Estates and trusts are both accounting and taxable entities. A person acting as a legal representative of an estate or a trust is known as a fiduciary. An executor of an estate is named in the will of the decedent; if the will does not name an executor, a probate court appoints an administrator. A trustee is the fiduciary of a trust.
State laws (known as probate codes) regulate the administration of estates. Because these laws differ widely, a Uniform Probate Code (Code) has been drafted with the expectation that most states eventually will adopt all or part of it.
The Code defines an estate as all property of a decedent, trust, or other person whose affairs are subject to the Code. A person is deemed to be an individual or organization.
All property of a decedent is awarded to devisees specified in the decedent's will; in the absence of a will (intestacy) the property of the decedent is transferred directly to heirs as specified in the Code.
A valid will should be in writing, signed by the testator and at least two witnesses. A will is probated by a probate court (also known as a surrogate or orphan's court). Probate may be formal or informal. After completion of any hearings, the court issues an order for formal probate of a valid will, or an order that the decedent died intestate.
The executor or administrator takes possession and control of the decedent's property in trust for the benefit of creditors and devisees. Executors and administrators have the authority to continue a single proprietorship of the decedent for not more than four months, and to allocate cash receipts and payments to estate principal (corpus) or to estate income pursuant to the provisions of the will or applicable state statutes.
Within 30 days after appointment, the personal representative (executor or administrator) must inform the decedent's devisees or heirs of the appointment. A devisee is any person or trust named in a will to receive, through a devise, property of the decedent. Within three months after appointment, the personal representative prepares an inventory (at current fair value) of the decedent's property and debts on the date of death. No earlier than six months after the date of appointment, the personal representative may close an estate by filing appropriate legal documents and financial statements with the probate court.
Certain allowances and exemptions are stipulated for estates by the Code. These are:
Homestead allowanceThe decedent's surviving spouse, or surviving minor and dependent children, are entitled to a total homestead allowance of a specified amount.
Family allowanceThe surviving spouse and minor children of the decedent are entitled to a reasonable cash allowance during the administration of the estate.
Exempt propertythe decedent's surviving spouse or children are entitled to an aggregate specified total current fair value of automobiles and household and personal effects.
The personal representative is required to publish a notice in a newspaper once a week for three successive weeks requesting creditors of an estate to present their claims within four months after the date of the first publication. Claims not filed within this period are not valid claims against the estate. Payments are made in the following order: (a) costs of administering the estate, (b) decedent's funeral costs and costs of last illness, (c) debts and taxes with preference under federal or state laws, and (d) all other items.
After payment of creditors, estate property is distributed in the following order:
Specific devises (gifts of identifiable objects, such as named paintings, automobiles, or real property)
General devises (gifts of amounts of money or monetary assets, such as corporate bonds)
Residuary devises (gifts of all estate property remaining after specific devises and general devises are distributed). If estate property (that is not exempt property) is insufficient to pay estate creditors and the devises, the devises abate (are reduced) or are eliminated. Residuary devises are reduced or eliminated first, followed by general devises and specific devises in that order.
The federal estate tax assessed against an estate and state inheritance taxes levied against devisees sometimes are called death taxes. These taxes either are apportioned against the various devises according to the provisions of the will or are prorated according to provisions of the Code.
The allocation of revenue and expenses of the estate between principal and income is important because the income beneficiary and the principal beneficiary (or remainderman) may be different persons. If the will does not provide specific instructions for such allocation, provisions of the Revised Uniform Principal and Income Act or state laws would apply.
Following are some general guidelines of the Revised Uniform Principal and Income Act for allocation of revenue and expenses to principal and income:
Income is the return derived from the use or investment of the principal assets and includes rent, interest, cash dividends, and revenue received during administration of the estate.
Principal consists of property to be held in trust for delivery to a devisee remainderman. Principal includes proceeds of insurance on principal property, stock dividends, and liquidating dividends. Any accrued revenue on the date of the decedent's death is considered principal.
Premium or discount on investments in bonds included in principal is not amortized. All proceeds from disposal of bonds are principal. Depreciation on all property except property used by a beneficiary as a residence is charged against income. Income is also charged for costs of administering income-producing estate property. Principal is charged with expenditures incurred in preparing property for sale or rent, extraordinary repairs to principal property, and income taxes on gains allocable to principal. Administrative and other costs for periodic reporting to the probate court are apportioned between principal and income.
The accounting records of an estate are opened to record the inventory of estate property by debits to Principal Cash and other appropriate asset ledger accounts; liability accounts for liens on estate property and Estate Principal Balance are credited. Property subsequently discovered is recorded by a debit to an asset account and a credit to Property Discovered. Receipts of income are debited to Income Cash, and distributions of income are debited to Distributions to Income Beneficiaries and credited to Income Cash. Distributions to devisees are debited to Devises Distributed and credited to Principal Cash or other asset accounts. Payments of decedent's debts, illness costs, and funeral costs are recorded by a debit to Liabilities Paid and a credit to Principal Cash.
A charge and discharge statement may be prepared by the executor or administrator periodically and on closing of the estate. This statement, prepared from a trial balance, consists of two sections—principal and income. The "charges" include, for example, the inventory of principal property, property discovered, gains on disposal of principal property, and receipts of income; "credits" consist essentially of losses on disposal of principal property, liabilities paid, devises and income distributed, and administrative costs. Appropriate exhibits in support of the "charges" and "credits" accompany the charge and discharge statement.
The charge and discharge statement summarizes the accountability of the personal representative of the decedent. Once the probate court accepts the final charge and discharge statement, the accounting records for the estate may be closed.
A trust created by a will is termed a testamentary trust. A trust created by a living person is known as an inter vivos or living trust. A trust is created by the settlor (also known as donor or trustor); it is administered by a trustee for the benefit of income beneficiaries and principal beneficiaries.
The trustee must comply fully with the provisions established by the settlor during the stated term of the trust and must maintain accounting records for both trust principal and trust income. Such accounting records usually are maintained on the cash basis.
There is no need to accrue revenue or expenses for a trust because a balance sheet and an income statement generally are not prepared. The periodic financial report prepared by the trustee is a charge and discharge statement.
A closing journal entry is required for a trust at the end of each reporting period for which a charge and discharge statement is prepared, to clear the revenue, expense, and distributions ledger accounts for the next reporting period.
