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Tax Duties of an Executor

May 21, 2012

When someone dies, a personal representative is in charge of the estate to collect assets, pay off the debts, and distribute the remaining assets to heirs or beneficiaries. (FYI – The personal representative is called an “Executor” if the person was identified in the will, or an “Administrator” if he or she was appointed by the court because there was no Will).  The personal representative is also in charge of taxes, both federal and state, for the individual and for the estate. Here are a few important points for tax purposes:

1.     Form 1040 – Individual Income Tax Return

The personal representative will file a Form 1040 tax return for the year the individual died, covering January 1 until the date of death. Form 1040 is due on the usual date, April 15. If the individual was married at death, this can be a joint return.

2.    Form 1041 – Estate Income Tax Return

Any income earned on assets after the decedent’s death but before the asset is distributed to a beneficiary is treated as income to the estate. Uncle Sam won’t let that income slide past his reach, so the estate files an income tax return if the annual gross income to the estate is $600 or greater.  Small estates or estates with assets that can be distributed quickly often avoid this tax. Form 1041 is due on the 15th day of the 4th month following the close of the tax year. If the estate uses the calendar year, the return is due April 15.

3.     Form 706 – Inheritance and/or Estate Tax Return

 A federal estate tax return must be filed (and estate tax due) if the gross estate exceeds the exemption amount, which is $5.12 million in 2012. Form 706 is due nine months after death, but can be extended for six months. An Iowa inheritance return will likely be required if the estate is distributed to persons other than a spouse, lineal descendants or lineal ascendants.  

 4.    EIN Number

 If the estate will be filing Form 1041 and/or Form 706, the estate must get its own Federal Employer Identification Number (EIN or FEIN).  An EIN for an estate is equivalent to a social security number for an individual. An EIN will be needed to open a checking account for the estate.

 A personal representative has many duties when it comes to administering an estate, which is probably why most personal representatives hire a tax professional to complete the tax matters. After all, if you dread doing your own taxes, doing someone else’s taxes probably isn’t too appealing.


Reporting All Income

May 9, 2012

As a follow-up to my post on keeping tax records, I came across this article on 1099s and reporting income (acknowledgment to the Roth & Company Tax Update Blog for pointing out the article in their May 8th Tax Roundup).  My prior post focused on keeping records after you file a tax return. This article reminds us of the records to keep throughout the tax year. Specifically, it discusses the misconception that if you don’t receive a Form 1099 for income, you do not have to report the income. Wrong. All income must be reported, whether or not you received a 1099, W-2, etc. For example, most banks will not issue a Form 1099-INT if the interest on the account is less than $10, but that interest is still income and needs to be reported on your tax return.

Moral of the story:  Save records like bank account statements throughout the year so you know how much income to report, even if you don’t get a 1099. For more information, read the full article here.

Can I write my children and/or spouse out of my will?

April 23, 2012

The short answer is yes, you can write your spouse and children out of your will, but there is of course a “but.”  Multiple times recently I have found myself explaining to clients and friends just what “testamentary freedom” means in Iowa.  As a general rule in the United States, we are free to choose who gets what property when we leave the world behind. I will spare us all the history lesson, but historically this was not the case and many countries still limit the ability to completely disinherit a surviving spouse or children. Iowa still has protections in place for those individuals also.

Children have no “right” to inherit from their parents, but there are certain assumptions in place that protect the children. For instance, children born or adopted after the execution of a will (referred to as “pretermitted heirs”) typically receive a share of the estate. Some wills specifically provide for this by defining the term “children” in the will to include any children born to or adopted by the testator after the date of the will. Including such a statement saves a couple from needing to change their wills every time a child is born.  Even if the will does not address it, Iowa law provides a share to children born after the date of the will unless it appears the omission was intentional. (Iowa Code Section 633.267).  Also, children and grandchildren are among the classes of beneficiaries who are not charged inheritance tax in Iowa.  Does inheritance tax really stop someone from disinheriting a distant child? Probably not, but if a parent is indifferent between leaving property to nieces and nephews or estranged children, the tax difference may be a factor.

Spouses in Iowa have more protection than children. While you can draft a will leaving nothing to your spouse, the surviving spouse has a right to an elective share, meaning he or she can “elect” to take approximately one-third of your property instead of the share given under the will. (Iowa Code 633.238). (The exception here is if the couple had a valid prenuptial agreement. If the couple is already married, it is too late for that, but that is a topic for another day.)  The elective share is not discussed with most couples during estate planning because the surviving spouse often receives all or most of the assets, which is more than the one-third elective share. The biggest thing to remember about the elective share in Iowa is that the law is unclear as to whether retirement assets or life insurance can be reached by the one-third election. In some estates. that can make a huge difference.

After the long explanation, the conclusion is yes, you can write family members out of your will, but the will needs to be carefully drafted in light of these state law protections.

Keeping Tax Records

April 12, 2012

Now that we have all filed our taxes (or are close to filing, hopefully), what do you do with your records? How long do you keep them? How do you organize them? Well, here are some tips from the IRS:

  1.  Tax records should be kept for a minimum of three years. Be sure to keep a copy of your filed tax returns. In addition, keep the records that prove your income and expenses, including W2s, 1099s, K-1s, receipts for deductions, bank statements, statements for investment accounts, mileage logs, and canceled checks. The three years represents the time period in which the IRS can audit your return and assess additional tax. If you failed to report income, that time period is 6 years, and there is no time limit if the return was fraudulent or if you failed to file (and should have).
  2. Organize/store the documents in a way that is sensible to you. There is no specific way to keep the records, though logically the information would be broken down by tax year. The important part is that you can find a specific piece of information if the IRS asks for it two or three years from now. Most documents can be kept electronically now, making it easier to organize (but be sure to back up those files).
  3. Certain documents need to be kept longer. These include records for a home purchase or sale, purchase or sale of stock, and IRA contributions. The records should enable you to determine your basis in the investment so you may determine gain or loss when you sell the property. Real estate used for business or as a rental property also requires more detailed records.

When in doubt, DON’T throw it out.  I am by no means telling you to keep every receipt for a tax return you filed 10 years ago, rarely would that be useful, but if it relates to an asset you still have (such as a home or retirement accounts) you likely still need it.

Part 2: Are Frequent Flyer Miles Taxable Income?

March 29, 2012

In a February post, I discussed Citibank issuing a Form 1099 to customers who received frequent flyer miles in exchange for opening a bank account. Little did I know that two months later, it would still be highly publicized. This article, also from February, has more detail on the many ways you could receive frequent flyer miles (credit card use, rewards for flying, prizes), and the likely tax implications of each method. A March 2012 article in the Journal of Taxation is what prompted this post. The article discusses the possible ways to calculate the value of the miles to report on the 1099. The main conclusion to the article seems to be that there are many methods, and it seems there is a reasonable cause defense for each.  Here are some of the methods discussed in the article:

  • Sale Price:  Look at the price the miles would sell for in the open market. For example, if you could purchase 5,000 miles from the airline for $100, a mile is worth two cents. But the problem here is most airlines will charge a different price per mile for 5,000 miles than for 10,000 miles.
  • Cost to Company:   Look at the cost to the company to get the miles. How much did the bank pay the airline per mile?  This seems logical, but an IRS spokesperson has already pointed out that income is valued at the value of the property received, not at the cost to the company.
  • Average:  Why not just determine the average price per mile, looking at the average ticket price across all companies and average number of frequent flyer miles to purchase the same ticket. That hardly seems like a method the IRS would follow.

The debate continues as to (1) whether the miles are taxable, and (2) if taxable, how to determine the value.  The IRS has stated that any guidance on how to value the miles (and presumably whether or not the miles are taxed) would be prospective only.  Until then, the uncertainty continues.

Estate Planning For Fido?

March 8, 2012

Estate planning for pets hit the news in 2007 when Leona Helmsley, a hotel operator and real estate developer, left most of her $12 million fortune to her dog, Trouble, leaving little to her children or grandchildren.  Trouble (the dog) died in 2011, but was pampered until death with $100,000 spent annually for her care. Also, after receiving death and kidnapping threats, the dog had her own security guard.

While it is interesting, and at least slightly entertaining, for many, ensuring a pet is provided for after the owner dies is a priority.  Many states, including Iowa, allow a trust for the benefit of a pet or pets. As a general rule, trusts must have an ascertainable beneficiary or beneficiaries, most commonly meaning a person.  The first exception years ago was to allow a charity to be a beneficiary. Legally, a dog is considered property, not a person, and therefore is not an ascertainable beneficiary. However, in Iowa, as in other states, by statute an owner can create a trust for a pet or pets which will run until the pet dies.  There is one caveat – in Iowa, a court has discretion to determine whether the value in trust “substantially exceeds the amount required” and direct such funds to another purpose. (Iowa Code Section 633A.2105)  Though I am unaware of any cases in Iowa discussing this provision, it seems an Iowa court wouldn’t allow a $12 million trust for a pet. Then again, maybe a security guard is a required expense…

Estate planning for your pets may be something to discuss with your estate planner. If nothing else, you can talk with family members who would take care of the pet. If you decide to create a trust to support the pet, you will need to appoint a trustee to handle all the financial decisions. While the caregiver and trustee can be the same person, it is not required.

Is the day coming when estate planners will ask about pets in the initial consultation with a client just like we often ask about children?


Education Tax Credits

February 28, 2012

As you work on your tax returns for last year, here is some helpful information from the IRS on the education tax credits available. The American Opportunity Credit can be up to $2,500 per student for the first four years of college, and up to $1,000 of that is refundable (meaning, even if you don’t owe any tax, you can receive up to $1,000 in a refund).  The other credit is the Lifetime Learning Credit, which can be up to $2,000 per student per year, and as the name implies, is for an unlimited number of years os postsecondary education. The Lifetime Learning credit is not refundable.  

These credits are available to most people paying postsecondary tuition and fees for yourself, your spouse, or your dependent. Alternatively, a taxpayer can take a deduction for tuition and fees paid.

Remember as you go through tax season, the IRS website has helpful tips and tools for taxpayers, and a decent search feature if you are looking for specific information.

Reasons You Need a Will

February 10, 2012

Wills do more than just distribute property. A will lets you decide who gets what assets, and also who should take care of your minor children.  Without a will, the state will decide who gets what without consideration of your wishes, or the needs or wishes of the family and friends you leave behind. Here are some of the top reasons to have a will:

1.  Appoint a Guardian for Minor Children

If you have minor children, a will lets you appoint a guardian to take care of your minor children. If parents don’t have a will, the court will likely choose among family members, but don’t you have a preference? By making the decision in a will, you can be assured it’s the person you want to raise your children (or make sure it isn’t someone you don’t want) and you can likely save some family arguments.

2.  Delay Distributions for Minor Children

By state law, any money transferred to a child under age 18 or 21 (depending on the state) must be held by the courts until the child reaches 18 or 21. Then, the child gets the lump sum, free and clear. Would you have wisely spent a lump sum of money at age 18 or even 21? Probably not. A will lets you delay when your children receive that distribution or divide the distribution over a few years.

3.  Appoint an Executor

An executor is in charge of winding up all of your affairs. He or she makes sure all the bills are paid, cancels your credit cards, notifies banks, and terminates any leases. Your executor will also be in charge of finding and distributing all your assets.   This is a good time to make a list of assets you own that others might not know about. Do your children know where all of your retirement accounts are held? Do your parents know where you have bank accounts? That information isn’t necessarily in the will, but can be on a list stored with the will.

4.  Distribute Personal Property

A will controls more than just the house and the car, it can control who gets your Grandmother’s heirloom jewelry and your Grandfather’s stamp collection. Make sure these things go to the relatives that will treasure the items most by putting it in your will. Avoid the “mom would have wanted me to have it” arguments.

5.  Address Non-Traditional Families

State intestate laws are old and typically don’t address non-traditional family situations such as second marriages, stepchildren, children from a prior marriage, or unmarried significant others.  To make sure those people are taken care of, you need a will.

6. Provide for Certain Family Members

You may have certain family members or friends who need more of your support, or certain close relatives you want to exclude. Making a will ensures your property goes to the family and friends you want.

7.  Minimize Estate Taxes

Depending on the size of your estate, a will can be designed to minimize estate taxes. While all property passing to a spouse is tax-free, when the second spouse dies all the property (both husband’s and wife’s) could be subject to tax if over the exemption amount. In 2012, the estate tax exemption is $5.12 million.  Hard to say what the exemption amount will be in future years, but in 2013 it could drop to $1 million. Two people can quickly get to $1 million in assets with a house, cars, retirement accounts, etc.

8.  Support Charities

If you have provided support for a certain charity during your life, you may want that support to continue after your death also. Even if your family members agree to create a memorial fund in your honor, designating a charity or charities in your will ensures the funds go where you want, not where your family wants.

9.  Powers of Attorney

Technically a power of attorney is a separate document from a will, but they really go hand-in-hand, and if you are making a will, you might as well get powers of attorney too. By granting someone power of attorney, you are giving them permission to make certain decisions for you when you are incapable. (That person is your “agent.”) Who will pay your mortgage and electric bills? If you run a business by yourself, how will the bills get paid if you can’t sign the checks? The documents can be worded so your agent can only make decisions when you are medically incapable. Without powers of attorney, a court has to step in to appoint someone to make decisions. That takes time and legal fees. Plus, healthcare and financial decisions can be very personal, don’t  you prefer to pick who makes those decisions for you?

10.  Peace of Mind

Finally, having a will saves everyone a little stress. Not just you, but also the family and friends you leave behind. Having a will ensures your wishes are carried out, the family and friends who depend on you are cared for, and your family won’t have to piece together all the details after you are gone.

Drafting a will isn’t nearly as burdensome or painful as everyone makes it out to be. The sooner you do it, the easier it will be. This list likely has you thinking about some of the most important decisions. Why not do it now?

Are Frequent Flyer Miles Taxable Income?

February 2, 2012

Citibank is treating certain frequent flyer miles as taxable income, and they are sending IRS Form 1099 to customers who were given miles in exchange for opening bank accounts.  (1099s report income other than wages to the IRS.) Now, don’t panic, not all frequent flyer miles are taxable.  In fact, the IRS issued a policy announcement in 2002 regarding frequent flyer miles stating “[t]here are numerous technical and administrative issues relating to these benefits,” including issues of timing and valuation, and as a result of the unresolved issues, “the IRS has not pursued a tax enforcement program.” 

How is the Citibank situation different?  Frequent flyer miles and cash back on credit cards have historically been treated as rebates on spending which are not taxed as income. That is likely the type of miles the IRS announcement was referring to. Citibank takes the position that the miles they are taxing are different, the miles were given as a reward/prize for opening a bank account, not as a rebate on spending, and therefore the miles are taxable. (The IRS said earlier this year taxpayers must pay income tax on prizes greater than $600.) However, one news agency refers to a statement by IRS representatives that the 2002 announcement focused on a specific area and does not address the issue Citibank faces.  The IRS has not released an official statement on this issue.  This may be the beginning of a debate whether these particular frequent flyer miles are taxable.  United States Senator Sherrod Brown of Ohio wrote a letter earlier this week that is receiving a lot of attention, urging Citibank to stop treating the miles as income.

Bottom Line: The only certainty at this point is if you received a Form 1099 from Citibank, the IRS sees those miles as income to you.

Online Sales: Should You Be Collecting Sales Tax?

January 17, 2012

You have likely heard about the recent debate regarding collecting state sales tax for online sales. What’s the big deal? Typically, online retailers collect sales tax only from sales in a state where they have a physical presence. As a result, many online sales do not get taxed. The argument is this makes it hard for small businesses (who have to charge sales tax) to compete with the out-of-state online retailers.

 If this bill passes, what happens? The idea is that states would require the online retailers to charge sales tax based on your address, meaning, if the retailer sells to an Iowa address, it would charge Iowa sales tax.  At least one tax attorney sees constitutional issues here and does not expect the bill to move quickly.

 Speaking of online sales, weren’t you meaning to sell that old furniture and all of those toys the kids have outgrown? Selling things online seems easier than a garage sale, but should you be charging sales tax on those old “treasures”?  Most likely not, regardless of the outcome of this bill, thanks to the casual sales exception. 

Iowa has a 6% tax on retail sales (and any additional local option taxes) unless the sale fits a stated exception. Looking deep enough into the statute, there is an exception for “casual sales.”  So, just what is a casual sale?   In Iowa, it is a sale which is (1) “nonrecurring” and (2) by someone who is not in the business of selling that property for profit.  So, selling the items collecting dust in your basement is likely a casual sale.  But, if you are selling a certain type of product consistently, that seems recurring and starts to look like a business, and you should look into the sales tax issue a little further.

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