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Katie Szymanski Wealth Management
November 28, 2017 Article 4 min read

Upon the passing of a loved one, there are several decisions to make regarding the person’s personal and financial lives. While tax considerations can seem overwhelming, the decision of making a §645 election doesn’t need to be complicated. Here are some factors to consider when faced with this decision.

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Let’s imagine, your 90-year-old mother has recently passed away, and you are the executor of her probate assets and the trustee of her revocable trust assets. During this time of emotional hardship, you also have to consider all of the financial responsibilities. You meet with your trusted advisor, and they ask you if you would like to make a §645 election, and you think, what is that?

Well, a §645 election allows the executor of an estate and the trustee of a revocable trust to elect to treat the estate and the trust as one for tax purposes. Generally, estates have the ability to elect a fiscal year end or a calendar year end, whereas trusts default to a calendar year end. If you elect §645, it gives you the ability to have the trust on a fiscal year end as well, meaning only one tax return. That sounds great, but why would you want a fiscal year end?

One reason a fiscal year end could be beneficial is that it allows the trustee to make additional progress on the estate settlement before a tax return would be due. This tends to be more helpful the later in the year  a person passes away. So, let’s say your mother passed away on Oct. 15, 2017. The fiscal year end would be Sept. 30, 2018; however, the first tax return would not be due until Jan. 15, 2019. Having so long between the passing and the tax filing, the estate could be fully administered, meaning a first and final tax return for the estate. If you chose to use a calendar year end, the first return for your mother’s estate would be due April 15, 2018. Assuming it takes longer than six months to fully administer all assets, a second return would be due for calendar year 2018, on April 15, 2019. So, there is potentially a cost savings on the tax preparation as well as the deferral, but not a saving of tax due. However, with a fiscal year end also comes the need for additional awareness of deadlines and manual tracking. Standard tax reporting is all completed on a calendar year end and is therefore easier to track and administer.

Beyond that, here are six additional things to consider when evaluating the §645 election.

(1) Mechanics. The election is irrevocable and must be filed on the first Form 1041 trust return. Meaning once you elect the fiscal year on the first filing, you cannot go back to a calendar year end or separate the trust and estate until the election expires. Additionally, you are responsible for making sure all filings are timely.

 

(2) Income shifting. As mentioned above, this is the ability to shift income reporting and taxability into a later year. However, the election is only valid for two years, and if the trust is not distributed before the election terminates, income distributions would be increased in the final reporting year. This could result in an increase in total tax paid (more on this below). An exception to the two-year election length is when a Form 706 estate tax return is filed. At that point, the election would be the later of two years from the date of death or six months after a closing letter is received from the IRS.

 

(3) Charitable causes. Trusts are generally allowed a charitable deduction only for amounts given to charities in the current or following year. However, estates are allowed a charitable deduction for amounts permanently set aside for charitable purposes. So, you can set aside income and get a deduction, but not actually distribute any funds until a later date.

 

(4) Exemptions. Trusts are allowed a personal exemption of either $100 or $300, depending on whether or not all the income from the trust is required to be paid out. Estates however, are allowed a $600 exemption. While both of these are relatively low, electing §645 will allow the trust to utilize the $600 exemption.

 

(5) Estimated tax payments. Estates are exempt from making estimated tax payments for two years following the date of passing. Trusts may need to make estimated payments depending on the situation. It should be noted, it is possible for a trust to qualify for a two-year exemption from making estimated payments without electing, but, these provisions are very narrow.

 

(6) S corporation stock. An estate is allowed to own S corporations stock for a longer period of time than a trust. Trusts can hold the stock only for the two-year period beginning at the date of death. Estates can hold the stock through the period of administration. This could be an advantage for trusts that own S corporation stock.

 

So what happens in the end? At the end of the election period or upon the distribution of assets from the original trust to a new trust, the new trust will return to calendar year-end filings. As such, the trust would need to file a return from the end of the fiscal year end to the calendar year end following the termination. This may lead to the beneficiaries receiving two K-1’s; therefore, they would have increased income to report on their personal tax returns. While this might not be detrimental to all, it could push other beneficiaries into a higher tax bracket. If that were true, it could cost the beneficiaries more in the end than the deferral of the tax in the first year. This consideration is often missed. However, if they are already in the highest tax bracket or reporting the additional income will not move them from their current bracket, the deferral could be advantageous.

As you can see, there are several factors to consider when looking at tax strategies after a loved one passes away. Contact us to learn more about Plante Moran’s holistic approach to these decisions.