Chapter Nineteen

1. Chapter Nineteen Accounting for Estates and Trusts

2. Accounting for an “Estate” • “Estate” literally means property owned by an individual • More usually refers to a separate legal entity holding title to the assets of a deceased person • “Estate accounting” focuses on “the recording and reporting of financial events from the time of a person’s death until the ultimate distribution of all property held by the estate”

3. Estate Accounting When someone dies: If they possess a Valid Will, they Are “testate” If they do Not, they are “intestate”

4. Laws governing wills and estates are called “probate laws”. Each state establishes its own laws of descent and laws of distribution. 50% of states have adopted the Uniform Probate Code. Estate Accounting Will Probate Laws generally have 3 purposes: • Gather and preserve all of the decedent’s property. • Carry out an orderly and fair settlement of all debts. • Discover and implement the decedent’s intentions for remaining property at death.

5. Administration of the Estate Probate Process 1. The will is presented to the court. 3. An executor or administrator is assigned. Entitled to compensation. 2. The court rules on the will’s validity. 4. The terms of the will are carried out.

6. Executor Responsibilities • Take possession of all decedent’s assets and complete an inventory of the property. • Discover claims against the estate and settle those claims. • File estate tax returns. • Federal and State • Distribute property • Make a full accounting to the probate court.

7. Estate Property Includes: • Cash • Investments in stocks and bonds • Interest accrued to the date of death • Dividends declared prior to death • Investments in businesses • Unpaid wages • Accrued rents and royalties • Valuables such as jewelry, paintings and antiques

8. Order of priority: Expenses of administering the estate. Funeral and medical expenses (during last illness). Debts and taxes. All other claims. Discovery of Claims Against the Estate

9. Legacies and Devises Gifts of personal property are called “legacies” or “bequests” • Specific legacy. (Directly identified) • Demonstrative legacy. (Cash gift from particular source) • General legacy. • Residual Legacy. A gift of real property is called a “devise”

10. If funds are insufficient to satisfy all of the legacies, the reduction of these gifts is called “the process of abatement” Estate Distributions Priority: Specific legacies. Demonstrative legacies. General legacies. Residual legacies.

11. Estate and Inheritance Taxes

12. Federal Estate Taxes • Funeral expenses • Admin. expenses • Liabilities • Casualties & thefts • Charitable bequests • Marital deduction For 2006, the tax applies only to estates in excess of $2 million

13. Federal Estate Tax Rates The rates below were established by Congress in the Economic Growth and Tax Relief Reconciliation Act of 2001.

14. State Inheritance Taxes Often, recipients of property must contribute cash to the estate to cover the applicable taxes. Estate Income Taxes Any income from the estate assets is taxable to the estate. An exemption of $600 is provided. Separate tax rates are available for estate income. Other Estate Issues

15. The recipient of estate income is called the “income beneficiary”. The recipient of the estate principal (also called “corpus”) is called the “remainderman”. How income is to be determined should be defined by the decedent in the will to avoid confusion. The Distinction Between Income and Principal Principal of the Estate often includes: • Life insurance proceeds. • Dividends. • Debts. • Funeral expenses. • Gains and Losses from sale of assets. • Homestead and family allowances. Income of the Estate often includes: • Recurring taxes such as property taxes. • Ordinary repair expense. • Utility expense. • Insurance expense. • Other expenses necessary for the management and preservation of the estate.

16. The Distinction Between Income and Principal (continued) Income of the estate includes all revenues and Expenses recognized after the date of death. Reductions to income include: Recurring taxes (such as real and personal property taxes) Ordinary repair expenses Water and other utility expenses Insurance expenses Other ordinary expenses required for “the management and preservation of the estate”

17. The Distinction Between Income and Principal (continued) Some costs must be apportioned between the principal and interest “in some fair manner,” including: Executor’s fee Court costs Attorney’s fees Accountant’s fees

18. Recording the Transactions of an Estate

19. A periodic statement disclosing progress in settling the estate. Separate statements are required for income and principal. Each statement reports: Assets under the control of the executor. Disbursements made to date. Any property still remaining. Charge and Discharge Statement

20. Accounting for a Trust A TRUST IS the conveyance of assets to a fiduciary (or trustee) who manages the assets according to the stipulated instructions. Trustee may be an Individual or Organization

21. Why Establish a Trust? • Reduce the size of an estate (for tax purposes) • To protect assets • To ensure that assets are used as intended • The trustee may be better able to manage the assets than the beneficiary

22. Accounting for a Trust inter vivos trust testamentary trust A TRUST IS the conveyance of assets to a fiduciary who manages the assets according to the stipulated instructions. VS. A trust established while the trustor is still alive. A trust established by the will after the trustor’s death.

23. Revocable Living Trust Credit Shelter Trust Qualified Terminable Interest Property Trust Charitable Remainder Trust Charitable Lead Trust Grantor Retained Annuity Trust Minor’s Section 2503(c) Trust Spendthrift Trust Irrevocable Life Insurance Trust Qualified Personal Resident Trust Different Types of Trusts

24. Revocable Living Trusts • Trustor usually manages the fund and receives most (if not all) of the income until death • Revocability means that the trustor can change beneficiaries and other terms at any time • Avoids delay and expense of probate • Allows for privacy (Wills are public documents)

25. Other Types of Trusts • Credit Shelter Trust • Designed for couples • Each spouse agrees to transfer at death an amount up to the tax-free exclusion ($2 million in 2006) to the benefit of the other • Reduces the estate of the surviving spouse • Qualified Terminable Interest Property Trust (QTIP Trust) • Property is conveyed to the trust with the income (and sometimes a portion of the principal) being paid to the beneficiary (usually the spouse) • At a specified time, the remainder is conveyed to a designated party • Allows steady income for one beneficiary, while protecting the principal for later transfer to another

26. Other types of Trusts • Charitable Remainder Trust • All income paid to beneficiary • After a period of time (or the death of the beneficiary) the principal is given to a stated charity • Useful for dealing with appreciated property requiring liquidation (renders it nontaxable) • Charitable Lead Trust • The income goes to benefit a charity for a specified period of time • Remaining principal is then given to a different beneficiary • Reduces the cost of transferring a highly valued asset • Grantor Retained Annuity Trust (GRAT) • Trustor collects fixed payments from the trust • Principal given to beneficiary after a specified time or at the death of the trustor • Allows for reduction of gift tax

27. Other Types of Trusts • Minor’s Section 2503(c) Trust • Eligible to receive a tax-free gift of $11,000 ($22,000 if from a couple) each year • Allows for systematic removal of estate assets • Spendthrift Trust • Beneficiary cannot transfer or assign any payments not yet received • Irrevocable Life Insurance Trust • Money is contributed to purchase life insurance on the donor • Beneficiary can use the proceeds to pay estate and inheritance taxes • Qualifies Personal Resident Trust (QPRT) • Donor’s home is given, but the donor retains the right to live there for a period rent free

28. Adjustments to the Trust’s Principal: Investing costs and commissions. Income taxes on gains added to the principal. Costs of preparing property for sale. Extraordinary repairs. Record-Keeping for a Trust Fund Usually, the cash basis is used to record trust fund transactions.

29. Adjustments to the Trust’s Income: Rent expense Lease cancellation fees Interest expense Insurance expense Income taxes on trust income Property taxes Record-Keeping for a Trust Fund Usually, the cash basis is used to record trust fund transactions.

30. Summary • Estates are legal entities holding title to a decendent’s property until final settlement and distribution can be effected. • State laws (known as probate laws) govern this process, and are particularly important if the decedent dies intestate (lacking a valid will) • Devises are gifts of real property, while legacies (or bequests) are gifts of personal property • Federal estate taxes are assessed on the value of estate property. This is currently an area of political conflict • A variety of trust fund types exist in which assets are conveyed to a trustee who manages them and ultimately disposes of them to a beneficiary or beneficiaries

31. Possible Criticisms • Estate taxes have become quite controversial in recent years. One group, who re-labels these as “death taxes,” claims that they are unfair “additional” taxes on wealth that has already been taxed as income. Others claim that they only affect the extremely wealthy and are an important tool to protect a democratic society from a concentration of inherited wealth • Similarly, some critics have contended that trusts are primarily designed as schemes for the wealthy to avoid taxation WHAT DO YOU THINK????

32. End of Chapter 19 Bob, if anything happens to you, can I have your beaver hat? Wow! Sounds like Bob’s trip could be dangerous!