Chapter Nineteen Accounting for Estates and Trusts Copyright © 2015 McGraw-Hill Education All rights reserved No reproduction or distribution without the prior written consent of McGraw-Hill Education Learning Objective 19-1 Understand the proper methods of accounting for and administering an estate and the corresponding legal terminology 19-2 Estate Accounting The term estate refers to the property (assets) owned by an individual More specifically defined as a separate legal entity holding title to the real and personal assets of a deceased person Estate accounting focuses on the recording and reporting of financial events from the time of a person’s death until the ultimate distribution of all property held by the estate 19-3 Estate Accounting A valid will ensures that asset disposition occurs as intended and avoids disputes when a person dies A will is a person’s declaration of how s/he desires the property they own to be disposed of after death When someone dies: With a valid will, they die testate • A will serves as the blueprint for settling the estate Without a valid will, they die intestate • State laws control the administration of the estate • Real property is conveyed based on laws of descent • Personal property transfers based on laws of distribution 19-4 Estate Accounting Laws governing wills and estates are called “probate laws” Each state establishes its own laws of descent and laws of distribution Almost half of the states have adopted the Uniform Probate Code Probate Laws Three general purposes: 1) Gather and preserve all of the property 2) Carry out orderly and fair settlement debts 3) Discover and implement the decedent’s intentions for remaining property 19-5 Administration of the Estate Probate Process The will is presented to the court OR Court rules on will’s validity An executor (administrator) is assigned Terms of will are carried out Entitled to compensation No will has been discovered Court appoints a representative as administrator State laws control administration of estate 19-6 Executor Responsibilities Take possession of all decedent’s assets and complete an inventory of the property Discover claims against the estate and settle those claims File estate tax returns • Federal and State Distribute property Make a full accounting to the probate court 19-7 Estate Property Estate Property Includes: Cash Investments in stocks and bonds Interest accrued to the date of death Dividends declared prior to death Investments in businesses Unpaid wages Accrued rents and royalties Valuables such as jewelry, paintings and antiques 19-8 Discovery of Claims Against the Estate Typical order of priority: Expenses of administering the estate Funeral and medical expenses (during last illness) Debts and taxes All other claims 19-9 Protection for Remaining Family Members A wide variety of probate laws exist and differ according to the states: Usually small monetary allowances are paid prior to payment of legal claims Homestead allowances are often provided to the surviving spouse and/or minor or dependent children A family allowance is often allowed for a limited time while the estate is being administered Limited amounts of exempt property (such as automobiles, furniture and jewelry) are often permitted to family 19-10 Distinction Between Income and Principal Income of the estate includes all revenues and expenses incurred after the date of death Reductions to income include: Recurring taxes (such as real and personal property taxes), Ordinary repair expenses, Water and other utility expenses, Insurance expenses, and Other ordinary expenses required for the management and preservation of the estate 19-23 Distinction Between Income and Principal Some costs must be apportioned between the principal and interest in some fair manner if manner of allocation has not been specified in the decedent’s last will and testament These costs include: Executor’s fee Court costs Attorney’s fees Accountant’s fees 19-24 Recording Transactions of an Estate Estate assets are recorded at FMV Subsequently discovered assets are disclosed separately Debts, taxes & other obligations are recorded when paid Distribution of legacies are not recorded until actually conveyed Separately identify income and principal transactions Often, two cash accounts are maintained 19-25 Learning Objective 19-5 Describe the financial statements and journal entries utilized to account for estate and trust transactions 19-26 Charge and Discharge Statement Periodic Charge and Discharge statements report disclose progress in settling the estate Separate statements are required for income and principal Each statement reports: Assets under the control of the executor Disbursements made to date Any property still remaining 19-27 Learning Objective 19-6 Describe various trusts, their proper use, and accounting for activities 19-28 Trusts A TRUST is created by conveying assets to a fiduciary (or trustee) Trusts are often established: - from the provisions of a will, specified by the decedent to guide distribution of estate property - to reduce the size of a taxable estate and estate taxes that must be paid - to protect assets and ensure that the eventual use of these assets is as intended A trustee may be an individual or an organization 19-29 Trusts An inter vivos trust is established while a person is still alive A testamentary trust is established by the will after the trustor’s death The person who funds the trust is called the grantor, trustor, or settlor The person who funds the trust appoints a trustee to manage the investments of the trust 19-30 Revocable Trusts Trustor usually manages the fund and receives most (if not all) of the income until death Revocability means that the trustor can change beneficiaries and other terms at any time Avoids delay and expense of probate Allows for privacy (wills are public documents) At the trustor’s death, the trust continues and makes future payments as defined in the trust agreement 19-31 Different Types of Trusts Credit Shelter Trust Designed for couples, where each spouse agrees to transfer at death an amount up to the tax-free exclusion ($5.25 million in 2013) to the other Reduces the estate of surviving spouse Qualified Terminable Interest Property Trust (QTIP Trust) Property is conveyed to a trust; distributions are paid to the beneficiary (usually spouse) At a specified time, the remainder is conveyed to a designated party Allows steady income for one beneficiary, while protecting principal for another 19-32 Different Types of Trusts Charitable Remainder Trust Trust income is paid to a beneficiary for a period of time (or death of the beneficiary) Then the principal is given to a stated charity Renders appreciated property requiring liquidation nontaxable Charitable Lead Trust Trust income paid to a specified charity for a period of time, then the remaining principal is transferred to a different beneficiary Grantor Retained Annuity Trust (GRAT) Trustor collects fixed payments from the trust Principal given to beneficiary after a specified time or at the death of the trustor Allows for reduction of gift tax 19-33 Different Types of Trusts Minor’s Section 2503(c) Trust Eligible to receive a tax-free gift of $14,000 ($28,000 if from a couple) each year Spendthrift Trust Beneficiary cannot transfer or assign any payments not yet received Irrevocable Life Insurance Trust Money is contributed to purchase life insurance on the donor, so that proceeds can be used to pay estate and inheritance taxes Qualified Personal Resident Trust (QPRT) Donor’s home is given, but the donor retains the right to live there for a period rent free 19-34 Record-Keeping for a Trust Fund Usually, the cash basis of accounting is used to record trust fund transactions Adjustments to the Trust’s Principal: Investing costs and commissions Income taxes on gains added to the principal Costs of preparing property for sale Extraordinary repairs 19-35 Record-Keeping for a Trust Fund Adjustments to the Trust’s Income include: Rent expense Lease cancellation fees Interest expense Insurance expense Income taxes on trust income Property taxes Trustee fees and periodic reporting costs (accountant and legal fees) must be allocated between trust income and principal based on the value of the assets 19-36 Accounting for the Activities of a Trust An inter vivos trust reports on an annual basis (often more frequently) to all income and principal beneficiaries Testamentary trusts, under the jurisdiction of the courts, issues additional reports regularly Two accounts monitor changes that occur: Trust Principal Trust Income 19-37 ... Objective 19-1 Understand the proper methods of accounting for and administering an estate and the corresponding legal terminology 19-2 Estate Accounting The term estate refers to the property... Estate accounting focuses on the recording and reporting of financial events from the time of a person’s death until the ultimate distribution of all property held by the estate 19-3 Estate Accounting. .. based on laws of descent • Personal property transfers based on laws of distribution 19-4 Estate Accounting Laws governing wills and estates are called “probate laws” Each state establishes