Exemption and Deductions

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Exemption and Deductions

In figuring taxable income, an estate is generally allowed the same deductions as an individual. Special rules, however, apply to some deductions for an estate. This section includes discussions of those deductions affected by the special rules.

Exemption Deduction

An estate is allowed an exemption deduction of $600 in figuring its taxable income. No exemption for dependents is allowed to an estate. Even though the first return of an estate may be for a period of less than 12 months, the exemption is $600. If, however, the estate was given permission to change its accounting period, the exemption is $50 for each month of the short year.

Charitable Contributions

An estate qualifies for a deduction for gross income paid or permanently set aside for qualified charitable organizations. The adjusted gross income limits for individuals do not apply. However, to be deductible by an estate, the contribution must be specifically provided for in the decedent's will. If there is no will, or if the will makes no provision for the payment to a charitable organization, then a deduction will not be allowed even though all beneficiaries may agree to the gift.

You cannot deduct any contribution from income not included in the estate's gross income. If the will specifically provides that the contributions are to be paid out of the estate's gross income, the contributions are fully deductible. However, if the will contains no specific provisions, the contributions are considered to have been paid and are deductible in the same proportion as the gross income bears to the total of all classes (taxable and nontaxable) of income.

You cannot deduct a qualified conservation easement granted after the date of death and before the due date of the estate tax return. A contribution deduction is allowed to the estate for estate tax purposes.

For more information about contributions, see Publication 526, Charitable Contributions, and Publication 561, Determining the Value of Donated Property.

Losses

Generally, an estate can claim a deduction for a loss it sustains on the sale of property. This includes a loss from the sale of property (other than stock) to a personal representative of the estate, unless that person is a beneficiary of the estate.

For a discussion of an estate's recognized loss on a distribution of property in kind to a beneficiary, see Income To Include, earlier.

An estate and a beneficiary of that estate are generally treated as related persons for purposes of the disallowance of a loss on the sale of an asset between related persons. The disallowance does not apply to a sale or exchange made to satisfy a pecuniary bequest.

Net operating loss deduction. An estate can claim a net operating loss deduction, figured in the same way as an individual's, except that it cannot take the income distribution deduction (discussed later) or the deduction for charitable contributions in figuring the loss or the loss carryover. For a discussion of the carryover of an unused net operating loss to a beneficiary upon termination of the estate, see Termination of Estate, later.

For information on net operating losses, see Publication 536.

Casualty and theft losses. Losses incurred from casualties and thefts during the administration of the estate can be deducted only if they have not been claimed on the federal estate tax return (Form 706). The personal representative must file a statement with the estate's income tax return waiving the deduction for estate tax purposes. See Administration Expenses, later.

The same rules that apply to individuals apply to the estate, except that in figuring the adjusted gross income of the estate used to figure the deductible loss, you deduct any administration expenses claimed. Use Form 4684, Casualties and Thefts, and its instructions to figure any loss deduction.

Carryover losses. Carryover losses resulting from net operating losses or capital losses sustained by the decedent before death cannot be deducted on the estate's income tax return.

Administration Expenses

Expenses of administering an estate can be deducted either from the gross estate in figuring the federal estate tax on Form 706 or from the estate's gross income in figuring the estate's income tax on Form 1041. However, these expenses cannot be claimed for both estate tax and income tax purposes. In most cases, this rule also applies to expenses incurred in the sale of property by an estate (not as a dealer).

To prevent a double deduction, amounts otherwise allowable in figuring the decedent's taxable estate for federal estate tax on Form 706 will not be allowed as a deduction in figuring the income tax of the estate or of any other person unless the personal representative files a statement, in duplicate, that the items of expense, as listed in the statement, have not been claimed as deductions for federal estate tax purposes and that all rights to claim such deductions are waived. One deduction or part of a deduction can be claimed for income tax purposes if the appropriate statement is filed, while another deduction or part is claimed for estate tax purposes. Claiming a deduction in figuring the estate income tax is not prevented when the same deduction is claimed on the estate tax return so long as the estate tax deduction is not finally allowed and the preceding statement is filed. The statement can be filed with the income tax return or at any time before the expiration of the statute of limitations that applies to the tax year for which the deduction is sought. This waiver procedure also applies to casualty losses incurred during administration of the estate.

Accrued expenses. The rules preventing double deductions do not apply to deductions for taxes, interest, business expenses, and other items accrued at the date of death. These expenses are allowable as a deduction for estate tax purposes as claims against the estate and also are allowable as deductions in respect of a decedent for income tax purposes. Deductions for interest, business expenses, and other items not accrued at the date of the decedent's death are allowable only as a deduction for administration expenses for both estate and income tax purposes and do not qualify for a double deduction.

Expenses allocable to tax-exempt income. When figuring the estate's taxable income on Form 1041, you cannot deduct administration expenses allocable to any of the estate's tax-exempt income. However, you can deduct these administration expenses when figuring the taxable estate for federal estate tax purposes on Form 706.

Interest on estate tax. Interest paid on installment payments of estate tax is not deductible for income or estate tax purposes.

Depreciation and Depletion

The allowable deductions for depreciation and depletion that accrue after the decedent's death must be apportioned between the estate and the beneficiaries, depending on the income of the estate allocable to each.

An estate cannot elect to treat the cost of certain depreciable business assets as an expense under section 179.

Example.

In 2012, the decedent's estate realized $3,000 of business income during the administration of the estate. The personal representative distributed $1,000 of the income to the decedent's son, Ned, and $2,000 to another son, Bill. The allowable depreciation on the business property is $300. Ned can take a deduction of $100 [($1,000 ÷ $3,000) × $300], and Bill can take a deduction of $200 [($2,000 ÷ $3,000) × $300].

Income Distribution Deduction

An estate is allowed a deduction for the tax year for any income that must be distributed currently and for other amounts that are properly paid, credited, or required to be distributed to beneficiaries. This deduction is limited to the distributable net income of the estate.

For special rules about distributions that apply in figuring the estate's income distribution deduction, see Bequest under Distributions to Beneficiaries From an Estate, later.

Distributable net income. Distributable net income (figured on Form 1041, Schedule B) is the estate's taxable income, excluding the income distribution deduction, with the following additional modifications.

Tax-exempt interest. Tax-exempt interest, including exempt-interest dividends, is included in the distributable net income but is reduced by the following items.
  • Expenses not allowed in computing the estate's taxable income because they were attributable to tax-exempt interest (see Expenses allocable to tax-exempt income under Administration Expenses, earlier).

  • The portion of tax-exempt interest deemed to have been used to make a charitable contribution. See Charitable Contributions, earlier.

The total tax-exempt interest earned by an estate must be shown in the “Other Information” section of Form 1041. The beneficiary's portion of the tax-exempt interest is shown on Schedule K-1 (Form 1041).

Exemption deduction. The exemption deduction is not allowed.

Capital gains. Capital gains are not automatically included in distributable net income. However, they can be included in distributable net income if any of the following apply.
  • The gain is allocated to income in the accounts of the estate or by notice to the beneficiaries under the terms of the will or by local law.

  • The gain is allocated to the corpus or principal of the estate and is actually distributed to the beneficiaries during the tax year.

  • The gain is used, under either the terms of the will or the practice of the personal representative, to determine the amount that is distributed or must be distributed.

  • Charitable contributions are made out of capital gains.

Generally, when you determine capital gains to be included in distributable net income, the exclusion for gain from the sale or exchange of qualified small business stock is not taken into account.

Capital losses. Capital losses are excluded in figuring distributable net income unless they enter into the computation of any capital gain that is distributed or must be distributed during the year.

Separate shares rule. The separate shares rule must be used if both of the following are true.
  • The estate has more than one beneficiary.

  • The economic interest of a beneficiary does not affect and is not affected by the economic interest of another beneficiary.

A bequest of a specific sum of money or of property is not a separate share (see Bequest, later).

If the separate shares rule applies, the separate shares are treated as separate estates for the sole purpose of determining the distributable net income allocable to a share. Each share's distributable net income is based on that share's portion of gross income and any applicable deductions or losses. The personal representative must use a reasonable and equitable method to make the allocations.

Generally, gross income is allocated among the separate shares based on the income each share is entitled to under the will or applicable local law. This includes gross income not received in cash, such as a distributive share of partnership tax items.

If a beneficiary is not entitled to any of the estate's income, the distributable net income for that beneficiary is zero. The estate cannot deduct any distribution made to that beneficiary and the beneficiary does not have to include the distribution in its gross income. However, see Income in respect of a decedent, later in this discussion.

Example.

Patrick's will directs you, the executor, to distribute ABC Corporation stock and all dividends from that stock to his son, Edward, and the residue of the estate to his son, Michael. The estate has two separate shares consisting of the dividends on the stock left to Edward and the residue of the estate left to Michael. The distribution of the ABC Corporation stock qualifies as a bequest, so it is not a separate share.

If any distributions, other than the ABC Corporation stock, are made during the year to either Edward or Michael, you must determine the distributable net income for each separate share. The distributable net income for Edward's separate share includes only the dividends attributable to the ABC Corporation stock. The distributable net income for Michael's separate share includes all other income.

Income in respect of a decedent. This income is allocated among the separate shares that could potentially be funded with these amounts, even if the share is not entitled to receive any income under the will or applicable local law. This allocation is based on the relative value of each share that could potentially be funded with these amounts.

Example 1.

Frank's will directs you, the executor, to divide the residue of his estate (valued at $900,000) equally between his two children, Judy and Ann. Under the will, you must fund Judy's share first with the proceeds of Frank's traditional IRA. The $90,000 balance in the IRA was distributed to the estate during the year. This amount is included in the estate's gross income as income in respect of a decedent and is allocated to the corpus of the estate. The estate has two separate shares, one for the benefit of Judy and one for the benefit of Ann. If any distributions are made to either Judy or Ann during the year, then, for purposes of determining the distributable net income for each separate share, the $90,000 of income in respect of a decedent must be allocated only to Judy's share.

Example 2.

Assume the same facts as in Example 1, except that you must fund Judy's share first with DEF Corporation stock valued at $300,000, rather than the IRA proceeds. To determine the distributable net income for each separate share, the $90,000 of income in respect of a decedent must be allocated between the two shares to the extent they could potentially be funded with that income. The maximum amount of Judy's share that could be funded with that income is $150,000 ($450,000 value of share less $300,000 funded with stock). The maximum amount of Ann's share that could be funded is $450,000. Based on the relative values, Judy's distributable net income includes $22,500 ($150,000/$600,000 X $90,000) of the income in respect of a decedent and Ann's distributable net income includes $67,500 ($450,000/$600,000 X $90,000).

Income required to be distributed currently. The income distribution deduction includes any income that, under the terms of the decedent's will or by reason of local law, must be distributed currently. This includes an amount that may be paid out of income or corpus (such as an annuity) to the extent it is paid out of income for the tax year. The deduction is allowed to the estate even if the personal representative does not make the distribution until a later year or makes no distribution until the final settlement and termination of the estate.

Any other amount paid, credited, or required to be distributed. Any other amount paid, credited, or required to be distributed is included in the income distribution deduction of the estate only in the year actually paid, credited, or distributed. If there is no specific requirement by local law or by the terms of the will that income earned by the estate during administration be distributed currently, a deduction for distributions to the beneficiaries will be allowed to the estate, but only for the actual distributions during the tax year.

If the personal representative has discretion as to when the income is distributed, the deduction is allowed only in the year of distribution.

The personal representative can elect to treat distributions paid or credited within 65 days after the close of the estate's tax year as having been paid or credited on the last day of that tax year. The election is made by completing line 6 in the “Other Information” section of Form 1041. If a tax return is not required, the election is made on a statement filed with the IRS office where the return would have been filed. The election is irrevocable for the tax year and is only effective for the year of the election.

Interest in real estate. The value of an interest in real estate owned by a decedent, title to which passes directly to the beneficiaries under local law, is not included as any other amount paid, credited, or required to be distributed.

Property distributed in kind. If an estate distributes property in kind, the estate's deduction ordinarily is the lesser of its basis in the property or the property's fair market value when distributed. However, the deduction is the property's fair market value if the estate recognizes gain on the distribution. See Gain or loss on distributions in kind under Income To Include, earlier.

Property is distributed in kind if it satisfies the beneficiary's right to receive another property or amount, such as the income of the estate or a specific dollar amount. It generally includes any noncash distribution other than the following.

  • A specific bequest (unless it must be distributed in more than three installments).

  • Real property, the title to which passes directly to the beneficiary under local law.

Tax-exempt income not deductible. The estate cannot take an income distribution deduction for any item of distributable net income not included in the estate's gross income.

Example.

An estate has distributable net income of $2,000, consisting of $1,000 of dividends and $1,000 of tax-exempt interest. Distributions to the beneficiary total $1,500. Except for this rule, the income distribution deduction would be $1,500 ($750 of dividends and $750 of tax-exempt interest). However, as the result of this rule, the income distribution deduction is limited to $750, because no deduction is allowed for the tax-exempt interest distributed.

Denial of double deduction. A deduction cannot be claimed twice. If an amount is considered to have been distributed to a beneficiary of an estate in a preceding tax year, it cannot again be included in figuring the deduction for the year of the actual distribution.

Example.

The decedent's will provides that the estate must distribute currently all of its income to a beneficiary. For administrative convenience, the personal representative did not make a distribution of part of the income for the tax year until the first month of the next tax year. The amount must be deducted by the estate in the first tax year, and must be included in the income of the beneficiary in that year. This amount cannot be deducted again by the estate in the following year when it is paid to the beneficiary, nor must the beneficiary again include the amount in income in that year.

Charitable contribution. Any amount allowed as a charitable deduction by the estate in figuring the estate's taxable income cannot be claimed again as a deduction for a distribution to a beneficiary.

Funeral and Medical Expenses

No deduction can be taken for funeral expenses or medical and dental expenses on the estate's income tax return, Form 1041.

Funeral expenses. Funeral expenses paid by the estate are not deductible in figuring the estate's taxable income on Form 1041. They are deductible only for determining the taxable estate for federal estate tax purposes on Form 706.

Medical and dental expenses of a decedent. The medical and dental expenses of a decedent paid by the estate are not deductible in figuring the estate's taxable income on Form 1041. You can deduct them in figuring the taxable estate for federal estate tax purposes on Form 706. If these expenses are paid within the 1-year period beginning with the day after the decedent's death, you can elect to deduct them on the decedent's income tax return (Form 1040) for the year in which they were incurred. See Medical Expenses under Final Income Tax Return for Decedent—Form 1040, earlier.