1041 Estate - very high tax rate

[ButterUtterD]

Hello All

Background: Helping a friend complete a 1041 Estate Income Tax Return for Estates and Trusts for their deceased Father.

- Friends father died in June of 2019 (Mother long gone)
- no assets other a traditional IRA with $17,000.
- No beneficiaries on the IRA
- Estimated Tax payment made to Fed Gov of ~1500$ at the time of taking the distribution for the full 17k (received a 1099R)

Ran through the form using tax software and its saying total tax owed is ~4400$

I believe I have completed this form correctly, I have doubled checked the math and it seems correct. My Question is, this tax seems brutal...
$4400 tax on a measly $17,000... A ~25% tax rate .

The amount is irrelevant and will be paid without issue, its more a point of curiosity , the tax treatment seems pretty harsh for such a small amount of money.

Unless i'm calculating it wrong...

Thank you!

[bsteiner]

Are you sure he didn’t have any other assets?

You can deduct the administration expenses.

If the beneficiaries are in lower brackets the executors can make distributions which would carry out income.

If it’s helpful the executors could pick a fiscal year.

[Katietsu]

The IRA had no beneficiaries listed so it was paid to the estate?

Who or what originally received the $17,000? And if it went to an estate account, were there fees such as probate fees? This would be one example of an administrative fee that bsteiner referenced.

Where is the $17,000 now? Had it been distributed? If so, as bsteiner mentioned, what is the marginal tax bracket of the beneficiaries?

Do you understand that you may choose estate tax year which might not correspond to a calendar year.

[ButterUtterD]

Hi Katietsu and bsteiner

Answers
- no other assets
-The IRA had no beneficiaries listed so it was paid to the estate of the deceased father - Correct.
-The check for $17000 (really 15,500 as 1500$ were withheld for federal taxes) was sent to the executor (my friend and the deceased's son) and cashed.
Half was kept by him and the other half was given to a sibling.
This was done in Nov 2019. Date of Death was in June

My Friend (the executor ) is in a lower tax bracket, his sibling is probably in a ~15-20% effective

I do not follow your comments on the executor making distributions or selecting a fiscal year.

Thank you for your help

[JimInIllinois]

-The check for $17000 (really 15,500 as 1500$ were withheld for federal taxes) was sent to the executor (my friend and the deceased's son) and cashed.
Half was kept by him and the other half was given to a sibling.
This was done in Nov 2019. Date of Death was in June

The estate should have a $15,500 income distribution deduction, and the siblings should each receive a form K-1 showing $7,750 in income (on which they will have to pay taxes). There is also likely a way to include the withheld taxes on the K-1 so they can count it towards their liability. Any other expenses that the estate can deduct will reduce the remaining $1,500 of income, and can also reduce the siblings liability, although if there were no other assets its not clear how the various estate and other final expenses were covered.

When you file the first tax return of the estate you can choose the final month of the tax year, up to 12 months including the month of death, so the tax year could end in May in your case. Picking a tax year ending in 2020 makes the distributed income taxable on the recipients 2020 taxes due next year, and avoids the need for them to wait for the executor to send a K-1 to to their 2019 taxes.

There are some decent books on estate administration available, e.g., "Estate & Trust Administration For Dummies" (https://www.amazon.com/dp/B07L8R4XK1).

Jim

[JimInIllinois]

The estate should have a $15,500 income distribution deduction, and the siblings should each receive a form K-1 showing $7,750 in income (on which they will have to pay taxes). There is also likely a way to include the withheld taxes on the K-1 so they can count it towards their liability.

From the instructions for form 1041: "Report on Schedule K-1 (Form 1041), box 13, code B, any credit for backup withholding on income distributed to the beneficiary." I think you can treat the entire $17,000 as distributed (i.e., including the withholding credit), so the estate would have no taxable income, but the siblings would owe tax on the full $17,000 but can treat the $1,500 as a payment on their returns.

I should have mentioned before that you should also read "Publication 559, Survivors, Executors and Administrators" at https://www.irs.gov/forms-pubs/about-publication-559

[Gill]

Don’t file that return until you get it correct. From your description of the facts, no income tax is due from the estate and you need correct K-1’s for the beneficiaries. File it on a 2020 fiscal year which will relieve the beneficiaries of including it on their 2019 returns.
Gill

[MarkNYC]

The estate should have a $15,500 income distribution deduction, and the siblings should each receive a form K-1 showing $7,750 in income (on which they will have to pay taxes). There is also likely a way to include the withheld taxes on the K-1 so they can count it towards their liability.

From the instructions for form 1041: "Report on Schedule K-1 (Form 1041), box 13, code B, any credit for backup withholding on income distributed to the beneficiary." I think you can treat the entire $17,000 as distributed (i.e., including the withholding credit), so the estate would have no taxable income, but the siblings would owe tax on the full $17,000 but can treat the $1,500 as a payment on their returns.

In the same section of the form 1041 instructions it states: "Caution! Except for backup withholding (as explained below), withheld income tax can't be passed through to beneficiaries on either Schedule K-1 or Form 1041-T."

The tax withheld on the IRA distribution is not "backup withholding." Putting that tax withholding onto the beneficiaries K-1s will very likely be denied and generate some inconvenient IRS correspondence affecting not just the estate income tax return but also the personal returns of the beneficiaries.

It's worth noting that federal estimated income tax payments are not required in the first 2 taxable years of an estate.

[JimInIllinois]

Thanks Mark. In that case it looks like the estate will owe taxes on the undistributed $1,500 (less the exclusion and any expense deductions) and receive a refund to distribute.

[ButterUtterD]

Hi All,

Thanks for the great feedback. this opens up a lot of items to research/consider

I went back and spoke with my friend regarding expenses.

There was a ~3000 cremation/burial cost. He just paid it himself out of his checking account though.

Is there a way to claim this as an expense against the estate?

Thank you!

[Gill]

Hi All,

Thanks for the great feedback. this opens up a lot of items to research/consider

I went back and spoke with my friend regarding expenses.

There was a ~3000 cremation/burial cost. He just paid it himself out of his checking account though.

Is there a way to claim this as an expense against the estate?

Thank you!

No, that is a funeral expense and not deductible.
Gill

[ButterUtterD]

Hi Gill

In reading this link:
https://turbotax.intuit.com/tax-tips/fa ... /L7pVU9Hlf

I interpret it that the estate could deduct the expense?
( I suppose the one thing being did the "estate" really pay the expense

Thank you

[Gill]

I'd put the estate on a January 31 fiscal year and file the return now and the beneficiaries won't have to worry about reporting the income for another year in their 2020 personal return.
Gill

[JimInIllinois]

There was a ~3000 cremation/burial cost. He just paid it himself out of his checking account though.

Is there a way to claim this as an expense against the estate?

The estate can reimburse him for the burial, but cannot deduct it on the estate's income tax return (form 1041). Funeral/burial expenses can only be deducted against the estate tax (form 706), which this estate is far too small to owe.

From Pub 559: "Funeral expenses paid by the estate aren't deductible in figuring the estate's taxable income on Form 1041. They are deductible only for determining the taxable estate for federal estate tax purposes on Form 706."

[Gill]

Hi Gill

In reading this link:
https://turbotax.intuit.com/tax-tips/fa ... /L7pVU9Hlf

I interpret it that the estate could deduct the expense?
( I suppose the one thing being did the "estate" really pay the expense

Thank you

No, that source is incorrect. Funeral expenses can't be deducted on the estate's income tax return.
Gill

[gokartmozart]

I'd like to explain something that is fundamental to income taxation of estates and trusts. The replies above talked around it but did not spell it out explicitly.

Estates are taxed as "pass through" entities. When estates pass their income through to their beneficiaries, they pay little or no tax. If they don't pass through then their tax rates are very steep compared to individuals.

The tax rate in the original post's scenario is ($1,500 paid as estimated + $4,400 calculated w/software)/($17,000 distribution) = 35% which matches the 2019 tax tables for estates and trusts for an income of $17,000. This is very steep compared to what an individual would pay on $17,000.

If the estate pays out the income of $17,000 (or nearly so) to beneficiaries*, then that amount is entered on the 1041's line 18. Then the estate gets a tax deduction of $17,000 and the estate's taxable income is now zero. The tax on zero is zero! One has to fill out Schedule B and one or more K-1s too.

The individual beneficiaries* will get K-1s reporting what they received as income. They will pay taxes on this income but at individual tax rates, not estate income tax rates. Their individual rates will be probably lower than 35%.

* (edit to add:) Estate beneficiaries, not IRA beneficiaries.

[SpideyIndexer]

IRS mentions funeral expenses are not 1041 deductions but does not specifically mention burial expenses. Anyone know if burial expenses are deductible? There are fees from cemeteries, caskets are usually not cheap. Or per the OP, cremation.

To me "funeral expenses" would be for the ceremony to honor the deceased, often in line with religious traditions.

[MarkNYC]

IRS mentions funeral expenses are not 1041 deductions but does not specifically mention burial expenses. Anyone know if burial expenses are deductible? There are fees from cemeteries, caskets are usually not cheap. Or per the OP, cremation.

To me "funeral expenses" would be for the ceremony to honor the deceased, often in line with religious traditions.

When filing an estate income tax return Form 1041, there is allowed (with certain exceptions) a deduction for expenses in connection with the "administration of the estate." That term generally means the management of the decedent's assets and liabilities. As such, funeral and burial costs do not meet the definition of administration expenses thus are not deductible.

[SpideyIndexer]

Not an IRS source, Kiplinger in June 2023 disagreed and says funeral expenses paid by the estate are deductible:

https://www.kiplinger.com/personal-fina ... ed-to-know

However, in Pub 559 the IRS says funeral expenses are not deductible but does not mention burial expenses. I would have to believe a burial or cremation is indeed necessary for the estate. Here is a snip from Pub 559 p29:

Funeral and Medical Expenses
No deduction can be taken for funeral expenses or medical and dental expenses on the estate's Form 1041.
Funeral expenses. Funeral expenses paid by the estate
aren't deductible in figuring the estate's taxable income on
Form 1041. They are deductible only for determining the
taxable estate for federal estate tax purposes on Form
706.

But it doesn't exclude burial or cremation expenses.

[SpideyIndexer]

Not an IRS source, Kiplinger in June 2023 disagreed and says funeral expenses paid by the estate are deductible:

https://www.kiplinger.com/personal-fina ... ed-to-know

Many other sources agree with Kiplinger.

However, in Pub 559 the IRS says funeral expenses are not deductible but does not mention burial expenses. I would have to believe a burial or cremation is indeed necessary for the estate. Here is a snip from Pub 559 p29:

Funeral and Medical Expenses
No deduction can be taken for funeral expenses or medical and dental expenses on the estate's Form 1041.
Funeral expenses. Funeral expenses paid by the estate
aren't deductible in figuring the estate's taxable income on
Form 1041. They are deductible only for determining the
taxable estate for federal estate tax purposes on Form
706.

But it doesn't exclude burial or cremation expenses. And it's puzzling to me why many financial columnists disagree with the Pub 559, and claim even funeral expenses can be deducted on the estate 1041. Am I overlooking something? Was the law changed recently?

[MarkNYC]

Not an IRS source, Kiplinger in June 2023 disagreed and says funeral expenses paid by the estate are deductible:

https://www.kiplinger.com/personal-fina ... ed-to-know

The Kiplinger article you linked does not disagree. It states that funeral expenses paid by the estate are deductible against the gross estate for purposes of calculating "estate tax." Estate tax is reported and paid on Estate Tax Return Form 706. That is different from "estate income tax" reported and paid on Form 1041.

[toddthebod]

Not an IRS source, Kiplinger in June 2023 disagreed and says funeral expenses paid by the estate are deductible:

https://www.kiplinger.com/personal-fina ... ed-to-know

Many other sources agree with Kiplinger.

However, in Pub 559 the IRS says funeral expenses are not deductible but does not mention burial expenses. I would have to believe a burial or cremation is indeed necessary for the estate. Here is a snip from Pub 559 p29:

Funeral and Medical Expenses
No deduction can be taken for funeral expenses or medical and dental expenses on the estate's Form 1041.
Funeral expenses. Funeral expenses paid by the estate
aren't deductible in figuring the estate's taxable income on
Form 1041. They are deductible only for determining the
taxable estate for federal estate tax purposes on Form
706.

But it doesn't exclude burial or cremation expenses. And it's puzzling to me why many financial columnists disagree with the Pub 559, and claim even funeral expenses can be deducted on the estate 1041. Am I overlooking something? Was the law changed recently?

I don't see disagreement in Kiplinger:

Instead of an individual, only funeral expenses paid out of the estate (the funeral costs are paid by the estate of the decedent, and not just any single individual) are instead tax-deductible against the decedent’s gross estate to determine the net taxable estate and corresponding estate taxes, subject to a threshold.

That's what Pub 559 says as well.

[SpideyIndexer]

I know about the funeral expenses only being deductible against the fed estate tax which only benefits very high value estates. Some of the financial advice forums don't clarify whether they are discussing deductions for federal estate tax or federal income tax of the estate (1041.)

Burial expenses are have not been mentioned either here (so far) nor can I find an IRS source.

[toddthebod]

I know about the funeral expenses only being deductible against the fed estate tax which only benefits very high value estates. Some of the financial advice forums don't clarify whether they are discussing deductions for federal estate tax or federal income tax of the estate (1041.)

Burial expenses are have not been mentioned either here (so far) nor can I find an IRS source.

Here's the definition of funeral expenses that are deductible against a taxable estate:

§ 20.2053-2 Deduction for funeral expenses.
Such amounts for funeral expenses are allowed as deductions from a decedent's gross estate as (a) are actually expended, (b) would be properly allowable out of property subject to claims under the laws of the local jurisdiction, and (c) satisfy the requirements of paragraph (c) of § 20.2053-1. A reasonable expenditure for a tombstone, monument, or mausoleum, or for a burial lot, either for the decedent or his family, including a reasonable expenditure for its future care, may be deducted under this heading, provided such an expenditure is allowable by the local law. Included in funeral expenses is the cost of transportation of the person bringing the body to the place of burial.

I don't see how you can read that and think that burial expenses are something different.

[SpideyIndexer]

Yes, I had read § 20.2053-2 before without understanding its scope. Does it refer to the Estate Federal Income Tax or the Federal Estate Tax or both?

[bsteiner]

You have to start with the Code. See Section 2053, in particular the first few words of Section 2053(a): https://www.law.cornell.edu/uscode/text/26/2053.

For the cross-reference, here's Section 2001: https://www.law.cornell.edu/uscode/text/26/2001.

The estate tax sections of the Code begin with 2001. The estate tax sections of the regulations begin with 20. Here's Treas. Reg. § 20.2053-2: https://www.law.cornell.edu/cfr/text/26/20.2053-2.

Unlike funeral expenses, you may deduct administration expenses either on the estate tax return (most common until recently) or the estate's fiduciary income tax returns (most common in recent years).