Comprehensive Example

The following is an example of a typical situation. All figures on the filled-in forms have been rounded to the nearest whole dollar.

On April 9, 2001, your father, John R. Smith, died at the age of 62. He had not resided in a community property state. His will named you to serve as his executor (personal representative). Except for specific bequests to your mother, Mary, of your parents' home and your father's automobile and a bequest of $5,000 to his church, your father's will named your mother and his brother as beneficiaries.

After the court has approved your appointment as the executor, you should obtain an employer identification number for the estate. (See Duties under Personal Representatives, earlier.) Next, you should notify the Internal Revenue Service that you have been appointed his executor. You should use Form 56.

Assets of the estate. Your father had the following assets when he died.

• His checking account balance was $2,550 and his savings account balance was $53,650.
• Your father inherited your parents' home from his parents on March 5, 1979. At that time it was worth $42,000, but was appraised at the time of your father's death at $150,000. The home was free of existing debts (or mortgages) at the time of his death.
• Your father owned 500 shares of ABC Company stock that had cost him $10.20 a share in 1983. The stock had a mean selling price (midpoint between highest and lowest selling price) of $25 a share on the day he died. He also owned 500 shares of XYZ Company stock that had cost him $20 a share in 1988. The stock had a mean selling price on the date of death of $62.
• The appraiser valued your father's automobile at $6,300 and the household effects at $18,500.
• Your father owned a coin collection and a stamp collection. The face value of the coins in the collection was only $600, but the appraiser valued it at $2,800. The stamp collection was valued at $3,500.
• Your father's employer sent a check to your mother for $11,082 ($12,000 - $918 for social security and Medicare taxes), representing unpaid salary and payment for accrued vacation time. The statement that came with the check indicated that no amount was withheld for income tax. Since the check was made out to the estate, your mother gave you the check.
• The Easy Life Insurance Company gave your mother a check for $275,000 because she was the beneficiary of his life insurance policy.
• Your father was the owner of several series EE U.S. savings bonds on which he named your mother as co-owner. Your father purchased the bonds during the past several years. The cost of these bonds totaled $2,500. After referring to the appropriate table of redemption values (see U.S. savings bonds acquired from decedent, earlier), you determine that interest of $840 had accrued on the bonds at the date of your father's death. You must include the redemption value of these bonds at date of death, $3,340, in your father's gross estate.
• On July 1, 1991, your parents purchased a house for $90,000. They have held the property for rental purposes continuously since its purchase. Your mother paid one-third of the purchase price, or $30,000, and your father paid $60,000. They owned the property, however, as joint tenants with right of survivorship. An appraiser valued the property at $120,000. You include $60,000, one-half of the value, in your father's gross estate because your parents owned the property as joint tenants with right of survivorship and they were the only joint tenants.

Your mother also gave you a Form W-2, Wage and Tax Statement, that your father's employer had sent. In examining it, you discover that your father had been paid $11,000 in salary between January 1, 2001, and April 9, 2001, (the date he died). The Form W-2 showed $11,000 in box 1 and $23,000 ($11,000 + $12,000) in boxes 3 and 5. The Form W-2 indicated $2,305 as federal income tax withheld in box 2. The estate received a Form 1099-MISC from the employer showing $12,000 in box 3. The estate received a Form 1099-INT for your father showing he was paid $1,900 interest on his savings account at the First S&L of Juneville, in 2001, before he died.

Final Return for Decedent

From the papers in your father's files, you determine that the $11,000 paid to him by his employer (as shown on the Form W-2), rental income, and interest are the only items of income he received between January 1 and the date of his death. You will have to file an income tax return for him for the period during which he lived. (You determine that he timely filed his 2000 income tax return before he died.) The final return is not due until April 15, 2002, the same date it would have been due had your father lived during all of 2001.

Since the check representing unpaid salary and earned but unused vacation time was not paid to your father before he died, the $12,000 is not reported as income on his final return. It is reported on the income tax return for the estate (Form 1041) for 2001. The only taxable income to be reported for your father will be the $11,000 salary (as shown on the Form W-2), the $1,900 interest, and his portion of the rental income that he received in 2001.

Your father was a cash basis taxpayer and did not report the interest accrued on the series EE U.S. savings bonds on prior tax returns that he filed jointly with your mother. As the personal representative of your father's estate, you choose to report the interest earned on these bonds before your father's death ($840) on the final income tax return.

The rental property was leased the entire year of 2001 for $1,000 per month. Under local law, your parents (as joint tenants) each had a half interest in the income from the property. Your father's will, however, stipulates that the entire rental income is to be paid directly to your mother. None of the rental income will be reported on the income tax return for the estate. Instead, your mother will report all the rental income and expenses on Form 1040. Checking the records and prior tax returns of your parents, you find that they previously elected to use the alternative depreciation system (ADS) with the mid-month convention. Under ADS, the rental house is depreciated using the straight-line method over a 40-year recovery period. They allocated $15,000 of the cost to the land (which is never depreciable) and $75,000 to the rental house. Salvage value was disregarded for the depreciation computation. Before 2001, $17,735 had been allowed as depreciation. For information on ADS, see Publication 946.

In September 2001, your mother received an advance payment check of $600 from the IRS. The check was in both her and your father's name. Your mother filed a completed Form 1310 to have the check reissued in her name alone so that she would be able to cash the check. The $600 is not included in your parents' income for federal tax purposes.

Deductions. During the year, you received a bill from the hospital for $615 and bills from your father's doctors totaling $475. You paid these bills as they were presented. In addition, you find other bills from his doctors totaling $185 that your father paid in 2001 and receipts for prescribed drugs he purchased totaling $36. The funeral home presented you a bill for $6,890 for the expenses of your father's funeral, which you paid.

Because the medical expenses you paid from the estate's funds ($615 and $475) were for your father's care and were paid within 1 year after his death, and because they will not be used to figure the taxable estate, you can treat them as having been paid by your father when he received the medical services. See Medical Expenses under Final Return for Decedent, earlier. However, you cannot deduct the funeral expenses either on your father's final return or from the estate's income tax return. They are deductible only on the federal estate tax return (Form 706).

In addition, after going over other receipts and canceled checks for the tax year with your mother, you determine that the following items are deductible on your parents' 2001 income tax return.

Rental expenses included real estate taxes of $700 and mortgage interest of $410. In addition, insurance premiums of $260 and painting and repair expenses for $350 were paid. These rental expenses totaled $1,720.

Because your mother and father owned the property as joint tenants with right of survivorship and they were the only joint tenants, her basis in this property upon your father's death is $95,859. This is found by adding the $60,000 value of the half interest included in your father's gross estate to your mother's $45,000 share of the cost basis and subtracting your mother's $9,141 share of depreciation (including 2001 depreciation for the period before your father's death), as explained next.

For 2001, you must make the following computations to figure the depreciation deduction.

1. For the period before your father's death, depreciate the property using the same method, basis, and life used by your parents in previous years. Since they used the mid-month convention, the amount deductible for three and a half months is $547. (This brings the total depreciation to $18,282 ($17,735 + $547) at the time of your father's death.
2. For the period after your father's death, you must make two computations.
1. Your mother's cost basis ($45,000) minus one-half of the amount allocated to the land ($7,500) is her depreciable basis ($37,500) for half of the property. She continues to use the same life and depreciation method as was originally used for the property. The amount deductible for the remaining eight and a half months is $664.
2. The other half of the property must be depreciated using a depreciation method that is acceptable for property placed in service in 2001. You chose to use ADS with the mid-month convention. The value included in the estate ($60,000) less the value allocable to the land ($10,000) is the depreciable basis ($50,000) for this half of the property. The amount deductible for this half of the property is $886 ($50,000 × .01771). See chapter 3 and Table A-13 in Publication 946.

Show the total of the amounts in (1) and (2)(a), above, on line 17 of Form 4562, Depreciation and Amortization. Show the amount in (2)(b) on line 16c. The total depreciation deduction allowed for the year is $2,097.

Filing status. After December 31, 2001, when your mother determines the amount of her income, you and your mother must decide whether you will file a joint return or separate returns for your parents for 2001. Your mother has rental income and $400 of interest income from her savings account at the Mayflower Bank of Juneville, so it appears to be to her advantage to file a joint return.

Tax computation. The illustrations of Form 1040 and related schedules appear near the end of this publication. These illustrations are based on information in this example. The tax refund is $1,131. The computation is as follows:

Income Tax Return of an Estate--Form 1041

The illustrations of Form 1041 and the related schedules for 2001 appear near the end of this publication. These illustrations are based on the information that follows.

2001 income tax return. Having determined the tax liability for your father's final return, you now figure the estate's taxable income. You decide to use the calendar year and the cash method of accounting to report the estate's income. This return also is due by April 15, 2002.

In addition to the amount you received from your father's employer for unpaid salary and for vacation pay ($12,000) entered on line 8 (Form 1041), you received a dividend check from the XYZ Company on June 16, 2001. The check was for $750 and you enter it on line 2 (Form 1041). The estate received a Form 1099-INT showing $2,250 interest paid by the bank on the savings account in 2001 after your father died. Show this amount on line 1 (Form 1041).

In September, a local coin collector offered you $3,000 for your father's coin collection, and since your mother was not interested in keeping the collection, you accepted the offer and sold him the collection on September 22, 2001, receiving his certified check for $3,000.

The estate has a gain from the sale of the collection. You will have to report the sale on Schedule D (Form 1041) when you file the income tax return of the estate. The estate has a capital gain of $200 from the sale of the coins. The gain is the excess of the sale price, $3,000, over the value of the collection at the date of your father's death, $2,800. See Gain (or loss) from sale of property under Income Tax Return of an Estate-Form 1041 and its discussion, Income To Include, earlier.

Deductions. In November 2001, you received a bill for the real estate taxes on the home. The bill was for $2,250, which you paid. Include real estate taxes on line 11 (Form 1041). (Real estate tax on the rental property was $700; this amount, however, is reflected on Schedule E (Form 1040).)

You paid $325 for attorney's fees in connection with administration of the estate. This is an expense of administration and is deducted on line 14 (Form 1041). You must, however, file with the return a statement in duplicate that such expense has not been claimed as a deduction from the gross estate for figuring the federal estate tax on Form 706, and that all rights to claim that deduction are waived.

Distributions. You made a distribution of $2,000 to your father's brother, James. The distribution was made under the terms of the will from current income of the estate.

The income distribution deduction ($2,000) is figured on Schedule B of Form 1041 and deducted on line 18 (Form 1041).

The distribution of $2,000 must be allocated and reported on Schedule K-1 (Form 1041) as follows:

Step 1
Allocation of Income & Deductions

Step 2
Allocation of Distribution
(Report on the Schedule K-1 for James)

The estate took an income distribution deduction, so you must prepare Schedule I (Form 1041), Alternative Minimum Tax, regardless of whether the estate is liable for the alternative minimum tax.

The other distribution you made out of the assets of the estate in 2001 was the transfer of the automobile to your mother on July 1. Because this is included in the bequest of property, it is not taken into account in computing the distributions of income to the beneficiary. The life insurance proceeds of $275,000 paid directly to your mother by the insurance company are treated as a specific sum of money transferred to your mother under the terms of the will.

Tax computation. The taxable income of the estate for 2001 is $10,025, figured as follows:

Since the estate had a net capital gain and taxable income, you use Part V of Schedule D (Form 1041) and the Schedule D Worksheet to figure the tax, $2,900, for 2001.

Note. For purpose of this example, we have illustrated the filled-in worksheet. You would not file the worksheet with the return. You would keep the worksheet for your records.

2002 income tax return for estate. On January 7, 2002, you receive a dividend check from the XYZ Company for $500. You also have interest posted to the savings account in January totaling $350. On January 28, 2002, you make a final accounting to the court and obtain permission to close the estate. In the accounting you list $1,650 as the balance of the expense of administering the estate.

You advise the court that you plan to pay $5,000 to Hometown Church, under the provision of the will, and that you will distribute the balance of the property to your mother, Mary Smith, the remaining beneficiary.

Gross income. After making the distributions already described, you can wind up the affairs of the estate. The gross income of the estate for 2002 is more than $600, so you must file an income tax return, Form 1041, for 2002 (not shown). The estate's gross income for 2002 is $850 (dividends $500 and interest $350).

Deductions. After making the following computations, you determine that none of the distributions made to your mother must be included in her taxable income for 2002.

Note that because the contribution of $5,000 to Hometown Church was not required under the terms of the will to be paid out of the gross income of the estate, it is not deductible and was not included in the computation.

The estate had no distributable net income in 2002, so none of the distributions made to your mother have to be included in her gross income. Furthermore, because the estate in the year of termination had deductions in excess of its gross income, the excess of $800 will be allowed as a miscellaneous itemized deduction subject to the 2%-of-adjusted-gross-income limit to your mother on her individual return for the year 2002, if she is otherwise eligible to itemize deductions.

Termination of estate. You have made the final distribution of the assets of the estate and you are now ready to terminate the estate. You must notify the IRS, in writing, that the estate has been terminated and that all of the assets have been distributed to the beneficiaries. Form 56, mentioned earlier, can be used for this purpose. Be sure to report the termination to the IRS office where you filed Form 56 and to include the employer identification number on this notification.

Page 1 of Form 1040 for John R. Smith

Page 2 of Form 1040 for John R. Smith

Schedule A (Form 1040) for John R. Smith

Schedule B (Form 1040) for John R. Smith

Schedule E (Form 1040) for John R. Smith

Form 4562 for John R. Smith

Form 1041 for the estate of John R. Smith

Page 2 of Form 1041 for the estate of John R. Smith

Page 3 of Form 1041 for the estate of John R. Smith

Page 1 of Schedule D (Form 1041) for the estate of John R. Smith

Page 2 of Schedule D (Form 1041) for the estate of John R. Smith

Schedule K-1 (Form 1041) for the estate of John R. Smith

Schedule D Tax Worksheet

Checklist of forms and due dates

Worksheet to reconcile amounts reported in name of decedent on information returns

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