can be any surviving descendent of the decedent, as well as any spouse, children, grandchildren, or lineal descendants and their spouses.
2. Gain or Loss from a Property Transferred to a Political Organization or Committee
It is entirely possible for a decedent's will to demand the transfer of their personal or business property to a political entity or committee. If this were to occur, then the gain or loss experienced by the estate would be analyzed by comparing the fair market value property on the day of the transfer versus the same fair market value assessment done on the day of the decedent's death. If the property has appreciated between the death of the decedent and the transfer of the property, the sale is considered a gain. If the property has depreciated in value between those two dates, the sale is termed a loss for tax reporting purposes.
3. Gain Or Loss From the Distribution of a Property to One or More Beneficiaries
Gains or losses can also be reported to the federal government when a property is transferred "in kind" to a beneficiary as part of two conditions:
- The property was transferred to the beneficiary to satisfy a disbursement requirement made clear in the estate's bylaws or the decedent's will
- The property can rightly be received in kind by the beneficiary in lieu of receiving a different property that they have no interest in receiving.
In this case, the government laws dictate that a fair market value assessment be conducted on the property at the time of transfer. If the property has appreciated in value since the time of the decedent's death, then the amount of appreciation is considered a gain and must be reported as part of Schedule D. If the value has maintained its same level or fallen by any amount, this is termed a loss and must be reported as such on the same schedule.
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