(7)
Gross income of
an estate.
a.
In
general.
26 U.S.C.
Section
641(b) provides that
the taxable income of an estate or trust shall be computed in the same manner
as the taxable income of an individual, except as modified in Subchapter J of
the Internal Revenue Code. The gross income of an individual and, therefore,
the gross income of an estate or trust, is not given a definitive meaning in
26 U.S.C. Section
641. Paragraphs 700.8(7)
"d"
to
"q" describe the most common kinds of income of an estate
or trust. However, those paragraphs are not intended to identify all types of
taxable income.
b.
Definition of the period of administration. The income charged
to the decedent's estate is reportable by the personal representative for each
taxable year during the period of the administration of the decedent's estate,
if the minimum filing requirements are met. The period of administration for
Iowa income tax purposes is determined by applying federal tax law to Iowa
estates because Iowa taxable income is the same as federal taxable income,
subject to the adjustments provided in Iowa Code sections
422.7 and
422.9.
Old Virginia
Brick Co., Inc. v. Commissioner, 367 F.2d
276 (4th CA 1966);
First National Bank of Ottumwa v. Bair, 252 N.W.2d 723 (Iowa
1977). It is the period actually required by the personal representative to
perform the ordinary duties of administration, such as the collection of assets
and the payment of debts, taxes, legacies and bequests, whether the period
required is longer or shorter than the period specified under the probate code.
See federal regulations 1.641(b)-3(a). An estate will be considered terminated
for income tax purposes when all of the assets have been distributed, except
for a reasonable amount set aside in good faith for the payment of
unascertained or contingent liabilities and expenses. The delay in closing the
estate cannot be capricious.
Frederich v. Commissioner, 147
F.2d 796 (5th CA 1944). If the period of administration is terminated for
income tax purposes, the heir or beneficiary is charged with the
income.
c.
The estate's
first return-special considerations. Death terminates the decedent's
taxable year. Income received the day of the decedent's death is to be reported
on the decedent's final individual return. See
26 U.S.C.
443(a)(2); federal
regulation Section 1.443-1(a)(1).
The taxable year of a decedent's estate begins the day after
the decedent's death. Income received after the decedent's death is either
chargeable to the decedent's estate or to the person succeeding to the property
producing the income. See 700.8(5)"a" and
700.8(5)"b." Income the decedent had a right to receive prior
to death, but did not receive before death, is not the decedent's income, but
is income in respect of a decedent and is chargeable either to the decedent's
estate when received or to the person succeeding to the right to income. See
26 U.S.C. Section
691(a) and applicable
federal regulations on what constitutes income in respect of a decedent. Trade
or business expenses, interest, taxes and expenses for the production of income
owing by the decedent at death, but unpaid, and the allowance for depletion on
income not received at death, are not deductible on the decedent's final
return. These are deductible by the estate or the person succeeding to the
property when paid. Medical expenses incurred by the decedent, but unpaid at
death, are not deductible by the estate. These are deductible on the decedent's
individual return for the year the expenses were incurred, if paid within one
year after the decedent's death and if the medical expense is not claimed as a
deduction for federal estate tax purposes under
26 U.S.C. Section
2053. See
26 U.S.C. Section
213(d) and federal
regulations thereunder relating to deductible medical expense of a decedent.
Funeral expense is not a deductible item for income tax purposes, although it
is a deductible expense for federal estate tax and Iowa inheritance tax
purposes. See 701-paragraphs 900.6(1)"g" and
900.6(3)"b." Unused ordinary and capital losses remaining
after the decedent's income tax liability for the year of death has been
determined are not carried forward to the decedent's estate. The unused losses
terminate with death, except to the extent they may be used by the decedent's
surviving spouse. See Rev. Ruling 74-175, 1 CB 52 (1974). The estate of a
decedent is a different taxpayer than the decedent.
d.
Dividends. All income
classified as dividends under
26 U.S.C. Section
61 and federal regulation section 1.61-9,
received or constructually received, during the taxable year constitutes gross
income to the estate or trust. However, some income labeled as dividends is for
tax purposes classified as interest. For example, income from cooperative
banks, credit unions, domestic building and loan associations, domestic savings
and loan associations, federal savings and loan associations and mutual savings
banks are considered interest and not dividends.
e.
Interest. All interest
received or constructually received during the taxable year, with the exception
of interest, but not capital gain, from federal securities and from certain
bonds issued by the state of Iowa and its political subdivisions listed in rule
701-302.3 (422) is income to the
estate or trust. Interest from securities issued by a state and its political
subdivisions or from foreign securities is included in gross income for Iowa
tax purposes, even though the interest may be exempt from federal income tax,
except for those bonds listed in rule
701-302.3 (422).
f.
Partnerships and other estates and
trusts. If a partnership in which the decedent had an interest is not
terminated at death, the deceased partner's share of the partnership income is
considered to be all received at the end of the partnership taxable year. As a
result, none of the partnership income is chargeable to the deceased partner,
unless the day of the partner's death coincides with the day the partnership
year ends. It is chargeable to the deceased partner's estate or the person
succeeding to the partner's interest, notwithstanding the fact the deceased
partner may have withdrawn most or all of the deceased partner's share of the
partnership income prior to death. Federal regulation section
1.706-1(C)(3)(ii); Rev. Ruling 68-215, 18 I.R.B. 14 (1968).
In general, if an estate or trust and its beneficiaries have
different taxable years, the beneficiary is required to report the income from
the estate or trust as if it were all paid on the last day of the taxable year
of the estate or trust. Federal regulation section 1.662(C)-1. Hay v.
U.S., 263 F. Supp. 813 (D.C. Tex. 196 7). However, if the beneficiary
dies during the taxable year of an estate or trust, the taxable income of the
beneficiary's estate includes only the portion of the income of the other
estate or trust which was required to be distributed to the beneficiary, but
was not in fact distributed to the beneficiary before death. The income that
was in fact distributed by the other estate or trust prior to the beneficiary's
death is properly included in the beneficiary's final income tax return. See
federal regulation 1.662(C)-2.
g.
Rents and royalties.
Income received after death for the use or occupancy of the decedent's real and
personal property is the income of the decedent's estate or the income of the
person succeeding to the property. See 700.8(5)
"a" and
700.8(5)
"b." If the rental income was accrued, but unpaid at
death, the accrued rent is income in respect of a decedent and is to be
included as income, either by the estate or the person succeeding to the right
to the income, in the taxable year when payment is received. Rent is not
limited to payments in cash. It includes, but is not limited to, crop share
rental payments when the decedent was a nonparticipating landlord.
Alvin R. Huldeen Estate v. Department of Revenue, Sac County
District Court, Probate No. 14,6 61 (1975). Income from the sale of grain and
livestock in the estate of a participating landlord which was on hand at death
is classified as income from a farm or business and not rental income.
Income from royalties would include, but is not limited to,
payment for rights in books, plays, copyrights, trademarks, formulas, patents
and from the exploitation of natural resources.
h.
Farm and business income-in
general. The death of the decedent does not alter the rules under
which business and farm income is computed for income tax purposes. However,
the decedent's estate as a new taxpayer may adopt a taxable year which is
different from the decedent's taxable year. Also, the decedent's estate may
adopt a different accounting method. The rules for determining a gain or loss
from the sale or exchange of assets in the decedent's estate are the same as
those for an individual. However, see 700.8(7)"i" and
700.8(7)"j" for the basis for gain or loss from the sale or
exchange of property acquired from a decedent and 700.8(7)"l"
for depreciation rules for property acquired from a decedent.
i.
Basis for gain or loss-the
stepped-up basis. Property acquired from a decedent receives a new
basis for determining gain or loss when the property is sold or exchanged. This
rule does not apply to property which is classified as income in respect of a
decedent and certain other property designated in
26 U.S.C. Section
1014(b) and (c) and the
federal regulations thereunder. The basis of property acquired from a decedent
is either:
(1) its fair market value at the
time of death or the alternative value when it has been elected for federal
estate tax purposes under 26
U.S.C. Section
2032, or
(2) its special use value when the property
has been valued for federal estate tax purposes under
26 U.S.C. Section
2032A. The decedent's basis in the property
is not relevant.
If an estate files a federal estate tax return, then the
basis is governed by the federal estate tax value determination. However, if an
estate does not file a federal estate tax return, then Iowa inheritance tax
valuation governs the basis for the property that is acquired.
EXAMPLE 1. Decedent A died July 1, 1995, owning a 160-acre
Iowa farm which the decedent purchased in 1955 for $200 per acre, or $32,000.
At the time of A's death, the farm had a fair market value of $2,000 per acre,
or $320,000. In 1965, A and surviving spouse B purchased a residence for
$35,000 in joint tenancy. Surviving spouse B, a school teacher, contributed one
half of the purchase price of the residence; therefore, one-half of the
residence is excluded from A's gross estate. At the time of A's death, the
residence had a fair market value of $100,000. Surviving spouse B received the
entire estate and did not elect the alternative or special use
valuation.
B's basis for gain or loss in the farm and residence is
computed as follows:
|
Asset
|
Fair Market Value at
Death
|
New Basis for Gain or
Loss
|
|
|
160-acre farm
|
$320,000
|
|
$320,000
|
|
Residence
|
100,000
|
1/2 new basis
|
50,000
|
|
|
1/2 old basis
|
17,500
|
|
|
|
$ 67,500
|
Since the entire farm was acquired from A, its basis is 100
percent of the fair market value at death. Only one-half of the residence was
acquired from A; therefore, only one half of the residence receives a new basis
on A's death.
j.
No new basis-income in respect of a decedent. Property or
rights to income, classified as income in respect of a decedent under
26 U.S.C. Section
691, do not receive a new basis upon the
decedent's death. It is a special exception to the stepped-up basis rule. See
26 U.S.C. Section
1014(c) and federal
regulation section 1.1014-1(c).
Examples of income in respect of a decedent include, but are
not limited to, the following:
1.
Wages, salary or other compensation for personal services earned which are
unpaid at death.
2. Interest
accrued on obligations, such as bank accounts, certificates of deposit, bonds
and promissory notes.
3. Accrued
interest and unpaid capital gain on real and personal property installment
contracts.
4. Federal income tax
refunds, if claimed as a deduction on an Iowa income tax return.
5. Accounts receivable, if the decedent was
on a cash accounting basis.
6. Crop
share rent if the decedent was a nonparticipating landlord on a cash basis.
This also includes growing crops, which are to be valued at the time of the
decedent's death or alternate valuation date.
The basis for gain or loss for property classified as income
in respect of a decedent is the decedent's basis in the property at the time of
death.
k.
Gain or loss-holding period. For the purpose of determining
whether the sale or exchange of property is a long- or short-term gain or loss,
the holding period of property acquired from a decedent begins the day after
the decedent's death, regardless of how long the property was held by the
decedent. See 26 U.S.C. Section
1.1223, federal regulation Section 1.1223-1(j).
However, if the property acquired from a decedent is sold or otherwise disposed
of within one year of the decedent's death, it will be considered to have been
held over one year. In general, this is a sufficiently long holding period to
qualify the sale or exchange as a long-term gain or loss transaction. However,
a one-year holding period does not qualify horses and cattle held for draft,
breeding or dairy purposes for long-term gain or loss treatment. A 24-month
holding period is required by
26 U.S.C. Section
1231(b)(3) for the
transaction to be considered long-term.
Therefore, if this kind of livestock is acquired from a
decedent (which is usually the case) and is sold or exchanged within 24 months
after the decedent's death, the sale is considered a short-term transaction.
See Rev. Ruling 75-361, 2 C.B. 344 (1975). However, even if the sale or
exchange results in a short-term gain or loss transaction, the property has a
stepped-up basis, because it is acquired from a decedent. See
700.8(7)"i."
l.
Depreciation-property acquired
from a decedent. Property acquired from a decedent which is subject to
the allowance for depreciation, receives the same value for depreciation
purposes as its basis for gain or loss in a sale or exchange, regardless of its
basis or remaining useful life in the hands of the decedent. See
26 U.S.C. Sections
167(g) and
1011; federal regulation Section
1.167(g)-1. For the purpose of determining the life of an asset subject to the
allowance for depreciation, the property is treated as if it were acquired the
day after the decedent's death. See federal regulation Section 1.167(a)-10. The
decedent's estate or other person acquiring depreciable property from the
decedent may adopt a depreciation method different from that used by the
decedent for the depreciable asset. See federal regulation section
1.167(a)-7.
m.
Section
641(c) gain for sales or exchanges before August 6, 1997. The gain
that is excluded from federal taxable income under
26 U.S.C. Section
641(c) for sales or
exchanges before August 6, 1997, constitutes Iowa gross income to the estate or
trust. This gain for sales or exchanges before August 6, 1997, is excluded from
taxable income for federal purposes because it is subject to a special federal
tax under 26 U.S.C. Section
644(a). This special federal
tax was repealed for sales or exchanges occurring on or after August 6, 1997.
The effect is to tax the gain for sales or exchanges before August 6, 1997,
which receives separate treatment for federal income tax purposes, in the same
manner as this gain was taxed prior to the enactment of the federal Tax Reform
Act of 1976.
n.
Nonrecognition of gain-installment sale contracts before October 20,
1980. No gain or loss is realized by the estate of a decedent-seller
dying before October 20, 1980, when the purchaser in an installment sale
contract inherits the seller's rights under the contract of sale. The merger of
the asset with the liability is considered to be a nontaxable transfer.
Therefore, any unreported gain from the installment sale contract is not
subject to income tax when there is a merger of the asset with the liability.
See Senate Finance Committee Report to P.L. 96-471.
o.
Recognition of gain-installment
sale contracts after October 19, 1980. Effective for estates of
decedents dying after October 19, 1980, Section 3 of Public Law
96-471
(Installment Sales Revision Act of 1980) provides for the recognition of the
remaining gain on installment sales contracts when the debtor inherits the
obligation and thereby causes a merger of the asset with the liability. The
rule after October 19, 1980, is if, as a result of the death of the holder of
an installment sale obligation (usually the seller), the installment sale
obligation is transferred to the debtor (usually the purchaser); or, if the
installment sale obligation is canceled either as a result of the holder's
death or by the personal representative of the holder's estate, the remaining
gain from the installment sale contract not previously reported is recognized
by the holder's estate, as if the remaining balance due had been immediately
paid in full. The merger of the asset with the debt is treated as a taxable
transfer by the estate of the holder (seller) of the obligation and is income
in respect of a decedent realized by the holder's estate.
If the obligation was held by a person other than the seller,
such as a trust, the cancellation of the obligation will be treated by that
person as a taxable transfer immediately after the seller's death. In the
absence of some act of canceling the obligation, such as by distribution or
notation which results in cancellation under Iowa Code chapter 554 (Uniform
Commercial Code), the disposition is considered to occur no later than the time
the period of administration of the estate is ended. See Senate Committee
Report to P.L. 96-471.
For gain recognition purposes, if the seller and the debtor
were related parties, the value of the installment contract is considered to be
not less than full face value, regardless of its value for Iowa inheritance tax
or federal estate tax purposes. A related party includes, but is not limited
to, the spouse, child (including an adopted child), grandchild, or parent of
the seller; an estate in which the seller is a beneficiary; a partnership in
which the seller is a partner; a corporation in which the seller owns 50
percent or more of the stock; and a trust where the seller is a beneficiary or
is treated as the owner.
If the debtor inherits the obligation to pay or another share
of the estate, the personal representative of the holder's estate must set off
the contract of sale to the debtor when satisfying the debtor's share of the
estate if the debtor's share of estate equals or exceeds the face value of the
contract. In this case, the entire contract is canceled and all of the
unreported gain is income in respect of a decedent to the estate. If the
debtor's share of the estate is less than the face value of the contract of
sale, the contract of sale is canceled only to the extent of the debtor's share
of the estate and only a like percentage of the unreported gain is considered
income in respect of a decedent received immediately by the estate. See Iowa
Code section 633.471 for the right of
retainer and setoff. In re Estate of Ferris, 234 Iowa 960, 14
N.W.2d 889 (1944).
p.
Nonresident aliens-sales of Iowa real estate. Nonresident
aliens and estates and trusts with a situs outside the United States must
include the gain from the sale or exchange of Iowa real estate as taxable
income, even though the real estate was not effectively connected with a trade
or business carried on in the United States. See Public Law
96-499. Any gain
paid or distributed to a nonresident alien or an estate or trust with a situs
outside the United States is subject to Iowa income composite tax, unless the
gain has been previously accumulated and any tax due paid. Paragraph
700.4(9)
"d" and 701-Chapter 405 contain more information on
the requirement to pay Iowa composite tax on distributions to nonresident
beneficiaries and individuals.
q.
Miscellaneous income. Miscellaneous income is an inclusive
term. It includes those items of income that are subject to Iowa income tax
under Iowa Code section
422.6 which are not classified
as dividends, interest, rent and royalties, income from partnerships and other
fiduciaries, business or farm income and gain or loss from the sale or exchange
of assets. Examples of miscellaneous income include, but are not limited to:
wages and salaries earned by the decedent which are unpaid at death; federal
income tax refunds, if the refund was deducted from an Iowa income tax return;
and distributions to the estate from an employee's pension or retirement plan,
if subject to Iowa income tax.
r.
Grantor trusts. If the income of a trust is subject to the
grantor trust rules under 26
U.S.C. Sections
671 to
679, the grantor of the trust or
other person specified in the trust instrument, and not the trust, is
considered the owner of the income. This income is properly reportable on the
Iowa individual income tax return of the grantor or other individual treated as
the owner. The fiduciary income tax return of a grantor trust is an
informational return only. Items of income, deductions and credits of a grantor
trust should be reported on a separate statement attached to the fiduciary
return of income. See federal regulation Section 1.671-4. The taxable year of a
grantor trust must be the same as the taxable year of the grantor, or of the
other individual considered the owner of the income for tax purposes.
William Scheft, 59 T.C. 428. Examples of grantor trusts are,
but not limited to: trusts where the grantor or a nonadverse party has the
power to revoke the trust or to return the corpus to the grantor; trusts where
the grantor or a nonadverse party has the power to distribute income to or for
the benefit of the grantor or the grantor's spouse; and trusts where the
grantor has retained a reversionary interest in the trust, within specified
time limits. See federal regulation Section 1.671-1.
s.
"Equity trusts"-assignment of
future wages and salaries. The assignment of future wages, salaries or
other compensation for future services by a grantor to a trust (commonly called
"equity" or "family estate" trust) does not shift the tax burden on this income
from the grantor to the trust. The trust is subject to the grantor trust rules
under 26 U.S.C. Sections
671 to
679. The income of the trust is to
be reported by the grantor on an Iowa individual income tax return.
Lucas v. Earl, 281 U.S.
111, 74 L.Ed. 731, 50 S.Ct. 241
(1930);
Vnuk v. Commissioner, 621 F.2d
1318 (8th CA 1980);
Revenue Ruling 75-257, 2 C.B. 251 (1975);
In re August Erling, Jr., et
al., Director of Revenue decision, Docket No. 77- 237-2C-A
(1979).
t.
Adjustments to
federal taxable income. Iowa Code section
422.4(16)
provides that the Iowa taxable income of estates and trusts is federal taxable
income, without the deduction for the personal exemption, subject to the
specific adjustments set forth in Iowa Code section
422.7 and the modifications
relating to federal and state income tax specified in Iowa Code section
422.9. The modifications have
these results:
(1) Federal income tax on the
income of Iowa situs estates and trusts is deductible for Iowa income tax
purposes in the year paid or accrued depending on the method of
accounting.
(2) Federal income tax
owed by Iowa resident decedents at the time of death is a deduction against
estate income in the year paid.
(3)
The federal income tax deduction allowable for estates and trusts with a situs
outside Iowa is the same as the deduction allowed for an estate or trust with a
situs in Iowa.
(4) Federal income
tax owed by a nonresident decedent at the time of death may be deducted the
same as a deduction allowed for an Iowa resident decedent. See 701-paragraph
303.3(4)"b" for the federal income tax deduction for
nonresident individuals.
(5) Iowa
income tax paid by the estate is not a deduction in computing Iowa taxable
income.
(6) The federal exemption
allowed to estates and trusts under
26 U.S.C. Section
642(b), that is, $600 for an
estate, $300 for simple trust and $100 for a complex trust, is not deductible
for Iowa income tax purposes.
(7)
Interest and dividends from federal securities, but not capital gain or loss,
is exempt from Iowa income tax and, therefore, is not part of the Iowa taxable
income of estates and trusts.
(8)
Interest and dividends from securities of a state and its political
subdivisions and from foreign securities are included in Iowa taxable income in
the year received, regardless of whether such interest and dividends are exempt
from federal income tax. However, see
701-302.3 (422) and
700.8(7)
"e" for the exemption for certain bonds issued by the
state of Iowa and its political subdivisions which are not included in Iowa
taxable income.
(9) See
700.8(7)
"m" for the includability of the gain for sales or
exchanges before August 6, 1997, excluded by
26 U.S.C. Section
641(c), in the Iowa taxable
income of a trust.
(10) See
701-paragraph 900.5(12)"b" for the inheritance tax exemption
for the portion of an employee's pension or retirement plan subject to Iowa
income tax.
(8)
Deductions from gross income.
a.
In general. The
deductions allowable in computing taxable income of estates and trusts are
generally those relating to a trade or business and the expenses attributable
to investment income. The important distinction between the deductions
allowable in computing federal adjusted gross income and itemized deductions
for individual income tax has only limited application in determining the
taxable income of estates and trusts. Many deductions in computing the taxable
income of an individual have no application to the deductions allowable in
computing the taxable income of an estate or trust, due to the nature of
estates and trusts and the sources of their income. For example, medical
expense and moving expense deductions are applicable only to individuals, but
taxes and interest expense can be incurred by both individuals and estates and
trusts. Also the deduction for distribution to beneficiaries has no application
to individual income tax.
b.
Interest expense. Interest paid on obligations secured by
property subject to the personal representative or trustee's right of
possession is a deduction from gross income in the year paid. Interest on debts
or charges which the personal representative or trustee is obligated to pay is
also a deduction against gross income in the year paid. Interest on obligations
secured by property, not subject to the personal representative's right of
possession, is not deductible from the gross income of the estate, but is a
deduction for the person succeeding to the encumbered property. No distinction
is made between business and nonbusiness interest. See Iowa Code section
633.278 (probate code) for
circumstances when the personal representative of the decedent's estate is
required to pay the debt and interest on encumbered property, even though the
property is not subject to the personal representative's right of possession.
J.S. Dean, 35 T.C. 1083 (1961); Revenue Ruling 57-481, 2 C.B.
48 (1957).
c.
Taxes. The taxes deductible against the gross income of an
estate or trust are limited to the taxes deductible for individual income tax
purposes under 26 U.S.C.
Section
164, subject to the adjustments
specified in Iowa Code section
422.9 relating to federal and
state income taxes. Real estate and personal property taxes, including the
taxes due, but unpaid at death, are only deductible by the estate on the
decedent's property which is subject to the personal representative's right of
possession. Federal income tax on the income of an estate or trust and federal
income tax owing by an Iowa decedent at the time of death, including the
federal income tax owing on the decedent's final return for the year of death,
are deductible by the estate or trust in the year paid. For tax years on or
after January 1, 1982, the federal income tax deduction attributable to Iowa by
nonresidents of Iowa shall be the same deduction as is available for resident
taxpayers. See 701-subrule 303.3(4) and Iowa Code section
422.5(1)
"j." Examples of taxes not deductible include, but are not
limited to: federal estate tax (except federal estate tax paid on income in
respect of a decedent); Iowa income and inheritance tax; federal gift taxes;
and special assessments increasing the value of property. See
26 U.S.C. Section
275.
d.
Depreciation and
depletion-allocation. If the personal representative of a decedent's
estate has the right to the possession of property eligible for the
depreciation allowance, the depreciation is a deduction from the estate's gross
income when the income for the taxable year is accumulated by the estate. If
all or part of the income for the year is distributed to the beneficiaries, the
deduction for depreciation is apportioned between the estate and the
beneficiaries on the basis of the income allocated to each. In the case of an
estate, the deduction for depreciation follows the income.
The same depreciation rules apply to simple and complex
trusts, with the exception that if the trustee has the right to maintain a
reserve for depreciation, and in fact does so, the deduction for depreciation
is allocated to the trust to the extent of the reserve maintained, regardless
of whether the income is accumulated or distributed. See
26 U.S.C. Section
167, federal regulation 1.167 H-1(b); Revenue
Ruling 74-530, 2 C.B. 188 (1974).
The rules governing the allowance for depreciation are also
the rules to be applied to the allowance for depletion under
26 U.S.C. Section
611.
e.
The charitable deduction.
The charitable deduction allowed estates and trusts under
26 U.S.C. Section
642(c) is not subject to the
percentage of income limitation applicable to individual taxpayers under
26 U.S.C. Section
170(b). The allowable
deduction is governed by the terms of the will or trust instrument, which can
provide for unlimited payments for charitable purposes. However, an unused
charitable contribution carryover of the decedent remaining after the
decedent's individual income tax liability for the year of death is determined
is not available to the estate. The unused carryover terminates at death,
except to the extent it may be used by the surviving spouse. See federal
regulation Section 1.170A-10(d)(4)(iii). The deduction is limited to payments
of gross income or amounts permanently set aside for charitable uses. A simple
pecuniary bequest to charity in the decedent's will does not qualify for the
charitable deduction from the estate's income. It is a payment from the corpus
of the estate.
Frank Trust of 1931, 145 F.2d
411 (3rd CA
1949). However, the pecuniary bequest to charity is exempt from the Iowa
inheritance tax under Iowa Code section
450.4 if it meets the exemption
requirements.
f.
Other
deductions. The category of other deductions includes those deductions
allowable in computing taxable income not receiving special itemized treatment
on the Iowa fiduciary return of income. The most common kind of other
deductions is the expense of administration of an estate or trust paid during
the taxable year. Expenses of administration include, but are not limited to: a
reasonable fee and the necessary expenses of the attorney employed by the
personal representative of an estate or the trustee of a trust; a reasonable
fee and the necessary expenses of the personal representative of an estate or
the trustee of a trust; accounting fees; court costs; and interest paid on
federal estate tax during an extension of time to pay. However, administration
expenses are subject to the no double deduction rule. See
26 U.S.C. Section
642(g) and 700.8(8)
"g." Salaries or fees paid during the taxable year for the
management of a farm or business are expenses directly attributable to the
production of a specific kind of income and are more properly deductible on the
farm schedule F or the business schedule C.
g.
The no double deduction
rule. Expenses of administration, certain debts of the decedent like
medical expenses incurred prior to death and losses during the period of
administration are proper deductions in computing both the taxable income of an
estate or trust (or on the decedent's individual return in case of medical
expenses) and the taxable estate for federal estate tax purposes under
26 U.S.C. Sections
2053 and
2054. The no double deduction rule
only applies to trusts when the trust assets are included for federal estate
tax purposes. 26 U.S.C.
Section
642(g) prohibits the
double deduction of those items which qualify as deductions for both taxes. To
prevent the double deduction, it is a prerequisite for the allowance of the
deduction for income tax purposes that a statement be filed with the fiduciary
return of income waiving the right to claim the item or portion of the item as
a deduction on the federal estate tax return. The waiver once filed with the
fiduciary return of income is irrevocable. However, unless the waiver has been
filed, the decision to claim the deduction or portion of the deduction on the
federal estate tax return can be changed anytime prior to the time the item or
portion of the item is finally allowed for federal estate tax purposes.
The waiver requirement has no application to estates and
trusts not required to file a federal estate tax return.
The no double deduction rule has no application to deductions
in respect of a decedent, such as deductions relating to trade or business
expenses, interest, taxes, expenses for the production of income and the
allowance for depletion, which are deductible both for income tax purposes and
federal estate tax purposes. See
26 U.S.C. Section
691(b) and 26 CFR Section
1.691(b)-1 for what constitutes deductions in respect of a decedent.
The no double deduction rule does not apply to the deduction
of an item for Iowa inheritance tax purposes. Items are deductible or not in
computing the taxable shares for Iowa inheritance tax purposes by reference
alone to Iowa Code chapter 450.
Assuming an item is otherwise deductible for income and
inheritance tax purposes, the no double deduction rule has the following
applications for Iowa income and inheritance tax:
1. Estates and trusts not required to file a
federal estate tax return can claim the item as a deduction on both the Iowa
inheritance tax return and the Iowa fiduciary income tax return.
2. Estates and trusts required to file a
federal estate tax return can claim the item as a deduction on the Iowa
inheritance tax return. In addition, the same item or portion of the item is a
deduction on the Iowa fiduciary income tax return if the item or portion of the
item is not claimed as a deduction on the federal estate tax return. If it is
claimed as a deduction on the federal estate tax return, it is not deductible
on the Iowa fiduciary income tax return.
3. For tax years ending on or after July 1,
2015, estates or trusts required to file a federal estate tax return can claim
administrative expenses as a deduction on the Iowa fiduciary income tax return,
regardless of whether the item or a portion of the item was claimed on the
federal estate tax return.
This paragraph applies both to estates and trusts with a
situs within and without Iowa.
h.
The net operating loss
deduction. Subject to the modifications specified in federal
regulation Section 1.642(d)-1, an estate or trust is allowed a deduction for
net operating loss which is computed in the same manner as the net operating
loss deduction allowable to individual taxpayers. The modification especially
applicable to estates and trusts is: The charitable deduction allowable under
26 U.S.C. Section
642(C) is disregarded. See
federal regulation Section 1.642(d)-1.
The rule that nonbusiness deductions are only taken into
account to the extent of nonbusiness income applies equally to estates and
trusts and individual taxpayers. Attorney fees and the fees of the trustee or
personal representative, without a showing that these administrative expenses
were incurred in carrying on the decedent's or grantor's trade or business, are
a nonbusiness deduction. Refling v. Commissioner, 47 F.2d 895
(8th CA 1930). Therefore, any excess fees over income are not available for a
carryback to a prior taxable year or a carryforward to a future taxable year.
Mary C. Westphal, 37 T.C. 340 (1961). However, see
700.8(9)"a" for the special rule on excess deductions in the
year the estate or trust terminates. Net operating losses are available to the
estate or trust and can be carried back for distribution to a beneficiary, with
the exception that any unused loss must be distributed to the beneficiaries in
the year the estate or trust terminates.
Estates and trusts with a situs outside Iowa are allowed a
deduction only for a net operating loss attributable to a trade or business
activity carried on in the state of Iowa. In the event the trade or business
activity giving rise to the loss is carried on both in Iowa and another state,
the net operating loss deduction for Iowa income tax purposes must be prorated
on the ratio of the Iowa gross receipts from the trade or business to the total
gross receipts from the trade or business. See 701-subrule 302.18(2) for the
computation of the net operating loss deduction of a nonresident
decedent.
i.
Capital
loss deduction. The capital loss deduction of an estate or trust is
computed in the same manner as the capital loss deduction for individual
taxpayers. However, it is a deduction only for the estate or trust and is not
distributable to a beneficiary, except in the year the estate or trust
terminates.
Grey v. Commissioner, 118 F.2d
153, 141 ALR 1113
(7th CA 1941);
Jones v. Whittington, 194 F.2d
812 (10th CA
1952). Capital losses do not enter into the computation of the deduction for
income required to be distributed currently to beneficiaries. During the period
of administration of the estate or trust, capital losses can be used only to
offset capital gain for simple trusts required to distribute income currently.
However, beneficiaries may derive immediate benefit from capital losses when
capital gain is required or permitted to be distributed to beneficiaries prior
to closure of the estate or trust, since the losses can be used to offset gain
before distribution.
j.
The
distribution deduction. Estates and trusts are allowed to deduct the
amounts of income required to be distributed currently and also other amounts
properly paid, credited or required to be distributed to the extent of the
distributable net income for the year. For income tax purposes, an estate of a
decedent is treated as a complex trust, because normally the personal
representative of an estate has the discretion whether or not to distribute
current income. Therefore, most distributions of income from a decedent's
estate fall under the category of "other amounts properly paid, credited or
required to be distributed." However, see
Colthurst v.
Colthurst, 265 N.W.2d 590 (Iowa 1978) for circumstances when the
personal representative of an estate is required to distribute current income
during the period of administration to a life tenant (the surviving spouse in
this case).
The distribution deduction allowed is limited to the
distributable net income of the estate or trust for the taxable year. If
amounts in excess of distributable net income are distributed to a beneficiary
of a decedent's estate, the excess does not constitute taxable income to the
beneficiary. Distributions made to a beneficiary of a complex trust in excess
of the distributable net income for the taxable year may or may not be
includable in the beneficiary's taxable income depending on whether the excess
distribution is governed by the throwback distribution rules under
26 U.S.C. Sections
665 through
668.
Estates and trusts with tax years beginning on or after
August 5, 1997, may elect to treat distributions made within 65 days of the end
of the tax year as having been made in the tax year of the estate or trust. If
amounts in excess of distributable net income are distributed to a beneficiary
of a decedent's estate, the excess does not constitute taxable income to the
beneficiary. Distributions made to a beneficiary of a complex trust in excess
of the distributable net income for the taxable year may or may not be
includable in the beneficiary's taxable income depending on whether the excess
distribution is governed by the throwback distribution rules under
26 U.S.C. Sections
665 through
668. Effective for distributions
made by domestic trusts in tax years beginning after August 5, 1997, there is a
repeal of the throwback rules found in
26 U.S.C. Sections
665 through
668. However, the repeal of the
throwback rules does not apply to trusts created before March 1, 1984, foreign
trusts, or domestic trusts that were once treated as foreign trusts, except as
provided by federal regulations.
Income distributed to a beneficiary of an estate or trust
retains the same character in the hands of the beneficiary as it had in the
estate or trust, with the exception of unused capital loss distributed on
closure to a corporation, in which case the loss is treated as a short-term
loss, regardless of its character in the estate or trust. See federal
regulation Section 1.642(h)-1(g). In addition, unless the will or trust
instrument specifically provides otherwise, a distribution to beneficiaries is
considered to be a proportionate distribution of the different kinds of income
composing the distributable net income of the estate or trust. See 26 U.S.C.
Section 662.2(b) and federal regulation Section 1.662(b)-1. The same character
and proportionate distribution rule is illustrated by the following:
EXAMPLE:
Decedent A, a resident of Iowa, died February 15, 1997. Under
the terms of the will, all the decedent's property was devised in equal shares
to beneficiary B, a resident of Phoenix, Arizona, and beneficiary C, a resident
of Cedar Rapids, Iowa. The estate adopted a calendar year as its taxable year.
For calendar year 1997, the estate had distributable net income of $50,000,
which is composed of:
|
Interest income
|
$10,000
|
|
Dividend income
|
5,000
|
|
Net Iowa farm income
|
35,000
|
|
Total
|
$50,000
|
On December 20, 1997, the estate distributed $12,500 to
beneficiary B, and $12,500 to beneficiary C. Beneficiaries B and C have
received a distribution for 1997 as follows:
|
Beneficiary
B
|
Beneficiary C
|
|
Interest income
|
$2,500
|
Interest income
|
$2,500
|
|
Dividends
|
1,250
|
Dividends
|
1,250
|
|
Farm income
|
8,750
|
Farm income
|
8,750
|
|
Total
|
$12,500
|
Total
|
$12,500
|
The estate is entitled to a deduction of $25,000 against
gross income in 1997 for the distribution to beneficiaries B and C and owes
Iowa income tax on the $25,000 income retained in the estate. Since the
interest income of the estate is 20 percent of the distributable net income, 20
percent of the distribution to beneficiaries B and C is considered interest
income. Likewise, 10 percent of the estate's distributable net income is
dividends and 70 percent farm income. The distribution to B and C consists of a
corresponding percentage of dividends and farm income. Beneficiary C, a
resident of Iowa, must report the entire distribution of $12,500 on a 1997 Iowa
individual income tax return. Beneficiary B, a resident of Arizona, is only
required to report the farm income portion of the distribution ($8,750) on a
1997 nonresident individual income tax return, because dividends and interest
are income from intangible personal property and were not derived from a
business, trade, profession or occupation carried on within Iowa by the
nonresident. See 701-subrule 302.16(5).
k.
The dividend exclusion.
Estates and trusts are eligible for the dividend exclusion allowed individual
taxpayers under 26 U.S.C.
Section
116 (the Iowa exclusion is $100 for
1981). The exclusion is allocated to the estate or trust if the dividend income
for the taxable year is accumulated. The dividend exclusion is allocated to the
beneficiaries when all of the distributable net income for the taxable year is
distributed. The distribution must not be diminished by the exclusion. The
dividend exclusion is then available to the beneficiaries after the dividends
distributed are added to any other dividends received by the beneficiaries
during the taxable year. If there is only a partial distribution of the
distributable net income of the estate or trust for the taxable year, the
dividend exclusion must be prorated between the beneficiaries and the estate or
trust on the basis of the percentage of the distributable net income
accumulated by the estate or trust and the percentage distributed to the
beneficiaries. A partial distribution of the dividends and exclusion is to be
reported and used by the beneficiaries for income tax purposes in the same
manner as the full distribution of dividends. See federal regulation Sections
1.116-1(a) and 1.661(c)-1.
l.
The capital gains deduction.
26 U.S.C. Section
1202(b) provides that an
estate or trust is allowed a deduction for net capital gain received during the
taxable year. Except for the requirement of allocation between the
beneficiaries and the estate or trust, the deduction is computed in the same
manner as the net capital gain deduction allowed individuals. See federal
regulation Section 1.1202-1 (b). If the net capital gain is allocated to
corpus, the estate or trust is entitled to the deduction. If the will or trust
instrument requires capital gain to be distributed to the beneficiaries or if
the trustee or personal representative of a decedent's estate is authorized to
allocate capital gain to income and distributes the capital gain, then the net
capital gain deduction is allocated to the beneficiaries and is not a deduction
to the estate or trust. The gain distributed must not be diminished by the
deduction. It must first be combined with any other capital gains and losses of
the beneficiary prior to determining whether the net capital gain deduction is
applicable for the beneficiary's taxable year.
If the net capital gain for the taxable year is partially
allocated to corpus and partially distributed, then the net capital gain
deduction is available to the beneficiaries only on the gain distributed and to
the estate or trust only on the gain accumulated. A partial distribution of
capital gain is treated for purposes of a beneficiary's income tax liability in
the same manner as a full distribution of capital gain.
m.
The Iowa throwback rule.
Iowa Code section
422.6 allows a trust beneficiary
receiving an accumulation distribution subject to the throwback rules under
26 U.S.C. Sections
665 through
668 a credit against the
beneficiary's income tax liability for the Iowa income tax paid by the trust on
the accumulated income distributed. The Iowa income tax paid by the trust on
the accumulated income distributed is deemed distributed to the trust
beneficiary, without interest, and is a credit for the year of distribution
against the portion of the Iowa income tax liability of the beneficiary which
is attributable to the accumulated distribution. The accumulated distribution
must be adjusted by the beneficiary to reflect income subject to Iowa income
tax. No refund is allowed the trust for the Iowa income tax deemed distributed
to the beneficiary. The beneficiary is not allowed a refund if the tax
distributed is in excess of the income tax liability attributable to the
distribution. Effective for distributions made by domestic trusts in tax years
beginning after August 5, 1997, there is a repeal of the throwback rules found
in 26 U.S.C. Sections
665 through
668. However, the repeal of the
throwback rules does not apply to trusts created before March 1, 1984, foreign
trusts, or domestic trusts that were once treated as foreign trusts, except as
provided by federal regulations.
n.
Federal estate tax paid on income in respect of a decedent.
For Iowa income tax purposes, Iowa Code section
422.7 makes no provision for
adjusting the deduction for federal estate tax paid when the income in respect
of a decedent includes interest from federal securities. Therefore, the federal
estate tax paid on interest from federal securities, which is classified as
income in respect of a decedent under
26 U.S.C. Section
691(a), is a deduction for
Iowa income tax purposes in the taxable year the interest is received. However,
interest and dividends from securities of a state or political subdivision,
which are exempt from federal income tax, do not constitute the kind of income
in respect of a decedent on which the deduction is computed. Since the
deduction under 26 U.S.C.
Section
691(c) does not
apply to income exempt from federal income tax, there is no deduction on the
Iowa return for the federal estate tax paid on the exempt interest, even though
under Iowa Code section
422.7 this interest is subject
to Iowa income tax.
The deduction allowable in any taxable year is limited to a
percentage of the total federal estate tax deduction which is determined by the
ratio of income in respect of a decedent received for the year to the total
amount of the net income in respect of a decedent on which federal estate tax
was paid. See 26 U.S.C.
Section 691(c) and federal
regulation Section 1.691(c)-1 for the computation of the
deduction.
(11)
Credits against the
tax.
a.
The personal
exemption credit. The estate of a decedent and a trust, whether simple
or complex, are allowed the same credit against the tax as the credit allowed
an individual taxpayer, that is currently $40. The personal exemption credit is
not prorated for short taxable years. The federal exemption allowed estates and
trusts under 26 U.S.C.
Section
642(b), in lieu of
the personal exemption for individuals, has no application to Iowa income
tax.
b.
Credit for tax paid
to another state or foreign country. Iowa Code section
422.8 grants Iowa situs trusts
and estates of Iowa resident decedents, which have income derived from sources
in another state or foreign country, a credit against the Iowa tax for the
income tax paid to the state or foreign country where the income was derived.
The credit is computed in the same manner as a full-year resident under rules
701-304.6 (422) and
701-304.7 (422). Foreign situs
trusts and estates of foreign decedents are not allowed a credit against the
Iowa tax for the income tax paid another state or foreign country on Iowa
source income. Rule
701-304.6 (422) as applied to an
Iowa situs trust or estate is illustrated by the following example:
Decedent A died a resident of Webster City, Iowa, on February
15. Decedent A at the time of death owned incomeproducing property both in Iowa
and the state of Missouri. For the short taxable year ending December 31, A's
estate had the following income and expenses:
|
Interest
|
$ 5,000.00
|
|
Dividends
|
7,500.00
|
|
Iowa farm income
|
20,000.00
|
|
Missouri farm income
|
10,000.00
|
|
Iowa gross income
|
$ 42,500.00
|
|
Less allowable deductions
|
8,000.00
|
|
Iowa taxable income
|
$ 34,500.00
|
|
Iowa computed tax
|
$2,587.87
|
|
Less personal credit
|
40.00
|
|
Tax subject to credit for foreign taxes
paid
|
$2,547.87
|
|
Tentative credit for tax paid to
Missouri
|
$ 413.00
|
|
Maximum credit
|
$ 604.20
|
|
Lesser of tentative credit or maximum
credit
|
413.00
|
|
Iowa tax due
|
$2,134.87
|
A's estate paid $413.00 income tax to the state of Missouri
on the $10,000 Missouri farm income. This is A's tentative credit.
The maximum credit on the foreign source income is $604.20
computed as follows:
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*$2,547.87 is the Iowa computed tax less the $40.00 personal
credit.
The allowable out-of-state tax credit is $413.00, because the
$413.00 of income tax paid to Missouri (tentative credit) is less than the
maximum credit of $604.20. If the Missouri tax paid had been greater than the
maximum credit, the allowable credit would have been the maximum credit.
c.
Motor vehicle fuel tax
credit. An estate or trust incurring Iowa motor vehicle fuel tax
expense attributable to nonhighway uses may, in lieu of obtaining an Iowa motor
vehicle fuel refund, claim as a credit against its Iowa income tax liability,
the Iowa motor vehicle fuel taxes paid during the taxable year.
A copy of the Iowa motor vehicle fuel tax credit Form IA 4136
must be submitted with the fiduciary return of income to substantiate the claim
for credit. Any credit in excess of the income tax due shall be refunded to the
estate or trust, subject to the right of offset against other state taxes
owing.
d.
Nonresident/part-year resident credit. The
nonresident/part-year resident credit is available for part-year trusts
described in subrule 700.3(3) and trusts whose situs is outside Iowa. See rule
701-304.5 (422) for the
computation of the nonresident/part-year resident credit allowed for
individuals who are either part-year residents of Iowa or nonresidents of
Iowa.
e.
Other tax
credits. All other tax credits set forth in Iowa Code chapter 422,
division II, are also available for any estate or trust that meets the criteria
for claiming these tax credits. For tax years beginning on or after January 1,
2013, estates and trusts with a situs in Iowa which are shareholders in S
corporations which carry on business within and without Iowa can take advantage
of the apportionment provisions for S corporation income set forth in
701-Chapter 403. The criteria to determine whether the S corporation is
carrying on business within and without Iowa is set forth in 701-subrule
503.1(4).
This rule is intended to implement Iowa Code sections
422.3 to
422.12,
422.14,
422.23, and
633.471 and chapter
452A.
