Fiduciaries of trusts or final-year estates possess the ability to funnel estimated tax payments made at the trust or estate level down to beneficiaries to help with tax liabilities that may be generated at the personal level.
Under IRC §643(g), a fiduciary can make an election by filing Form 1041-T “Allocation of Estimated Tax Payments to Beneficiaries” within 65 days after the close of the tax year to have estimated payments allocated to the beneficiaries on their Schedule K-1. These estimated tax payments will now be considered a distribution to the beneficiary that potentially carries out distributable net income (DNI) and generates a distribution deduction on the trust or estate return. The estimated tax payments allocated to beneficiaries of trusts will be considered as a fourth-quarter personal estimated tax payment or, in relation to final year estates and trusts, estimated tax payment for the quarter following the tax year-end of the fiduciary return.
Caution must be taken as the allocated estimated tax payments to beneficiaries that are removed from the trust can create a balance due with the return. This could also result in underpayment penalties when the return is filed due to the reduction in payments at the trust level. Generally speaking, only estimated tax payments qualify for treatment under IRC §643(g). Other forms of payments (such as withholding from wages, pensions, annuities, IRA’s, etc.) can change character when applied as an overpayment from a succeeding tax year. This overpayment is then defined as an estimated tax payment under IRC §643(g).
Quick Fun Fact – Seventeen states and the District of Columbia impose either an estate tax or an inheritance tax with Maryland as the only state that imposes both. Also, while Washington State has no personal income tax, they have the highest estate tax bracket at a 20% tax rate.