Have Your Cake And Eat It Too: Tax Deferment and Lower Tax Preparation Costs By Making A 645 Election

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What is a 645 Election:
The Internal Revenue Code §645 allows an irrevocable election to treat a qualified revocable trust (QRT) as part of the decedent’s estate for federal income tax purposes. The election allows tax advantages available to an estate to be available to the trust.

A qualified revocable trust (QRT) is a grantor trust under Sec. 676 (with revocation power retained by the grantor) as of the decedent’s date of death. Typical Revocable or Living Trusts are QRTs because the grantor retained the right to revoke the trust.

When the decedent has both a QRT and probate estate, the Sec. 645 election allows the trustee and the executor to combine a QRT and an estate into one tax return, filed as an estate. Even if there is not a separate probate estate, this election can be used to file the trust return (or several separate QRTS) as though the trust were an estate.

Tax identification numbers (TINs) must be obtained for both the electing QRT and the related estate. If there is no executor, a TIN is only required for the QRT.

Note: ***This election is valid for only two years following the decedent’s date of death (if no federal estate tax return is required); otherwise, it is effective until 6 months after the final determination of estate tax liability. One must therefore consider the anticipated length of the trust and/or estate administration before making the election. ***

Advantages:

  1. The estate and trust file a single Form 1041, lowering preparation costs.
  2. The trust can adopt a fiscal year for income tax purposes and thereby permit the executor to defer reporting of income, allowing time to plan for deductible expenses (see example below).
  3. The trust is not subject to the active-participation requirement under the passive loss rules for two years.
  4. The Trust can hold S corporation stock without terminating the corporation’s S election.
  5. The Trust is allowed a charitable deduction under Sec. 642(c) for amounts permanently set aside for charitable purposes.

How Does The Tax Deferral Work:
For illustration let’s suppose that a trust receives income after the grantor dies on July 15, 2016.  If the trust uses a calendar year end, a distribution carrying out distributable net income during 2016 will be reported on the beneficiary’s 2016 income tax return.  The beneficiary must pay any income tax on the distribution when his or her return is filed on April 18, 2017.

Now, if that trust using a fiscal year end distributes income during a fiscal year ending in 2017, the beneficiary would report that distribution on his or her 2017 income tax return, and any resulting income tax liability would be due on April 15, 2018. This would be true even if the actual distribution occurred during the 2016 calendar year.

When the grantor’s death occurs during the end of a year, say November or December, the tax deferral length is not a great but still may be advantageous.

Disadvantages:

  1. Loss of the trust’s personal exemption. A separately filed income tax return for a trust would get a $100 or $300 exemption. A separately filed income tax return for an estate would get a $600 exemption. Filling separately the combined total exemptions can total up to $900. By making the election and filing one return, only the $600 exemption will be utilized.
  2. Other reasons (i.e. litigation between the estate and trust) for not making the election.

Who Makes It:
The trustees for each qualified revocable trust and the executor of the related estate make a section 645 election. If there is more than one trustee, only one must sign.

How:
By filing Form 8855, not later than the due date for the estate income tax return Form 1041.

Duration of election period:
The election period begins on the date of the decedent’s death and terminates on the earlier of the day on which both the electing trust and related estate, if any, have distributed all of their assets, or the day before the applicable date. The election does not apply to successor trusts (trusts that are distributees under the trust instrument).

Deferral of taxes and costs savings in tax preparation by making a 645 election typically outweigh the possible disadvantages, thus the election should almost always be made for a QRT upon the grantor’s passing. If you need assistance making a 645 election or have questions, contact us at Oakstone Law.

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Naples, Florida 34109
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