|Douglas D. Wilson , CFP, CTFA, is senior vice-president of the First Hawaiian Bank, Honolulu, where he is in charge of trust business development.|
Over the next 20 years the largest transfer of wealth in the United States will take place as baby boomers inherit their parents wealth. Cornell University economists Robert B. Avery and Michael S. Rendall estimate that boomers will inherit $4.8 trillion through the year 2015. Most of this wealth will be transferred through probate proceedings and a variety of trusts established under parents estates. Executors and trustees will be responsible for managing the wealth transfer process.
Estate and trust administration has long been the domain of banks and trust companies. However, a clear trend has developed over the last decade toward naming individuals as executors and trustees. Many of these individuals—lacking the experience and expertise necessary to administer an estate or trust properly— have no idea of what this responsibility involves. Once they discover the difficulties and personal liability that come with serving as an executor or trustee, the informed individual fiduciary will seek professional help. But that help may not come from the attorney who prepared the will or trust. Some attorneys hesitate to advise executors and trustees because of the potential conflict of interest and ethical problems associated with the question of who they represent—the fiduciary, the estate or trust or the surviving spouse.
CPAs are in a unique position to provide professional services to individual fiduciaries. The accounting profession apparently agrees, as evidenced by Accounting Todays survey of the top 100 CPA firms, which ranked estate, trust and gift matters as the third highest area of growth. CPAs have the technical and business expertise required to help clients manage estates and trusts. They also have the ability to interact on a professional level with lawyers, financial planners, other accountants, insurance agents, realtors and members of the decedents family.
In addition, CPAs must adhere to the American Institute of CPAs Code of Professional Conduct, which parallels in many ways the standards of conduct under statutory and common law that apply to executors and trustees (see the exhibit ). While CPAs themselves have no fiduciary duty, they can advise individual executors and trustees about the applicable standards of conduct for individual fiduciaries. Understanding and abiding by these standards is essential to acting as a fiduciary and avoiding personal liability.
Individual fiduciaries need professional help in several critical areas of estate and trust administration to get the job done. They include
- Fiduciary accounting.
- Preparation and filing of tax returns.
- Tax elections.
- The funding of the marital and credit shelter trusts.
These areas, described below in greater detail, clearly fall within the purview of the CPA profession.
Beneficiaries under a will or trust have a right to be kept informed at all times about the management of the estate or trust and the fiduciary has a duty to so inform them. Managing and maintaining records for an estate or trust requires understanding the principles of fiduciary accounting. Receipts and expenditures are classified as either income or principal. For example, dividends, interest and rents (income) must be accounted for separately from the trusts assets (principal). This characteristic distinguishes fiduciary accounting from any other type of account recordkeeping. The allocation between income and principal is significant for estates but has greater importance in trust administration. A trust has two classes of beneficiaries—the current beneficiaries and the remaindermen. The current beneficiaries have a beneficial interest in income or principal, or both, during the life of the trust. The remaindermen inherit the trust principal when the trust terminates. The classification of receipts and expenditures between income and principal has a direct impact on what each class of beneficiary receives.
A trustee is required to follow the terms of the trust instrument in making allocations between income and principal. For example, the trust may direct the trustee to credit capital gain distributions from mutual funds—normally allocated to principal—to income. Absent specific direction in the will or trust, the Uniform Principal and Income Act (or the revised version many states have adopted—refer to state statutes) can provide guidance. Here are some general rules defined under the act:
- Income receipts. Income consists of earnings from the use or investment of principal. It includes dividends, interest, rents, royalties and other receipts received as a return on principal.
- Principal receipts. Principal is the trust property itself and is accounted for separately from income. It includes the proceeds received from the sale of any assets, stock dividends, insurance proceeds, royalties from depletable resources, allowances for depreciation, principal payments received on loans and other receipts that eventually will be distributed to the remaindermen.>
- Income charges. This includes all expenses incurred in connection with the administration, management or preservation of the trust property.
- Principal charges. This includes the costs of investing and reinvesting principal, principal payments on debts and obligations of the trust, trustee fees attributable to principal as provided by law or the terms of the trust, expenses incurred in taking or defending any action to protect the trust property, extraordinary expenses in making capital improvements to principal assets and taxes on capital gains or other receipts allocated to principal.
Making the wrong accounting choice can be costly for an individual fiduciary as errors are not always discovered during administration. Such errors typically are caught by a remainderman beneficiary or court appointed master when the trust terminates, which can be many years after its inception. The fiduciary can be assessed for statutory interest or lost opportunity costs to make the trust whole. A CPA is the logical choice to help an individual fiduciary address fiduciary accounting issues and maintain accounting records for the estate or trust.
PREPARING AND FILING TAX RETURNS
Executors and trustees are responsible for filing a variety of tax returns for the estates and trusts they manage. If accountants practice in this area of taxation, they can provide this service; if they dont, they can advise clients on what is required and refer them to a specialist. Obviously, CPAs need to understand the basic requirements and tax planning issues before advising a client.
Decedents final income tax returns. Under Internal Revenue Code section 6012(b)(1), the executor or trustee is responsible for filing any tax returns the decedent would have been required to file if still living, including the decedents final income tax returns, and for paying any taxes due. However, section 6013(a) says the surviving spouse shares this responsibility if a joint return is filed. Filing a joint return with the surviving spouse is an election the fiduciary must make after considering income splitting to possibly lower the tax bracket, using the decedents deductions, avoiding joint and several liability, increasing the availability of medical deductions and casualty losses. Tax planning considerations are important here, and the individual fiduciary needs competent advice.
Fiduciary income tax returns. An executor or trustee is responsible—under IRC section 6012(b)(4)—for filing a fiduciary income tax return and paying any taxes due for each year an estate or trust exists. In general, the beneficiaries are taxed on the income paid out or required to be distributed under the terms of a trust. Retained income is taxed to the estate or trust. Estate or trust income that exceeds $7,900 is taxed at the maximum federal rate of 39.6%. Since any estate income not needed to pay estate expenses will be distributed to the beneficiaries when estate administration is completed, the executor or trustee must consider whether to distribute income to the beneficiaries before the estate is closed.
Federal estate tax return. The executor of an estate generally is responsible for filing the estate tax return (Form 706, United States Estate Tax Return ), if one is required. If the value of the gross estate exceeds $600,000, the executor must file a federal estate tax return no later than nine months from the date of death, with a possible six-month filing extension under IRC section 6018(a). If the court has not appointed an executor because there is no probate estate, IRC section 2203 says the executor for purposes of filing the return is "any person in actual or constructive possession of any property of the decedent." The trustee of the decedents trust is required to file the return under this circumstance. The executor or the trustee is personally liable for filing the estate tax return and paying any tax due. To protect himself or herself, the executor or trustee should make a request for early determination of the tax and discharge from personal liability under IRC section 2204. This request should be made at the time the return is filed.
Generation-skipping tax. Executors or trustees must report generation-skipping transfers and pay any taxes due. Such transfers fall into three general categories:
- Taxable termination. Termination of an interest in a trust that results in a distribution to a skip person (IRC section 2612[a]).
- Taxable distributions. Any distribution from a trust to a skip person (section 2612[b]).
- Direct skip. A transfer, subject to federal gift or estate tax, of a property interest to a skip person (section 2612[c]).
A skip person is someone who is two or more generations below the transferor—typically the transferors grandchild. An executor must file Form 709, United States Gift (and Generation-Skipping Transfer ) Tax Return, to report a predeath direct skip transfer the decedent made but did not report before his or her death. An executor also must report on form 706 any generation-skipping transfers that occur at the decedents death by bequest under a will or trust. A trustee is required to report generation-skipping distributions from a trust and distributions that are the result of a taxable termination under a trust on form 709.
Executors or trustees are required—or have the option—to make a number of tax elections. Fiduciaries can achieve significant tax and other economic benefits for the estates and trusts they manage and the beneficiaries they serve. Since most individual fiduciaries do not have the skills to handle this level of planning, they need professional assistance. With most of the elections involving tax planning issues, CPAs are in a unique position to provide the necessary expertise.
Qualified terminable interest property (QTIP) election. This election under IRC section 2056(b)(7) is made on the estate tax return to qualify all or part of the QTIP for the marital deduction. The election gives the executor a chance to equalize the estates of the decedent and the surviving spouse to take advantage of lower estate tax brackets in each estate. Alternatively, the executor can elect all of the QTIP for the marital deduction if deferring the estate tax to the surviving spouses death is more advantageous. Careful analysis is required because once the election is made, it is irrevocable.
Allocation of generation-skipping tax (GST) exemption. The executor or trustee can allocate the $1 million GST exemption to any property transferred by the decedent. The allocation should take into consideration maximizing the use of the exemption to shelter future asset growth and to minimize the amount of tax to be paid. If an election is not made, IRC section 2631 says the allocation is made first to direct skips made by the decedent before death, then to generation-skipping transfers made at death and finally to trusts created by the decedent.
Administration expenses, medical expenses and casualty losses. Fiduciaries have tax planning opportunities for certain deductible estate expenses. Administration expenses such as fees paid to attorneys, accountants, appraisers, trustees and executors can be deducted on either the estate tax return or the fiduciary income tax returns. Final medical expenses can be deducted on either the estate tax return or the decedents final individual income tax return. Casualty losses can be deducted on either the fiduciary income tax returns or the decedents final income tax returns (IRC sections 2053 and 2054).
Alternate valuation. Under IRC section 2032, an executor or trustee may elect to value estate assets at their date of death value or use an alternate valuation date six months after the decedents death. In addition to evaluating the effect on the estate tax liability of using the alternate date, the executor or trustee needs to consider what effect the election will have on the step up in basis of the assets and the capital gains tax that will be paid on any future sale. The timing of sales and distributions within six months of death also is a consideration. Property sold or distributed within six months of death is valued as of the date of sale or distribution if the alternate valuation is elected.
Special use valuation. Section 2032A says an executor can elect to value real property used in farming or in other trades or businesses based on the propertys current use rather than on its so-called highest and best use value. The intent is to allow family members to continue to operate the business instead of having to sell business property to pay death taxes. Before using the special use valuation, an executor must consider its effect on other estate tax issues such as the IRC section 303 redemption election, section 6166 deferral election, minimization of taxes in the survivors estate and other tax planning considerations.
Disclaimers. If a decedents beneficiary declines to accept an interest in property, that interest passes to an alternate beneficiary. Qualified disclaimers also may be used to disclaim an interest in jointly owned property. The use of this election is primarily a tax planning issue. However, disclaimers also can be used to correct a drafting error in a will or trust. For example, a marital trust would not qualify for the marital deduction if it allowed either income or principal to go to both spouse and children. The children can disclaim their current interest in the trust to correct the problem. Timing is critical. The disclaimer must be made within nine months from the date the interest came into being—usually the date of death.
Extension of time to pay estate taxes. The federal estate tax is due nine months from the date of death. However, four IRC provisions allow the executor to defer the payment, including
- A 12-month extension.
- A 10-year extension for reasonable cause.
- An extension for a reversionary (the right to the return of property after a period of time) or remainder interest.
- A 5-year extension and 10-year installment payment for a closely held business.
These elections, found in IRC sections 6075(a) and 6151(a), require a thorough analysis of the interest costs and the advantage, if any, of deferring the sale of assets to raise the necessary funds to pay the taxes.
|Standards of Conduct *|
FUNDING MARITAL AND CREDIT SHELTER TRUSTS
Another area of trust administration that few individual trustees have sufficient knowledge to handle themselves is the funding of marital and credit shelter trusts. Under most trust agreements and trust provisions of a will, funding a marital trust and credit shelter trust (also referred to as the bypass, family or B trust) will either be a pecuniary or fractional bequest. A pecuniary bequest is a disposition of a specific fixed-dollar amount. It can be expressed as an amount to be distributed to the marital trust with the residue to the credit shelter trust or vice versa. A fractional bequest under a will or trust distributes a fractional share of the remaining assets to the marital and credit shelter trusts in accordance with a formula described in the document.
D ividing property between the marital and credit shelter trusts is required only if the decedent left a surviving spouse and the estate is over $600,000. The pecuniary bequest—the most flexible of the two types of funding provisions—gives the executor or trustee several planning opportunities. Pecuniary bequests can be funded in three ways:
- The fair market values of assets at the time of funding ("true worth").
- The date of death values or the date of funding values, whichever is lower ("minimum worth").
- The date of death values ("fairly representative").
While all three allow the executor or trustee to pick and choose to one degree or another the assets that will fund the pecuniary bequest trust (either marital or credit shelter), a pecuniary bequest that uses the date of funding values has the greatest flexibility. One of the principal planning objectives is to fund the credit shelter trust with assets that will appreciate over time since those assets, including any appreciation in value, will not be taxed at the death of the surviving spouse.
Date of funding values. True worth is the most common and the most flexible of the three types of pecuniary bequests. Under this method the executor or trustee can pick and choose any asset to fund each trust. Appreciating assets can be allocated to the credit shelter trust, and assets with little growth potential can be distributed to the marital trust. However, any asset used to fund the pecuniary bequest trust that has appreciated in value from the date of death to the date of funding triggers a capital gain. The Internal Revenue Service views funding under this method as a sale of the asset to the trust being funded. The tax is paid by the residuary estate and, therefore, the nonpecuniary trust is reduced by that amount. Capital losses are recognized only if a testamentary trust (a trust created under the provisions of a will) is being funded.
Date of death values or date of funding values, whichever is lower. The minimum worth method also allows the executor or trustee to pick and choose assets. However, no capital gain is recognized on funding because the assets used to fund the pecuniary trust will never exceed their basis.
Date of death values. Under the fairly representative method, the executor or trustee can pick and choose the assets to fund the pecuniary bequest. Sheltering opportunities are limited because assets selected to fund the trust must be fairly representative of gains and losses that have occurred from the date of death to the date of funding. No capital gain is recognized because funding is based on date of death values.
In addition to the obvious estate tax sheltering opportunities, an executor or trustee needs counseling on income tax planning issues, asset management and trust administration planning concerns and other funding issues, such as the allocation of special use valuation property to the marital trust, to qualify for continued special use valuation in the surviving spouses estate.
The need for advisory services for individual executors and trustees will continue to grow over the next 20 years. The demand for those services will be driven by individual executors and trustees who become aware of the complex administration issues they face. Properly informed, they will recognize the risks associated with serving as a fiduciary and seek professional help to minimize their exposure. CPAs are in a unique position to provide services in this area because most administration issues are accounting and tax-related. CPAs who do not currently work in this area but have a desire to expand their practices should consider taking some of these steps:
- Study the code sections that apply to estate and trust issues, particularly those referred to in this article.
- Become familiar with the Uniform Principal and Income Act.
- Write articles on the areas of estate and trust administration that are of interest to individual fiduciaries.
- Conduct educational seminars targeted at individual executors and trustees. Use featured speakers with expertise in this area.
- Network with estate planning attorneys.
- Educate clients about estate and trust administration issues. Clients themselves may need professional assistance some day or know of someone who does.
Services provided to individual fiduciaries generally require special expertise. The rates CPAs can charge for such services make this an excellent area to generate additional fee income. Many CPAs now serve or would like to serve as executors or trustees. Although the fees fiduciaries earn may seem attractive, acting as an adviser to a fiduciary does not have the same level of liability as acting as an executor or trustee. If you have little experience administering estates and trusts, advising fiduciaries might be a better alternative than serving as one.
Helping Executors and Trustees Help Themselves
M any of the individuals named as executors or trustees do not have all the skills they need to fulfill these responsibilities. Some turn to Ronald Linders firm for help. Linder is a partner in the CPA firm Delagnes, Mitchell & Linder in San Francisco. He also is a partner in the San Francisco law firm of Delagnes, Linder & Zippel. Linder describes the bulk of his CPA firms clients as high net worth individuals and related entities—trusts, estates and closely held businesses.
Linder agrees there has been a shift away from naming institutional executors and trustees in favor of individuals—friends, relatives or business associates. As the number of trusts increases—primarily for tax purposes—Linder says it generally is not necessary to have a corporate outsider involved. Banks that still have trust departments dont want to handle small trusts and wont take on certain kinds. And technology has made trust information easier to deal with. At one time, for example, Linder says a banks ability to keep track of real estate was a major attraction. "Now, with computers, just about anybody can handle it. What the banks offer is no longer unique."UNDERSTANDING RESPONSIBILITIES
When working with individual executors and trustees, Linder says its important to make sure they "understand the responsibilities they are undertaking." While many of these are mechanical—forms, filings—a fiduciary also must be prepared to account to the beneficiaries for his or her actions. In Linders experience, most people feel more responsibility for keeping track of somebody elses money. "People who dont worry whether their own checkbooks balance understand that kind of behavior is not acceptable for a trustee." Still, many individuals find the job of executor or trustee too onerous. In this case, Linder says he reminds them that "one of their options is to resign."
Linder believes CPAs have a "real advantage" in helping individual executors and trustees. Two areas CPAs can help with are the accounting function and tax reporting responsibilities. Because trust tax rules differ from those that apply to individuals, inexperienced executors and trustees find those rules to be what Linder calls a "different world." But the accounting system needed to "trap" information to prepare the estate tax return, the decedents final return and ongoing trust tax reporting is something an accounting firm can easily set up. Linder emphasizes that "death causes many things to shift; CPAs who do trust and estate tax work will understand what those things are."
Most clients want help from someone who is familiar with the process of settling and administering an estate. But does it have to be an attorney? In many states—California, for example—where the use of trusts in estate planning helps to avoid probate, Linder says an attorney does not have to be involved. "There may be no legal documents to prepare," he says. Last year more than half the estates his firm was involved in did not require true "legal" work—only preparation of an estate tax return, which can be done by a CPA. "If a revocable trust works as it is intended, a CPA can provide all the services needed to administer an estate."BUSINESS DEVELOPMENT
Linder says most CPAs get involved in trusts and estates through the trust work they do for their tax clients. He says building on this base is the best way for CPAs to develop a trust and estate practice.
Until now, most of Linders own clients have come from referrals. Lately, he has undertaken speaking engagements to publicize the firms abilities. Linder, who will make a presentation at the January 1998 AICPA Personal Financial Planning Conference in Orlando on the opportunities for CPAs in working with executors and trustees, expects to cover some of the pitfalls and to suggest a curriculum for CPAs hoping to gain more expertise in this area.
Linder says letting attorneys know a CPA firm is willing to work on trust and estate tax returns is a proven method of marketing and practice development. Most CPAs who are interested in this field already have an income tax background they can use in working with probate attorneys. Linder says CPAs can learn a lot by assisting attorneys in this way. "In the beginning, you may not be able to do all of the necessary work, but you learn the pieces as you go along and eventually become more knowledgeable."EXPERIENCE AND TRAINING
Linder emphasizes that a CPA needs to get appropriate training and experience to expand his or her practice into the estate and trust niche. A wide variety of classes are offered that qualify for continuing education credit to give CPAs what Linder calls "initial" education. He points out that even if a CPA retains someone else to do estate work—an attorney or another CPA—the CPA will have an opportunity to learn and will be better prepared for the next opportunity.
Linder cautions that CPAs who work in this area are going to get involved with peoples personal problems—some of which they would choose not to deal with otherwise. But, he says, "it comes with the territory and you have to be prepared for it." What happens, he asks hypothetically, when a trustee walks in and says, "Youve explained all the accounting rules to me and all my legal obligations, but one of the beneficiaries is on drugs—what do I do now?"
Someone, Linder says, is going to have to sit down with this client and brainstorm about what can be done. The solutions are likely to include working with legal counsel to enlist the courts help in withholding funds that are required to be distributed to that beneficiary. "The answers to such problems may not always be obvious and will be difficult to deal with." But if family problems and conflicts make a CPA feel uncomfortable, estates and trusts are not the right place to be, Linder says.CPA AS EXECUTOR OR TRUSTEE
On occasion, Linder or the partners in his firm will serve as executors or trustees for a large client or in special situations that allow the firm to be compensated appropriately for its work. Deciding whether to serve is "primarily a business decision for the firm—one that may have drawbacks and liability exposures." Being a fiduciary involves detailed recordkeeping, filing and reporting requirements and spending time with beneficiaries that may conflict with a CPAs time commitments to his or her practice or may entail hiring support personnel with new skills. A CPA who is asked to be a trustee should consider these drawbacks carefully and ask, "Am I willing to take on these responsibilities?" For many, according to Linder, the answer is yes, "as long as Im compensated properly."
On the compensation side, Linder says the one thing that is "delightful" is that while as a CPA you arent clear what competitors are charging for a particular service, as a trustee, you can find out what fee schedules banks use and set your fees accordingly. In addition, CPAs who are willing to be trustees have to decide whether they want to be paid as trustees or as accountants. In most states, Linder says, "you cant be paid as both."
The best time to deal with conflict-of-interest problems that arise from being a CPA and trustee is during the drafting of the trust. This prevents someone from later saying there were unknown conflicts. For example, if the CPA does audits, it is important for the trust document to acknowledge that the creator of the trust understands the CPA cant—as a trustee—invest in clients for whom he or she performs audits. Basically, the client must understand that the trusts investment horizon has been restricted because the CPA was selected as trustee. Most CPAs, Linder says, insist the trust have a provision "protecting them from liability for not using confidential information they gain as a CPA."
When Linder and his partners arent willing to serve as trustees, the firm usually helps to find someone else. Sometimes, however, the client may decide the nuisance of finding a third party to manage the trust is not warranted based on why he or she wanted to create a trust with an independent trustee in the first place. "A trust is not always the perfect answer," Linder says. The result is the client asks the attorney to revise the estate plan and eliminate the trust or he or she asks a family member to serve as trustee.LAWYER OR ACCOUNTANT?
While Linder himself is a lawyer and practices both law and accounting, most CPAs do not. How should CPAs avoid crossing the line? "The way you deal with this problem is to build up a network of probate attorneys. If you get a problem you cant deal with as a CPA, you have someone you can turn to. Linder says "a lot of CPAs who work in this area are as knowledgeable as attorneys. They cant go to court, but they do know what needs to be done. We live in a time when networking is the answer to many problems." And, Linder says, a CPA who becomes knowledgeable at estate and trust matters will get referrals from probate attorneys in return, making the investment of time worthwhile.
— Peter D. Fleming