off the top of your - head Estate ? who pays the tax?

[WITAXLADY]

Client came in for a LLC set-up - barely making it - single parent, etc. Mentions she will inherit 2.5 million when 90+ year old parents die 1 of 11 children,

They were farmers in east central WI!! One time farms made money.

I suggested she ask for a gift now! But she said as the youngest, she was pretty much ignored..

The question is - who pays for the tax - Her or the Estate? Depends on how the will is written? The parents do have a financial advisor..

 

Thank you..

 

D

 

[Sara EA]

If there ends up being an estate tax, it is paid by the estate.  As for the beneficiaries, it depends on what the estate does with the assets and what it distributes to the heirs and when.  If it both sells the farm and distributes the cash in its final year, the heirs pay any cap gains tax on their portion.  If it sells and doesn't distribute in the same year, it pays any cap gains.  You can't really answer the client's questions because there are too many unknowns here.  I'm not sure I'd like a client who is counting her money before her parents pass away.  Hope my kids aren't doing that.

[Corduroy Frog]

It's a classic case of "follow the money."  The mechanics work somewhat like this:

The estate is taxable on all income, with a very small exemption amount.  And the rate accelerates rapidly, such that a surprisingly large amount of tax will be assessed against a small amount of income.

The way out of a tax bill is to distribute the income.  The estate will take an exemption for all amounts distributed to beneficiaries. i.e. $40,000 in estate income minus $35000 distributed to beneficiaries, means the estate will only pay tax on $5000.  The beneficiaries are to receive a K-1 for any income distributed to them, and the K-1 reflects the character of income as well.  The beneficiaries will pay tax on that income at their own tax rate.  Hence "follow the money."

It can get complicated, as the exemption applies to "income" only.  For example, a $20,000 cash account that draws $750 interest means that the only income distributed is $750.  The estate cannot claim an exemption for the $20,000, only the $750.

The best bookkeeping should separate the "corpus" from "income".  For the above example, the $20,000 is subtracted from corpus and $750 from income.  When the estate is settled, the corpus will be reduced to $0, and unable to generate more income as well.

The "year" for the estate is not a calendar year.  The "year" begins on the date of death of decedent, and if not settled, will end on the last day of the month prior to the anniversary of date of death.  I mention this because the best tax planning should occur BEFORE the end of the "year" as to how much to distribute to the beneficiaries.

Edited July 9, 2023 by Corduroy Frog

[Abby Normal]

Not sure which tax you're referring to. The estate might owe some estate tax.

The parents should have been making annual gifts to all 11 heirs in the amount of the annual gift limit to both help the heirs and reduce the estate value. Parents could jointly gift 34,000 to each heir now, and to the heir's spouses or any other family members.

[Gail in Virginia]

Interesting deduction.  I have an estate that will only be filing a fiduciary return.  The bulk of the income is from an IRA distribution.  The bulk of the estate will be distributed to a church.  If the distribution is made before the end of the tax year for the estate, will that make the IRA distribution effectively non-taxable?  It seems to me that it should, but it also seems like IRA's should be taxed on distribution.  

[BrewOne]

Gail, I have experience with a trust trying to claim a charitable deduction on a 1041--the rules are very strict on the language of the trust document, and in my case, there was no deduction for a $100,000 donation.  Not sure if same goes for an estate, but I suspect that the charity must be named in the will and possibly it must designate that income go to the charity, otherwise it is assumed to come from corpus.  I'll take a look see if no one knows the answer off the top of their head.

[Gail in Virginia]

The charity is the remainder beneficiary under the will, after a couple of small bequests to family.  I am thinking that if you do it all in one year, which is the plan, then the K-1's would divide the income between the beneficiaries, including the church.  However, a church is not required to file a tax return and therefore would owe no tax on their portion of the estate..  But not sure that I am thinking about this correctly.  

[BrewOne]

Gail, you may want to reference code Section 642(c)1

I believe the sequence is:

1) determine the amount of distributable net income (DNI) that the charity receives

2) enter that amount on Schedule A (deducted on page 1 of the 1041)

3) remaining DNI goes to non-charitable beneficiaries.

As I understand it, the church would not get a K-1.

[WITAXLADY]

Thank you all..

D

[Sara EA]

Bequests come from corpus. The beneficiaries will not get K1s for bequests.  The charity will get the income and the rest of the corpus.