“Hey, when am I going to get my money?” I can’t tell you how many times I’ve heard beneficiaries ask that question when they’ve been named in a Will or Trust. It’s not uncommon for the beneficiary to put pressure on the executor or trustee to speed up the process. And if the person settling the estate caves to the pressure and distributes the assets too early, it can create an expensive mess.
Many executors focus on estate taxes and making sure the state and the IRS get their required cut of anything due to them. But estates, just like individuals, are subject to income taxes too. An estate has to file an annual income tax return for every calendar year the estate is open, even if it’s only open for part of a year. The tax return has to list all income received and deductible expenses paid during the year.
Some executors distribute income to estate beneficiaries as soon as the estate receives it. That way, the estate doesn’t have to pay taxes on the income. The estate takes a deduction for the distributions and the beneficiaries claim the distributions as income and pay taxes on what they receive.
Here’s where problems can arise. If the estate receives some unexpected income, or there are tax consequences from transactions that took place, the estate owes income taxes. And if all the estate assets have been distributed, there’s no money to pay those taxes and the executor can be personally responsible for the amount due.
Here are a couple of examples from CPA Bob Carlson:
#1
An executor assumes some estate expenses are deductible and the IRS says no. The executor doesn’t discover the mistake until after the estate has been distributed. That causes the estate to have an income tax liability and no cash to pay it.
#2
The estate receives a stock dividend that is taxable based on its value on the date of distribution. The executor waits until later in the year to distribute the stock to the beneficiaries. When the distribution is made, the value of the stock has declined.
The estate has to claim the stock as income equal to the stock’s value on the date the stock was received. On the income tax return, the executor claims the stock as income equal to the lower stock value on the date the stock was distributed to the beneficiaries. The estate is liable for income taxes on the difference between the value at the time the stock was received and the value at the time it was distributed to the beneficiaries. If all the assets have been distributed and there’s no cash to pay the tax bill, there’s a mess to straighten out that will be time-consuming and costly.
If executors are pressured by beneficiaries to give them their money, it’s a good idea to retain some cash in the estate. If there’s any money left after the final income tax return has been filed and you’re confident there are no tax surprises, you can distribute the remainder to the beneficiaries then. Remember, speed is not always of the essence when you’re settling an estate.
This article is for information purposes only and should not be considered legal, tax, or financial advice.