Distributions to Beneficiaries From an Estate

If you are the beneficiary of an estate that must distribute all its income currently, you must report your share of the distributable net income whether or not you have actually received it.

If you are the beneficiary of an estate that does not have to distribute all its income currently, you must report all income that must be distributed to you (whether or not actually distributed) plus all other amounts paid, credited, or required to be distributed to you, up to your share of distributable net income. As explained earlier in Distributions Deduction under Income Tax Return of an Estate--Form 1041, for an amount to be currently distributable income, there must be a specific requirement for current distribution either under local law or the terms of the decedent's will. If there is no such requirement, the income is reportable only when distributed.

If the estate has more than one beneficiary, the separate shares rule discussed earlier under Distributions Deduction may have to be used to determine the distributable net income allocable to each beneficiary. The beneficiaries in the examples shown next do not meet the requirements of the separate shares rule.

Income That Must Be Distributed Currently

Beneficiaries who are entitled to receive currently distributable income generally must include in gross income the entire amount due them. However, if the currently distributable income is more than the estate's distributable net income figured without deducting charitable contributions, each beneficiary must include in gross income a ratable part of the distributable net income.

Example. Under the terms of the will of Gerald Peters, $5,000 a year is to be paid to his widow and $2,500 a year is to be paid to his daughter out of the estate's income during the period of administration. There are no charitable contributions. For the year, the estate's distributable net income is only $6,000. Since the distributable net income is less than the currently distributable income, the widow must include in her gross income only $4,000 [($5,000 × $7,500) × $6,000], and the daughter must include in her gross income only $2,000 [($2,500 × $7,500) × $6,000].

Annuity payable out of income or corpus. Income that must be distributed currently includes any amount that must be paid out of income or corpus (principal of the estate) to the extent the amount is satisfied out of income for the tax year. An annuity that must be paid in all events (either out of income or corpus) would qualify as income that must be distributed currently to the extent there is income of the estate not paid, credited, or required to be distributed to other beneficiaries for the tax year.

Example 1. Henry Frank's will provides that $500 be paid to the local Community Chest out of income each year. It also provides that $2,000 a year is currently distributable out of income to his brother, Fred, and an annuity of $3,000 is to be paid to his sister, Sharon, out of income or corpus. Capital gains are allocable to corpus, but all expenses are to be charged against income. Last year, the estate had income of $6,000 and expenses of $3,000. The personal representative paid the $500 to the Community Chest and made the distributions to Fred and Sharon as required by the will.

The estate's distributable net income (figured before the charitable contribution) is $3,000. The currently distributable income totals $2,500 ($2,000 to Fred and $500 to Sharon). The income available for Sharon's annuity is only $500 because the will requires that the charitable contribution be paid out of current income. The $2,500 treated as distributed currently is less than the $3,000 distributable net income (before the contribution), so Fred must include $2,000 in his gross income and Sharon must include $500 in her gross income.

Example 2. Assume the same facts as in Example 1 except that the estate has an additional $1,000 of administration expenses, commissions, etc., that are chargeable to corpus. The estate's distributable net income (figured before the charitable contribution) is now $2,000 ($3,000 - $1,000 additional expense). The amount treated as currently distributable income is still $2,500 ($2,000 to Fred and $500 to Sharon). The $2,500, treated as distributed currently, is more than the $2,000 distributable net income, so Fred has to include only $1,600 [($2,000 × $2,500) × $2,000] in his gross income and Sharon has to include only $400 [($500 × $2,500) × $2,000] in her gross income. Because Fred and Sharon are beneficiaries of amounts that must be distributed currently, they do not benefit from the reduction of distributable net income by the charitable contribution deduction.

Other Amounts Distributed

Any other amount paid, credited, or required to be distributed to the beneficiary for the tax year also must be included in the beneficiary's gross income. Such an amount is in addition to those amounts that must be distributed currently, as discussed earlier. It does not include gifts or bequests of specific sums of money or specific property if such sums are paid in three or fewer installments. However, amounts that can be paid only out of income are not excluded under this rule. If the sum of the income that must be distributed currently and other amounts paid, credited, or required to be distributed exceeds distributable net income, these other amounts are included in the beneficiary's gross income only to the extent distributable net income exceeds the income that must be distributed currently. If there is more than one beneficiary, each will include in gross income only a pro rata share of such amounts.

The personal representative can elect to treat distributions paid or credited by the estate 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 following are examples of other amounts distributed.

• Distributions made at the discretion of the personal representative.
• Distributions required by the terms of the will upon the happening of a specific event.
• Annuities that must be paid in any event, but only out of corpus (principal).
• Distributions of property in kind as defined earlier in Distributions Deduction under Income Tax Return of an Estate--Form 1041.
• Distributions required for the support of the decedent's surviving spouse or other dependent for a limited period, but only out of corpus (principal).

If an estate distributes property in kind, the amount of the distribution ordinarily is the lesser of the estate's basis in the property or the property's fair market value when distributed. However, the amount of the distribution is the property's fair market value if the estate recognizes gain on the distribution. See Gain or loss on distributions in kind in the discussion Income To Include under Income Tax Return of an Estate--Form 1041, earlier.

Example. The terms of Michael Scott's will require the distribution of $2,500 of income annually to his wife, Susan. If any income remains, it may be accumulated or distributed to his two children, Joe and Alice, in amounts at the discretion of the personal representative. The personal representative also may invade the corpus (principal) for the benefit of Scott's wife and children.

Last year, the estate had income of $6,000 after deduction of all expenses. Its distributable net income is also $6,000. The personal representative distributed the required $2,500 of income to Susan. In addition, the personal representative distributed $1,500 each to Joe and Alice and an additional $2,000 to Susan.

Susan includes in her gross income the $2,500 of currently distributable income. The other amounts distributed totaled $5,000 ($1,500 + $1,500 + $2,000) and are includible in the income of Susan, Joe, and Alice to the extent of $3,500 (distributable net income of $6,000 minus currently distributable income to Susan of $2,500). Susan will include an additional $1,400 [($2,000 × $5,000) × $3,500] in her gross income. Joe and Alice each will include $1,050 [($1,500 × $5,000) × $3,500] in their gross incomes.

Discharge of a Legal Obligation

If an estate, under the terms of a will, discharges a legal obligation of a beneficiary, the discharge is included in that beneficiary's income as either currently distributable income or other amount paid. This does not apply to the discharge of a beneficiary's obligation to pay alimony or separate maintenance.

The beneficiary's legal obligations include a legal obligation of support, for example, of a minor child. Local law determines a legal obligation of support.

Character of Distributions

An amount distributed to a beneficiary for inclusion in gross income retains the same character for the beneficiary that it had for the estate.

No charitable contribution made. If no charitable contribution is made during the tax year, you must treat the distributions 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. Distributable net income was defined earlier in Distributions Deduction under Income Tax Return of an Estate--Form 1041. However, if the will or local law specifically provides or requires a different allocation, you must use that allocation.

Example 1. An estate has distributable net income of $3,000, consisting of $1,800 in rents and $1,200 in taxable interest. There is no provision in the will or local law for the allocation of income. The personal representative distributes $1,500 each to Jim and Ted, beneficiaries under their father's will. Each will be treated as having received $900 in rents and $600 of taxable interest.

Example 2. Assume in Example 1 that the will provides for the payment of the taxable interest to Jim and the rental income to Ted and that the personal representative distributed the income under those provisions. Jim is treated as having received $1,200 in taxable interest and Ted is treated as having received $1,800 of rental income.

Charitable contribution made. If a charitable contribution is made by an estate and the terms of the will or local law provide for the contribution to be paid from specified sources, that provision governs. If no provision or requirement exists, the charitable contribution deduction must be allocated among the classes of income entering into the computation of the income of the estate before allocation of other deductions among the items of distributable net income. In allocating items of income and deductions to beneficiaries to whom income must be distributed currently, the charitable contribution deduction is not taken into account to the extent that it exceeds income for the year reduced by currently distributable income.

Example. The will of Harry Thomas requires a current distribution out of income of $3,000 a year to his wife, Betty, during the administration of the estate. The will also provides that the personal representative, using discretion, may distribute the balance of the current earnings either to Harry's son, Tim, or to one or more of certain designated charities. Last year, the estate's income consisted of $4,000 of taxable interest and $1,000 of tax-exempt interest. There were no deductible expenses. The personal representative distributed the $3,000 to Betty, made a contribution of $2,500 to the local heart association, and paid $1,500 to Tim.

The distributable net income for determining the character of the distribution to Betty is $3,000. The charitable contribution deduction to be taken into account for this computation is $2,000 (the estate's income ($5,000) minus the currently distributable income ($3,000)). The $2,000 charitable contribution deduction must be allocated: $1,600 [($4,000 × $5,000) × $2,000] to taxable interest and $400 [($1,000 × $5,000) × $2,000] to tax-exempt interest. Betty is considered to have received $2,400 ($4,000 - $1,600) of taxable interest and $600 ($1,000 - $400) of tax-exempt interest. She must include the $2,400 in her gross income. She must report the $600 of tax-exempt interest, but it is not taxable.

To determine the amount to be included in Tim's gross income, however, take into account the entire charitable contribution deduction. Since the currently distributable income is greater than the estate's income after taking into account the charitable contribution deduction, none of the amount paid to Tim must be included in his gross income for the year.

How and When To Report

How you report your income from the estate depends on the character of the income in the hands of the estate. When you report the income depends on whether it represents amounts credited or required to be distributed to you or other amounts.

How to report estate income. Each item of income keeps the same character in your hands as it had in the hands of the estate. If the items of income distributed or considered to be distributed to you include dividends, tax-exempt interest, or capital gains, they will keep the same character in your hands for purposes of the tax treatment given those items. Generally, you report the dividends on line 9 of your Form 1040, and the capital gains on your Schedule D (Form 1040). The tax-exempt interest, while not included in taxable income, must be shown on line 8b of your Form 1040. Report business and other nonpassive income in Part III of your Schedule E (Form 1040).

The estate's personal representative should provide you with the classification of the various items that make up your share of the estate income and the credits you should take into consideration so that you can properly prepare your individual income tax return. See Schedule K-1 (Form 1041), later.

When to report estate income. If income from the estate is credited or must be distributed to you for a tax year, report that income (even if not distributed) on your return for that year. 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. If this election is made, you must report that distribution on your return for that year.

Report other income from the estate on your return for the year in which you receive it. If your tax year is different from the estate's tax year, see Different tax years, next.

Different tax years. You must include your share of the estate income in your return for your tax year in which the last day of the estate's tax year falls. If the tax year of the estate is the calendar year and your tax year is a fiscal year ending on June 30, you will include in gross income for the tax year ended June 30 your share of the estate's distributable net income distributed or considered distributed during the calendar year ending the previous December 31.

Death of individual beneficiary. If an individual beneficiary dies, the beneficiary's share of the estate's distributable net income may be distributed or be considered distributed by the estate for its tax year that does not end with or within the last tax year of the beneficiary. In this case, the estate income that must be included in the gross income on the beneficiary's final return is based on the amounts distributed or considered distributed during the tax year of the estate in which his or her last tax year ended. However, for a cash basis beneficiary, the gross income of the last tax year includes only the amounts actually distributed before death. Income that must be distributed to the beneficiary but, in fact, is distributed to the beneficiary's estate after death is included in the gross income of the beneficiary's estate as income in respect of a decedent.

Termination of nonindividual beneficiary. If a beneficiary that is not an individual, for example a trust or a corporation, ceases to exist, the amount included in its gross income for its last tax year is determined as if the beneficiary were a deceased individual. However, income that must be distributed before termination, but which is actually distributed to the beneficiary's successor in interest, is included in the gross income of the nonindividual beneficiary for its last tax year.

Schedule K-1 (Form 1041). The personal representative for the estate must provide you with a copy of Schedule K-1 (Form 1041) or a substitute Schedule K-1. You should not file the form with your Form 1040, but should keep it for your personal records.

Each beneficiary (or nominee of a beneficiary) who receives a distribution from the estate for the tax year or to whom any item is allocated must receive a Schedule K-1 or substitute. The personal representative handling the estate must furnish the form to each beneficiary or nominee by the date on which the Form 1041 is filed.

Nominees. A person who holds an interest in an estate as a nominee for a beneficiary must provide the estate with the name and address of the beneficiary, and any other required information. The nominee must provide the beneficiary with the information received from the estate.

Penalty. A personal representative (or nominee) who fails to provide the correct information may be subject to a $50 penalty for each failure.

Consistent treatment of items. You must treat estate items the same way on your individual return as they are treated on the estate's income tax return. If your treatment is different from the estate's treatment, you must file Form 8082, Notice of Inconsistent Treatment or Administrative Adjustment Request (AAR), with your return to identify the difference. If you do not file Form 8082 and the estate has filed a return, the IRS can immediately assess and collect any tax and penalties that result from adjusting the item to make it consistent with the estate's treatment.

Bequest

A bequest is the act of giving or leaving property to another through the last will and testament. Generally, any distribution of income (or property in kind) to a beneficiary is an allowable deduction to the estate and is includible in the beneficiary's gross income to the extent of the estate's distributable net income. However, a distribution will not be an allowable deduction to the estate and will not be includible in the beneficiary's gross income if the distribution meets the following requirements.

• It is required by the terms of the will.
• It is a gift or bequest of a specific sum of money or property.
• It is paid out in three or fewer installments under the terms of the will.

Specific sum of money or property. To meet this test, the amount of money or the identity of the specific property must be determinable under the decedent's will as of the date of death. To qualify as specific property, the property must be identifiable both as to its kind and its amount.

Example 1. Dave Rogers' will provided that his son, Ed, receive Dave's interest in the Rogers-Jones partnership. Dave's daughter, Marie, would receive a sum of money equal to the value of the partnership interest given to Ed. The bequest to Ed is a gift of a specific property ascertainable at the date of Dave Rogers' death. The bequest of a specific sum of money to Marie is determinable on the same date.

Example 2. Mike Jenkins' will provided that his widow, Helen, would receive money or property to be selected by the personal representative equal in value to half of his adjusted gross estate. The identity of the property and the money in the bequest are dependent on the personal representative's discretion and the payment of administration expenses and other charges, which are not determinable at the date of Mike's death. As a result, the provision is not a bequest of a specific sum of money or of specific property, and any distribution under that provision is a deduction for the estate and income to the beneficiary (to the extent of the estate's distributable net income). The fact that the bequest will be specific sometime before distribution is immaterial. It is not ascertainable by the terms of the will as of the date of death.

Distributions not treated as bequests. The following distributions are not bequests that meet all the requirements listed earlier that allow a distribution to be excluded from the beneficiary's income and do not allow it as a deduction to the estate.

Paid only from income. An amount that can be paid only from current or prior income of the estate does not qualify even if it is specific in amount and there is no provision for installment payments.

Annuity. An annuity or a payment of money or of specific property in lieu of, or having the effect of, an annuity is not the payment of a specific property or sum of money.

Residuary estate. If the will provides for the payment of the balance or residue of the estate to a beneficiary of the estate after all expenses and other specific legacies or bequests, that residuary bequest is not a payment of a specific property or sum of money.

Gifts made in installments. Even if the gift or bequest is made in a lump sum or in three or fewer installments, it will not qualify as a specific property or sum of money if the will provides that the amount must be paid in more than three installments.

Conditional bequests. A bequest of a specific property or sum of money that may otherwise be excluded from the beneficiary's gross income will not lose the exclusion solely because the payment is subject to a condition.

Installment payments. Certain rules apply in determining whether a bequest of specific property or a sum of money has to be paid or credited to a beneficiary in more than three installments.

Personal items. Do not take into account bequests of articles for personal use, such as personal and household effects and automobiles.

Real property. Do not take into account specifically designated real property, the title to which passes under local law directly to the beneficiary.

Other property. All other bequests under the decedent's will for which no time of payment or crediting is specified and that are to be paid or credited in the ordinary course of administration of the estate are considered as required to be paid or credited in a single installment. Also, all bequests payable at any one specified time under the terms of the will are treated as a single installment.

Testamentary trust. In determining the number of installments that must be paid or credited to a beneficiary, the decedent's estate and a testamentary trust created by the decedent's will are treated as separate entities. Amounts paid or credited by the estate and by the trust are counted separately.

Termination of Estate

The termination of an estate generally is marked by the end of the period of administration and by the distribution of the assets to the beneficiaries under the terms of the will or under the laws of succession of the state if there is no will. These beneficiaries may or may not be the same persons as the beneficiaries of the estate's income.

Period of Administration

The period of administration is the time actually required by the personal representative to assemble all of the decedent's assets, pay all the expenses and obligations, and distribute the assets to the beneficiaries. This may be longer or shorter than the time provided by local law for the administration of estates.

Ends if all assets distributed. If all assets are distributed except for a reasonable amount set aside, in good faith, for the payment of unascertained or contingent liabilities and expenses (but not including a claim by a beneficiary, as a beneficiary) the estate will be considered terminated.

Ends if period unreasonably long. If settlement is prolonged unreasonably, the estate will be treated as terminated for federal income tax purposes. From that point on, the income, deductions, and credits of the estate are considered those of the person or persons succeeding to the property of the estate.

Transfer of Unused Deductions to Beneficiaries

If the estate has unused loss carryovers or excess deductions for its last tax year, they are allowed to those beneficiaries who succeed to the estate's property. See Successor beneficiary, later.

Unused loss carryovers. An unused net operating loss carryover or capital loss carryover existing upon termination of the estate is allowed to the beneficiaries succeeding to the property of the estate. That is, these deductions will be claimed on the beneficiary's tax return. This treatment occurs only if a carryover would have been allowed to the estate in a later tax year if the estate had not been terminated.

Both types of carryovers generally keep their same character for the beneficiary as they had for the estate. However, if the beneficiary of a capital loss carryover is a corporation, the corporation will treat the carryover as a short-term capital loss regardless of its status in the estate. The net operating loss carryover and the capital loss carryover are used in figuring the beneficiary's adjusted gross income and taxable income. The beneficiary may have to adjust any net operating loss carryover in figuring the alternative minimum tax.

The first tax year to which the loss is carried is the beneficiary's tax year in which the estate terminates. If the loss can be carried to more than one tax year, the estate's last tax year (whether or not a short tax year) and the beneficiary's first tax year to which the loss is carried each constitute a tax year for figuring the number of years to which a loss may be carried. A capital loss carryover from an estate to a corporate beneficiary will be treated as though it resulted from a loss incurred in the estate's last tax year (whether or not a short tax year), regardless of when the estate actually incurred the loss.

If the last tax year of the estate is the last tax year to which a net operating loss may be carried, see No double deductions, later. For a general discussion of net operating losses, see Publication 536. For a discussion of capital losses and capital loss carryovers, see Publication 550.

Excess deductions. If the deductions in the estate's last tax year (other than the exemption deduction or the charitable contributions deduction) are more than gross income for that year, the beneficiaries succeeding to the estate's property can claim the excess as a deduction in figuring taxable income. To establish these deductions for the beneficiaries, a return must be filed for the estate along with a schedule showing the computation of each kind of deduction and the allocation of each to the beneficiaries.

An individual beneficiary must itemize deductions to claim these excess deductions. The deduction is claimed on Schedule A (Form 1040), subject to the 2% limit on miscellaneous itemized deductions. The beneficiaries can claim the deduction only for the tax year in which or with which the estate terminates, whether the year of termination is a normal year or a short tax year.

No double deductions. A net operating loss deduction allowable to a successor beneficiary cannot be considered in figuring the excess deductions on termination. However, if the estate's last tax year is the last year in which a deduction for a net operating loss can be taken, the deduction, to the extent not absorbed in the last return of the estate, is treated as an excess deduction on termination. Any item of income or deduction, or any part thereof, that is taken into account in figuring a net operating loss or a capital loss carryover of the estate for its last tax year cannot be used again to figure the excess deduction on termination.

Successor beneficiary. A beneficiary entitled to an unused loss carryover or an excess deduction is the beneficiary who, upon the estate's termination, bears the burden of any loss for which a carryover is allowed or of any deductions more than gross income.

If decedent had no will. If the decedent had no will, the beneficiaries are those heirs or next of kin to whom the estate is distributed. If the estate is insolvent, the beneficiaries are those to whom the estate would have been distributed had it not been insolvent. If the decedent's spouse is entitled to a specified dollar amount of property before any distributions to other heirs and the estate is less than that amount, the spouse is the beneficiary to the extent of the deficiency.

If decedent had a will. If the decedent had a will, a beneficiary normally means the residuary beneficiaries (including residuary trusts). Those beneficiaries who receive a specific property or a specific amount of money ordinarily are not considered residuary beneficiaries, except to the extent the specific amount is not paid in full.

Also, a beneficiary who is not strictly a residuary beneficiary, but whose devise or bequest is determined by the value of the estate as reduced by the loss or deduction, is entitled to the carryover or the deduction. For example, this would include the following beneficiaries.

• A beneficiary of a fraction of the decedent's net estate after payment of debts, expenses, and specific bequests.
• A nonresiduary beneficiary, when the estate is unable to satisfy the bequest in full.
• A surviving spouse receiving a fractional share of the estate in fee under a statutory right of election when the losses or deductions are taken into account in determining the share. However, such a beneficiary does not include a recipient of a dower or curtesy, or a beneficiary who receives any income from the estate from which the loss or excess deduction is carried over.

Allocation among beneficiaries. The total of the unused loss carryovers or the excess deductions on termination that may be deducted by the successor beneficiaries is to be divided according to the share of each in the burden of the loss or deduction.

Example. Under his father's will, Arthur is to receive $20,000. The remainder of the estate is to be divided equally between his brothers, Mark and Tom. After all expenses are paid, the estate has sufficient funds to pay Arthur only $15,000, with nothing to Mark and Tom. In the estate's last tax year there are excess deductions of $5,000 and $10,000 of unused loss carryovers. Since the total of the excess deductions and unused loss carryovers is $15,000 and Arthur is considered a successor beneficiary to the extent of $5,000, he is entitled to one-third of the unused loss carryover and one-third of the excess deductions. His brothers may divide the other two-thirds of the excess deductions and the unused loss carryovers between them.

Transfer of Credit for Estimated Tax Payments

When an estate terminates, the personal representative can choose to transfer to the beneficiaries the credit for all or part of the estate's estimated tax payments for the last tax year. To make this choice, the personal representative must complete Form 1041-T, Allocation of Estimated Tax Payments to Beneficiaries, and file it either separately or with the estate's final Form 1041. The Form 1041-T must be filed by the 65th day after the close of the estate's tax year.

The amount of estimated tax allocated to each beneficiary is treated as paid or credited to the beneficiary on the last day of the estate's final tax year and must be reported on line 14a, Schedule K-1 (Form 1041). If the estate terminated in 2001 this amount is treated as a payment of 2001 estimated tax made by the beneficiary on January 15, 2002.

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