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Electing to treat a revocable trust as part of an estate.

Many taxpayers have a will and revocable trust as part of their estate plan. Frequently, once the taxpayer dies, his or her revocable trust contains most of the estate assets. Before Congress enacted Sec. 645, the estate and the revocable trust each had to file separate returns; the trust could not use the income tax advantages available to the estate. The Taxpayer Relief Act of 1997 added Sec. 645. Under this section, if both the estate executor and the trustee of a qualified revocable trust (QRT) so elect, the trust will be treated and taxed as part of the estate.

The IRS has issued final regulations (TD 9032) under Sec. 645, which replace the proposed regulations issued on Dec. 18, 2000. Many of the proposed regulations' provisions have remained in the final rules; however, there are significant amendments and clarifications. The election continues to make it possible for taxpayers to gain various income tax advantages available to estates, but not otherwise available to trusts. The advantages are outlined below.


When the election is made, the QRT will be treated and taxed for income tax purposes as if part of the estate (and not as a separate trust).The election applies to all of the estate's tax years ending after the decedent's date of death (DOD) and before the "applicable date." Under Sec. 645(b)(2), the applicable date is:

1. The date two years after the DOD (if no estate tax return is required to be filed); or

2. The date six months after the date of the final determination of estate tax liability (if an estate tax return is required).

If an estate tax return is required, Regs. Sec. 1.645-1(f)(2)(ii) further defines the applicable date as it pertains to the date of final determination of estate tax liability, as the earliest of.

1. Six months after the IRS issues an estate tax closing letter, unless a claim for refund is filed within 12 months after it issues the letter;

2. Final disposition of a refund claim (as defined in Regs. Sec. 1.6451 (f)(2)(ii)) that resolves the estate tax liability, unless a suit is instituted within six months after the claim's final disposition;

3. Execution of a settlement agreement with the IRS that determines the estate tax liability;

4. Issuance of a decision, judgment, decree or other order by a court of competent jurisdiction resolving the estate tax liability, unless a notice of appeal or a petition for certiorari is filed within 90 days after issuance; or

5. Expiration of the limitations period for assessing the estate tax, as provided in Sec. 6501.

Under Sec. 645(c), the election must be made no later than the time for filing the income tax return for the estate's first tax year (including extensions). Once made, the election is irrevocable.

Definition of a QRT. For purposes of the election, Sec. 645(b)(1) defines a QRT as any trust, a portion or all of which was treated under Sec. 676 as owned by the decedent for whom the election is being made, by reason of a power in the grantor determined without regard to the grantor's spouse; see Sec. 672(e). A QRT is also a trust treated as owned by the decedent under Sec. 676 by reason of a power exercisable by the decedent only with the approval or consent of a nonadverse party or the decedent's spouse. However, a trust treated as owned by the decedent under Sec. 676 solely by reason of a power held by a nonadverse party or the decedent's spouse is not a QRT.

The proposed regulations required that a QRT be a domestic trust and that the election result in a domestic estate. The final regulations do not contain this requirement. Note: The Sec. 645 election is made for the purposes of income tax rules; thus, information-reporting requirements for foreign trusts will continue to apply.

Making the Election

As provided in Regs. Sec. 1.6451(c)(i), an election can be made by filing an IRS form, properly completed and signed under penalties of perjury, or in any other manner prescribed after Dec. 24, 2002, by IRS forms or by other published guidance for making the election. (Form 8855, Election to Treat a Qualified Revocable Trust as Part of an Estate, was supposed to be available within six months after the publication of the final regulations.)

If the related estate has an executor, that person and the trustee of each QRT must join in filing a properly completed election form. In addition to providing the information required by the election form, the executor and the trustee must agree (by signing the election form under penalties of perjury) to certain conditions to the election. Under Regs. Sec. 1.645-1(c)(1)(ii)(A), the trustee must timely provide the executor with all of the mast's pertinent information to permit the executor to file a complete, accurate and timely Form 1041, U.S. Income Tax Return for Estates and Trusts, for which he or she is responsible. The executor and the trustee must agree to allocate the tax burden of the combined estate and QRT in a way that reasonably reflects each's tax obligation (or, according to the IRS, gifts may arise). They are also responsible for ensuring that they pay timely their respective shares of the tax obligations.

If there is no executor, Regs. Sec. 1.645-1(c)(2) requires the trustee of each QRT joining in the election to file a properly completed election form. The trustee must also agree to certain conditions, under penalties of perjury.

Under Regs. Sec. 1.645-1(c)(2)(ii)(F), if an executor is appointed after the filing of the election form, he or she must agree to the trustee's election and notify the IRS with a revised election form, fried within 90 days of the executor's appointment. If returns were filed before the executor was appointed, amended Forms 1041 must be filed. Also, the amended return for the tax year ending immediately before the executor was appointed must indicate that it is a final return.

Filing Requirements

Regs. Sec. 1.645-1 (d) requires that a tax identification number (TIN) be obtained for the QRT following the decedent's death. If a proper Sec. 645 election is filed, the QRT trustee is not required to file Form 1041 for the QRT'S short tax year (beginning with the decedent's DOD and ending on December 31 of that year). If there is an executor, he or she would file annually a single Form 1041 for the combined QRT and related estate, under the estate's name and TIN, according to Regs. Sec. 1.645-1(e)(2). If there is no executor, then, according to Regs. Sec. 1.645-1 (e)(3)(i), the trustee would treat the QRT, during the election period, as an estate and would file Form 1041 under the TIN the trustee obtained on the DOD, treating the trust as an estate.

Applying the Separate-Share Rules

Under Regs. Sec. 1.645-1(e)(2)(iii), the electing trust and related estate are treated as separate shares for purposes of computing distributable net income (DNI).The final regulations discuss how to adjust the DNI of the separate shares for distributions between the shares. Under Regs. Sec. 1.645-1(e)(2)(iii)(B), the share making the distribution reduces its DNI by the distribution deduction amount that it would have been entitled to under Sec. 661, had the distribution been made to another beneficiary; solely for purposes of calculating DNI, the share receiving the distribution increases its gross income by the same amount. The distribution has the same character in the recipient's hands as in the distributing share's.

Treatment Following Election Termination

According to Regs. Sec. 1.645-1(h)(2), on termination of the election period, the electing trust is deemed to be distributed. On the close of the election period's last day, the combined electing trust and related estate (if there is an executor) or the electing trust (if there is no executor) will distribute its DNI to the new trust and can take a distribution deduction as a result of the deemed distribution. The new trust will include the deemed distribution in gross income.

If there is an executor and if the electing trust terminates during the election period, under Regs. Sec. 1.645-1(h)(2)(i)(B), the QRT's trustee must file a final Form 1041 under that trust's name and TIN and indicate that it is a final return. This notifies the IRS that the electing trust no longer exists, as its items of income, deduction and credit are still reported on the final Form 1041 for the combined QRT and related estate. Also, the former electing trust may need to obtain a new TIN; if the related estate continues after the termination of the election period, it must continue to use the TIN originally assigned during the election period.

If there is no executor, Regs. Sec. 1.645-1(h)(2)(ii) provides that the electing trust's tax year closes on the election period's last day; the Form 1041 must indicate that it is a final return. Also, according to Regs. Sec. 1.645-1(h)(3), the former electing trust must obtain a new TIN if the trust will continue after the termination of the election period.

On termination of the Sec. 645 election, the estate's tax year remains the same as during the election period, while the new trust takes a calendar year, under Regs. Sec. 1.645-1(h)(4).

Effective Dates

Regs. Sec. 1.645-1(j) states that the election procedures, rules on obtaining a TIN for the electing trust and QRT, rules on duration of the election period and rules on executors appointed later are effective for estates and trusts of decedents dying after Dec. 23, 2002. The rules on the tax treatment and general filing requirements during the election period, and the rules on the tax treatment on terminating the election period, are effective for tax years ending after Dec. 23, 2002.

The preamble indicates that estates and trusts of decedents dying before that date may follow the election procedures in the proposed regulations or in Rev. Proc. 98-13. For obtaining a TIN for a QRT and filing Form 1041 for the short tax year beginning with the decedent's death and ending December 31 of that year, estates and trusts of decedents dying before Dec. 24, 2002, may follow the procedures in the final regulations, the proposed regulations or in Rev. Proc. 98-13.

Finally, under Notice 2003-33, the IRS now permits trusts and estates of decedents dying before Dec. 24, 2002 (provided a Form 1041 has not been filed that treats the election period as terminated), to rely on the final regulations to determine when the election terminates. Thus, the election period can potentially last longer than that determined under the proposed regulations.

Reasons for Making the Election

Once an election is made, a QRT can take advantage of the differences between the income tax treatment of estates and revocable trusts, as follows:

1. Estates are allowed a charitable deduction for amounts permanently set aside for charitable purposes, while postdeath revocable trusts are allowed a charitable deduction only for amounts paid to charities.

2. Estates are entitled to the $25,000 passive-loss deduction for active rental real estate activities; trusts are not. The election will allow active rental losses realized by the trust to be deducted on the estate income tax return. Caveat: If the election is made, the trust income, added to the estate income, could exceed the $150,000 adjusted-gross-income limit for estate income tax returns and the deduction.

3. The active participation requirement under the passive loss rules is waived for estates (but not for revocable trusts) for two years after the owner's death, for activities in which the decedent actively participated.

4. A trust must use a calendar year for Federal income tax purposes, while an estate can have a fiscal year-end. By using a fiscal year, income-deferral techniques can be used. By making the election, the trust can now have a fiscal year, providing additional deferral opportunities. This could be advantageous if the trust has significant assets.

5. The Federal income tax exemption for estates is $600, while the exemption for trusts required to distribute all of their income is currently $300; it is $100 for all other trusts.

6. Estates do not have to make estimated tax payments for the first two years after the DOD, while trusts are required to do so.

7. An estate may own S corporation stock, but only certain trusts may do so if the appropriate elections are made. A trust must meet the Sec. 1361(c)(2) requirements to qualify as an S shareholder. If the Sec. 645 election were made, a QRT would be able to own S stock even if it does not fall within one of the trust categories under Sec. 1361. Note: A QRT would only be treated as part of the estate until the "applicable date."

8. An estate distribution may be a direct skip; however, a trust distribution may be a taxable distribution or a taxable termination that can affect the timing and amount of the generation-skipping-transfer allocation needed to produce a desired inclusion ratio.

9. Estates can qualify for amortization of reforestation expenditures; trusts do not.


The Sec. 645 election has significant advantages. The final regulations, which clarified and changed provisions from the proposed regulations, are generally pro-taxpayer. For planning purposes, the decision to make the election should be made as soon as possible by the trustees and executors, and before making major trust distributions (as these could jeopardize potential income tax planning). Trustees, executors and their advisers should consider all the consequences in making this election.

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Article Details
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Author:Scarpa, Michele D.
Publication:The Tax Adviser
Date:Aug 1, 2003
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