Income Tax Return of an Estate-- Form 1041

An estate is a taxable entity separate from the decedent and comes into being with the death of the individual. It exists until the final distribution of its assets to the heirs and other beneficiaries. The income earned by the assets during this period must be reported by the estate under the conditions described in this publication. The tax generally is figured in the same manner and on the same basis as for individuals, with certain differences in the computation of deductions and credits, as explained later.

The estate's income, like an individual's income, must be reported annually on either a calendar or fiscal year basis. As the personal representative, you choose the estate's accounting period when you file its first Form 1041. The estate's first tax year can be any period that ends on the last day of a month and does not exceed 12 months.

Once you choose the tax year, you generally cannot change it without IRS approval. Also, on the first income tax return, you must choose the accounting method (cash, accrual, or other) you will use to report the estate's income. Once you have used a method, you ordinarily cannot change it without IRS approval. For a more complete discussion of accounting periods and methods, see Publication 538, Accounting Periods and Methods.

Filing Requirements

Every domestic estate with gross income of $600 or more during a tax year must file a Form 1041. If one or more of the beneficiaries of the domestic estate are nonresident alien individuals, the personal representative must file Form 1041, even if the gross income of the estate is less than $600.

A fiduciary for a nonresident alien estate with U.S. source income, including any income that is effectively connected with the conduct of a trade or business in the United States, must file Form 1040NR, U.S. Nonresident Alien Income Tax Return, as the income tax return of the estate.

A nonresident alien who was a resident of Puerto Rico, Guam, American Samoa, or the Commonwealth of the Northern Mariana Islands for the entire tax year will, for this purpose, be treated as a resident alien of the United States.

Schedule K-1 (Form 1041)

As personal representative, you must file a separate Schedule K-1 (Form 1041), or an acceptable substitute (described below), for each beneficiary. File these schedules with Form 1041.

You must show each beneficiary's taxpayer identification number. A $50 penalty is charged for each failure to provide the identifying number of each beneficiary unless reasonable cause is established for not providing it. When you assume your duties as the personal representative, you must ask each beneficiary to give you a taxpayer identification number (TIN). A nonresident alien beneficiary that gives you a withholding certificate generally must provide you with a TIN ( see Publication 515, Withholding of Tax on Nonresident Aliens and Foreign Entities). A TIN is not required for an executor or administrator of the estate unless that person is also a beneficiary.

As personal representative, you must also furnish a Schedule K-1 (Form 1041), or a substitute, to the beneficiary by the date on which the Form 1041 is filed. Failure to provide this payee statement can result in a penalty of $50 for each failure. This penalty also applies if you omit information or include incorrect information on the payee statement.

You do not need prior approval for a substitute Schedule K-1 (Form 1041) that is an exact copy of the official schedule or that follows the specifications in Publication 1167, Substitute Printed, Computer-Prepared, and Computer-Generated Tax Forms and Schedules. You must have prior approval for any other substitute Schedule K-1 (Form 1041).

Beneficiaries. The personal representative has a fiduciary responsibility to the ultimate recipients of the income and the property of the estate. While the courts use a number of names to designate specific types of beneficiaries or the recipients of various types of property, it is sufficient in this publication to call all of them beneficiaries.

Liability of the beneficiary. The income tax liability of an estate attaches to the assets of the estate. If the income is distributed or must be distributed during the current tax year, the income is reportable by each beneficiary on his or her individual income tax return. If the income does not have to be distributed, and is not distributed but is retained by the estate, the income tax on the income is payable by the estate. If the income is distributed later without the payment of the taxes due, the beneficiary can be liable for tax due and unpaid to the extent of the value of the estate assets received.

Income of the estate is taxed to either the estate or the beneficiary, but not to both.

Nonresident alien beneficiary. As a resident or domestic fiduciary, in addition to filing Form 1041, you may have to file the income tax return (Form 1040NR) and pay the tax for a nonresident alien beneficiary. Depending upon a number of factors, you may or may not have to file Form 1040NR for that beneficiary. For information on who must file Form 1040NR, see Publication 519, U.S. Tax Guide for Aliens.

You do not have to file the nonresident alien's return and pay the tax if that beneficiary has appointed an agent in the United States to file a federal income tax return. However, you must attach to the estate's return (Form 1041) a copy of the document that appoints the beneficiary's agent.

You also must file Form 1042, Annual Withholding Tax Return for U.S. Source Income of Foreign Persons, and Form 1042-S, Foreign Person's U.S. Source Income Subject to Withholding, to report and transmit withheld tax on distributable net income (discussed later) actually distributed. This applies to the extent the distribution consists of an amount subject to withholding. For more information, see Publication 515.

Amended Return

If you have to file an amended Form 1041, use a copy of the form for the appropriate year and check the Amended return box. Complete the entire return, correct the appropriate lines with the new information, and refigure the tax liability. On an attached sheet, explain the reason for the changes and identify the lines and amounts changed.

If the amended return results in a change to income, or a change in distribution of any income or other information provided to a beneficiary, you must file an amended Schedule K-1 (Form 1041) and give a copy to each beneficiary. Check the Amended K-1 box at the top of Schedule K-1.

Information Returns

Even though you may not have to file an income tax return for the estate, you may have to file Form 1099-DIV, Form 1099-INT, or Form 1099-MISC, if you receive the income as a nominee or middleman for another person. For more information on filing information returns, see the General Instructions for Forms 1099, 1098, 5498, and W-2G.

You will not have to file information returns for the estate if the estate is the owner of record and you file an income tax return for the estate on Form 1041 giving the name, address, and identifying number of each actual owner and furnish a completed Schedule K-1 (Form 1041) to each actual owner.

Penalty. A penalty of up to $50 can be charged for each failure to file or failure to include correct information on an information return. (Failure to include correct information includes failure to include all the information required.) If it is shown that such failure is due to intentional disregard of the filing requirement, the penalty amount increases.

See the General Instructions for Forms 1099, 1098, 5498, and W-2G for more information.

Two or More Personal Representatives

If property is located outside the state in which the decedent's home was located, more than one personal representative may be designated by the will or appointed by the court. The person designated or appointed to administer the estate in the state of the decedent's permanent home is called the domiciliary representative. The person designated or appointed to administer property in a state other than that of the decedent's permanent home is called an ancillary representative.

Separate Forms 1041. Each representative must file a separate Form 1041. The domiciliary representative must include the estate's entire income in the return. The ancillary representative files with the appropriate IRS office for the ancillary's location. The ancillary representative should provide the following information on the return.

• The name and address of the domiciliary representative.
• The amount of gross income received by the ancillary representative.
• The deductions claimed against that income (including any income properly paid or credited by the ancillary representative to a beneficiary).

Estate of a nonresident alien. If the estate of a nonresident alien has a nonresident alien domiciliary representative and an ancillary representative who is a citizen or resident of the United States, the ancillary representative, in addition to filing a Form 1040NR to provide the information described in the preceding paragraph, must also file the return that the domiciliary representative otherwise would have to file.

Copy of the Will

You do not have to file a copy of the decedent's will unless requested by the IRS. If requested, you must attach a statement to it indicating the provisions that, in your opinion, determine how much of the estate's income is taxable to the estate or to the beneficiaries. You should also attach a statement signed by you under penalties of perjury that the will is a true and complete copy.

Income To Include

The estate's taxable income generally is figured the same way as an individual's income, except as explained in the following discussions.

Gross income of an estate consists of all items of income received or accrued during the tax year. It includes dividends, interest, rents, royalties, gain from the sale of property, and income from business, partnerships, trusts, and any other sources. For a discussion of income from dividends, interest, and other investment income and also gains and losses from the sale of investment property, see Publication 550. For a discussion of gains and losses from the sale of other property, including business property, see Publication 544, Sales and Other Dispositions of Assets.

If, as the personal representative, your duties include the operation of the decedent's business, see Publication 334. That publication provides general information about the tax laws that apply to a sole proprietorship.

Income in respect of the decedent. As the personal representative of the estate, you may receive income that the decedent would have reported had death not occurred. For an explanation of this income, see Income in Respect of the Decedent under Other Tax Information, earlier. An estate may qualify to claim a deduction for estate taxes if the estate must include in gross income for any tax year an amount of income in respect of a decedent. See Estate Tax Deduction, earlier, under Other Tax Information.

Gain (or loss) from sale of property. During the administration of the estate, you may find it necessary or desirable to sell all or part of the estate's assets to pay debts and expenses of administration, or to make proper distributions of the assets to the beneficiaries. While you may have the legal authority to dispose of the property, title to it may be vested (given a legal interest in the property) in one or more of the beneficiaries. This is usually true of real property. To determine whether any gain or loss must be reported by the estate or by the beneficiaries, consult local law to determine the legal owner.

Redemption of stock to pay death taxes. Under certain conditions, a distribution to a shareholder (including the estate) in redemption of stock that was included in the decedent's gross estate may be allowed capital gain (or loss) treatment.

Character of asset. The character of an asset in the hands of an estate determines whether gain or loss on its sale or other disposition is capital or ordinary. The asset's character depends on how the estate holds or uses it. If it was a capital asset to the decedent, it generally will be a capital asset to the estate. If it was land or depreciable property used in the decedent's business and the estate continues the business, it generally will have the same character to the estate that it had in the decedent's hands. If it was held by the decedent for sale to customers, it generally will be considered to be held for sale to customers by the estate if the decedent's business continues to operate during the administration of the estate.

An estate and a beneficiary of that estate are generally treated as related persons for purposes of treating the gain on the sale of depreciable property between the parties as ordinary income. This does not apply to a sale or exchange made to satisfy a pecuniary bequest.

Holding period. An estate (or other recipient) that acquires a capital asset from a decedent and sells or otherwise disposes of it is considered to have held that asset for more than 1 year, regardless of how long the asset is held.

Basis of asset. The basis used to figure gain or loss for property the estate receives from the decedent usually is its fair market value at the date of death. See Basis of Inherited Property under Other Tax Information, earlier, for other basis in inherited property.

If the estate purchases property after the decedent's death, the basis generally will be its cost.

The basis of certain appreciated property the estate receives from the decedent will be the decedent's adjusted basis in the property immediately before death. This applies if the property was acquired by the decedent as a gift during the 1-year period before death, the property's fair market value on the date of the gift was greater than the donor's adjusted basis, and the proceeds of the sale of the property are distributed to the donor (or the donor's spouse).

Schedule D (Form 1041). To report gains (and losses) from the sale or exchange of capital assets by the estate, file Schedule D (Form 1041), Capital Gains and Losses, with Form 1041. For additional information about the treatment of capital gains and losses, see the instructions for Schedule D (Form 1041).

Installment obligations. If an installment obligation owned by the decedent is transferred by the estate to the obligor (buyer or person obligated to pay) or is canceled at death, include the income from that event in the gross income of the estate. See Installment obligations under Income in Respect of the Decedent, earlier. See Publication 537 for information about installment sales.

Gain from sale of special-use valuation property. If you elected special-use valuation for farm or other closely held business real property and that property is sold to a qualified heir, the estate will recognize gain on the sale if the fair market value on the date of the sale exceeds the fair market value on the date of the decedent's death (or on the alternate valuation date if it was elected).

Qualified heirs. Qualified heirs include the decedent's ancestors (parents, grandparents, etc.) and spouse, the decedent's lineal descendants (children, grandchildren, etc.) and their spouses, and lineal descendants (and their spouses) of the decedent's parents or spouse.

For more information about special-use valuation, see Form 706 and its instructions.

Gain from transfer of property to a political organization. Appreciated property that is transferred to a political organization is treated as sold by the estate. Appreciated property is property that has a fair market value (on the date of the transfer) greater than the estate's basis. The gain recognized is the difference between the estate's basis and the fair market value on the date transferred.

A political organization is any party, committee, association, fund, or other organization formed and operated to accept contributions or make expenditures for influencing the nomination, election, or appointment of an individual to any federal, state, or local public office.

Gain or loss on distributions in kind. An estate recognizes gain or loss on a distribution of property in kind to a beneficiary only in the following situations.

1. The distribution satisfies the beneficiary's right to receive either--
1. A specific dollar amount (whether payable in cash, in unspecified property, or in both), or
2. A specific property other than the property distributed.
2. You choose to recognize the gain or loss on the estate's income tax return (section 643(e)(3) election).

The gain or loss is usually the difference between the fair market value of the property when distributed and the estate's basis in the property. But see Gain from sale of special-use valuation property, earlier, for a limit on the gain recognized on a transfer of such property to a qualified heir.

If you choose to recognize gain or loss, the choice applies to all noncash distributions during the tax year except charitable distributions and specific bequests. To make the choice, report the transaction on Schedule D (Form 1041) attached to the estate's Form 1041 and check the box on line 7 in the Other Information section of Form 1041. You must make the choice by the due date (including extensions) of the estate's income tax return for the year of distribution. However, if you timely filed your return for the year without making the choice, you can still make the choice by filing an amended return within six months of the due date of the return (excluding extensions). Attach Schedule D (Form 1041) to the amended return and write "Filed pursuant to section 301.9100-2" on the form. File the amended return at the same address you filed the original return. You must get the consent of the IRS to revoke the choice.

For more information, see Property distributed in kind under Distributions Deduction, later.

Under the related persons rules, you cannot claim a loss for property distributed to a beneficiary unless the distribution is in discharge of a pecuniary bequest. Also, any gain on the distribution of depreciable property is ordinary income.

Exemption and Deductions

In figuring taxable income, an estate is generally allowed the same deductions as an individual. Special rules, however, apply to some deductions for an estate. This section includes discussions of those deductions affected by the special rules.

Exemption Deduction

An estate is allowed an exemption deduction of $600 in figuring its taxable income. No exemption for dependents is allowed to an estate. Even though the first return of an estate may be for a period of less than 12 months, the exemption is $600. If, however, the estate was given permission to change its accounting period, the exemption is $50 for each month of the short year.

Contributions

An estate qualifies for a deduction for amounts of gross income paid or permanently set aside for qualified charitable organizations. The adjusted gross income limits for individuals do not apply. However, to be deductible by an estate, the contribution must be specifically provided for in the decedent's will. If there is no will, or if the will makes no provision for the payment to a charitable organization, then a deduction will not be allowed even though all of the beneficiaries may agree to the gift.

You cannot deduct any contribution from income that is not included in the estate's gross income. If the will specifically provides that the contributions are to be paid out of the estate's gross income, the contributions are fully deductible. However, if the will contains no specific provisions, the contributions are considered to have been paid and are deductible in the same proportion as the gross income bears to the total of all classes (taxable and nontaxable) of income.

You cannot deduct a qualified conservation easement granted after the date of death and before the due date of the estate tax return. A contribution deduction is allowed to the estate for estate tax purposes.

For more information about contributions, see Publication 526, Charitable Contributions, and Publication 561, Determining the Value of Donated Property.

Losses

Generally, an estate can claim a deduction for a loss that it sustains on the sale of property. This includes a loss from the sale of property (other than stock) to a personal representative of the estate, unless that person is a beneficiary of the estate.

For a discussion of an estate's recognized loss on a distribution of property in kind to a beneficiary, see Income To Include, earlier.

An estate and a beneficiary of that estate are generally treated as related persons for purposes of the disallowance of a loss on the sale of an asset between related persons. The disallowance does not apply to a sale or exchange made to satisfy a pecuniary bequest.

Net operating loss deduction. An estate can claim a net operating loss deduction, figured in the same way as an individual's, except that it cannot deduct any distributions to beneficiaries (discussed later) or the deduction for charitable contributions in figuring the loss or the loss carryover. For a discussion of the carryover of an unused net operating loss to a beneficiary upon termination of the estate, see Termination of Estate, later.

For information on net operating losses, see Publication 536, Net Operating Losses (NOLs) for Individuals, Estates, and Trusts.

Casualty and theft losses. Losses incurred for casualty and theft during the administration of the estate can be deducted only if they have not been claimed on the federal estate tax return (Form 706). You must file a statement with the estate's income tax return waiving the deduction for estate tax purposes. See Administration Expenses, later.

The same rules that apply to individuals apply to the estate, except that in figuring the adjusted gross income of the estate used to figure the deductible loss, you deduct any administration expenses claimed. Use Form 4684, Casualties and Thefts, and its instructions to figure any loss deduction.

Carryover losses. Carryover losses resulting from net operating losses or capital losses sustained by the decedent before death cannot be deducted on the estate's income tax return.

Administration Expenses

Expenses of administering an estate can be deducted either from the gross estate in figuring the federal estate tax on Form 706 or from the estate's gross income in figuring the estate's income tax on Form 1041. However, these expenses cannot be claimed for both estate tax and income tax purposes. In most cases, this rule also applies to expenses incurred in the sale of property by an estate (not as a dealer).

To prevent a double deduction, amounts otherwise allowable in figuring the decedent's taxable estate for federal estate tax on Form 706 will not be allowed as a deduction in figuring the income tax of the estate or of any other person unless the personal representative files a statement, in duplicate, that the items of expense, as listed in the statement, have not been claimed as deductions for federal estate tax purposes and that all rights to claim such deductions are waived. One deduction or part of a deduction can be claimed for income tax purposes if the appropriate statement is filed, while another deduction or part is claimed for estate tax purposes. Claiming a deduction in figuring the estate income tax is not prevented when the same deduction is claimed on the estate tax return so long as the estate tax deduction is not finally allowed and the preceding statement is filed. The statement can be filed with the income tax return or at any time before the expiration of the statute of limitations that applies to the tax year for which the deduction is sought. This waiver procedure also applies to casualty losses incurred during administration of the estate.

Accrued expenses. The rules preventing double deductions do not apply to deductions for taxes, interest, business expenses, and other items accrued at the date of death. These expenses are allowable as a deduction for estate tax purposes as claims against the estate and also are allowable as deductions in respect of a decedent for income tax purposes. Deductions for interest, business expenses, and other items not accrued at the date of the decedent's death are allowable only as a deduction for administration expenses for both estate and income tax purposes and do not qualify for a double deduction.

Expenses allocable to tax-exempt income. When figuring the estate's taxable income on Form 1041, you cannot deduct administration expenses allocable to any of the estate's tax-exempt income. However, you can deduct these administration expenses when figuring the taxable estate for federal estate tax purposes on Form 706.

Interest on estate tax. Interest paid on installment payments of estate tax is not deductible for income or estate tax purposes.

Depreciation and Depletion

The allowable deductions for depreciation and depletion that accrue after the decedent's death must be apportioned between the estate and the beneficiaries, depending on the income of the estate that is allocable to each.

Example. In 2001 the decedent's estate realized $3,000 of business income during the administration of the estate. The personal representative distributed $1,000 of the income to the decedent's son Ned and $2,000 to another son, Bill. The allowable depreciation on the business property is $300. Ned can take a deduction of $100 [($1,000 × $3,000) × $300], and Bill can take a deduction of $200 [($2,000 × $3,000) × $300].

Distributions Deduction

An estate is allowed a deduction for the tax year for any income that must be distributed currently and for other amounts that are properly paid, credited, or required to be distributed to beneficiaries. The deduction is limited to the distributable net income of the estate.

For special rules that apply in figuring the estate's distribution deduction, see Bequest under Distributions to Beneficiaries From an Estate, later.

Distributable net income. Distributable net income (determined on Schedule B of Form 1041) is the estate's income available for distribution. It is the estate's taxable income, with the following modifications.

Distributions to beneficiaries. Distributions to beneficiaries are not deducted.

Estate tax deduction. The deduction for estate tax on income in respect of the decedent is not allowed.

Exemption deduction. The exemption deduction is not allowed.

Capital gains. Capital gains ordinarily are not included in distributable net income. However, you include them in distributable net income if any of the following apply.

• The gain is allocated to income in the accounts of the estate or by notice to the beneficiaries under the terms of the will or by local law.
• The gain is allocated to the corpus or principal of the estate and is actually distributed to the beneficiaries during the tax year.
• The gain is used, under either the terms of the will or the practice of the personal representative, to determine the amount that is distributed or must be distributed.
• Charitable contributions are made out of capital gains.

Generally, when you determine capital gains to be included in distributable net income, the 50% exclusion for gain from the sale or exchange of qualified small business stock is not taken into account.

Capital losses. Capital losses are excluded in figuring distributable net income unless they enter into the computation of any capital gain that is distributed or must be distributed during the year.

Tax-exempt interest. Tax-exempt interest, including exempt-interest dividends, though excluded from the estate's gross income, is included in the distributable net income, but is reduced by the following items.

• The expenses that were not allowed in computing the estate's taxable income because they were attributable to tax-exempt interest (see Expenses allocable to tax-exempt income under Administration Expenses, earlier).
• The part of the tax-exempt interest deemed to have been used to make a charitable contribution. See Contributions, earlier.

The total tax-exempt interest earned by an estate must be shown in the Other Information section of Form 1041. The beneficiary's part of the tax-exempt interest is shown on Schedule K-1, Form 1041.

Separate shares rule. The separate shares rule must be used if both of the following are true.

• The estate has more than one beneficiary.
• The economic interest of a beneficiary does not affect and is not affected by the economic interest of another beneficiary.

A bequest of a specific sum of money or of property is not a separate share (see Bequest, later).

Note. The separate shares rule applies to the estates of decedents dying after August 5, 1997. The IRS will accept any reasonable interpretation of the rule for estates of decedents who died before December 28, 1999. The rules discussed in this section apply to the estates of decedents dying on or after December 28, 1999.

If the separate shares rule applies, the separate shares are treated as separate estates for the sole purpose of determining the distributable net income allocable to a share. Each share's distributable net income is based on that share's portion of gross income and any applicable deductions or losses. You must use a reasonable and equitable method to make the allocations.

Generally, gross income is allocated among the separate shares based on the income that each share is entitled to under the will or applicable local law. This includes gross income that is not received in cash, such as a distributive share of partnership tax items.

If a beneficiary is not entitled to any of the estate's income, the distributable net income for that beneficiary is zero. The estate cannot deduct any distribution made to that beneficiary and the beneficiary does not have to include the distribution in its gross income. However, see Income in respect of a decedent, later in this discussion.

Example. Patrick's will directs you, the executor, to distribute ABC Corporation stock and all dividends from that stock to his son, Edward, and the residue of the estate to his son, Michael. The estate has two separate shares consisting of the dividends on the stock left to Edward and the residue of the estate left to Michael. The distribution of the ABC Corporation stock qualifies as a bequest, so it is not a separate share.

If any distributions, other than the ABC Corporation stock, are made during the year to either Edward or Michael, you must determine the distributable net income for each separate share. The distributable net income for Edward's separate share includes only the dividends attributable to the ABC Corporation stock. The distributable net income for Michael's separate share includes all other income.

Income in respect of a decedent. This income is allocated among the separate shares that could potentially be funded with these amounts, even if the share is not entitled to receive any income under the will or applicable local law. This allocation is based on the relative value of each share that could potentially be funded with these amounts.

Example 1. Frank's will directs you, the executor, to divide the residue of his estate (valued at $900,000) equally between his two children, Judy and Ann. Under the will, you must fund Judy's share first with the proceeds of Frank's traditional IRA. The $90,000 balance in the IRA was distributed to the estate during the year. This amount is included in the estate's gross income as income in respect of the decedent and is allocated to the corpus of the estate. The estate has two separate shares, one for the benefit of Judy and one for the benefit of Ann. If any distributions are made to either Judy or Ann during the year, then, for purposes of determining the distributable net income for each separate share, the $90,000 of income in respect of the decedent must be allocated only to Judy's share.

Example 2. Assume the same facts as in Example 1, except that you must fund Judy's share first with DEF Corporation stock valued at $300,000, rather than the IRA proceeds. To determine the distributable net income for each separate share, the $90,000 of income in respect of the decedent must be allocated between the two shares to the extent they could potentially be funded with that income. The maximum amount of Judy's share that could be funded with that income is $150,000 ($450,000 value of share less $300,000 funded with stock). The maximum amount of Ann's share that could be funded is $450,000. Based on the relative values, Judy's distributable net income includes $22,500 ($150,000/$600,000 X $90,000) of the income in respect of the decedent and Ann's distributable net income includes $67,500 ($450,000/$600,000 X $90,000).

Income that must be distributed currently. The distributions deduction includes any amount of income that, under the terms of the decedent's will or by reason of local law, must be distributed currently. This includes an amount that may be paid out of income or corpus (such as an annuity) to the extent it is paid out of income for the tax year. The deduction is allowed to the estate even if the personal representative does not make the distribution until a later year or makes no distribution until the final settlement and termination of the estate.

Support allowances. The distribution deduction includes any support allowance that, under a court order or decree or local law, the estate must pay the decedent's surviving spouse or other dependent for a limited period during administration of the estate. The allowance is deductible as income that must be distributed currently or as any other amount paid, credited, or required to be distributed, as discussed next.

Any other amount paid, credited, or required to be distributed. Any other amount paid, credited, or required to be distributed is allowed as a deduction to the estate only in the year actually paid, credited, or distributed. If there is no specific requirement by local law or by the terms of the will that income earned by the estate during administration be distributed currently, a deduction for distributions to the beneficiaries will be allowed to the estate, but only for the actual distributions during the tax year.

If the personal representative has discretion as to when the income is distributed, the deduction is allowed only in the year of distribution.

The personal representative can elect to treat distributions paid or credited within 65 days after the close of the estate's tax year as having been paid or credited on the last day of that tax year. The election is made by completing line 6 in the Other Information section of Form 1041. If a tax return is not required, the election is made on a statement which is filed with the IRS office where the return would have been filed. The election is irrevocable for the tax year and is only effective for the year of the election.

Alimony and separate maintenance. Alimony and separate maintenance payments that must be included in the spouse's or former spouse's income may be deducted as income that must be distributed currently if they are paid, credited, or distributed out of the income of the estate for the tax year. That spouse or former spouse is treated as a beneficiary.

Payment of beneficiary's obligations. Any payment made by the estate to satisfy a legal obligation of any person is deductible as income that must be distributed currently or as any other amount paid, credited, or required to be distributed. This includes a payment made to satisfy the person's obligation under local law to support another person, such as the person's minor child. The person whose obligation is satisfied is treated as a beneficiary of the estate.

This does not apply to a payment made to satisfy a person's obligation to pay alimony or separate maintenance.

Interest in real estate. The value of an interest in real estate owned by a decedent, title to which passes directly to the beneficiaries under local law, is not included as any other amount paid, credited, or required to be distributed.

Property distributed in kind. If an estate distributes property in kind, the estate's deduction ordinarily is the lesser of its basis in the property or the property's fair market value when distributed. However, the deduction is the property's fair market value if the estate recognizes gain on the distribution. See Gain or loss on distributions in kind under Income To Include, earlier.

Property is distributed in kind if it satisfies the beneficiary's right to receive another property or amount, such as the income of the estate or a specific dollar amount. It generally includes any noncash distribution other than the following.

• A specific bequest (unless it must be distributed in more than three installments).
• Real property, the title to which passes directly to the beneficiary under local law.

Character of amounts distributed. If the decedent's will or local law does not provide for the allocation of different classes of income, you must treat the amount deductible for distributions to beneficiaries as consisting of the same proportion of each class of items entering into the computation of distributable net income as the total of each class bears to the total distributable net income. For more information about the character of distributions, see Character of Distributions under Distributions to Beneficiaries From an Estate, later.

Example. An estate has distributable net income of $2,000, consisting of $1,000 of taxable interest and $1,000 of rental income. Distributions to the beneficiary total $1,500. The distribution deduction consists of $750 of taxable interest and $750 of rental income, unless the will or local law provides a different allocation.

Limit on deduction for distributions. You cannot deduct any amount of distributable net income not included in the estate's gross income.

Example. An estate has distributable net income of $2,000, consisting of $1,000 of dividends and $1,000 of tax-exempt interest. Distributions to the beneficiary total $1,500. Except for this rule, the distribution deduction would be $1,500 ($750 of dividends and $750 of tax-exempt interest). However, as the result of this rule, the distribution deduction is limited to $750, because no deduction is allowed for the tax-exempt interest distributed.

Denial of double deduction. A deduction cannot be claimed twice. If an amount is considered to have been distributed to a beneficiary of an estate in a preceding tax year, it cannot again be included in figuring the deduction for the year of the actual distribution.

Example. The will provides that the estate must distribute currently all of its income to a beneficiary. For administrative convenience, the personal representative did not make a distribution of a part of the income for the tax year until the first month of the next tax year. The amount must be deducted by the estate in the first tax year, and must be included in the income of the beneficiary in that year. This amount cannot be deducted again by the estate in the following year when it is paid to the beneficiary, nor must the beneficiary again include the amount in income in that year.

Charitable contribution. The amount of a charitable contribution used as a deduction by the estate in determining taxable income cannot be claimed again as a deduction for a distribution to a beneficiary.

Funeral and Medical Expenses

No deduction can be taken for funeral expenses or medical and dental expenses on the estate's income tax return, Form 1041.

Funeral expenses. Funeral expenses paid by the estate are not deductible in figuring the estate's taxable income on Form 1041. They are deductible only for determining the taxable estate for federal estate tax purposes on Form 706.

Medical and dental expenses of a decedent. The medical and dental expenses of a decedent paid by the estate are not deductible in figuring the estate's taxable income on Form 1041. You can deduct them in figuring the taxable estate for federal estate tax purposes on Form 706. If these expenses are paid within the 1-year period beginning with the day after the decedent's death, you can elect to deduct them on the decedent's income tax return (Form 1040) for the year in which they were incurred. See Medical Expenses under Final Return for Decedent, earlier.

Credits, Tax, and Payments

This section includes brief discussions of some of the tax credits, types of taxes that may be owed, and estimated tax payments that are reported on the estate's income tax return, Form 1041.

Credits

Estates generally are allowed some of the same tax credits that are allowed to individuals. The credits generally are allocated between the estate and the beneficiaries. However, estates are not allowed the credit for the elderly or the disabled, the child tax credit, the rate reduction credit, or the earned income credit discussed earlier under Final Return for Decedent.

Foreign tax credit. Foreign tax credit is discussed in Publication 514, Foreign Tax Credit for Individuals.

General business credit. The general business credit is available to an estate that is involved in a business. For more information, see Publication 334.

Tax

An estate cannot use the Tax Table that applies to individuals. The tax rate schedule to use is in the instructions for Form 1041.

Alternative minimum tax (AMT). An estate may be liable for the alternative minimum tax. To figure the alternative minimum tax, use Schedule I (Form 1041), Alternative Minimum Tax. Certain credits may be limited by any tentative minimum tax figured on line 37, Part III of Schedule I (Form 1041), even if there is no alternative minimum tax liability.

If the estate takes a deduction for distributions to beneficiaries, complete Part I and Part II of Schedule I even if the estate does not owe alternative minimum tax. Allocate the income distribution deduction figured on a minimum tax basis among the beneficiaries and report each beneficiary's share on Schedule K-1 (Form 1041). Also show each beneficiary's share of any adjustments or tax preference items for depreciation, depletion, and amortization.

For more information, see the instructions to Form 1041.

Payments

The estate's income tax liability must be paid in full when the return is filed. You may have to pay estimated tax, however, as explained below.

Estimated tax. Estates with tax years ending 2 or more years after the date of the decedent's death must pay estimated tax in the same manner as individuals.

If you must make estimated tax payments for 2002, use Form 1041-ES, Estimated Income Tax for Estates and Trusts, to determine the estimated tax to be paid.

Generally, you must pay estimated tax if the estate is expected to owe, after subtracting any withholding and credits, at least $1,000 in tax for 2002. You will not, however, have to pay estimated tax if you expect the withholding and credits to be at least:

1. 90% of the tax to be shown on the 2002 return, or
2. 100% of the tax shown on the 2001 return (assuming the return covered all 12 months).

The percentage in (2) above is 112% if the estate's 2001 adjusted gross income (AGI) was more than $150,000. To figure the estate's AGI, see the instructions for line 15b, Form 1041.

The general rule is that you must make your first estimated tax payment by April 15, 2002. You can either pay all of your estimated tax at that time or pay it in four equal amounts that are due by April 15, 2002; June 17, 2002; September 16, 2002; and January 15, 2003. For exceptions to the general rule, see the instructions for Form 1041-ES and Publication 505, Tax Withholding and Estimated Tax.

If your return is on a fiscal year basis, your due dates are the 15th day of the 4th, 6th, and 9th months of your fiscal year and the 1st month of the following fiscal year.

If any of these dates fall on a Saturday, Sunday, or legal holiday, the payment must be made by the next business day.

You may be charged a penalty for not paying enough estimated tax or for not making the payment on time in the required amount (even if you have an overpayment on your tax return). Use Form 2210, Underpayment of Estimated Tax by Individuals, Estates, and Trusts, to figure any penalty.

For more information, see the instructions for Form 1041-ES and Publication 505.

Name, Address, and Signature

In the top space of the name and address area of Form 1041, enter the exact name of the estate from the Form SS-4 used to apply for the estate's employer identification number. In the remaining spaces, enter the name and address of the personal representative (fiduciary) of the estate.

Signature. The personal representative (or its authorized officer if the personal representative is not an individual) must sign the return. An individual who prepares the return for pay must manually sign the return as preparer. You can check a box in the signature area that authorizes the IRS to contact that paid preparer for certain information. See the instructions for Form 1041 for more information.

When and Where To File

When you file Form 1041 (or Form 1040NR if it applies) depends on whether you choose a calendar year or a fiscal year as the estate's accounting period. Where you file Form 1041 depends on where you, as the personal representative, live or have your principal office.

When to file. If you choose the calendar year as the estate's accounting period, the Form 1041 for 2001 is due by April 15, 2002 (June 17, 2002, in the case of Form 1040NR for a nonresident alien estate that does not have an office in the United States). If you choose a fiscal year, the Form 1041 is due by the 15th day of the 4th month (6th month in the case of Form 1040NR) after the end of the tax year. If the due date is a Saturday, Sunday, or legal holiday, the for must be filed by the next business day.

Extension of time to file. An extension of time to file Form 1041 may be granted if you have clearly described the reasons that will cause your delay in filing the return. Use Form 2758, Application for Extension of Time To File Certain Excise, Income, Information, and Other Returns, to request an extension. The extension is not automatic, so you should request it early enough for the IRS to act on the application before the regular due date of Form 1041. You should file Form 2758 in duplicate with the IRS office where you must file Form 1041.

If you have not yet established an accounting period, filing Form 2758 will serve to establish the accounting period stated on that form. Changing to another accounting period requires prior approval by the IRS.

Generally, an extension of time to file a return does not extend the time for payment of tax due. You must pay the total income tax estimated to be due on Form 1041 in full by the regular due date of the return. For additional information, see the instructions for Form 2758.

Where to file. As the personal representative of an estate, file the estate's income tax return (Form 1041) with the Internal Revenue Service center for the state where you live or have your principal place of business. A list of the states and addresses that apply is in the instructions for Form 1041.

You must send Form 1040NR to the Internal Revenue Service Center, Philadelphia, PA 19255.

Electronic filing. Form 1041 can be filed electronically or on magnetic media. See the instructions for Form 1041 for more information.

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