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. 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, so 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 2002 this amount is treated as a payment of 2002 estimated tax made by the beneficiary on January 15, 2003.

Form 706

Generally, for estate tax purposes, you must file Form 706, United States Estate (and Generation-Skipping Transfer) Tax Return. If death occurred in 2002, Form 706 must be filed if the gross estate is more than $1,000,000.

If you must file Form 706, it has to be done within 9 months after the date of the decedent's death unless you receive an extension of time to file. Use Form 4768, Application for Extension of Time To File a Return and/or Pay U.S. Estate (and Generation-Skipping Transfer) Taxes, to apply for an extension of time.

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, 2002, 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 use Form 56 to notify the Internal Revenue Service that you have been appointed executor of your father's estate.

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. The check was made out to the estate, so 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, 1992, 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, 2002, and April 9, 2002, (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 $1,305 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 2002, 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 2001 income tax return before he died.) The final return is not due until April 15, 2003, the same date it would have been due had your father lived during all of 2002.

The check representing unpaid salary and earned but unused vacation time was not paid to your father before he died, so 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 2002. 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 2002.

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 2002 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 2002, $17,735 had been allowed as depreciation. (For information on ADS, see Publication 946.)

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 2002 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.

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 they will not be used to figure the taxable estate, so 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 on 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' 2002 income tax return.

Health insurance	$3,250
State income tax paid	891
Real estate tax on home	1,100
Contributions to church	3,800

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.

Your mother and father owned the property as joint tenants with right of survivorship and they were the only joint tenants, so 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 2002 depreciation for the period before your father's death), as explained next.

For 2002, 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. They used the mid-month convention, so 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 2002. 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 20c. The total depreciation deduction allowed for the year is $2,097.

Filing status.   After December 31, 2002, 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 2002. 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 $542. The computation is as follows:

Income:
Salary (per Form W-2)	$11,000
Interest income	3,140
Net rental income	8,183
Adjusted gross income		$22,323
Minus: Itemized deductions		8,678
Balance		$13,645
Minus: Exemptions (2)		6,000
Taxable Income		$7,645
Income tax from tax table		$763
Minus: Tax withheld		1,305
Refund of taxes		$542

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