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IRC Section 645 Elections: Filing a Combined Qualified Revocable Trust and Estate Income Tax ReturnWEDNESDAY, FEBRUARY 3, 2021, 1:00-2:50 pm Eastern

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February 3, 2021

IRC Section 645 Elections: Filing a Combined Qualified Revocable Trust and Estate Income Tax Return

Jeremiah W. (Jere) Doyle, IV

Senior Vice President

Bank of New York Mellon

jere.doyle@bnymellon.com

Erin Fukuto, CPA, MST

Partner

Raimondo Pettit Group

efukuto@rpgcpa.com

Notice

ANY TAX ADVICE IN THIS COMMUNICATION IS NOT INTENDED OR WRITTEN BY THE SPEAKERS’ FIRMS TO BE USED, AND CANNOT BE USED, BY A CLIENT OR ANY OTHER PERSON OR ENTITY FOR THE PURPOSE OF (i) AVOIDING PENALTIES THAT MAY BE IMPOSED ON ANY TAXPAYER OR (ii) PROMOTING, MARKETING OR RECOMMENDING TO ANOTHER PARTY ANY MATTERS ADDRESSED HEREIN.

You (and your employees, representatives, or agents) may disclose to any and all persons, without limitation, the tax treatment or tax structure, or both, of any transaction described in the associated materials we provide to you, including, but not limited to, any tax opinions, memoranda, or other tax analyses contained in those materials.

The information contained herein is of a general nature and based on authorities that are subject to change. Applicability of the information to specific situations should be determined through consultation with your tax adviser.

I.R.C. Section 645 Elections: Filing a Combined Qualified Revocable Trust and

Estate Income Tax Return

Erin Fukuto, CPARaimondo Pettit Group21515 Hawthorne Blvd.

Suite 1250Torrance, CA 90503-6583

efukuto@rpgcpa.com

Jeremiah W. Doyle IV, Esq.Senior Vice President

BNY Mellon Wealth ManagementOne Boston PlaceBoston, MA 02108

Jere.doyle@bnymellon.com

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Agenda

• What is the Section 645 election and what are the advantages of the election?

• How is the election made?

• What are the filing requirements?

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Location of Applicable Rules

• Reg. 1.645-1(b)(1) – definition of “qualified revocable trust”• Reg. 1.645-1(c) – rules governing the QRT election• Reg. 1.645-1(b)(5) – definition of “related estate”• Reg. 1.645-1(b)(6) – definition of the “election period”• Reg. 1.645-1(d) – rules regarding use of taxpayer identification numbers and the

filing of a Form 1041 • Reg. 1.645-1(e)(2) – rules regarding the tax treatment of an electing trust and the

related estate and the general filing requirements for the combined entity during the election period

• Reg. 1.645-1(e)(3) – rules regarding the tax treatment of an electing trust and its filing requirements during the election period if no executor is appointed for a related estate.

• Reg. 1.645-(f) rules for determining the duration of the Section 645 election period

• Reg. 1.645- 1(h) – rules regarding the tax consequences of the termination of the election.

• Reg. 1.645-1(g) – rules regarding the tax consequences of the appointment of an executor after a trustee has made a Section 645 election believing that an executor would not be appointed for a related estate

What is the Section 645 Election?

• Allows a “qualified revocable trust” to be treated and taxed as part of an estate for income tax purposes during the election period.

• It is not taxed as a separate trust.

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What is a “Qualified Revocable Trust?”

• A “qualified revocable trust” (QRT) is any trust (or portion of a trust) which on the date of death of the decedent was treated under Section 676 as owned by the decedent by reason of a power in the grantor which is determined without regard to Section 672(e).

• Section 672(e) treats a grantor as holding any power or interest held by the grantor’s spouse in certain situations.

• Thus, a trust is not treated as a QRT if the origin of the grantor’s revocation power is due to his spouse having a revocation power which is attributed to the grantor under Section 672(e). Reg. 1.645-1(b)(1).

• However, the trust is treated as a QRT if it is treated as owned by the decedent because he or she had the power to revoke the trust with the consent of a non-adverse party, including the decedent’s spouse. Reg. 1.645-1(b)(1).

– The decedent must hold the power to revoke. A non-adverse party’s right to revoke, acting alone, will not qualify as a QRT. Reg. 1.645-1(b)(1).

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What are the Advantages of Making the Election?

• Can elect fiscal year-end for the combined entity

• Qualify for estate fiduciary income tax charitable deduction

– More liberal than trust fiduciary income tax charitable deduction

• $25,000 PAL deduction for rental R/E for 2 years of estate. Section 469(h)(4).

• Eligible to hold S stock for duration of election

• No estimated tax payments for 2 years after date of death. Reg. 1.645-1(e)(4).

• Income of estate and trust can be combined and deductions and losses can offset each other e.g. PALs, NOL, capital loss carryover, investment interest expense

• $600 exemption. Reg. 1.645-1(e)(2)(ii)(A).

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What are the Advantages of Making the Election?

• Can recognize loss on funding pecuniary bequest with depreciated assets. Section 267(b)(13).

– A QRT is entitled to recognize a loss on funding a pecuniary bequest with depreciated assets.

– Absent the QRT election, the trust could not recognize a loss on funding a pecuniary bequest with depreciated assets.

• Eligible to deduct medical expenses incurred by the decedent but paid by the estate in the one year period after the decedent’s death. Section 213(c).

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Benefit of a Fiscal Year Election

• A revocable trust becomes irrevocable and a separate taxpayer after the death of the grantor.

• Trusts must adopt a calendar year. Section 644(a).

• Estates may adopt a calendar year or any fiscal year it wants as long as the first fiscal year does not exceed 12 months. Section 441(b); Reg. 1.441-1(b)(5))A); Section 7701(a)(1), (14).

• A electing QRT may adopt a calendar year or any fiscal year it wants as long as the first fiscal year does not exceed 12 months. Reg. 1.645(e)(2), (3).

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Benefit of a Fiscal Year Election

• A is the beneficiary of a QRT for which a Section 645 election is made.

• The QRT and estate have a fiscal year ending January 31, 2021.

• A receives a taxable distribution on September 1, 2020.

• Under the rule set forth in Section 662(c), the September 1, 2020 distribution would not have to be reported by A until his tax year 2021, with the return being due on April 15, 2022.

• If no election had been made, the distribution would have been taxable to A in 2020 and the tax paid on April 15, 2021.

• The election permits a deferral of the reporting and payment of the tax.

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Election of Estate’s Fiscal Year End

12/31

12/31

2020 2021

2020 2021

1/31

Distribution Taxed

Estate

Beneficiary

FYE

Beneficiary includes a distribution in the estate or trust’s year ending with or within the beneficiary’s year. Section 662(c).

Ability to Take a Section 642(c) “Set Aside” Deduction

• An estate or trust is allowed an income tax charitable deduction under Section 642(c).

• The deduction is unlimited in amount. There are no percentage of AGI limitations.

• The distribution must be paid for a “purpose” set forth in Section 170(c).

• There are two requirements for the charitable deduction:

– It must be paid from gross (taxable) income of the estate or trust, and

– It must be paid pursuant to the terms of the governing instrument

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Ability to Take a Section 642(c) “Set Aside” Deduction

• In general, the charitable deduction is allowed if the amount is paid in the current year or paid before the end of the following year. There must be an actual payment to the charity.

• An estate, however, can claim an income tax charitable deduction for an amount permanently set aside for charity.

• A QRT, which is treated as an estate for income tax purposes, can claim an income tax charitable deduction for an amount permanently set aside for charity.

• Example. The remainder interest in a QRT is payable to charity. QRT incurs a long-term capital gain on the sale of stock. The gain is allocated to principal. The QRT can claim an income tax charitable deduction for the gain as it is permanently “set aside” for charity.

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$25,000 PAL Deduction for Rental R/E for 2 Years of Estate

• Under the PAL rules, a deduction for losses from a passive activity are suspended. Losses are only deductible if the material participation rules are satisfied.

• Section 469(i) allows a deduction of up to $25,000 of passive losses attributable to real estate rental activities in which the taxpayer actively participates. The up to $25,000 deduction phases out as the taxpayer’s income exceeds $100,000.

– Active participation means making management decisions, such as approving new tenants, deciding on rental terms or approving expenses.

• In the case of the taxable years of an estate ending less than 2 years after the decedent’s death, up to $25,000 of passive losses may be deductible by the decedent’s estate for all real estate rental activities with respect to which the decedent actively participated prior to his death. Section 469(i)(4).

• A QRT is also eligible for this provision. Reg. 1.645-1(e)(2).

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Eligibility to Hold S Corporation Stock for Duration of Election

• Only certain trusts are eligible to be S Corporation shareholders.

• Grantor trusts are one such trust. However, death causes a termination of the grantor trust status.

• A former grantor trust is an eligible S corporation shareholder for 2 years after the death of the grantor. Section 1361(c)(2)(A)(ii).

• A testamentary trust is also an eligible S corporation shareholder for 2 years after the transfer of the stock from an estate.

• A trust loses it identity as a separate trust during the QRT election period. The QRT can hold S corporation stock for the later of two years after the grantor’s death or until 6 months after the estate is settled. Subsequently, the trust receiving the S corporation stock from the QRT can hold the stock for an additional 2 years. After the expiration of the Section 645 period, the trust is treated as a testamentary trust. Reg. 1.3161-1(h)(1)(iv) (B).

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No Estimated Tax Payments for 2 Years After Date of Death

• An estate does not have to file or pay estimated tax payments for any tax year ending before the date that is 2 years after the decedent’s death. Section 6654(l)(2)(A).

• A QRT does not have to file or pay estimated tax payments for any tax year ending before the date that is 2 years after the decedent’s death. Reg. 1.645-1(e)(4).

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Income, Deductions and Credit of Estate and QRT Combined

• The income of estate and trust is combined and deductions and losses can offset each other e.g. PALs, NOL, capital loss carryover, investment interest expense.

• Reporting is under the TIN of the estate.

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Treatment as a Complex Trust

• Even if the trust is a simple trust, the Section 645 election will cause the trust to be treated as a complex trust because it will be combined with the estate for income tax purposes.

• Thus, the tier system for allocating DNI among beneficiaries and the 65 day rule under Section 663(b) will be applicable.

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How is the Election Made?

• If there is no executor appointed, the QRT trustee files the election. The election must include the QRT trustee’s representation that there is no executor and to the trustee’s knowledge and belief, one will not be appointed.

• Otherwise, the trustee of the QRT and the executor of the decedent’s estate make the election.

• If more than one jurisdiction has appointed an executor, for purposes of the election, only the person from the primary or domiciliary proceeding is the executor.

• The election causes the QRT to be treated as part of the decedent’s estate for Federal income tax purposes.

• Once made the election is irrevocable. Reg. 1.645-1(e)(1).

• The QRT, while not treated as a separate trust, is treated as a separate share under Section 663(c). Reg. 1.645-1(e)(2)(iii)(A).

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How is the Election Made?

• There can be more than one QRT.

• If so, only one trustee is required to sign the Form 8855 unless the governing instrument requires all trustees to sign.

• The election can be made for some or all of the QRTs. Reg. 1.645-1(c)(3).

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How is the Election Made?

• The election is made on Form 8855.

• The Form 8855 is filed with the initial Form 1041 of the estate, if there is an executor, and, if not, with the Form 1041 filed for the first year of the QRT.

• The election must be made by the due date (including extensions) for filing the income tax return for the first taxable year of the decedent’s estate.

• If the Section 645 election will be made, the trustee of a QRT is not required to file a Form 1041 for the QRT for the short taxable year beginning with the decedent’s date of death and ending December 31 of that year, i.e. the “stub” year. Reg. 1.645-1(d)(2).

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How is the Election Made?

• Conditions to election – trustee of each QRT:

– Agrees to the election;

– Is responsible for timely providing the executor of the estate with all the trust information necessary to permit the executor to file a complete, accurate and timely Form 1041 for the combined electing trust(s) and estate for each taxable year during the election period;

– Agrees with the executor to allocate the tax burden of the combined electing trust(s) and estate for each taxable year during the election period in a manner that reasonably reflects the tax obligation of each electing trust and the estate; and

– Is responsible for insuring that the electing trust’s share of the tax obligations of the combined electing trust(s) and estate is timely paid to the Secretary.

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How is the Election Made?

• Conditions to election – executor:

– Agrees to the election;

– Is responsible for filing a complete, accurate and timely Form 1041 for the combined electing trust(s) and estate for each taxable year during the election period;

– Agrees with the trustee of each electing trust to allocate the tax burden of the combined electing trust(s) and estate for each taxable year during the election period in a manner that reasonably reflects the tax obligation of each electing trust and the estate; and

– Is responsible for insuring that the estate’s share of the tax obligation of the combined electing trust(s) and estate is timely paid to the Secretary.

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How is the Election Made?

• The trustee of the QRT must obtain a new TIN for the QRT upon the death of the decedent.

• Form 8855, Part 1 and III require the trustee enter the TIN.

• Regardless of whether or not an executor is appointed, the trustee of each QRT must obtain a TIN upon the death of the grantor

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How is the Election Made?

• If there is an executor:

– The executor must obtain a TIN for the estate before filing the Section 645 election.

– The executor must complete the information requested in Part I of the Form 8855.

– The executor attests to making the Section 645 election and that the conditions for making a valid Section 645 election have been met by dating the Form 8855 and signing it under the penalties of perjury.

– For a foreign, the city, province or state and country must be entered. The Instructions to the Form 8855 say to follow the country’s practice for entering the postal code and do not abbreviate the country name.

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How is the Election Made?

• If there is no executor:

– The filing trustee must obtain a TIN for the QRT prior to filing the election. The Form 1041 is filed under the QRT’s TIN. If there is more than one electing trust, the Form 1041 must be filed by the filing trustee under the name and TIN of the electing trust of the filing trustee. Reg. 1.645-1(e)(3)(ii).

• The filing trustee completes the information requested in Part I of the Form 8855.

• If there is more than one QRT joining in the election, the trustee of each QRT joining in the election must appoint one trustee to be responsible for filing the Form 1041 for the combined electing trusts for each taxable year during the election period. This person is called the “filing trustee.”

• The filing trustee attests to making the Section 645 election and that the conditions for making a valid Section 645 election have been met by dating the Form 8855 and signing it under the penalties of perjury.

– For a foreign, the city, province or state and country must be entered. The Instructions to the Form 8855 say to follow the country’s practice for entering the postal code and do not abbreviate the country name.

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How is the Election Made?

• If an executor is appointed after the trustee has made the Section 645 election, an amended Form 8855 must be filed within 90 days of the executor’s appointment and the executor and trustee of each electing trust must complete and sign the amended Form 8855 and print AMENDED ELECTION on the top of the form. Reg. 1.645-1(g)(1).

• If the amended Form 8855 is not timely filed, the election period terminates the day before the executor is appointed. Reg. 1.645-1(g)(1).

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How is the Election Made?

• The executor or the filing trustee must complete Part II which requests the following information about the decedent:

– The name of the decedent

– The SSN of the decedent

– The decedent’s date of death

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How is the Election Made?

• Part III must be completed if there is more than one QRT joining in the election.

• Part III is completed by the trustee of each electing trust.

• Part III contains only enough space for two QRTs. If there are more than two QRTs, simply use additional Part III pages.

– If additional pages of Part III are attached, the executor or trustee should indicate on the top of the first page of Part III how many additional pages are attached and the total number of QRTs that are joining the election.

– Retain copies of the filings. The executor and trustee of each electing trust must retain a copy of the Form 8855 as well as any amended Form 8855. Also, file by certified mail, return receipt, to be able to prove that the election was timely filed.

How Long Does the Election Last?

• The election begins on the date of the decedent’s death and terminates on the earlier of:

– The day on which the electing trust and estate have distributed all its assets; and

– The day before the “applicable date.” Reg. 1.645-1(f)(1).

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What is the “Applicable Date?”

• If no Federal estate tax return is required to be filed, the applicable date is the date which is two years after the date of the decedent’s death.

• If a Federal estate tax return is required to be filed, the applicable date is the later of:

– The day two years after the decedent’s death; or

– The day 6 months after the date of the final determination of the Federal estate tax liability.

• Authority: 1,645-1(f)(2).

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When is the Estate Tax Liability Finally Determined?

• It is the earliest of the following five dates:

– The date 6 months after the issuance of the estate tax closing letter, unless a claim for refund is filed within 12 months after issuance of the closing letter;

– The date of the final disposition of the claim for refund, unless a suit is commenced within 6 months after final disposition;

– The date of execution of a settlement agreement with the IRS that determines the liability for the estate tax;

– The date of issuance of a decision, judgment, decree, or other order of a court resolving the liability for the estate tax unless a notice of appeal or petition for certiorari is filed within 90 days after issuance of the decision, judgment, decree, or other order of a court.

– The date of the expiration of the statute of limitation for assessment of the estate tax in Section 6501.

• Authority: Reg. 1.645-1(f)(2)(ii).

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What Are the Filing Requirements?

• If there is an executor, one Form 1041 is filed for the combined income of the QRT and the related estate under the name and TIN of the estate. Reg. 1.645-1(e)(2)(ii).

• If there is no executor, the QRT trustee files Form 1041 treating the trust as an estate.

• The QRT does not need to file a Form 1041 for the balance of the tax year containing the decedent’s death.

• Only one $600 exemption is allowed.

• All of the income, deductions and credits for the estate and QRT are combined, unless otherwise required under the separate share rule. Remember, the QRT is a separate share of the estate for which distributable net income (DNI) is calculated separately.

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What is the Separate Share Rule?

• Separate shares exist if a single trust has more than one beneficiary, and if different beneficiaries have substantially separate and independent shares.

• The QRT and the estate are treated as separate shares for the sole purpose of calculating distributable net income (DNI).

• If distributions are made from the QRT and/or the estate, the DNI of the entity making the distribution must be determined, i.e., the DNI of each share must be determined.

• The beneficiary is only taxed on the DNI from his or her separate share.

• The separate share rule is not elective. If it applies, the separate share rule must be followed.

• The following slide contains an example from the regulations.

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What is the Separate Share Rule - Example

• The residue of A’s estate is distributed to an electing QRT. The sole beneficiary of the QRT is C.

• The estate share has $15,000 of gross income, $5,000 of deductions and $10,000 of taxable income and DNI.

• A’s estate distributes $15,000 to the QRT. The distribution reduces the DNI of A’s estate by $10,000.

• The QRT has $25,000 of gross income and $5,000 of deductions. The QRT’s DNI is increased by $10,000 received from the estate. Thus, the QRT’s DNI is $30,000.

• The QRT distributes $35,000 to C. The distribution deduction reported on the Form 1041 for the combined estate and QRT is $30,000. As a result, C must include $30,000 in gross income.

• The Form 1041 filed for A’s estate and the QRT would report $40,000 of gross income ($10,000 from the estate and $30,000 from the QRT).

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What Happens When the Election Period Terminates?

• At the close of the election period (the “applicable date”), a distribution is deemed to be made from the combined QRT and estate, if there is an executor, or, of there is no executor, from the QRT. Reg. 1.645-1(h).

• All items of income, including net capital gains, are included in the DNI of the electing trust and are treated as distributed to a new trust.

• The deemed distribution is to a new trust and consists of the QRT share, as determined under the separate share rule discussed previously.

• The combined QRT and estate, or the QRT, as the case may be, is entitled to a distribution deduction with respect to the deemed distribution.

• The new trust will include the distribution in gross income to the extent required under the inclusion rules under Section 662.

• Following termination of the election period, the trustee of the electing trust must obtain a new TIN.

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What Happens When the Election Period Terminates?

• Filing of the Form 1041 upon termination of the Section 645 election of there is an executor:

– Form 1041 is filed under the name an TIN of the estate. If the estate continues after the termination of the election period, the estate must continue to use the TIN assigned to the estate during the election period.

– Items of income, deduction and credit of the electing trust for the year of termination plus the income, deductions and credits of the estate are included on the Form 1041.

– A distribution deduction is allowed for the deemed distribution of the electing trust to the new trust.

– The trustee of the electing trust must file a final Form 1041 under the name and TIN of the electing trust and indicate that the return is a final return to indicate to the IRS that the electing trust is no longer in existence. The items of income, deduction and credit of the trust are not reported on this Form 1041 but on the Form 1041 for the combined electing trust and estate.

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What Happens When the Election Period Terminates?

• Filing of the Form 1041 upon termination of the Section 645 election if there is no executor:

– File a Form 1041 reporting the income, deduction and credit of the electing trust for the short period ending with the last day of the election period.

– The trust takes a distribution deduction for the deemed distribution.

– The Form 1041 must indicate that it is a final return.

– The former electing trust must obtain a new TIN if the trust will continue after the termination of the election period.

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What Happens When the Election Period Terminates?

• Taxable year of the estate and trust upon termination of the election:

– The taxable year of the estate is the same taxable year used during the election period.

– The taxable year of the new trust is a calendar year. Reg. 1.645-1(h)(4). Following termination, the new trust will be required to file a Form 1041 from the end of the fiscal year selected for the QRT to the end of the calendar year.

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Conclusion

• We discussed:

– The Section 645 election and its advantages

– Making the election

– Filing requirements.

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Thank you!