Karyn Scott
One of the most versatile elections available to an estate is the ability to make a fiscal year election for the estate. The executor or personal representative may elect any year end provided it ends on the last day of the month and does not exceed 12 months in length.
How does one elect a year end? The election of a year end is made by the filing of the initial estate income tax return. This return is due three months and 15 days after the elected year end, so it is important to address this early in the administrative process. One of the first step in the estate process is to file for a tax identification number. This application (Form SS-4) will ask for the year end of the trust. The attorney or accountant preparing the application will often select a calendar year end (December) or the month preceding the decedent’s death with anticipation of using this as the fiscal year. However, even if the Form SS-4 was completed using a one of these year ends, the executor of the estate is not held to this and may select any year end that accommodates the needs of the estate.
So how do you decide on a year end? Well, there are an endless number of factors that you may want to consider, but the most common are:
- Deferring income – this is perhaps the most obvious reason, especially if the estate holds an interest in a pass-through entity, for electing a fiscal year. For example, income reported to an estate on a 2012 K-1 can effectively be deferred until 2013. To achieve the maximum time to defer income would be to select the month end preceding the decedent’s death.
- Manage tax rates – this was the primary reason for electing fiscal year ends for decedents who passed away in 2012. With the American Tax Relief Act of 2012 (passed in 2013), the highest tax rate moved from 35% in 2012 to 39.6% in 2013. In addition, the 3.8% Net Investment Income Tax went into affect from the 2010 Affordable Care Act, thus creating an effective highest marginal rate of 43.4%. Because tax rates are applied for years “beginning in” the calendar year, for most 2012 decedents, the preferred year end was Nov 30th. Because the following year began on Dec 1 of 2012 and effectively allowed the estate to benefit from the lower rates for an additional 11 months.
- Managing tax capacity – Estates will often collect large sums of income that were due to the decedent in the first couple of months after
his/her date of death, but administration expenses tend to be paid later in the administration process. This may cause the estate to pay tax at a higher rate the first year and then lose the benefit of deductions in the subsequent years. If the executor knows that administration is going to take longer than 12 months, it may make sense to elect a fiscal year that ends two – three months after the decedent’s date of death. This will split the collection of income into multiple years, allow the estate to offset the income with a $600 exemption each year, and potentially take advantage of a lower tax rate. This strategy is particularly useful in a small estate where distributions may be delayed. - Minimizing the number of returns required to be filed – administration of an estate is expensive and being able to administer and distribute an estate in less than 12 months is unlikely. By maximizing the first year to 12 months through electing a fiscal year, the executor may be able to limit the number of income tax returns required to be filed.
Despite the benefits of a fiscal year election, sometimes a calendar year is more practical. If an estate is not well organized and holds mostly investment accounts, you can simplify the tax reporting by electing a calendar year and filing income tax returns from the tax documents (e.g. Form 1099’s) that are issued to the estate. This is particularly true if the decedent passed away early in the calendar year and there is not much opportunity for deferral.
Another item to keep in consideration is that the fiscal year election is only available to estates. Trusts are generally required to file on a calendar year. However, certain revocable living trusts may qualify to elect to be treated as an estate for income tax reporting.
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