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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. 1. State probate laws govern wills and estates. These statutes facilitate three (3) goals. a. To gather and preserve the decedents property. b. To ascertain the decedent's intent for her property. c. To settle debts and distribute the remaining assets consistent with the decedents intentions. 2. Where no will exists, the laws of descent (for real property) and the laws of distribution (for personal property) govern the distribution of the decedents 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. 1. Expenses of administering the estate which include legal costs, executor fees and similar items. 2. Funeral expenses and medical expenses of last illness. 3. Debts and taxes given legal preference. 4. All other claims. D. Estate distributions. 1. Devisea testamentary gift of real property. 2. Specific legacy (or bequest)an item of personal property that is identified directly by the testatator in his will.

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3. Demonstrative legacya cash gift made from a particular identified source. 4. General legacya cash gift made with no source designated. 5. Residual legacya gift of any remaining estate property. 6. 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. 1. Federal estate taxan 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. Until 2009, the value of the estate is reduced by an exemption that gradually increases over the years. In 2010, the federal estate tax is repealed. However, a new law must be passed by Congress for the repeal of the tax to last beyond that one year. c. The federal gift tax will not be eliminated completely, but an individual is allowed an annual exclusion of $12,000 (indexed for inflation) plus a $1 million lifetime exclusion. 2. State inheritance taxassessed on the right to receive property. This tax varies significantly from state to state. 3. Estate income taxtax on income earned by estate property. F. Recording the transactions of an estate 1. Assets are recorded at fair market value. 2. Debts, expenses, and distributions are only recorded when paid. 3. Income and principal have their balances and transactions separately identified because testators often transfer income and principal to different beneficiaries. 4. 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. 1. Trusts ensure that the distribution of a person's assets is as intended. 2. An inter vivos trust is created by a living individual.
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3. 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: 1. Qualified Terminable Interest Property Trustincome goes to one or more parties with the principal eventually being conveyed to a different party. 2. Charitable Remainder Trustincome goes to one or more parties with the principal eventually being conveyed to a specified charity. 3. 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. 4. 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 insureds taxable estate. D. Accounting for a trust. 1. 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. 2. Income and principal have their transactions and balances separately identified.

Learning Objectives
Having completed Chapter 19, "Accounting for Estates and Trusts," students should be able to fulfill each of the following learning objectives: 1. Define and undertand key estate and trust terms. 2. Understand that state probate laws govern wills and estates. 3. Identify the three goals of probate laws. 4. Identify the responsibilities of an executor of an estate. 5. List the order of priority for claims against an estate. 6. Define the various types of legacies and explain the method by which the process of abatement reduces legacies where insufficient assets are available.
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7. Determine the value of an estate for federal tax purposes and be able to describe the changes created by the Economic Growth and Tax Relief Reconciliation Act of 2001. 8. Compute federal income taxes for an estate. 9. Identify adjustments to the principal of an estate and identity adjustments to the income of an estate. 10. Prepare journal entries to reflect the proper accounting for assets held in an estate. 11. Produce a Charge and Discharge statement for an estate. 12. Identify and explain reasons that individuals create trusts. 13. Identify several common types of trusts such as charitable remainder trusts, charitable lead trusts, and credit shelter trusts. 14. Explain which type of trust may be appropriate for given or hypothetical client situations. 15. Identify adjustments to the principal of a trust and identify adjustments to the income of a trust. 16. Prepare journal entries to reflect the proper accounting for assets held in a trust.

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? 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.

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Answers to Questions
1. 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. 2. 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. 3. Probate laws are state statutes which govern wills and estates. Depending upon the nature and extent of a decedents will, these statutes may play a significant role in the manner of administering and distributing the decedents estate. 4. Probate laws provide an orderly structure for the process of administering and distributing a decedents 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. 5. 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 estates 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 estates value. 6. 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. 7. All assets of an estate should be presented on the charge / 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. 8. 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. 9. 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. Debts and taxes given preference under federal or state laws. All other claims.

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10. An estate that is heavily in debt could possibly leave the members of the decedents 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 decedents death to fulfill specific or demonstrative legacies. 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 $2.0 million in 2007 and 2008, $3.5 million and gradually increases until the federal estate tax is eliminated completely in 2010. These changes were mandated by the Economic Growth and Tax Relief Reconciliation Act of 2001. 15. The Economic Growth and Tax Relief Reconciliation Act of 2001 had several provisions that affected the conveyance of property. First, the amount of assets that could be conveyed tax free by a decedent was increased gradually from $1 million in 2002 to $3.5 million in 2009. In 2010, the federal estate tax will be eliminated although Congress must pass new legislation to extend the repeal beyond that one year. During this same period, the highest tax rate to be paid on taxable estates was reduced to 45%. The generationskipping tax will also be abolished. The federal gift tax will continue but with a $1 million lifetime exclusion. Starting in 2010, the maximum gift tax rate will be the maximum individual tax rate.

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16. Individuals are allowed to make gifts of up to $12,000 per person per year (the amount is $24,000 if given by a married couple) without incurring any gift taxes. This amount is to be indexed for inflation. Despite passage of the Economic Growth and Tax Relief Reconciliation Act of 2001, the federal gift tax will not be eliminated completely. Instead, an individual will be allowed a $1 million lifetime exclusion for gifts above the annual exclusion. 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 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 individuals unified transfer credit has not been previously decreased in order to avoid taxation of gifts, an estate of a certain size is tax free. For 2007 an estate of $2.0 million or less could be conveyed without creating a tax effect. Because of the Economic Growth and Tax Relief Reconciliation Act of 2001, that number will gradually increase until the estate tax is removed entirely. Hence, if all other property is conveyed to the decedents 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 desireable results occur: 1. No estate taxes are paid on the first decedents estate. 2. The income of the trust fund assets can still be used for the benefit of the spouse. 3. The assets of the trust fund can be directed to a chosen recipient at the spouses eventual death. 4. The estate of the spouse is reduced by a considerable amount of assets, creating a large savings in estate taxes at the second spouses 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 estates 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:

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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. 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 estates liabilities are often not fully identified until a point in time well after the decedents 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 executors progress in administering and distributing the decedents 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 trusts 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 parites. 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 trustors taxable estate upon 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 TrustAll income is paid to one or more beneficiaries until death or for a stated period. The principal is then given to a named charity.

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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.

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Answers to Problems 1. B (the laws of distribution apply to the distribution of an intestate persons personal property). 2. 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). 3. A (the laws of distribution are state statutes that apply to the transfer of personal property when someone passes without a valid will). 4. 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). 5. B (although it is prudent to have a will, the law does not require such). 6. A (although state probate statutes vary, most states require the publication of notice of death and then permit claims against the decedents estate only for a statutorily shortened period of time). 7. B (many persons pass without sufficient assets to satisfy their obligations and the prioritization of the decedents claims permits an executrix to distribute assets with the confidence that she will not be personally liable for a misapplication of estate assets). 8. D (personal debts, such as unpaid rent, are typically not priority claims against an estate). 9. 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 testators will). 12. C (a demonstrative legacy is the transfer of assets, often cash, from a specificed source). 13. A (if an estate is not sufficient to permit all of the transfers identified by the testatrix, 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). 15. C (the 2001 tax act ultimately eliminates the federal estate and generations skipping taxes, however this does not occur until 2010 and even then it is not presently permanent).
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16. B (losses are deductible for Estate income tax purposes). 17. A (only Fitzgerald will have a taxable estate since for calendar year 2007, a decedent is able to transfer $2,000,000 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 2001 tax act does not eliminate the gift tax, although the exemption amount is increased to $1,000,000). 21. A (the use of this estate / trust planning will reduce the overall size of the couples 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 decedents 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).

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30. (30 Minutes) (Define terms used in estate accounting) a. Willthe instructions, prepared consistent with the applicable state laws, given by an individual to direct the distribution to be made of the person's property after death. b. Estatethe legal entity that holds title to all of a decedent's property until those assets are properly distributed. c. Intestaterefers to the death of an individual who passes without having prepared a valid, legal will. d. Probate lawsstate laws that govern and regulate wills and estates. e. Trusta fund of assets that has been conveyed to a fiduciary who will manage and then distribute those assets according to the specifications of the individual who created the trust. f. Inter vivos trusta trust fund created by a living person rather than as a result of the specifications of a will. g. Charitable remainder trusta trust fund where the income is paid to one or more beneficiaries for a specified period (or until their death). After that point in time, the principal is conveyed to a named charity. h. Remaindermana beneficiary of a trust who is entitled to receive a principal balance but only after a specified time. Until then, the income is distributed to a different income beneficiary (often for the life of that person). i. Executoran individual who oversees an estate in a stewardship (fiduciary) capacity. The person must follow any applicable laws, locate all assets, discover and satisfy all valid claims against the estate, and uncover and follow (if possible) the intent of the decedent for any remaining property. j. Homestead allowancean amount that is provided to a decedent's surviving spouse and/or minor and dependent children before claims against the estate are paid. This allowance ensures that (if assets are available) some amount is given to the immediate family regardless of the amount of debt incurred by the decedent.

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31. (25 Minutes) (Discussion of questions about estates) a. Probate laws are state laws that govern wills and estates. These laws provide an orderly structure for the process of administering a decedents estate (property). The Uniform Probate Code has been adopted by many states so that laws are consistent, at least between those particular states. The general objectives of probate laws are: To gather and preserve all of the decedent's property held at death. To locate and provide a fair settlement for all debts. To discover the decedent's intent for any remaining property and to follow those wishes if possible. b. The executor must locate and preserve all of the assets owned by the decedent at death, discover and satisfy (if sufficient assets are available) all valid claims against the estate, determine the wishes of the decedent as to any remaining property, comply with all laws, and distribute assets according to the intentions of the decedent. The executor is also entitled to reasonable compensation for her performance of these tasks. c. All property of value should be included in an inventory of estate assets. Thus, cash, investments, receivables, and other valuables should all be listed. In some states, real property (such as land) is conveyed directly to a beneficiary at death so that it is not included in the estate. However, even this real property is assumed to be part of the estate for estate tax purposes. Additionally, chooses in action (the ability or right to pursue a claim) may have value and should be considered by the executor. d. The order of priority for paying claims against an estate are as follows: (1)expenses of administering the estate. (2)funeral expenses and the medical expenses of any last illness. (3)debts and taxes given preference under federal or state laws. (4)all other claims.

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32. (10 Minutes) (Identify parties in connection with will) a. Howard Amadeus has been designated to receive the principal of the trust fund after Lucy Van Jones' death and is, therefore, referred to as the remainderman. b. Josh OBrien has established the trust fund and is known legally as the trustor and in some states is referred to as the settlor same meaning as trustor. c. A demonstrative legacy is a cash gift from a particular source. The gift of all money from the First Savings Bank to Richard Blaine is a demonstrative legacy. d. Since the $9,000 cash gift to Nelson Tucker does not come from a designated source, it is known as a general legacy. If it were to originate from a specified source, then it would be a demonstrative legacy. e. The gift of the antique collection to Ilsa Lunn is a specific legacy because it is a gift of specified personal property. f. Lucy Van Jones will receive the income from the trust fund for the remainder of her life, a position known as a life tenant. g. Josh OBrien is the testator the decedent passing with a valid will. 33. (20 Minutes) (Distribution to be made of an estate) a. 800 shares of Coca-Cola Co. stock are given to Cindy Cheng. Since the estate does not own more Coca-Cola stock, this is all Cindy will receive. Title to the house goes to Dennis Davis as the decedent directed. $41,000 cash in the First National Bank goes to Jack Abrams. Because this bequest was limited to $50,000 in this bank account, and the account contained less than $50,000, the $41,000 is all that Jack Abrams will receive. $16,000 cash in the New Hampshire Savings and Loan still remains. However, the will specifically directs that Suzanne is to receive $18,000. Therefore, to have the $16,000 amount, more cash must be added. Either the Xerox stock or the other property (or both) must be liquidated in order to give Suzanne Benton $18,000. Any remaining property is conveyed to Wilbur N. Ed, the residuary beneficiary. b. 1,000 shares of Coca-Cola Co. stock are given to Cindy Cheng. The additional 200 shares will either be transferred to the residuary beneficiary, or liquidated if necessary to satisfy other bequests. $50,000 cash in the First National Bank goes to Jack Abrams. $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 Suzannes bequest. Either the Xerox stock,

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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 decedents 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 Economic Growth and Tax Relief Reconciliation Act of 2001 creates two gradual effects on federal estate taxes. First, the tax exempt exclusion increases from $1 million in 2002 to $3.5 million in 2009 before the federal estate tax is eliminated in 2010. Second, the highest tax rate decreases almost every year until the 2010 repeal. Thus, the amount of estate taxes to be paid will vary based upon the year of death. This difference is especially significant between 2008 and 2009 because of the differences in exemption amounts and tax rates. In 2008 the exemption amount is $2,000,000 and the maximum tax rate is 45%. The next year, in 2009, the exemption amount increases to $3,500,000. Thus the decedent who lives into January, 2009 can convey a significantly larger amount of property estate-tax free. In this situation the decedants taxable estate is less than the exemption amount for both 2008 and 2009. 36. (10 Minutes) (Computation of income tax on an estate) Rental income ................................................................. Interest income ................................................................ Dividend income .............................................................. Total income ..................................................................... Personal exemption ......................................................... Gift to charity .................................................................... Distributed to beneficiary ............................................... Taxable income ................................................................
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$ 9,000 6,000 5,000 $20,000 (600) (1,200) (6,000) $12,200

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Income Tax (based on 2007 tax rates): 15% of first $2,150 ........................................................... 25% on next $2,850 (up to $5,000) ................................. 28% on next $2,650(up to $7,650) .................................. 33% on next $2,800 (up to $10,450)................................ 35% on remaining $1,750 (up to $12,200)...................... Total income tax .........................................................

$322.50 712.50 742.00 924.00 612.50 $3,313.50

37. (50 Minutes) (Record journal entries for an estate and prepare charge and discharge statement) a. CashPrincipal .......................................................... 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

1. No entry. Estates do not record liabilities until assets are used in payment. 2. CashPrincipal .......................................................... 5,000 CashIncome ............................................................ 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.) 3. ExpensesIncome .................................................... 6,000 CashIncome .................................................. 6,000 (Ordinary repair expenses are made to rental property and are generally charged to income rather than principal.) 4. Debts of the Decedent .............................................. CashPrincipal ............................................... (To pay liabilities and obligations of the decedent.) 5. CashPrincipal ......................................................... Investments in Stocks and Bonds ................. 80,000 80,000 19,000 16,000 3,000

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 estates principal.) 6. CashPrincipal ......................................................... CashIncome ............................................................
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2,000 12,000

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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.) 7. LegacyJim Arness ................................................. CashIncome .................................................. (Payment is made to income beneficiary.) 8. CashPrincipal ......................................................... Life Insurance Receivable .............................. (Collection is made from life insurance policy.) 6,000 6,000 200,000 200,000

LegacyAmanda Blake ............................................. 200,000 CashPrincipal ............................................... (Payment is made of proceeds from life insurance policy.) 9. Funeral Expenses ....................................................... CashPrincipal................................................ (To record cost of decedent's funeral.) 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 ........................................................ 10,000

200,000

10,000

$820,000 $ 5,000 2,000 7,000 3,000 830,000

I credit myself with: Debts of decedent ...................................................... Funeral expenses ....................................................... Legacy: Amanda Blake (proceeds of life insurance) .............................................................. Estate principal ..................................................... Estate principal: Cash .............................................................................
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80,000 10,000 200,000 290,000 $540,000 $236,000

The McGraw-Hill Companies, Inc., 2009 19-17

Investments in stocks and bonds ............................ Rental property ........................................................... Personal property ....................................................... Estate principal ..................................................... 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 ............................................................................. 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 ..................................................... Estate principal: Cash ............................................................................ Investments ................................................................. Rental property ........................................................... Estate principal ..................................................... As to Income I charge myself with: Rental income .............................................................
McGraw-Hill/Irwin 19-18

84,000 90,000 130,000 $540,000

$ 7,000 12,000 $ 6,000 6,000

$19,000

12,000 $ 7,000 $ 7.000

$1,204,000 $ 4,000 2,000 6,000 3,000 $1,213,000

$ 81,000 33,000 300,000 32,000

446,000 $ 767,000 $ 422,000 45,000 300,000 $ 767,000

$ 7,000

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Dividend income ......................................................... I credit myself with: Repair expenses ......................................................... Legacy: income to beneficiary ................................. Balance as to income ........................................... Balance as to income: Cash ............................................................................ 39. (30 Minutes) (Prepare journal entries for an estate)

10,000 2,000 4,000

$17,000

6,000 $11,000 $11,000

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 .......................................................... b. Cash ................................................................................. Interest receivable ...................................................... Estate income interest ............................................... c. Funeral expenses ............................................................ Cash.............................................................................. d. No entry. Debts are only recorded by an estate when paid. e. Cash ................................................................................. Assets subsequently discovered ............................. f. LegacyKevin Simmons ................................................ Residence ................................................................. g. Cash ................................................................................. Life Insurance receivable (payable to estate) ......... h. Debts of the decedent ..................................................... Cash ............................................................................. 12,000 200,000 300,000 100,000 12,000 200,000 300,000 100,000 80,000 6,000 300,000 200,000 50,000 110,000 140,000 7,000

886,000 6,000 1,000 20,000

20,000

No entry for discovery of additional debts. Debts are only recorded by an estate when paid. i. LegacyThomas Thorne ................................................ Cash .............................................................................
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150,000

150,000

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j. Cash ................................................................................. Investment in Polaroid ............................................... Gain on sale ................................................................ k. Administrative expenses ................................................ Cash..............................................................................

112,000

110,000 2,000 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. 1. 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 ............................................................. 2. Cash ................................................................................. Life insurance receivable payable to estate ....... 3. Cash ................................................................................. Dividend receivable .................................................... Estate income ............................................................. 4. No entry. Debts are only recorded by an estate when paid. 5. LegacySue Pope .......................................................... Residence and personal effects ............................... 6. Land ................................................................................. Assets subsequently discovered ............................. 7. Debts of the decedent ..................................................... Cash ............................................................................. 470,000 15,000 108,000 470,000 15,000 108,000 19,000 90,000 3,000 450,000 470,000 72,000 97,000 450,000 4,000

1,201,000 450,000 3,000 1,000

No entry is made for the discovery of additional debts, since debts are only recorded by an estate when paid. 8. Funeral and administrative expenses ........................... Cash ............................................................................. 9. LegacyNed Pope .........................................................
McGraw-Hill/Irwin 19-20

31,000 110,000

31,000

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Cash ............................................................................. 10. Cash ................................................................................. Investment in Ford Motor Co..................................... Gain on sale ................................................................ 11. Funeral and administrative expenses ........................... Cash ............................................................................. 12. LegacyHarwood Pope.................................................. Cash.............................................................................. Part b. 81,000

110,000 72,000 9,000 16,000 81,000

16,000 81,000

I charge myself with: Assets per original inventory .................................... $1,201,000 Assets subsequently discovered: Land......................................................................... 15,000 Gain on sale of Ford Motor Co. stock ...................... 9,000 Dividend income ......................................................... 1,000 Total charges ........................................................ $1,226,000 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 ....................................................................... 41. (20 Minutes) (Prepare journal entries for a trust) a. CashPrincipal ............................................................... Investments in Stocks ..................................................... Rental Property ................................................................ Trust Principal ............................................................ 300,000 200,000 150,000 $108,000 47,000

ESTATE OF LENNIE POPE Charge and Discharge Statement As to principal and income

661,000

816,000 $ 410,000 $207,000 90,000 15,000 97,000 $409,000 $ 1,000

650,000

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The McGraw-Hill Companies, Inc., 2009 19-21

b. Investments in Bonds ...................................................... CashPrincipal .......................................................... Commission ExpensePrincipal .................................. CashPrincipal .......................................................... c. Repair ExpensePrincipal ............................................. CashPrincipal .......................................................... d. CashPrincipal ............................................................... CashIncome ................................................................. Trust Principal ............................................................ Trust IncomeDividends .......................................... e. Insurance ExpenseIncome .......................................... CashIncome ............................................................. f. CashIncome ................................................................. Trust IncomeRental ................................................ g. Trustee ExpensePrincipal ........................................... Trustee ExpenseIncome .............................................. CashPrincipal .......................................................... CashIncome ............................................................. h. Equity in Income: Beneficiary ........................................ CashIncome .............................................................

260,000 3,000 7,000 1,000 3,000

260,000 3,000 7,000

1,000 3,000 2,000 8,000

2,000 8,000 3,000 1,000

3,000 1,000 5,000

5,000

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The McGraw-Hill Companies, Inc., 2009 Solutions Manual

42. (15 Minutes) (Prepare journal entries for a trust) Land ................................................................................. TrustPrincipal........................................................... CashIncome ................................................................. TrustIncome ............................................................ Insurance ExpenseIncome .......................................... CashIncome ............................................................. Property Taxes ExpenseIncome ................................. CashIncome ............................................................. Land Improvements ......................................................... CashIncome ............................................................. 320,000 60,000 4,000 6,000 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 TrustPrincipal .............................................. Due to TrustIncome ................................................ Maintenance ExpenseIncome ..................................... CashIncome ............................................................. Equity in Income: Beneficiary ........................................ CashIncome ............................................................. 4,000 8,000 30,000 4,000 8,000 30,000

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Develop Your Skills Research Case 1 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 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 2005, up to $11,000 that is given by each person to the trust can be excluded from any gift tax consideration. In 2007, this amount is $12,000. 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
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McGraw-Hill/Irwin 19-24

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.

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 students grasp for the depth of information now available electronically.

Research Case 2 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 2007 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
McGraw-Hill/Irwin Hoyle, Schaefer, Doupnik, Advanced Accounting, 9/e The McGraw-Hill Companies, Inc., 2009 19-25

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. Research Case 3 This research case requires the student to use a legal or commercial search engine to locate a specific states 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 states laws. The student should ultimately arrive at the following link for the relevant statutory provisions: http://data.opi.state.mt.us/bills/mca/72/2/72-2-113.htm. Depending upon the students familiarity, it may be prudent for the professor to provide the link for the student and evaluate the students answer based on the students 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, 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.
McGraw-Hill/Irwin 19-26 The McGraw-Hill Companies, Inc., 2009 Solutions Manual

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. Vogas cousins could inherit from her grandmother through Ms. Vogas great grandparents, if in fact Ms. Vogas 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 1 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 donors 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 persons 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. 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.
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McGraw-Hill/Irwin Hoyle, Schaefer, Doupnik, Advanced Accounting, 9/e

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 2 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.

McGraw-Hill/Irwin 19-28

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