No matter which tax return you’re preparing (the decedent’s personal return or one for an estate or trust), you have to calculate the tax after you figure out the income and the deductions. If you’re working on the decedent’s return, you arrive at your tax liability exactly the same way as you would your own.
If you’re finishing up a Form 1041 and need to figure out Schedule G (on the back), read on. The following is a list of the different types of tax computations you may need to perform before you can put the finishing touches on the tax return you’re preparing.
Ordinary tax computation
You can find tax rate tables for estates and trusts, which change every year, in the Form 1041 instructions for that year, which you can locate at IRS.gov under “Forms and Instructions.”
One reason why many executors, administrators, and trustees choose to make distributions to beneficiaries is that the government taxes estates and trusts very heavily on ordinary income.
For example, in 2013, ordinary income for estates and trusts of more than $11,950 is taxed at 39.6 percent (the top rate), while an individual’s Form 1040 would have to show $400,000 of ordinary taxable income before paying tax at the 39.6 percent rate in that same year.
By making distributions, you pass that taxable income to the beneficiaries, who are, most likely, in a lower tax bracket, reducing the total amount of tax paid.
Capital gains and qualified dividends computation
No matter whether you’re filing a tax return for an individual, a trust, or an estate, capital gains and qualified dividends are taxed at special, fixed rates; you calculate these taxes on the worksheets attached to Schedule D. Even though the worksheet looks intimidating, all it does is strip out the various types of capital gains property and apply the correct tax rate to those gains.
If you have any entries on Schedule D, or if you have qualified dividends, taking a few minutes with this worksheet can save you big bucks because you pay far lower rates on most capital gains and qualified dividends than you do on other types of income.
For example, a trust with $22,000 total taxable income, of which $12,000 is ordinary income and $10,000 is a long-term capital gain, would pay $7,070 in tax if there were no preferential capital gains tax rate, but will actually pay only $5,110 ($3,110 tax on ordinary income, and $2,000 tax on long-term capital gains), a $1,960 tax savings.
Whether you calculate your tax by using the worksheet on the back of Schedule D or the tax rate table, place the total tax on taxable income on line 1a of Schedule G, Form 1041.
Tax on lump-sum distributions
Sometimes, through no fault of your own, the estate you’re administering is saddled with the payout of the entire balance of an employer’s qualified retirement account, which shoots the estate’s income tax liability through the roof.
If the decedent was born prior to January 2, 1936, his or her estate may be eligible to use ten-year averaging and/or 20 percent capital gains rules when calculating the taxes owed, which may result in substantially lower taxes than if you calculated the taxes in the ordinary way.
Prepare these special calculations on Form 4972, Tax on Lump-Sum Distributions. Instructions for this form are included with the form, which is available from IRS.gov. Just look for it under “Forms and Instructions.” After you finish Form 4972, you place the taxes on lump-sum distributions on line 1b of Schedule G, Form 1041.
Alternative minimum tax
Since 1986, every trust and estate has been required to do the alternative minimum tax (AMT) calculation, even if the trust or estate isn’t subject to the AMT. And, like the AMT calculations found on Form 6251 for individuals, the fiduciary calculation is also a bear.
You can find the AMT schedule (all 4 parts and 75 lines) for trusts and estates on pages 3 and 4 of Form 1041, under Schedule I. Using the following list, you should be able to prepare the AMT schedule by using a little patience. You can find the line-by-line directions in the Form 1041 instructions, available at IRS.gov under “Forms and Instructions.”
