Aidan Trotter Andrade

Advanced Accounting

UMPI

09/10/2024

Accounting for Estates & Trusts

Estates and trusts are important legal and financial structures that
come into play when managing and transferring assets, often after
someone passes away or when they want to set aside money for specific
purposes. An estate refers to all the property and assets a person owns at
the time of their death. A trust, on the other hand, is a legal arrangement
where one party (the trustee) holds and manages assets for the benefit of
another party (the beneficiary).

Proper accounting for estates and trusts is important for several

reasons. First, it ensures that the deceased person's wishes are carried out
correctly and that their assets are distributed as intended. Second,
accurate accounting helps in calculating and paying the right amount of
taxes, avoiding potential legal issues with tax authorities. Third, it provides
transparency to beneficiaries, executors, and trustees, reducing the
likelihood of disputes or misunderstandings about how assets are being
managed and distributed. Accounting for estates and trusts involves
tracking all income, expenses, assets, and liabilities. This process can be
complex, especially for large estates or trusts with multiple beneficiaries. It
requires a thorough understanding of various legal and financial concepts,
including probate laws, tax regulations, and fiduciary responsibilities.

Probate laws are the rules that govern how a deceased person's
estate is handled. These laws come into play when someone dies, whether
they have a will or not. The main goal of probate is to make sure that the
deceased person's debts are paid, and their remaining assets are given to
the right people. When someone dies, their estate usually goes through a
legal process called probate. This process is overseen by a court, typically
called a probate court. The court's job is to make sure everything is done
properly and fairly. During probate, the court will confirm that the will, if
there is one, is valid, appoint someone (called an executor or administrator)
to manage the estate, identify and list all the assets in the estate, pay off
any debts or taxes the deceased person owed, and distribute what's left to
the heirs or beneficiaries.

Probate laws can be different in each state. Some states have

simpler processes for smaller estates, while larger estates might need to go
through a more complex probate process. It's important to note that not all
assets go through probate. For example, life insurance policies with named
beneficiaries, joint bank accounts, and assets in a living trust usually don't
need to go through probate. The probate process can take several months
or even years, depending on how complicated the estate is and whether
there are any disputes among family members or potential heirs. It can also
be expensive, with court fees, lawyer fees, and other costs that come out of
the estate.

Some people try to avoid probate by using tools like living trusts or by
making sure their assets will pass directly to their beneficiaries. This is
because probate can be time-consuming and costly, and it makes the
details of the estate public. However, probate can also be helpful in some
cases, especially if there are disputes about the will or the distribution of
assets.

A will is a legal document that outlines how a person wants their

property and assets distributed after they die. It's an important tool for
ensuring that a person's final wishes are carried out and their loved ones
are taken care of. When someone dies with a valid will, they are said to
have died "testate." If they die without a will, they are considered
"intestate," and their estate is distributed according to state laws. A valid
will typically include several key components. First, it names an executor,
who is responsible for managing the estate and carrying out the
instructions in the will. The will also lists the beneficiaries - the people or
organizations who will receive the deceased person's assets. It often
includes specific instructions about who should receive items or amounts of
money, known as bequests or legacies. A will won’t control everything in a
person's estate. Some assets, like life insurance policies or retirement
accounts with named beneficiaries, pass outside of the will. Joint bank
accounts and property owned in joint tenancy also typically pass directly to
the surviving owner without going through the will.

For a will to be considered valid, it must meet certain legal

requirements. Generally, the person making the will (called the testator)
must be of legal age and sound mind. The will must be in writing and
signed by the testator. In most cases, it also needs to be witnessed by two
people who aren't beneficiaries in the will. The contents of a will can have a
significant impact on how an estate is distributed and taxed. For example,
leaving assets to a spouse or charity can reduce estate taxes. The will can
also create trusts to manage assets for minor children or other beneficiaries
who may need help managing their inheritance.

An executor is a person named in a will to manage the deceased

person's estate. If there's no will, or if the named executor can't or won't
serve, the court appoints someone called an administrator to perform this
role. Both executors and administrators are often referred to as personal
representatives of the estate. The executor has many important
responsibilities. They must locate and file the will with the probate court,
gather all the deceased person's assets, and create an inventory of these
assets. This inventory is important because it helps determine the total
value of the estate and what might be owed in taxes.

Another key duty of the executor is to pay off any debts the deceased
person had, including final bills and taxes. They use the estate's funds to
do this. The executor must also manage the estate's assets during the
probate process. This might involve making investment decisions or
maintaining properties. After debts and taxes are paid, the executor
distributes the remaining assets to the beneficiaries as specified in the will.
If there's no will, they follow state laws about who should inherit. The
executor must keep detailed records of all financial transactions related to
the estate and may need to provide an accounting to the court and
beneficiaries.

Being an executor can be a time-consuming job that requires

attention to detail and good organizational skills. Executors have a legal
duty to act in the best interests of the estate and its beneficiaries. They can
be held personally liable if they mismanage the estate's assets. Executors
are usually entitled to compensation for their services. The amount is often
set by state law or specified in the will but many executors who are close
family members choose to waive this fee.

Estate valuation is the process of determining the total worth of a

deceased person's estate. This is an important step in settling an estate
because it affects how assets are distributed, how much tax might be
owed, and how the estate is managed overall.

The first step in estate valuation is to identify all the assets owned by
the deceased. This includes things like real estate, bank accounts,
investments, vehicles, jewelry, and personal belongings. Once all assets
are identified, each item needs to be assigned a value. For some assets,
determining the value is straightforward. Bank accounts, for example, have
a clear cash value. For other assets, like real estate or valuable
collectibles, professional appraisers might be needed to determine their fair
market value. The fair market value is the price an asset would sell for on
the open market. The date of valuation is also important. Generally, assets
are valued as of the date of death. However, for very large estates that
might owe federal estate tax, there's an option to use an alternate valuation
date six months after the date of death. This can be helpful if the estate's
value has decreased significantly in that time.
 It's important to be accurate and thorough when valuing an estate.
Undervaluing assets could lead to accusations of tax evasion, while
overvaluing could result in paying more taxes than necessary. Executors
often work with professionals like accountants, lawyers, and appraisers to
ensure accurate valuation. The total value of the estate affects several
important factors. It determines whether the estate will owe federal or state
estate taxes. It also impacts how assets are distributed among
beneficiaries, especially if the will specifies percentages rather than specific
assets. Additionally, the value at the time of death becomes the new "cost
basis" for inherited assets, which is important for calculating capital gains
taxes if the heirs later sell the assets.

Devises, legacies, and bequests are terms used to describe different

types of gifts made in a will. While these terms are sometimes used
interchangeably, they have specific meanings in legal language. A devise
refers to a gift of real property, such as land or buildings, made through a
will. For example, if someone leaves their house to their child in their will,
this would be called a devise. A bequest is a gift of personal property made
in a will. This could include things like money, stocks, jewelry, or cars. If
someone leaves their collection of rare books to a friend in their will, this
would be a bequest. A legacy can include both devises and bequests. It
generally refers to any gift made through a will, whether it's real property,
personal property, or money.

There are different types of legacies that can be specified in a will. A

specific legacy is a gift of a particular item, like "I leave my diamond ring to
my daughter." A general legacy is typically a gift of money, like "I leave
$10,000 to my nephew." A residuary legacy refers to whatever is left in the
estate after all other legacies and debts have been paid. The order in which
these gifts are distributed can be important, especially if the estate doesn't
have enough assets to fulfill all the legacies. Typically, specific legacies are
paid first, followed by general legacies, and then residuary legacies.
However, the will can specify a different order if the person making the will
(the testator) wishes.
 Federal estate taxes are taxes that the U.S. government charges on
the transfer of property when a person dies. These taxes are paid by the
estate before the assets are distributed to the heirs. All estates have to pay
this tax. Only estates valued above a certain threshold are taxed. This
exemption is designed to protect smaller and medium-sized estates from
being burdened by these taxes.

Calculating the taxable estate involves several steps. First, the gross
estate is determined by adding up the fair market value of all assets owned
by the deceased at the time of death. This includes various types of
property such as cash, real estate, stocks, bonds, businesses, and even
some life insurance policies. Then, certain deductions are subtracted from
the gross estate. These can include debts, funeral expenses, legal fees,
and charitable donations. A significant deduction is the marital deduction,
which allows all assets passed to a surviving spouse to be exempt from
estate taxes. This provision is intended to prevent surviving spouses from
being forced to sell assets to pay estate taxes. After these deductions, if
the remaining amount (called the taxable estate) is above the exemption
threshold, then estate taxes are calculated on the excess amount. Many
people use estate planning strategies to reduce potential estate taxes, such
as making lifetime gifts, setting up trusts, or making charitable donations.
While these strategies can be complex, they can be effective tools for
managing estate tax liability.

In estate and trust accounting, there's an important distinction

between income and principal. Income refers to the money earned by the
estate or trust assets, such as interest from bank accounts, dividends from
stocks, or rent from properties. Principal, on the other hand, is the core
value of the assets themselves, like the original amount of money in a bank
account or the value of a house or stock shares. This distinction is crucial
because many wills and trusts have different rules for how income and
principal should be distributed. For example, a trust might specify that all
income should be paid to a beneficiary each year, while the principal
should be preserved for future generations.
 The allocation of expenses and receipts between income and
principal can have significant impacts on beneficiaries. For instance, if a
trust pays out all its income to one beneficiary but preserves the principle
for another, decisions about what counts as income versus principal
directly affect how much each beneficiary receives. There are standard
accounting rules to help determine what should be considered income and
what should be considered principal, but the terms of the will or trust
document usually take precedence if they specify how to handle certain
types of receipts or expenses. Executors and trustees have a responsibility
to manage and account for income and principal separately, ensuring that
they're distributed according to the terms of the will or trust and in
compliance with applicable laws. This often requires careful record-keeping
and may involve complex calculations, especially for long-term trusts or
estates with diverse assets.

A charge and discharge statement are an important accounting

documents used in estate and trust management. It provides a detailed
summary of all financial activities related to an estate or trust during a
specific period. The charge part of the statement shows everything the
executor or trustee is responsible for, including the initial value of the estate
or trust, any income earned, and any increases in asset value. The
discharge part shows how the executor or trustee has used or distributed
these assets, including payments of debts, taxes, and distributions to
beneficiaries. This statement helps ensure transparency and accountability
in the management of the estate or trust.

Charge and discharge statements are typically divided into two main
sections: principal and income. The principal section deals with the original
assets of the estate or trust and any changes to those assets. The income
section covers any earnings generated by the estate or trust assets, such
as interest, dividends, or rental income. This separation is important
because many wills and trusts have different rules for how the principal and
income should be handled or distributed. Executors and trustees use these
statements to show that they've managed the estate or trust properly and in
accordance with the terms of the will or trust document. Beneficiaries and
courts can review these statements to understand how the estate or trust
has been managed and to verify that all transactions have been handled
correctly.

Trust funds are legal arrangements where assets are held and
managed by one party (the trustee) for the benefit of another party (the
beneficiary). They can be set up for various purposes, such as providing for
minor children, managing assets for someone who can't manage them
themselves, or reducing estate taxes. There are different types of trusts,
including revocable trusts, which can be changed or canceled by the
person who created them, and irrevocable trusts, which generally can't be
altered once they're established. Some common types of trusts include
living trusts, charitable trusts, and special needs trusts. Each type of trust
has its own rules and benefits, and the choice depends on the specific
goals of the person setting up the trust.

Trust funds require careful management and accounting. The trustee

has a legal duty to manage the trust's assets in the best interest of the
beneficiaries, following the instructions laid out in the trust document. This
involves keeping detailed records of all transactions, investing the trust's
assets prudently, paying any necessary taxes, and distributing funds to
beneficiaries as specified in the trust. Trust accounting can be complex,
especially for larger trusts or those with multiple beneficiaries. It often
involves separating income and principal, as many trusts have different
rules for how each should be handled. Trustees may need to provide
regular accounting to beneficiaries and sometimes to courts, showing how
the trust's assets have been managed and distributed. Because of the legal
and financial complexities involved, many trustees work with lawyers and
accountants to ensure they're managing the trust properly and in
compliance with all relevant laws and regulations.

Estate and trust accounting often involves special considerations that

go beyond basic bookkeeping. One important aspect is the need to balance
the interests of different beneficiaries. For example, in a trust that pays
income to one beneficiary while preserving principal for another, the trustee
must carefully categorize receipts and expenses as either income or
principal. This can be complex, especially with assets like stocks that may
provide both dividends (income) and growth (principal). Another special
consideration is tax planning. Estates and trusts are subject to their own tax
rules, which can be quite different from individual or business taxes.
Executors and trustees need to make decisions that minimize the overall
tax burden on the estate or trust and its beneficiaries, which might involve
timing distributions or choosing particular investments.

Another important consideration in estate and trust accounting is

dealing with unique or hard-to-value assets. Estates might include things
like family businesses, art collections, or intellectual property rights, which
can be difficult to value and manage. Trustees may need to hire specialized
appraisers or consultants to properly account for these assets. Additionally,
many trusts are designed to last for long periods, even across generations.
This requires long-term planning and careful record-keeping to ensure that
the trust's purposes can be carried out over time, even as laws, economic
conditions, and beneficiaries' needs change. Executors and trustees also
need to be aware of legal requirements for providing information to
beneficiaries and courts. Different states have different rules about what
information must be shared and how often and failing to meet these
requirements can lead to legal problems.

Record keeping and reporting are essential aspects of estate and

trust management. Executors and trustees have a legal duty to maintain
accurate and detailed records of all financial transactions related to the
estate or trust. This includes keeping track of all income received,
expenses paid, assets bought or sold, and distributions made to
beneficiaries. Good record keeping involves organizing and storing
financial documents, such as bank statements, investment reports,
receipts, and tax returns. It's important to keep these records in a secure
place and in a format that's easy to understand and access. Many
executors and trustees now use specialized software or digital tools to help
manage this information, but even with these tools, maintaining organized
and complete records requires consistent effort and attention to detail.

Reporting is the process of sharing information about the estate or

trust with interested parties, such as beneficiaries, courts, and sometimes
tax authorities. The exact reporting requirements can vary depending on
the terms of the will or trust document, state laws, and the complexity of the
estate or trust. Typically, executors and trustees need to provide regular
accountings that show the current assets of the estate or trust, any income
earned, expenses paid, and distributions made. These reports help
beneficiaries understand how the estate or trust is being managed and
ensure that the executor or trustee is fulfilling their responsibilities. In some
cases, these reports must be filed with a court for review. Accurate and
timely reporting is crucial for maintaining transparency and trust, and for
avoiding legal disputes. It's also important for tax purposes, as estates and
trusts often need to file their own tax returns. Good record keeping makes
the reporting process much easier and more reliable, which is why these
two aspects of estate and trust management are so closely linked.