Estate Fiscal Year Strategy

[Snaggletooth]

Estate fiscal year can be chosen: a)end of 11th month after death, or b)any month end prior to that.

My client was the executor. Choosing a) means the estate had a good bit of undistributed income and the estate is paying tax at a high rate. No distributions would have been made during that year.

So we can choose b) and cut down on the income. This means the estate has to run its course for another fiscal year and the earnings will be distributed in the 2nd year, and the estate can then be closed and stop filing 1041s.

Option b) means less overall taxes for all parties. However, the filing deadline has passed if we choose this earlier fiscal year. This means less taxes, but opens the door for penalties, right? Does anyone have positive experience in getting such penalties abated?

What would YOU do?

[Roland Slugg]

Too confusing for my old brain, Snag. How about telling us the exact DOD?

[Snaggletooth]

November

November 29, 2010. Following my feeble logic from the OP, this means we can select October 31, 2011 as the estate "year", or alternatively, we can choose any other previous month, such as June 30, 2011. If we do that then the 2nd fiscal year begins July 1 2011 and closes as late as June 30 2012. The 2nd fiscal year can close earlier than this because final distribution was made December 24th, 2011. NO distribution was made to the heirs prior to then.

Decedent had $200,000 in deferred income from an annuity which was paid to the decedent's account on July 22, 2011. If the year ends on October 31, then ALL of this is taxable to the estate because NO distribution was made until December 24th.

If the year ends June 30, 2011 only some $3,000 in interest income is taxable to the estate. The big lump of $200,000 does not occur until the 2nd "year", and distribution of some $900,000 was made to eight children on 12/24/2011. The way I see it, each of the 8 heirs gets $25,000 on their K-1 if a June 30 fiscal year is chosen and the estate has little or no tax. All but one of the heirs has a lower tax bracket than the estate.

But if we select June 30 as fiscal year end, then the filing deadline has already passed. Penalties? How much?

p.s. not real numbers but are contrived to give substance to the question...

By the way, attorney told my client they "didn't HAVE to fool with a 1041." Naturally, my client believed him until they received a 1099 for $200,000 under the FEIN of the estate.

[Roland Slugg]

Well, I just noticed that in the OP it says that the $200k came into the estate in July 2011. So here is my THIRD rewrite of this reply. (I wonder if it's old age ... or those two dee-lishus Bloody Marys I had a while ago?)

Since the DOD was November 29, 2010, the only available fiscal year that's still available is October 31st. The only other choice is to use a calendar year, which is the default choice when no election is made or when the first return is filed late. But if you adopt an October fiscal year, the $200k would appear to be taxable to the estate, and there will be no offsetting deduction for distributions to the benes. But: Regarding Gary2's point about the "65-day" rule, the Regs say that this election applies to trusts. However, the instructions for F-1041 clearly state that it can be made by the executor of an estate as well. Hence, this election does appear to be available. If you wish to use an October 31st year-end, the first year's return must be filed (not extended) by February 15, 2012. Make the 663(b) election by checking the box at Question 6, and do not be late filing this return! If you go with a calendar year, you have two returns to file: (1) One covering the short period from November 30, 2010 to December 31, 2010, and (2) a second one covering the calendar year 2011. The 2010 return is already late, of course, and the 2011 return is due by April 17, 2012.

An estate's fiscal year must be elected on a timely filed return, not including extensions. Regs §1.441-1(c)(1). An estate's income tax return is due by the 15th day of the 4th month after the year ends; hence the February 15, 2012 due date if you want to elect the October year-end.

Whether you go with the October year-end (and elect the §663(b) "65-day" rule), or use a calendar year-end, the tax on the $200k will be reported on the eight benes' 2011 personal returns. So assuming that the "65-day" rule really is available to estates, it's about the same either way. Look at both options then decide which is better.

[Snaggletooth]

Tax Year

Sluggo - thanks for your usual response. I haven't seen the Code or Regs, but from the Tax Book:

An estate’s first year begins at the moment of death. The personal
representative chooses the year by filing the first return. The first
year can be any period of 12 months or less that ends the last day
of a month.
Example: Esther died on May 2, 2011. The shortest first year is May 2,
2011 through May 31, 2011. The longest first year is May 2, 2011 through
April 30, 2012.

However, having quoted the above from the Tax Book, are you saying that the election of a
fiscal year must be done on a timely filed return, or the IRS will reject the fiscal year?

In many ways I wish there were no choice, as this would eliminate some decision-making.
Also sounds like if we are able to choose June 30, then we are SOL late and they will ding us for late filing.

By the way, there really was $900K, including $700K decedent left in cash.

[Gary2]

Decedent had $200,000 in deferred income from an annuity which was paid to the decedent's account on July 22, 2011. If the year ends on October 31, then ALL of this is taxable to the estate because NO distribution was made until December 24th.

Wouldn't the 65 day rule apply? December 24 is 54 days after Oct 31, so can't the executor choose to treat them as if they were made on Oct. 31? Or am I misunderstanding that rule?

[Snaggletooth]

65 days

Gary2 you are quite correct. Thanks.

The plot thickens. Of course I made up hypothetical dates, so I'll have to get back to the clients records and see whether distribution was made within 65 days or not...

[Burke]

Wouldn't the 65 day rule apply? December 24 is 54 days after Oct 31, so can't the executor choose to treat them as if they were made on Oct. 31? Or am I misunderstanding that rule?

The 65-day distribution rule was extended to estates in 1997-1998.

[Burke]

. If we do that then the 2nd fiscal year begins July 1 2011 and closes as late as June 30 2012. The 2nd fiscal year can close earlier than this because final distribution was made December 24th, 2011. NO distribution was made to the heirs prior to then.

The one thing you cannot do in this case is treat the tax year as "clos[ing] as late as June 30, 2012." The 2nd fiscal year would end the date final distribution was made on 12/24/11. So any income must be passed through on the 2011 returns of the beneficiaries, and could not be carried over to 2012.