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The following is an outline of a presentation given in 1992 to the general public by John W. Ambrecht of Ambrecht & Associates, and Patricia A. Hiles, then IRS Estate and Gift Tax Attorney, Santa Barbara, California. This was a Seminar Co-Sponsored by the Estate Gift Tax Committee of the California State Bar Taxation Section, and the Internal Revenue Service as a public service.
I. Introduction by Moderator
Purpose of this presentation is generally to acquaint an individual (trustee) with what must be done on the death of a settlor (trustor) of a trust. The following individuals will review and discuss the steps that must be taken on the death of an individual that has established a living trust.
Definition of terms that will be used today by our speakers:
1. Trust: A written agreement directing a trustee how to manage and distribute assets.
2. Trustee: The person or corporation that has legal possession of assets in the trust.
3. Trustor (Settlor): The person(s) who established a trust; can be a single individual or a husband and wife.
4. Beneficiary: The person(s) who will benefit from the trust either now or in the future. A beneficiary may also be a charity or other entity.
5. Trust Estate: A general term used to denote the assets in the trust.
This seminar should not be construed to be providing legal or accounting advice. You must see a qualified professional for advice for your specific situation. It is not intended here today to cover all aspects of this subject, but to give an overview only.
Let us begin our presentation by first quickly examining what the settlor of a trust should have done prior to his or her passing.
II. Basic Estate
An individual has signed and had notarized a trust document and executed a Will. The trust document has been written to satisfy several objectives of the settlor.
1. The document will provide where and how the trust estate will be distributed to the settlor's beneficiaries. For example, the trust may provide that the trust estate will be distributed to the children of the settlor after death, free of trust, or be held in further trust until the child attains a specific age.
2. The second objective of the trust document is to arrange the trust estate in such a way to minimize estate taxes. There are many ways to save taxes, but the most popular technique is to create a by-pass trust (or other popular names for the same trust are the residual trust, the B trust, etc.) The by-pass trust is created to utilize the settlor's $600,000 estate tax exemption. Review briefly the estate tax system:
a. The estate tax rates: 37% to 55% on all assets an individual owns at death.
b. Each person has a $600,000 exemption before the payment of estate taxes is required and a Federal Estate Tax Return form 706 must be filed.
c. Tax planning can be accomplished by a Will, a trust, and other techniques.
3. A third objective of a living trust is to avoid probate fees.
a. All assets (some exceptions) must be actually transferred to the living trust by changing the title of the assets to the name of the trustee. For example, the deed to the residence of the settlor must be rewritten and re-recorded to show ownership in the name of the trustee.
b. Assets not properly transferred to the living trust usually are subject to probate. The usual Will of a person who has created a living trust generally provides that assets not properly transferred to the trustee will be distributed to trustee by court order at the termination of the probate process.
On the death of the settlor, the successor trustee is responsible to follow the testamentary instructions in the trust document and the tax law.
The trust document will name the successor trustee and, if not, the court will name such an individual or corporation.
Remember, the trust document will instruct the trustee how to handle the assets on the death of the settlor. In general, the first step that the successor must perform is to determine what assets are a part of the trust. Additionally, in most family situations, if a trustee determines assets have not been properly transferred to the trust, he or she must notify the executor to begin probate unless an exception to the requirement for a probate proceeding exists.
III. Marshalling the Assets of the Deceased Settlor as of the Date of Death.
A complete list of all of the assets owned directly or indirectly by the settlor should be developed. Each asset needs to be identified and a copy of the deed and/or other title of ownership of the assets reviewed, e.g., personal property, cash, cars, real estate, jewelry, stocks, and bonds.
All of the debts of the deceased settlor have to be listed: Utility bills, checks that have been written but not cashed, the exact amount of the mortgage on any property, and determination of any other debts of the settlor.
Steps should be taken to preserve assets, especially if a danger exists that they may disappear.
1. Personal property should be secured.
2. Insurance coverage reviewed (both casualty and liability).
3. Stocks reviewed and sold, if appropriate.
After all of the assets have been identified, the fair market value of each asset must be determined.
IV. Valuing the Assets of the Decedent as of the Date of Death
A. Reasons for valuing assets accurately. The income tax basis, distribution of assets and estate taxes.
B. Each asset of the decedent, whether in trust or held by the decedent in his or her own name, must be valued.
C. The fair market value must be determined as of the date of death. Fair market value is defined as the price a willing buyer would pay a willing seller, both with a "good" knowledge of the market where the asset is bought and sold, neither being "rushed" to buy or sell.
D. An independent appraiser is necessary to establish value unless circumstances dictate otherwise.
E. An example of techniques on how an asset should be valued is real property. (Review real estate appraisal methods.)
V. Preparation and Filing of the Federal Estate Tax Return (Form 706)
A. Requirements to prepare the Federal Estate Tax Return:
1. If a decedent's assets plus any taxable gifts exceed $600,000 in gross value, an IRS form 706 must be filed with the IRS. Note: Consideration should be given to filing Form 706 for smaller estates if there are any valuation questions. [This $600,000 figure has increased since 1992, see schedule here.]
2. A California Estate Tax Return (Form ET-1) is also required to be filed with the California State Controller.
3. The trustee or the executor is generally responsible to file the death tax forms.
B. All assets owned by the decedent need to be listed on the IRS Form 706.
1. Assets actually owned by the decedent, whether in the trust or held in the name of the decedent or jointly with another, have to be listed.
2. Some assets that may not be in the decedent's name may have to be listed on the death tax form, e.g., life insurance, pension plans.
3. The fair market value as determined above for each asset must be listed.
C. When is the 706 due?
1. Nine (9) months after the date of death of the decedent. DO NOT BE LATE.
2. One six-month extension of the time to file may be requested for reasonable cause before the expiration of the above nine (9)-month period for filing.
D. When are the estate tax payments due?
1. Nine (9) months after the date of death of the decedent.
2. If payment is late, interest will be added and penalties may be applicable.
E. When is an estate or trust released from liability? The statute of limitations.
VI. What Happens after Your File a Federal Estate Tax Return - the IRS Perspective
A. The form is stamped when received by the IRS and processed to the Estate Tax Auditor for the geographic location where the decedent lived.
B. Each return is reviewed by an IRS Estate and Gift Tax Attorney.
1. Valuations (appraisals) are reviewed to determine if correct.
2. Deductions are allowed if reasonable.
3. Obviously missing assets?
C. An audit may be initiated. What happens if the IRS audits the return?
1. Income tax returns and banking records are reviewed.
2. The return of a prior deceased spouse is requested and reviewed.
3. Trust records and tax returns are reviewed.
4. Valuations are questioned.
5. A search is made for undisclosed assets and gifts made prior to death.
VII. Following the Settlor's Testamentary Plan - Funding the By-pass Trust and/or Distributing the Trust Estate to the Beneficiaries
A. The instructions in the trust document need to be reviewed and implemented by the trustee. (Or, if property passes under a Will, by the executor.)
1. Assets allocated ("funded") to the by-pass trust or other trusts are selected in accordance with trust instructions.
2. Accounting records established.
3. Gifts to the designated beneficiaries completed by the trustee.
VIII. What Income Tax Returns Are Due on the Death of the Decedent-Settlor?
A. Final Federal and California Personal Income Tax Returns (Form 1040 and Form 540) must be filed that includes ALL income and appropriate deductions up to the date of death. These returns are due April 15th of the following year.
B. If a by-pass trust is established, annual Fiduciary Income Tax Returns (Forms 1041 and 541) are due April 15th of each successive year. The first return will include all income and appropriate deductions from the date of death of the decedent to December 31st of the year of death.
C. If a probate is established, annual Fiduciary Income Tax Returns (forms 1041 and 541) must be filed annually during the existence of the probate estate.
D. What records must be kept by the trustees and/or executor? The same requirements as an individual.
IX. Consequences for Failing to Properly Follow the Settlor's Testamentary Plan
A. The trustee may be personally liable to any beneficiary:
1. Who does not received her or his gift.
2. For failure to follow the instructions set forth in the trust document.
3. For the failure to file the appropriate income or death tax returns.
B. With regard to the failure to file the appropriate tax returns, the following will occur:
1. A Federal Tax Lien attaches to each asset of the decedent whether the asset was held in the trust or not. The holder of the asset may not be notified by the IRS of the lien, but the asset may be seized at any time by the IRS. If he asset has been sold, the new buyer may lose the property and may then sue the seller for reimbursement.
2. Penalties may be assessed against the trust and/or estate of the settlor; the trustee may be personally liable.
a. Failure-to-file penalty for returns filed late.
b. Failure-to-M penalty for taxes not paid on time.
c. "Accuracy" penalty can be applied:
- for negligence in preparing the return
- for large understatement of valuation
- for failure to follow the rules and regulations
d. Reasonable cause may be a defense for having a penalty waived, but it must be a good reason, not just an excuse for failure to do it correctly.
3. It is possible that you could lose all or part of the benefit of the first spouse's Unified Credit if proper records are not kept and the trusts are not properly funded after the first spouse's death.
IX. Questions
[See also a first-person account by Marion Murray Dentzel of trust administration following the death of her husband by clicking here.]
The contents of this publication are for information purposes only and are not meant nor should be construed to be legal advice. Note, also, the date of the document. Laws are constantly changing, and are subject to differing interpretations. We, therefore, urge you to do additional research or to contact your own legal or tax counsel before acting on the information contained herein.
This page: www.taxlawsb.com/resources/estates/tradm.htm
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