Date: March 31st 2006

An insightful followup was received from Peter Lingane for one of the Panel's answers. The issues raised were of sufficient import as to merit rebroadcast. The complete question and commentary are included below. You may cut-and-paste this into your file copy if you downloaded the Word version of the file, or you may access the revised version from the online archive, which you can get to by clicking the "subscribe" link and then clicking on the name of the mailing list.

22) TRUST K-1 TO BENEFICIARIES
Trust Estate, date of death 10/24/2004, 706 was timely filed. This is a large estate and we will have 2 years of trust estate returns. Fiscal year is 11/04 to 10/05. We forgot to file by February 15th and will file by the end of March. No heirs received any distribution in the fiscal year but the estate earned $60K that first year in DNI. Do the heirs have to claim their 2004 K-1 on their 2005 tax return or can they claim it on the 2006 tax return when they actually receive the money? Will I have a penalty on the 1041 with no taxes due (all passed thru to heirs)?
Joe: Income goes through in 2005 for beneficiaries. Chances are no penalty due to no tax due on a 1041 with pass-through.
Phil clarifies: As the FYE is in 05, the K-1s will therefore be reported on the beneficiaries’ 05 returns. I believe you have till 65 days after the FYE to distribute the DNI, so the fact that they did not get the $ in 05 may not be relevant if they get paid within 65 days of 2/15/06. I have to say that many of my own 1041 clients have distributed after the 65 day period, I don’t think the Service looks at it much. Further clarification, the fact that the 1041 had 60K of DNI gives it in essence a deduction for that, so the estate’s taxable income would end up at zero.

FOLLOWUP FROM PETER LINGANE:

The fiscal year of an estate must end no later than the last day of the month of the month before death. If death was 10/24, the longest fiscal year is 10/24/04 through 9/30/05. The tax return is due 3.5 months later or 1/15/06, not 2/1/506 as stated. The fiscal year is determined by the choice on the first return filed, not what it says on the SS4. Thus whether the IRS issued an EIN for a 11/30 year end is not relevant.

An estate is allowed to deduct income distributed during the tax year or within 65 days of the end of the tax year and any income it is required to distribute, whether or not distributed. While not stated in the problem, I assume that the estate was not required to distribute all income. The distribution period ended in mid December 2005. There were no distributions before mid December 2005. Thus all income is taxed at the trust level. No income is reported on the beneficiaries' returns.

The tax liability paid at the trust level is probably but not necessarily somewhat higher than the liability if the income had been distributed and reported on the beneficiaries' returns. I expect failure to file and failure to pay penalties and interest. There should be no underpayment penalties since an estate is not required to make estimated payments during its first two years.

I suspect that Phil was misquoted. An EA who recommends that an executor knowingly claim an income distribution deduction for a distribution after 65 days has probably recommended fraud and deserves to prosecuted to the full extent of the law. If the failure to distribute in a timely manner was caused by the oversight of the attorney or tax preparer, I would encourage the executor to seek redress from the attorney or tax preparer for any incremental tax and for all penalties.



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