1099-B and testamentary trust

[Tschurin]

I am using TurboTax Premier. TT wants me to review 1099-B information from my brokerage account about sales of stock I made in 2020. I had inherited certain of those  shares sold as my portion of a testamentary trust after my mother died in 2017. TT wants me to indicate whether the shares where purchased or inherited. So two questions [1] Since the basis of the shares was not stepped up upon my mother’s death, what difference does it make whether they were inherited or purchased? Wouldn’t the basis be the same? [2] The 1099-B has two types of long-term gains, one of which represents the initial purchase of the stock; the second that represents subsequent reinvestment of dividends. The shares that were purchased through reinvested dividends occurred both before my mother passed, and subsequent to her passing. In other words, some of those shares would be deemed purchased by the trust and “inherited” by me, and others deemed “purchased” by me individually after the trust assets were distributed. So do I enter “inherited” or “purchased” in the line on TT’s form?

[jtax]

Why do you say the basis wasn't stepped up?

If the trust were a living (intervivos) non-grantor trust and your mother gifted the shares to the trust during her lifetime, you would be right that there would be no step-up and you would not indicate to TT that they were inherited. Your basis would be your mother's basis and you'd have the same holding period. If you did indicated that they were inherited, but entered the correct basis and they were long-term I don't think it would matter.

On the other hand for a testamentary trust funded after you mother's death, from assets that she had full dominion and control over when she passed, you would get a step up. TT would care about that both for the basis stepup but also because inherited shares are consider long-term even if you sell then within a year of inheriting them I.R.C. 1223(9) https://www.law.cornell.edu/uscode/text/26/1223

How did you get the shares? I'm assuming the trust transferred the shares to you w/o selling them and without making an election to be taxed as if the trustee had sold them. If so then your basis is the trust's basis. It's the only thing that makes sense given that you got a 1099-B and not a K-1.

In any case the shares from dividend reinvestment from dividends received after your mother's death would not be "inherited" and would not get a stepup. The trust's basis in those would be the price paid for them. That would be your basis if you get the shares in-kind as described above.

[Tschurin]

@jtax This testamentary trust was what I believe is know as a credit bypass trust; set up by my father before he passed away, at which point the income from the trust was distributed to my mother until she passed away. I know for a fact that the basis was not stepped up upon my mother's death. I guess the main point is that just because an asset is inherited does not automatically mean its basis is stepped up. So I'd be interested to know why TurboTax  (or is it the IRS) needs to make the "purchased" versus "inherited" distinction. At least as concerns basis, that distinction might be useless unless more is know about what the asset is that was inherited. JMHO

[jtax]

@Tschurin thank you for the clarification. 

You are exactly right about how a bypass trust works after the death of surviving spouse. There is no stepup but there is also no estate tax.

I would suggest you do not answer inherited. Rather put in the date of your father's passing for those shares (with a basis as reported on his estate tax return) and the date of each reinvestment lot for the rest. Or summarize as allowed.

I think the reason TT does this is because with the estate tax exclusion amount of about $11M there are very few people who are in your situation and many of them will be hiring professionals to prepare their taxes.  TT has enough trouble keeping up with all the tax changes and probably doesn't prioritize that small segment of the market. for 99.999% of people inheriting a capital asset TT will handle it correctly. Explaining the difference would be complicated and would confuse most people. I know that isn't a satisfying answer and it's just my guess (I'm not a TT employee and this is a volunteer forum). And even if "Inherited" isn't right the tax calculation will be correct as long as you enter the correct (once but not twice stepped up) basis

[Tschurin]

@jtax Have a different point of view about people in my “situation”. Whether one has inherited a bypass trust isn't explained by what the estate tax exemption is today; it’s what the estate tax exemption was when the trust was set up. The reason for their former popularity was that only 20 years ago the exemption was less than 3/4 of a million dollars. And it is the mostly baby boomer children of those parents who set up the trusts 20, 30 or more years ago who have been inheriting and are now inheriting those trusts. I could easily guess their number may be in the tens or even hundreds of thousands. I would suggest TT could do a better job addressing the situation. JMHO