As a general rule, income earned by an estate or trust is taxed only once, and in the same manner as it would be taxed to an individual. See IRC Section 641. However, estates and trusts may deduct charitable contributions without any limitation based on adjusted gross income, and may take exemptions that are not pro-rated for shorter tax years or phased out
based on income thresholds. The exemption available to an estate is $600, while simple trusts may take a $300 exemption and complex trusts may take a $100 exemption.
The basis of property in a decedent’s estate or revocable trust is determined by the fair market value of the property on the decedent’s date of death, or if properly elected on the Form 706, the alternate valuation date that falls six months after the date of death. See IRC Section 1014. Capital assets from a decedent are presumed to have been held for longer than a year and thereby qualify for long-term gain or loss treatment. Property held in an inter vivos trust that is not included in the decedent’s taxable estate does not receive a step-up in basis.
Interest and Dividends
Reportable interest income includes the income generated from bank accounts, money market accounts, certificates of deposit, United States Treasury Bills, Notes and Bonds, credit unions, thrift institutions, mortgages, notes, loans, original issue discount, and REMIC income. Ordinary dividend income is taxed at the same rate as other income, while qualified dividend income, or income received from domestic corporations on common stock and certain qualified foreign corporations traded on recognized United States exchanges, are taxed at a lower rate. If a fiduciary is responsible for operating a business, a Schedule C (“(Form 1040) Profit or Loss From Business”) must be submitted with the Form 1041; however, the estate or trust will not owe self-employment tax.
Trusts and estates must report all income and loss generated from rents, royalties, partnerships, S corporations, other estates and trusts, and REMICs. The same risk and passive activity rules apply as to individuals. The estate or trust is only treated as materially participating in a business if its activities within the business are regular, continuous, and substantial. Also reported are state income tax refunds, ordinary income receipts from pension plans, profit sharing plans, IRAs and insurance contracts, and installment payments owed during the decedent’s life but paid after death.
Typical deductions allowed for trusts and estates are fiduciary commissions, attorney and return preparer fees, state income taxes, and court fees. Certain expenses, like investment advisory fees, are subject to the 2% floor – only deductible to the extent that they exceed two percent of adjusted gross income.