Trust question

[JenMO]

Mom died in 08 and assets were in a trust. Daughter is trustee. She says the only income that has been received is life insurance proceeds. They were used to pay for funeral and other type of expenses of Mom. I guess the trust was the beneficiary of the life insurance. It's time to do a fiduciary return, are the life insurance proceeds considered income for this return? I understand that if there is less than $600 in income, no return has to be filed. There were some expenses, like mortgage interest that was paid out of assets, but nothing has been distributed yet. I didn't think life ins was considered income since it is not taxable. Am I right?

[Koss]

Life Insurance Policy

You'll need to read the trust agreement, and the life insurance policy.

That thing might be an ILIT (irrevocable life insurance trust). It's an estate planning tool that has special features.

It's probably not taxable, but you won't know for sure until you read the source documents.

If the trust is in fact the beneficiary of the life insurance policy, then it may become subject to federal estate tax, even if it is not subject to federal income tax. And even if it isn't subject to federal estate tax, it might be subject to state taxation, depending on the state in which the trust is domiciled.

But that's probably not what really happened. Naming a trust as the beneficiary of a life insurance policy is usually a very bad idea, unless there are very young children and massive sums of money involved.

Here's my shot-in-the-dark guess:

The trust is probably the owner of the life insurance policy, but not the beneficiary.

When the beneficiary is an individual, the death benefit is not taxable, and, in most cases, does not have to be included in the estate of the decedent. And it wouldn't need to be reported on the trust return, because it isn't paid to the trust.

BMK

[JenMO]

Your probably right about the trust being the owner of the life insurance. It was put into a checking account and paid expenses, funeral, etc. I just didn't want to miss filing an initial return, because there was no other income to the trust. The trust was set up in CA, does that change things? If everything is in the trust, there really is no estate ( it's below the limit). and once the home is sold and the money is distributed, the trust will be over. Is there any legal proceeding that need to be done? I'm in MO, and don't know about CA things.

[Koss]

Trust

I don't know the California rules...

But the first step is, you gotta find out for sure who was the beneficiary of the life insurance policy. In theory, that should be the same as the payee on the check issued by the insurance carrier, but you shouldn't rely on the check. And you can't rely on the original policy document, either, because the beneficiary might have been changed, maybe even more than once, after the policy was issued. You gotta get a copy of the most recent beneficiary declaration.

I still think that it is likely that the trust was the policy owner, but not the beneficiary. And this may be the case even if the trustee happens to be the same person as the beneficiary.

If I'm right about this, then here's what may have happened:

The insurance carrier issued a check to the beneficiary, who is an individual, not a trust. That individual also happens to be the trustee. And because that person doesn't grasp these concepts, they endorsed the check and deposited the funds into a bank account that belongs to the trust. The bank never questioned it, because the payee is the trustee, with fiduciary control over the account, and the check was payable to that person. But the check was meant for that person in their individual capacity--not in their capacity as the trustee.

(Had it been the other way around, i.e., the check was payable to the "Ann Smith Irrevocable Trust," and the trustee attempted to endorse and deposit the check into their personal checking account, the bank would not have touched that check with a ten-foot pole.)

If this is what actually happened, then you have a simple clerical error. The life insurance proceeds do not belong to the trust, and the check was accidentally deposited into the wrong account. Life insurance benefits are not taxable income to an individual, and those funds don't belong in the trust account. The client should pull the money out. End of story. The trust may have little or no income, and may not have a filing requirement.

Being named as the executor or trustee sometimes causes a nonprofessional to freak out, especially if they are trying to perform their fiduciary duties right after their loved one died. They often get it wrong. On one end of the spectrum, you have full-blown fraud and breach of the fiduciary duty, such as when the person with the keys to the decedent's house allows family members to pick through jewelry and other personal property without first taking an inventory, and without reading the will or trust instrument. At the other end of the spectrum, you have people who just don't understand key concepts of estate planning, and in an effort to protect themselves and make sure all the t's are crossed, they might be too careful. And that may be what happened if your client deposited the funds into the trust account by mistake.

I admit that this is all nothing but educated speculation. You gotta find out who the beneficiary was.

BMK

[Koss]

Beneficiary

Keep in mind that the beneficiary of the life insurance policy is not necessarily the same person or persons as the beneficiary of the trust.

First find out who the beneficiary of the life insurance policy is.

If you ultimately do a return for the trust, you'll need to know who the beneficiaries of the trust are, as well.

But you need to make sure your client understands what you're asking. I'm not trying to insult anyone's intelligence. But I'm really not kidding. Your client may not understand that the beneficiary of the trust is not the same as the beneficiary of the life insurance policy.

They may give you something that identifies the beneficiaries of the trust, and that doesn't answer the question that I'm raising here...

BMK