Can you pass capital gains taxes through to beneficiaries for an estate 1041?

[Speedy3]

Hello,

I’m the personal rep of an estate. I’m wrapping selling all the assets and have begun filing two 1041s for the estate, first for a fiscal year July 6th 2020-June 30th 2021, and second short tax year for July 1st 2021-September 30th 2021. The only income that I’ve had for the estate has been canceled debt at around 75k that was reported as other income on first year 1041 and capital gains that I’m currently trying to report for the second short and final year 1041 for the estate. Can I pass through the capital gains tax to the beneficiaries to be taxed less, or is this something that only a trust can do?

If I cannot pass capital gains onto the beneficiaries, do K1s still need to be distributed during the final tax year of the estate, or could I just wait to distribute income to beneficiaries after I file the taxes and avoid reporting that income on K1s? Currently TurboTax business is showing that I’m paying capital gains tax on the home sale, but I’m still generating K1s to distribute with part II of K1 showing income to be distributed currently (line A1) as an amount, and an amount for income distribution deduction (line B1). Do these indicate taxes that the beneficiaries would have to pay as well by getting a K1.  I don’t want beneficiaries to end up having to pay tax as well as the estate.

Thanks,

Appreciate your time

[Carl]

Generally, an inheritance received by a beneficiary is not taxable or reportable at all on the beneficiary recipient's tax return. There are exceptions though; especially when dealing with a tax deferred retirement account of the deceased.  For the most part, all taxes are paid by the estate, and whatever is left is what gets distributed to the beneficiaries.

There are some scenarios where the beneficiary may prefer to pay any taxes on their personal tax return though. But I don't know enough about it to provide any example scenarios.

Overall, it depends on exactly what you're dealing with here, be it a tax deferred retirement account, off-shore annuity, or something else of that nature.

[Speedy3]

@CarlThanks for the response. To clarify the capital gains are from the sale of the estate home, if that can help bring more light o the question.

[tagteam]

---

@Speedy3 wrote:

Can I pass through the capital gains tax to the beneficiaries to be taxed less, or is this something that only a trust can do?

---

Capital gains typically remain with trusts and estates unless a provision is expressly made in the relevant document (will or trust) that the executor or trustee must (or has the discretion to) distribute such gains to the beneficiaries.

However, on the final return, trusts and estates can pass through capital gains to the beneficiaries as part of their DNI (pursuant to a reasonable and impartial exercise of discretion by the fiduciary).

[macuser_22]

---

@Speedy3 wrote:

@CarlThanks for the response. To clarify the capital gains are from the sale of the estate home, if that can help bring more light o the question.

---

[Mike9241]

Exceptions That Allow Capital Gains to Be Distributed
Reg. 1.643(a) – 3(b) has specific requirements that must be met to allocate capital gains to the beneficiaries.

Prerequisites that must be met
1) Trust agreement and local law; or
2) A reasonable and impartial exercise of discretion by the trustee

so if state law allows the distribution of capital gains in the year of termination you can

of course, there's item 2) which seems to allow the fiduciary total discretion

[Speedy3]

Appreciate the help,

As I am a beneficiary of the estate as well this would not make me impartial I'm guessing?

Am I then required to distribute any income that was generated during the final tax year if there is no governing instrument in place requiring me to do so, or could I put nothing in the “income to be distributed currently” fields of the 1041 for the beneficiaries and disregard the K1s entirely? I would then distribute the entire funds post tax year close for the estate without the need for K1s.

[tagteam]

---

@Speedy3 wrote:

As I am a beneficiary of the estate as well this would not make me impartial I'm guessing?

---

You are a fiduciary, as the executor, so you owe a duty to act reasonably and responsibly with respect to all beneficiaries, including yourself.

[tagteam]

---

@Speedy3 wrote:

I would then distribute the entire funds post tax year close for the estate without the need for K1s.

---

If there is no governing instrument, then state law would control.

If your state has adopted the UPIA (Uniform Principal and Income Act), then you have rather broad discretion with respect to distribution. Essentially, you have to avoid abusing your discretion as a fiduciary (i.e., act as would a reasonable person in a prudent manner).

[Speedy3]

Thank you to everyone for the help. I’ve spoken to a few CPAs and they say that distributing capital gains income, in my case, to beneficiaries is ok.

I’m wondering if I could do this for canceled debt income as well? I have not received 1099Cs for all of the debts. One of the debts, the larges at 65k, was agreed settled in the previous fiscal year of the estate. The income from the canceled debt, I’m guessing, would be reported in Jan 2022. So I’m wondering if I could distribute the income from that debt in the final tax year of the estate to the beneficiaries as the debt would most likely not be reported until Jan 31st 2022. The income that would be distributed would come from the principal of the estate, but would be income that would have been distributed to pay creditors, had it not been forgiven.

[tagteam]

There is no question that canceled debt is income. However, is the estate now insolvent? 

You might want to consult with legal counsel on this matter.

[Speedy3]

Estate is not insolvent.

Thanks

[tagteam]

Regardless, it would be the date the canceled debt is reported (when the 1099-C is received).

[ConeyIslandBear]

"However, on the final return, trusts and estates can pass through capital gains to the beneficiaries as part of their DNI (pursuant to a reasonable and impartial exercise of discretion by the fiduciary)."

How can I physically do this within TurboTaxBusiness? 

When I run TurboTax, it automatically subtracts off Capital Gains from DNI in Schedule B, so then the Estate ends up paying all the Capital Gains instead of putting them on the K-1s.

Is there a command in TurboTax to change that?

Thanks!

[tagteam]

@ConeyIslandBear 

You need to indicate that the return is the "final return" and also make an actual distribution in that section of the program.

Also, you probably need to allocate capital gains to the beneficiaries and to income in the program in order to get it to work properly.