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CHAPTER 19
ACCOUNTING FOR ESTATES AND TRUSTS
Chapter Outline
I. Estate accounting encompasses the recording and reporting of events that occur from the
time of a person's death until distribution of all property.
A. An individual who dies "testate" had prepared a valid will whereas one who dies
"intestate" expires without a valid will.
1. State probate laws govern wills and estates. These statutes facilitate three (3) goals.
a. To gather and preserve the decedent’s property.
b. To ascertain the decedent's intent for his/her property.
c. To settle debts and distribute the remaining assets consistent with the decedent’s
intentions.
2. Where no will exists, the laws of descent (for real property) and the laws of
distribution (for personal property) govern the distribution of the decedent’s property.
B. A will should name an executor of the estate to oversee the management and
conveyance of property. If an executor is not named or is not able to serve, the probate
court will appoint an administrator.
C. Claims against the estate must be paid in a specific order of priority.
1. Expenses of administering the estate – which include legal costs, executor fees and
similar items.
2. Funeral expenses and medical expenses of last illness.
3. Taxes and debts given legal preference.
4. All other claims.
D. Estate distributions.
1. Devise—a testamentary gift of real property.
2. Specific legacy (or bequest)—an item of personal property that is identified directly
by the testator in his/her will.
3. Demonstrative legacy—a cash gift made from a particular identified source.
4. General legacy—a cash gift made with no source designated.
5. Residual legacy—a gift of any remaining estate property.
6. If sufficient property is not available to satisfy all legacies, the process of abatement
is used to reduce the various gifts.
E. Estate and inheritance taxes.
1. Federal estate tax—an excise tax on the right to convey property.
a. The fair market value of estate property is taxed after reduction for funeral
expenses, estate administration expenses, liabilities, charitable bequests, and
the value of all property conveyed to spouse.
b. In 2010, the federal estate tax was repealed, except for estates electing to be
covered by such. Beginning in 2011 a portable exemption from federal estate
taxes in the amount of $5.0 million became available. This exemption is now
indexed and was $5.12 million in 2012 and $5.25 million in 2013.
c. An individual was allowed an annual exclusion from federal gift taxes of $13,000
per donee plus a $5.0 million lifetime exclusion for 2011 (indexed for inflation to
$5.12 million in 2012); $14,000 annual exclusion and $5.25 million lifetime
exclusion in 2013 which will continue to be indexed prospectively.
2. State inheritance tax—assessed on the right to receive property. This tax varies
significantly from state to state.
3. Estate income tax—tax on income earned by estate property.
F. Recording the transactions of an estate
1. Assets are recorded at fair value.
2. Debts, expenses, and distributions are only recorded when paid.
3. Income and principal have their balances and transactions separately identified
because testators often transfer income and principal to different beneficiaries.
4. Charge and Discharge statements are prepared as necessary to report on the
progress being made in settling the estate.
II. Trust funds are created so that a fiduciary can be put in charge of specified assets that will
be distributed ultimately (the income and/or principal) to one or more designated parties.
1. Trusts ensure that the distribution of a person's assets is as intended.
2. An inter vivos trust is created by a living individual.
3. A testamentary trust is created by a will.
B. CPAs often utilize trusts to decrease the size of a client's estate and, thus, reduce estate
taxes.
C. Many types of trusts exist including:
1. Qualified Terminable Interest Property Trust—income goes to one or more parties
with the principal eventually being conveyed to a different party.
2. Charitable Remainder Trust—income goes to one or more parties with the principal
eventually being conveyed to a specified charity.
3. Spendthrift Trust – income is utilized for the benefit of the beneficiaries in a manner
that protects the trust income and assets, from the beneficiaries’ creditors and also
from the beneficiaries’ own financial indiscretions.
4. Life Insurance Trust – assets are utilized to obtain life insurance on a party and
provided that the trust is irrevocable, the proceeds of the life insurance policies are
not included in the insured’s taxable estate.
D. Accounting for a trust.
1. In many trusts, the distinction between income and principal is essential.
a. Investing costs, improvements, and the cost of preparing property in order to sell
are viewed as adjustments to the trust's principal.
b. Interest, insurance, and rent are typically adjustments to the trust's income.
2. Income and principal have their transactions and balances separately identified.
Answer to Discussion Question
Is this Really an Asset?
Fulfilling the instructions found in a will is not always an easy task. In this case, the will contains
a specific legacy: letters written by the decedent's grandfather were to be given to a cousin.
Perhaps the decedent intended for this property to be retained by a family member. However,
The administrator should begin by contacting an attorney to learn of the specific probate laws of
the state in which the estate is located. For reporting purposes, the letters should be listed on a
The administrator will probably need to confer with representatives of the local church (which is
entitled to the $20,000 general legacy) as well as with any parties who are to receive residual
This discussion question identifies one of many situations in which an administrator should
obtain the services of a qualified professional – an attorney, or other experienced estate
representative.
Answers to Questions
1. The term "testate" refers to a decedent who dies leaving a valid will. "Intestate" indicates an
individual who has died without having written a valid will.
2. When an individual dies without having prepared a valid will, state inheritance laws become
applicable. Normally, these laws are written to correspond with the most common methods
3. Probate laws are state statutes which govern wills and estates. Depending upon the nature
4. Probate laws provide an orderly structure for the process of administering and distributing a
decedent’s estate. The objectives of probate laws are
5. The executor (or administrator if an executor is not named in the will or is unable to serve)
must first ensure that all applicable laws are satisfied. Second, the executor must attempt to
learn the decedent's wishes and then carry them out, if possible. The executor is a fiduciary
6. Estate assets are reported at fair market value since historical cost (if known) would not be
important in paying debts, making distributions, or determining transfer tax obligations.
7. All assets of an estate should be presented on the discharge statement. If the asset has a
speculative value the asset should be identified but without a dollar value. With assets of
8. Since an executor must satisfy (if possible) all of the claims against an estate, an adequate
search for these claims must be made. In most states, a public notice has to be placed in an
9. Because of the possibility that estate assets may be insufficient to satisfy all debts and
claims, state probate laws usually specify the following order of priority. Thus, if a shortage
of assets does occur, the claims at the top of this list are paid first followed by the second
level and so on.
10. An estate that is heavily in debt could possibly leave the members of the decedent’s
immediate family with nothing. This potential hardship is often viewed by state probate laws
as unfair. Therefore, a small homestead allowance is allowed to a surviving spouse and/or
11. A devise is a gift of real property such as land or a building. In contrast, a legacy (or
12.
—A specific legacy is the conveyance of an identified piece of personal property. The gift of
a car, for example, or shares of corporate stock would be viewed as a specific legacy.
—A demonstrative legacy is a cash gift that is made from a specific source. The gift of
13. The process of abatement is utilized if an estate has insufficient resources to satisfy all of
the legacies spelled out in a will. This guideline dictates the reductions that must be made to
14. The federal estate tax is an excise tax on the right to convey property. Thus, the value of the
decedent's property at death is the basis for this assessment although an alternate valuation
date (six months after death or at the date of distribution, whichever comes first) can be
chosen by the executor. The value of estate assets is then reduced by a series of costs,
debts, and distributions including:
15. The ATRA makes most changes made by the Tax Relief, Unemployment Insurance
Reauthorization, and Job Creation Act (TRA 2010) permanent with regard to federal
16. Individuals are allowed to make gifts of up to $14,000 per person per year (the amount is
17. Distributions to a spouse directly decrease the taxable value of an estate and, hence,
reduce the amount of federal estate taxes. However, when the spouse eventually dies, a
large estate may be left by the subsequently deceased spouse, thus creating a significant tax
If an individual’s unified transfer credit has not been previously decreased in order to avoid
taxation of gifts, an estate of a certain size is tax free. Because of the ATRA, an estate of
$5.25 million or less could be conveyed without creating a tax effect. Hence, if all other
property is conveyed to the decedent’s spouse or to charity, a trust fund of the appropriate
amount can be created (usually with the trust income going to the spouse until death)
without incurring an estate tax. Four desirable results occur:
1. No estate taxes are paid on the first decedent’s estate.
18. Several deductions are allowed in the computation of estate income taxes:
—A personal exemption of $600.
19. In addition to identifying the proper distribution of assets, a testator may identify proposed
20. The distinction between principal and income may be of paramount importance especially if
they are to be conveyed to different parties. Assets held at the decedent's death comprise
21. The following are examples of the usual method by which the distinction between the
principal and income of an estate is established:
Adjustments to principal: gains and losses on the sale of securities, debts incurred prior to
22. For federal estate tax purposes, the value of an estate at the date of the decedent's death
should be determined. An alternate valuation date may be chosen by the executor if this
decision will reduce the estate taxes to be paid. The alternate date is the earlier of six
months after death or the date of conveyance.
23. The executor is given the responsibility of locating, valuing, and distributing all estate assets.
Therefore, the reporting process emphasizes the value of all assets being held and their
24. The charge and discharge statement of an estate is produced for several purposes. It lists
the assets originally included in the estate. The statement also reports the assets that have
been distributed to date to satisfy debts, expenses, or the stipulations of the decedent's will.
distributing the decedent’s estate.
25. A trust fund is comprised of assets that have been conveyed to a fiduciary who will manage
26. Trust funds have become popular as a means of reducing the size of a decedent's estate, as
well as shielding assets from third parties. Thus, trusts may serve to decrease the amount
27. An inter vivos trust is simply one that is started by a living individual. Such a trust may be
28. A testamentary trust is simply a trust created by a will.
29.
—QTIP Trust (Qualified Terminable Interest Property Trust)—The income of the trust (and
possibly some of the principal) is conveyed to a party (frequently a spouse) for a period of
time. After that time, the remaining principal goes to a different party.
30. The distinction between principal and income is especially important in accounting for a trust
because in many cases they are to be given to different parties. Many trusts are created so
that one group of beneficiaries is to collect income for a period of time with the principal then
going to a different group of beneficiaries. Only by keeping principal and income balances
separate can all parties receive the amounts that are appropriate.
Answers to Problems
1. B (the laws of distribution apply to the distribution of an intestate person’s
personal property).
6. A (although state probate statutes vary, most states require the publication of
notice of death and then permit claims against the decedent’s estate only for a
statutorily shortened period of time).
10.C (the homestead allowance is designed to ensure that surviving spouses and
children have the financial ability to maintain a modest residence or homestead).
11.D (a specific legacy is a transfer of personal property that is actually or
‘specifically’ identified in the testator’s will).
date of asset distribution).
15.C (the ATRA of 2012 provided a $5.25 million exemption per transferor
beginning in 2013, as a result of indexing).
16.B (losses are deductible for Estate income tax purposes).
21.A (the use of this estate / trust planning will reduce the overall size of the
couple’s taxable estates while still providing income for the surviving spouse).
22.B (funeral expenses are deductible from the estate for federal estate tax
purposes).
23.A (the remainderman gets the ‘remainder’ – that is what is left after another
beneficiary receives income / assets for a specified period of time).
29.A (Rental income of $5,000 less $600 exemption).
