I am a Beneficiary of an Estate – Why Did I Receive a Schedule K-1?
For the most part, property you inherit is not included in your income for tax purposes. However, items which are considered “income in respect of a decedent,” or “IRD” may be taxable to you or a portion thereof.
First, let’s review what IRD actually is. IRD is income which the decedent (person from whom you inherited the property) would have included on his/her individual tax return, except the income was earned/received after their death. Some examples of IRD include but not limited to: Compensation-related benefits paid after death (vacation pay), benefits from an individual retirement account, stock dividends, interest income, stock sales, etc.
Now that we understand IRD, let’s review a decedent’s estate. A decedent’s estate is a separate legal entity for federal tax purposes and comes into existence at the time of death of an individual. A decedent’s estate figures its gross income in the same manner as an individual. However, there is one major distinction, which is that an estate is allowed an income distribution deduction for distributions to beneficiaries. The income distribution deduction determines the amount of any distributions taxed to the beneficiaries. For this reason, a decedent’s estate is sometimes referred to as a “pass-through” entity. The beneficiary, and not the decedent’s estate, pays income tax on his or her distributive share of income. Schedule K-1 is used to notify the beneficiaries of the amounts to be included on their individual income tax returns. Regulation section 1.651(a)-2 discusses income required to be distributed currently and reportable to the beneficiaries. Also, Code section 662 provides information on inclusion of amounts in gross income of beneficiaries of estate and trusts accumulating income or distributing corpus.
The distributable net income is calculated by taking the total IRD received for the estate in that year less expenses in respect of a decedent. The remaining net amount is the estates taxable net income before any distributions to beneficiaries. Distributions to a beneficiary(ies) can then be deducted on the estate’s fiduciary tax return, which decreases taxable income and helps to minimize any tax liability.
A beneficiary in most cases is not being taxed on 100% of the income from the estate’s tax return. Property and principal assets of the estate (which includes cash from the decedent’s bank accounts) are not taxed to the beneficiary since this is not included in IRD. Only the portion of the distribution you received from the DNI that is from the estate’s taxable income is taxable to the beneficiary and then reported on Schedule K-1.
Here is an example: At John’s death, $50,000 of IRD items were included in his gross estate, $10,000 of which was paid to Sally. There were also $3,000 of deductions in respect of a decedent, for a net value of $47,000. Sally will include in her income the $10,000 of IRD she receives from the distributable net income of the estate. The $10,000 will be reported on a Schedule K-1 and must be reported on Sally’s individual tax return for that year. The decedent’s estate return will then be taxed on $37,000 ($50,000 IRD – $3,000 expenses – $10,000 of distributions to Sally).
Since Estates have a higher tax bracket in most instances, it is usually more beneficial to record distributions to beneficiaries so that the Estate can receive a deduction for the distribution and will result in less taxable income.
Ask Kit Kat – Reviving Brook Trout
Hook Law Center: Kit Kat, what can you tell us about brook trout in Virginia?
Kit Kat: Well, this is truly a heartening tale! Apparently, brook trout used to be very common in Virginia and could be found in almost all parts of the state. However, today because of farming, foresting, mining, and development pressures, their range has been greatly reduced. In fact, their reduction represents a 38 percent complete disappearance from prior levels, and a 34 percent reduced presence in other areas of Virginia.
Now enter students from the Students for Environmental Action club at James Madison High School in Vienna, VA. They had an interest in raising brook trout and seeing whether they could re-introduce them in certain favorable areas and whether or not their lives could be sustained there. Fortunately, at their school, they had an excellent resource—a faculty adviser who in his 2011 dissertation for George Mason University rated streams that were suitable for brook trout habitation in Maryland. Using this information he and the club created a rating scale which could be used to evaluate streams in Virginia. A score of 80 or more on a 100-point scale indicated that brook trout could be sustained there. The club then checked out various streams in the Shenandoah Valley and northern Virginia and rated them. Their club had raised brook trout fingerlings, and they were looking for a place to launch them. They settled on Catharpin Creek in northwest Prince William County. It had a great score of 87.5, but it had one drawback of a summer water temperature being a little high. So their adviser, Kirk Smith, diverted a spring to cool down the area. They also decided to plant trees along the banks of the creek to lower the temperature of the area during the day. So state officials gave permission for the club to release 50 trout fingerlings, as the young are called, last spring in 2017. They then checked back in December 2017, and they found at least one survivor. That gave them the incentive to try again this spring with 55 more fingerlings.
Time will tell how well their endeavor will succeed. No matter the outcome, this club’s efforts will definitely yield a lot of great information, so that one day in the future the brook trout can be once again a live symbol of its status as being the freshwater fish of Virginia. (Peter Cary, “Budding scientists try to revive state’s once-thriving brook trout,” The Virginian-Pilot, May 7, 2018, p. 1 & 9)
Distribution of This Newsletter
Hook Law Center encourages you to share this newsletter with anyone who is interested in issues pertaining to the elderly, the disabled and their advocates. The information in this newsletter may be copied and distributed, without charge and without permission, but with appropriate citation to Hook Law Center, P.C. If you are interested in a free subscription to the Hook Law Center News, then please telephone us at 757-399-7506, e-mail us at [email protected] or fax us at 757-397-1267.