Solution manual advanced accounting 11th edition joe ben hoyle chap019

Chapter 19 - Accounting for Estates and Trusts 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 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 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 Expenses of administering the estate – which include legal costs, executor fees and similar items Funeral expenses and medical expenses of last illness Taxes and debts given legal preference All other claims D Estate distributions Devise—a testamentary gift of real property Specific legacy (or bequest)—an item of personal property that is identified directly by the testator in his/her will 19-1 Chapter 19 - Accounting for Estates and Trusts Demonstrative legacy—a cash gift made from a particular identified source General legacy—a cash gift made with no source designated Residual legacy—a gift of any remaining estate property 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 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charitable bequests, and the value of all property conveyed to spouse b In 2010, the federal estate tax was repealed, except for estates electing to be covered by such Beginning in 2011 a portable exemption from federal estate taxes in the amount of $5.0 million became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 c An individual is allowed an annual exclusion from federal gift taxes of $13,000 per done (indexed for inflation) plus a $5.0 million lifetime exclusion ($5.12 million in 2012) State inheritance tax—assessed on the right to receive property This tax varies significantly from state to state Estate income tax—tax on income earned by estate property F Recording the transactions of an estate Assets are recorded at fair value Debts, expenses, and distributions are only recorded when paid Income and principal have their balances and transactions separately identified because testators often transfer income and principal to different beneficiaries 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 Trusts ensure that the distribution of a person's assets is as intended 19-2 Chapter 19 - Accounting for Estates and Trusts An inter vivos trust is created by a living individual 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: Qualified Terminable Interest Property Trust—income goes to one or more parties with the principal eventually being conveyed to a different party Charitable Remainder Trust—income goes to one or more parties with the principal eventually being conveyed to a specified charity 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 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 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 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 cousin cannot now be located Moreover, sufficient cash does not exist to satisfy a general cash legacy of $20,000 that remains Normally, a sale of the letters would be ordered to help resolve this cash shortage but differing opinions exist as to the value of the property Finding a buyer (if one can be located) may take a considerable amount of time and energy How should the administrator report these letters and what should be done? 19-3 Chapter 19 - Accounting for Estates and Trusts 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 charge and discharge statement but with no dollar value attached They must, however, be identified as an asset of the estate With any property of this type, no true worth can be determined until a legitimate offer to purchase is made Thus, to report a value without any prospect of a buyer could be misleading and could even result in the imposition of a transfer or inheritance tax 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 amounts from the estate If the letters are clearly worth less than $6,000, church officials may opt to take the letters in hopes of eventually locating a future buyer Conversely, if the letters might be worth more than $6,000 (so that a residual legacy may be left), the administrator may have to convey the letters to a dealer with the order to liquidate the property so that the distribution of the estate can be concluded 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 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 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 used in distributing property, such as providing for spouses, children, and close relatives Such laws are referred to as "laws of descent" when they describe the appropriate conveyance of real property "Laws of distribution" specify the methods that are used for conveying personal property Probate laws are state statutes which govern wills and estates Depending upon the nature and extent of a decedent’s will, these statutes may play a significant role in the manner of administering and distributing the decedent’s estate Probate laws provide an orderly structure for the process of administering and distributing a decedent’s estate The objectives of probate laws are —To gather and preserve all of the decedent's property, —To discover the decedent's intent for the property held at death and then implement those wishes if possible, and —To carry out an orderly and fair settlement of all debts and distribution of property 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 of the estate and has a high standard of care when dealing with property for the benefit of the estate’s beneficiaries The student should note that the executor may be compensated for her responsibilities and such compensation is frequently based upon a percentage (%) of the estate’s value 19-4 Chapter 19 - Accounting for Estates and Trusts 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 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 this type, it is extremely difficult to ascertain a true value unless or until a legitimate offer to purchase is made Reporting a value without any prospect of a buyer could be misleading and could even result in the imposition of a transfer or inheritance tax 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 appropriate newspaper at least one time per week for two or three weeks All claims must then be received by the executor within a reasonable period of time, frequently four (4) months from the date of the first notice 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 —Expenses of administering the estate —Funeral expenses and the medical expenses of any last illness —Taxes and debts given preference under federal or state laws —All other claims 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 minor and dependent children prior to the payment of claims against the estate In addition, a monthly family allowance is provided (for a specified period) while the estate is being settled Consequently, family members are entitled to a relatively small amount of money from every estate prior to the payment of debts and expenses 11 A devise is a gift of real property such as land or a building In contrast, a legacy (or bequest) is the conveyance of personal property such as an automobile or cash It would also include the conveyance of intangible personal property 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 $6,000 from a savings account in a local bank would be deemed a demonstrative legacy —A general legacy is a cash gift where the source is not identified The gift of $6,000 in cash would be a general legacy —A residual legacy is simply a gift of any property that remains in an estate after all other legacies have been fulfilled 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 legacies during the distribution process The process of abatement is also relevant if specified property or cash from a particular source was no longer available at the time of the decedent’s death to fulfill specific or demonstrative legacies 19-5 Chapter 19 - Accounting for Estates and Trusts 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: —funeral expenses, —estate administration expenses, —liabilities —casualties and thefts during the administration of the estate, —charitable bequests, —marital deduction for property conveyed to spouse The federal estate tax is computed on the net value of the estate using graduated rates The estate is then allowed to reduce the amount of net assets based on an exemption that is $5.0 million in 2011 and $5.12 million in 2012 15 The Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 had several effects on federal estate taxes First, it confirmed the elimination of estate taxes for 2010 estates, unless the executor elected to apply the estate tax, presumably to utilize the step-up in basis provisions Second, it established a much larger exemption from the federal estate tax beginning in 2011 - $5.0 million per person which is portable for a surviving spouse to utilize if not utilized by the decedent Thus a decedent passing in 2010 may have been able to escape the federal estate tax entirely On the other hand, appreciated assets passing from such estate will not have a step up in basis and as such beneficiaries will ultimately pay a capital gain tax on the disposition of such assets Decedents passing in 2011 will have a $5.0 million exclusion coupled with the traditional step up in basis procedure The tax code indexes this $5.0 million exclusion and for 2012 the amount is $5.12 million 16 Individuals are allowed to make gifts of up to $13,000 per person per year (the amount is $26,000 if given by a married couple) without incurring any gift taxes This amount is to be indexed for inflation Amounts beyond the $13,000 per donee exclusion are taxable 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 17 (continued) large estate may be left by the subsequently deceased spouse, thus creating a significant tax liability Estate planners often attempt to devise methods to reduce the future value of the remaining spouse's estate One approach that is popular is the creation of a credit shelter trust fund at the time of the first death 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 Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010, for 2011 an estate of $5.0 million or less could be conveyed without creating a tax effect and this was increased to $5.12 million for 2012 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: 19-6 Chapter 19 - Accounting for Estates and Trusts No estate taxes are paid on the first decedent’s estate The income of the trust fund assets can still be used for the benefit of the spouse The assets of the trust fund can be directed to a chosen recipient at the spouse’s eventual death The estate of the spouse is reduced by a considerable amount of assets, creating a large savings in estate taxes at the second spouse’s death 18 Several deductions are allowed in the computation of estate income taxes: —A personal exemption of $600 —Amounts of income conveyed to charities —Amounts incurred as ordinary and necessary expenses for the production or generation of the estate’s taxable income (such as accountant or attorney fees) —Amounts of income conveyed currently to the beneficiaries 19 In addition to identifying the proper distribution of assets, a testator may identify proposed guardians for minor or incapacitated children in a will In fact for many individuals, this concern may be more compelling than the fear of estate or transfer taxes 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 the principal of an estate whereas any earnings thereafter are income Unfortunately, in reality, drawing a distinction may be quite difficult for a number of unique transactions Therefore, in the decedent's will, instructions as to the impact that transactions have on principal and on income should be specified If the decedent has not provided guidance in this area, state laws apply The answer to question 21 gives examples of the typical method by which this distinction is made 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 death, funeral expenses, major improvements to rental property, and dividends declared prior to death even if received after death Adjustments to income: property taxes, repair expenses, utilities, insurance, and management expenses Note that the decedent can vary from the above distinctions by addressing the allocation of expenses in her will 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 19-7 Chapter 19 - Accounting for Estates and Trusts 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 ultimate disposition Liabilities, expenses, and distributions are only recorded at the time that they reduce these estate assets The primary reason for this approach is that the estate’s liabilities are often not fully identified until a point in time well after the decedent’s date of death 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 Finally, the charge and discharge statement lists the value of assets still being held and indicates whether they are attributed to principal or income This statement permits the probate court and beneficiaries to monitor the executor’s progress in administering and distributing the decedent’s estate 25 A trust fund is comprised of assets that have been conveyed to a fiduciary who will manage and distribute them as specified by the party (the trustor) creating the fund The trust fund is managed for the benefit of the trust’s beneficiaries and the trustee has fiduciary obligations to the beneficiaries 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 that must be paid to the government in estate taxes Furthermore, they are often created so that professional managers will oversee a decedent's assets and ensure that these assets are used as that person intended 27 An inter vivos trust is simply one that is started by a living individual Such a trust may be revocable or irrevocable If the trust is revocable, the value of the assets in such a trust will be included in the trustor’s taxable estate upon his/her passing 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 —GRATs (Grantor Retained Annuity Trusts)—The trustor continues to collect fixed payments (ie: annuities) from the trust fund assets After a stated period, the principal is conveyed to a named beneficiary —Charitable Remainder Trust—All income is paid to one or more beneficiaries until death or for a stated period The principal is then given to a named charity 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 19-8 Chapter 19 - Accounting for Estates and Trusts Answers to Problems B (the laws of distribution apply to the distribution of an intestate person’s personal property) D (real property that is owned by joint tenants or by tenants in the entirety typically becomes the property of the surviving tenant (owner) by operation of law) A (the laws of distribution are state statutes that apply to the transfer of personal property when someone passes without a valid will) D (effectively a modified accrual process is utilized to determine how to treat earned – ie: accrued – interest which is received after the date of death) B (although it is prudent to have a will, the law does not require such) 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) B (many persons pass without sufficient assets to satisfy their obligations and the prioritization of the decedent’s claims permits an executor/executrix to distribute assets with the confidence that she will not be personally liable for a misapplication of estate assets) D (personal debts, such as unpaid rent, are typically not priority claims against an estate) C (the term for the transfer of real property is ‘devise’) 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) 12 C (a demonstrative legacy is the transfer of assets, often cash, from a specified source) 13 A (if an estate is not sufficient to permit all of the transfers identified by the testator, then the executor must reduce some transfers through the process of ‘abatement’ which instructs the executor how to go about reducing or eliminating transfers) 14 C (estate values are typically based upon the date of death, although an alternate date is permitted if such would result in a reduction in estate taxation – the alternate date is the earlier of six months after the date of death or the actual date of asset distribution) 19-9 Chapter 19 - Accounting for Estates and Trusts 15 C (the 2010 tax act provided a $5.0 million exemption per transferor beginning in 2011) 16 B (losses are deductible for Estate income tax purposes) 17 A (only Fitzgerald will have a taxable estate since for calendar year 2012, a decedent is able to transfer $5,120,000 without incurring a federal estate tax liability) 18 B (the alternate valuation date is the earlier of the date of distribution or six (6) months after the date of death) 19 B (the alternate valuation date is the earlier of the date of distribution or six (6) months after the date of death) 20 B (the 2010 tax act provides a $5.0 million exemption for gifts, increased to $5.12 million for 2012, but does not eliminate the gift tax entirely) 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) 24 C (property taxes relate to the production of income for / from rental property and are likely charged as an expense related to income) 25 D (liabilities are recorded when satisfied due in part to the fact that not all liabilities are known to the executor until after notice has been provided of the decedent’s passing) 26 B (inter vivos refers to being created ‘within the life’) 27 C (the charity gets the ‘lead’ portion of the trust) 28 B (1,400,000 – 700,000 – 420,000 – 50,000 – 20,000 – 110,000 = 100,000) 29 A (Rental income of $5,000 less $600 exemption) 19-10 Chapter 19 - Accounting for Estates and Trusts $5,000 cash remains in the First National Bank along with $6,000 in the New Hampshire Savings and Loan To this total, more cash must be added in order to obtain enough cash to satisfy Suzanne’s bequest Either the Xerox stock, the remaining Coca-Cola stock, and/or the other remaining property must be liquidated In order to give Suzanne Benton a total of $18,000 Any remaining property is conveyed to Wilbur N Ed 34 (5 Minutes) (Compute the taxable estate value) Value of estate assets Conveyed to spouse Conveyed to charities Funeral expenses Administrative expenses Debts Taxable estate $2,300,000 (1,000,000) (260,000) (23,000) (41,000) (246,000) $ 730,000 Amounts conveyed to children or to most trusts are not deductible in computing the taxable value of a decedent’s estate Thus the $500,000 transfer and the $230,000 transfers are components of the taxable estate 35 (15 Minutes) (Determine taxable estate value and the effect of the Unified Transfer Credit) a Gross Estate (fair market value) Funeral Expenses Administration Expenses Charity Bequests Marital Deduction Taxable Estate $ 20,000 10,000 60,000 870,000 $2,381,000 (960,000) $1,421,000 b The Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 had several effects on federal estate taxes First, it confirmed the elimination of estate taxes for 2010 estates, unless the executor elected to apply the estate tax, presumably to utilize the step-up in basis / value provisions Second, it established a much larger exemption from the federal estate tax beginning in 2011 - $5.0 million per person which is portable / available for a surviving spouse to utilize if not utilized by the decedent Thus a decedent passing in 2010 may have been able to escape the federal estate tax entirely On the other hand, appreciated assets passing from such estate will not have a step up in basis and as such beneficiaries will ultimately pay a capital gain tax on the disposition of such assets Decedents passing in 2011 will have a $5.0 million exclusion coupled with the traditional step up in basis procedure 19-14 Chapter 19 - Accounting for Estates and Trusts 36 (10 Minutes) (Computation of income tax on an estate) Rental income Interest income Dividend income Total income Personal exemption Gift to charity Distributed to beneficiary Taxable income $ 9,000 6,000 5,000 $20,000 (600) (5,000) (6,000) $ 8,400 Income Tax (based on 2012 tax rates): 15% of first $2,400 25% on next $3,200 (up to $5,600) 28% on next $2,800(up to $8,400) Total income tax $360.00 800.00 784.00 $1,944.00 37 (50 Minutes) (Record journal entries for an estate and prepare charge and discharge statement) a –– Cash—Principal Life Insurance Receivable Investment in Stocks and Bonds Rental Property Personal Property Estate Principal (To record property held by Rose Shields at death.) 300,000 200,000 100,000 90,000 130,000 820,000 No entry Estates not record liabilities until assets are used in payment Cash—Principal 5,000 Cash—Income 7,000 Assets Subsequently Discovered (Interest Rec.) 5,000 Estate Income 7,000 (To record receipt of interest income The $5,000 earned prior to the decedent's death was not included in original listing of estate assets so it is an ‘asset subsequently discovered’.) Expenses—Income 6,000 Cash—Income 6,000 (Ordinary repair expenses are made to rental property and are generally charged to income rather than principal.) Debts of the Decedent Cash—Principal (To pay liabilities and obligations of the decedent.) 19-15 80,000 80,000 Chapter 19 - Accounting for Estates and Trusts Cash—Principal Investments in Stocks and Bonds 19,000 16,000 Gain on Sale of Stocks Principal (To record sale of stocks and to reflect gain on such sale with the additional proceeds becoming part of the estate’s principal.) 3,000 Cash—Principal 2,000 Cash—Income 12,000 Assets Subsequently Discovered (Rent Rec.) 2,000 Estate Income 12,000 (To record receipt of rental income The $2,000 earned prior to the decedent's death was not included in original listing of estate assets and is therefore an ‘asset subsequently discovered’.) Legacy—Jim Arness Cash—Income (Payment is made to income beneficiary.) 6,000 Cash—Principal Life Insurance Receivable (Collection is made from life insurance policy.) 200,000 6,000 200,000 Legacy—Amanda Blake 200,000 Cash—Principal (Payment is made of proceeds from life insurance policy.) Funeral Expenses Cash—Principal (To record cost of decedent's funeral.) 19-16 200,000 10,000 10,000 Chapter 19 - Accounting for Estates and Trusts b ESTATE OF ROSE SHIELDS Charge and Discharge Statement As to Principal I charge myself with: Assets per original inventory Assets subsequently discovered: Interest receivable Rental income receivable Gain on sale of stocks Total charges I credit myself with: Debts of decedent Funeral expenses Legacy: Amanda Blake (proceeds of life insurance) Estate principal $820,000 $ 5,000 2,000 7,000 3,000 830,000 80,000 10,000 200,000 Estate principal: Cash Investments in stocks and bonds Rental property Personal property Estate principal 290,000 $540,000 $236,000 84,000 90,000 130,000 $540,000 As to Income I charge myself with: Interest income Rental income I credit myself with: Repair expenses Legacy: Jim Arness Balance as to Income Balance as to income: Cash 19-17 $ 7,000 12,000 $ 6,000 6,000 $19,000 12,000 $ 7,000 $ 7,000 Chapter 19 - Accounting for Estates and Trusts 38 (30 Minutes) (Prepare charge and discharge statement for an estate) ESTATE OF GINA PURCELL Charge and Discharge Statement As to Principal I charge myself with: Assets per original inventory Assets subsequently discovered: Rental income receivable Dividends receivable Gain on sale of Polaroid stock Total charges I credit myself with: Debts of decedent Funeral and executor expenses Legacy: Charitable remainder trust Transfer of Dell stock Estate principal $1,204,000 $ 4,000 2,000 $ 81,000 33,000 300,000 32,000 Estate principal: Cash Investments Rental property Estate principal As to Income I charge myself with: Rental income Dividend income I credit myself with: Repair expenses Legacy: income to beneficiary Balance as to income Balance as to income: Cash 19-18 6,000 3,000 $1,213,000 446,000 $ 767,000 $ 422,000 45,000 300,000 $ 767,000 $ 7,000 10,000 2,000 4,000 $17,000 6,000 $11,000 $11,000 Chapter 19 - Accounting for Estates and Trusts 39 (30 Minutes) (Prepare journal entries for an estate) Note: Since the income and principal of this estate are both to go to the same beneficiary, no reason exists for separately labeling the assets as being derived from principal and income a Cash Interest receivable Life insurance receivable (payable to estate) Residence Investment in Coca-Cola Investment in Polaroid Investment in Ford Estate Principal 80,000 6,000 300,000 200,000 50,000 110,000 140,000 b Cash Interest receivable Estate income interest 7,000 c Funeral expenses Cash 20,000 886,000 6,000 1,000 20,000 d No entry Debts are only recorded by an estate when paid e Cash Assets subsequently discovered 12,000 f Legacy—Kevin Simmons Residence 200,000 g Cash Life Insurance receivable (payable to estate) 300,000 h Debts of the decedent Cash 100,000 12,000 200,000 300,000 100,000 No entry for discovery of additional debts Debts are only recorded by an estate when paid i Legacy—Thomas Thorne Cash 150,000 j Cash Investment in Polaroid Gain on sale 112,000 19-19 150,000 110,000 2,000 Chapter 19 - Accounting for Estates and Trusts k Administrative expenses Cash 10,000 10,000 40 (45 Minutes) (Prepare journal entries for an estate and a charge and discharge statement) Note: Since the income and principal of this estate are both to go to the same beneficiary, no reason exists for separately labeling the assets as being derived from principal and income Cash Certificates of deposit Dividend receivable Life insurance receivable — payable to estate Residence and personal effects Investment in Ford Motor Co Investment in Xerox Estate Principal 19,000 90,000 3,000 450,000 470,000 72,000 97,000 Cash Life insurance receivable — payable to estate 450,000 Cash Dividend receivable 4,000 Estate income 1,201,000 450,000 3,000 1,000 No entry Debts are only recorded by an estate when paid Legacy—Sue Pope Residence and personal effects 470,000 Land Assets subsequently discovered 15,000 Debts of the decedent Cash 108,000 470,000 15,000 108,000 No entry is made for the discovery of additional debts, since debts are only recorded by an estate when paid Funeral and administrative expenses Cash 19-20 31,000 31,000 Chapter 19 - Accounting for Estates and Trusts Legacy—Ned Pope Cash 110,000 110,000 10 Cash 81,000 Investment in Ford Motor Co Gain on sale 72,000 9,000 11 Funeral and administrative expenses Cash 16,000 16,000 12 Legacy—Harwood Pope Cash 81,000 Part b 81,000 ESTATE OF LENNIE POPE Charge and Discharge Statement As to principal and income I charge myself with: Assets per original inventory Assets subsequently discovered: Land Gain on sale of Ford Motor Co stock Dividend income Total charges I credit myself with: Debts of decedent Funeral and administrative expenses Legacies distributed: Sue Pope $470,000 Ned Pope 110,000 Harwood Pope 81,000 Total credits Balance on hand As: Estate principal: Cash Certificates of deposit Land Shares of Xerox Estate principal Estate Income: Cash 19-21 $1,201,000 15,000 9,000 1,000 $1,226,000 $108,000 47,000 661,000 816,000 $ 410,000 $207,000 90,000 15,000 97,000 $409,000 $ 1,000 Chapter 19 - Accounting for Estates and Trusts 41 (20 Minutes) (Prepare journal entries for a trust) a Cash—Principal Investments in Stocks Rental Property Trust Principal 300,000 200,000 150,000 b Investments in Bonds Cash—Principal 260,000 Commission Expense—Principal Cash—Principal 3,000 c Repair Expense—Principal Cash—Principal 7,000 d Cash—Principal Cash—Income Trust Principal Trust Income—Dividends 1,000 3,000 e Insurance Expense—Income Cash—Income 2,000 f Cash—Income Trust Income—Rental 8,000 g Trustee Expense—Principal Trustee Expense—Income Cash—Principal Cash—Income 3,000 1,000 h Equity in Income: Beneficiary Cash—Income 5,000 19-22 650,000 260,000 3,000 7,000 1,000 3,000 2,000 8,000 3,000 1,000 5,000 Chapter 19 - Accounting for Estates and Trusts 42 (15 Minutes) (Prepare journal entries for a trust) Land Trust—Principal 320,000 Cash—Income Trust—Income 60,000 Insurance Expense—Income Cash—Income 4,000 Property Taxes Expense—Income Cash—Income 6,000 Land Improvements Cash—Income 4,000 320,000 60,000 4,000 6,000 4,000 (This payment for paving is made from cash income because no principal cash is held The trust agreement should indicate how such payments are to be made and recorded The following adjustment is also likely necessary to indicate that this payment has been made from income rather than principal.) Due from Trust—Principal Due to Trust—Income 4,000 Maintenance Expense—Income Cash—Income 8,000 Equity in Income: Beneficiary Cash—Income 30,000 4,000 8,000 30,000 Develop Your Skills Research Case This case is designed to help the student experience how the Internet can be used to research practical accounting issues in a quick way Here, a client wants to know about a Minor's Section 2503(c) Trust Perhaps no one currently with this CPA firm knows much about this type of trust However, a significant amount of information is readily available using the Internet The student is directed to www.finaid.org This particular website provides extensive information about a variety of financial strategies that can be utilized to finance a college education A search of the term "Minor's Section 2503(c) Trust" leads to http://www.finaid.org/savings/2503ctrust.phtml 19-23 Chapter 19 - Accounting for Estates and Trusts This page provides the following information about this specific type of trust Obviously, more information may be needed to enable the CPA to work at an appropriate level with the client but this coverage provides a basic understanding Some of the information that can be obtained from this site includes:  Gifts can be held in this type of trust until the child reaches the age of 21  In 2008, up to $12,000 that is given by each person to the trust can be excluded from any gift tax consideration In 2009, this amount is $13,000  For the exclusion to apply, the recipient must receive a present interest; in other words, the gift must be open to the recipient's immediate use  All property and income must be expended before the recipient reaches the age of 21 Any remaining assets must be distributed to the person at the time of the 21st birthday  The trustee can use the money in the trust to pay for the recipient's college costs (that is obviously why it is being covered on this particular website)  Some trusts of this type are set up so that the recipient can only withdraw the undistributed assets for a short period after the person's 21st birthday If not taken then, the money reverts to the trust fund  After the recipient's 21st birthday, gifts can still be made to the trust fund but no exclusion is allowed However, this problem can be avoided by setting up the Minor's Section 2503(c) Trust in conjunction with another type of trust known as a Crummey Trust  Income earned by the trust is taxed at trust income rates unless distributed directly to the recipient so that it is then taxed at the recipient's tax rates After the recipient's 21st birthday, the income is taxable to that person whether received or not  There are a number of specific problems associated with this type of trust including high administrative costs, high income tax rates on trust income, and the possibility of causing the recipient problems trying to qualify for other types of college financial aid  The website suggests considering the Uniform Gift/Transfer to Minor's Act as a good alternative to the Minor's Section 2503(c) Trust 19-24 Chapter 19 - Accounting for Estates and Trusts As can be seen, this website does not make the reader an expert in this type of trust but it certainly does provide a wealth of information so that initial discussions can be held in a knowledgeable way with the client The link to the New York State Society of CPAs provides additional information about this type of trust fund The student might be encouraged to search for other on-line resources which are not provided in the text, in order to enhance the student’s grasp for the depth of information now available electronically Research Case Students often believe that all answers can be found in textbooks or the needed information is simply a part of every CPA's basic knowledge However, in real life, most issues are resolved by research Here, the CPA firm is faced with a tax question concerning the deduction allowed an estate for distributable net income The CPA may well know the answer to that question or, if not, will have to look it up This assignment allows, and requires, the students to find instructions provided on-line by the Internal Revenue Service Once the instruction form for 1041 is found through a search, the student will probably go to the index of this document The link for the 1041 instructions can be located at: http://www.irs.gov/pub/irs-pdf/i1041.pdf "The income distribution deduction allowable to estates and trusts for amounts paid, credited, or required to be distributed to beneficiaries is limited to distributable net income (DNI) This amount, which is figured on Schedule B, line 7, is also used to determine how much of an amount paid, credited, or required to be distributed to a beneficiary will be includible in his or her gross income." From the above quote as well as from the table of contents for these instructions, the student can determine that Schedule B is used to compute the amount of distributable net income Therefore, the student can scroll down through these instructions (about 15-20 pages) and come upon over a page of actual guidance on how Schedule B is completed, including line-by-line instructions This schedule provides the student (and the CPA) with the necessary information to determine DNI Note, though, that some parts of this process are relatively easy while other steps are more complex However, through a careful reading, the method by which this figure is determined can be ascertained 19-25 Chapter 19 - Accounting for Estates and Trusts Research Case This research case requires the student to use a legal or commercial search engine to locate a specific state’s probate code Every state has a probate statutory scheme Approximately twenty (20) states have adopted a version of the uniform probate code, in an attempt to utilize a consistent asset distribution process Montana is one of the states that has adopted a version of the uniform probate code, although the professor may wish to permit students to work this research case based on their home state’s laws The student should ultimately arrive at the following link for the relevant statutory provisions: http://data.opi.mt.gov/bills/mca_toc/72.htm Depending upon the student’s familiarity, it may be prudent for the professor to provide the link for the student and evaluate the student’s answer based on the student’s application of the statute This statue, which is similar to the statutes of the other states which have adopted the uniform probate code, provides the following: 72-2-113 Share of heirs other than surviving spouse (1) Any part of the intestate estate not passing to the decedent's surviving spouse under 72-2-112, (http://data.opi.mt.gov/bills/mca/72/2/72-2-112.htm) or the entire intestate estate if there is no surviving spouse, passes in the following order to the individuals designated below who survive the decedent: (a) to the decedent's descendants by representation; (b) if there is no surviving descendant, to the decedent's parents equally if both survive or to the surviving parent; (c) if there is no surviving descendant or parent, to the descendants of the decedent's parents or either of them by representation; (d) if there is no surviving descendant, parent, or descendant of a parent and the decedent is: (i) survived by one or more grandparents or descendants of grandparents: (A) one-half to: (I) the decedent's paternal grandparents equally if both survive; (II) the surviving paternal grandparent; or (III) the descendants of the decedent's paternal grandparents or either of them if both are deceased, the descendants taking by representation; and (B) the other one-half to the decedent's maternal relatives in the same manner; or (ii) not survived by a grandparent or descendant of a grandparent on either the paternal or the maternal side, the entire estate to the decedent's relatives on the other side in the same manner as the half; (e) if there is no surviving descendant, grandparent, or descendant of a grandparent, to the person of the closest degree of kinship with the decedent 19-26 Chapter 19 - Accounting for Estates and Trusts Except as provided in subsection (2), if more than one person is of that closest degree, those persons share equally (2) If more than one person is of the closest degree as provided in subsection (1)(e) but they claim through different ancestors, those who claim through the nearer ancestor must receive to the exclusion of those claiming through a more remote ancestor Section 72-2-113-1(c) will provide that Ms Voga’s cousins could inherit from her grandmother through Ms Voga’s great grandparents, if in fact Ms Voga’s grandmother had no decendants Clearly the grandmother has at least one decendant – Ms Voga However, the prudent professional should explain this process to the client as there is no guarantee that Ms Voga will outlive her grandmother Analysis Case Many resources exist on the Internet to explain different legal and tax benefits of various estate planning techniques The suggested link correlates to a summary memo prepared by two (2) attorneys in Virginia It is one of dozens of links that are located by searching for “Grantor Retained Annuity Trust” The student should have little difficulty in locating relevant resources Included in the information about GRATs at this suggested link and at many other links is the following:  It can be used to transfer profitable and quickly appreciating property to a donee, such as the donor’s child(ren), in such a way as to minimize gift and estate taxes  Property is transferred into an irrevocable trust but the income is retained for a period of time (or for the shorter of a period of time or the person’s remaining life)  At the end of the specified period, the property goes to the named beneficiary  The person creating the trust is allowed to get a stream of cash from the income of the asset over the period specified  Hopefully, the value of the property placed in the estate will grow so that the beneficiary receives a particularly high amount in comparison to what was initially placed in the trust 19-27 Chapter 19 - Accounting for Estates and Trusts  For gift tax purposes, the conveyed value is the value when the trust was created less the value of the annuity interest that the original owner retains  The reduced value limits or eliminates any potential gift tax effects  Consequently, income is retained by the original owner while conveying the property to the eventual recipient at a lower set value as a way to reduce the amount taken by the government in taxes This trust is, thus, advantageous when an individual wishes to transfer wealth to subsequent generations while also minimizing the transfer taxes It is particularly useful if the transferor can identify and transfer rapidly appreciating assets Analysis Case In setting the value of an estate, the executor has the option to choose an alternate date for valuation purposes if that decision will reduce the taxes to be paid This case was created to help the student obtain additional information about this decision if ever encountered in the real world Because this is a tax issue, the student is being directed to make use of the Internal Revenue Service website as well as the instructions printed for each taxation area For many areas of accounting, the more the student knows about the IRS website the better prepared the student will be By doing a search of the IRS site, the instructions for the Form 706 can be located That is the form used for federal estate tax filing purposes By going directly to the index at the back of these instructions, the student can locate information on the topic of "alternate valuation." The information provided in the instructions discusses the basic issues concerning valuation at death versus the option of either six-months after death or the date of transfer whichever comes first Within that coverage, special issues such as interest, rents, and dividends are explained in detail Basically, this information is provided here by the IRS so that the average person can perform the duties of an executor or, at least, understand the impact of the decisions made by the executor, such as the decision as to the proper valuation date 19-28 ... 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... creating the fund The trust fund is managed for the benefit of the trust’s beneficiaries and the trustee has fiduciary obligations to the beneficiaries 26 Trust funds have become popular as a... occur: 19-6 Chapter 19 - Accounting for Estates and Trusts No estate taxes are paid on the first decedent’s estate The income of the trust fund assets can still be used for the benefit of the spouse