IRC Sec 645 Election
An IRC Sec 645 election is used to combine the trust and estate into one entity for tax purposes, thus requiring only one IRS Form 1041 to be filed.Although both entities use Form 1041 to report their income, the income tax reporting of a trust is separate from that of an estate.
As example, if a decedent died on October 1st, the returns for the year of the decedent’s death are as follows:
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Final IRS Form 1040 for the Decedent’s final year. (Income from Jan 1st - October 1st)
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IRS Form 1041 for the Decedent’s Estate (Income from October 1st - December 31st)
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IRS Form 1041 for the Revocable Trust (now irrevocable) (Income from October 1st - December 31st)
And this may not be all. If the estate is large enough there may also be a need to file a Form 706 – Estate Tax Return. If the taxpayer was married and a Form 706 is not required, it may be appropriate to file one anyway to take advantage of the portability election in order transfer any unused estate tax exclusion to the surviving spouse.
If the election is made, trust income and deductible expenses will be reported by the estate on the estate’s income tax return, and the trust will be treated as part of the estate. Only one Form 1041 (for the estate) is required even though legally, the trust, rather than the estate, continues to hold the assets. Of course, the income and expenses of the estate are reported by the estate on the estate’s income tax return.
Benefits
There are several other potential advantages to using the IRC Sec 645 election as follows.
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Fiscal Year Selections –While estates can select a fiscal year, without making a Sec 645 election, non-grantor trusts are required to adopt a calendar tax year. Thus, a Sec 645 election treating the trust and the estate as one entity allows a trust to use that fiscal year for tax reporting. This allows the trust’s income to be diverted from one reporting year to another.
Example: Decedent dies onDecember 1, 2023.Without a Sec 645 election: Decedent’s Trust would file an income tax return for the year endingDecember 31, 2023 (the decedent's year of death) and pay the income tax due by April 15, 2024. With a Sec 645 election, for tax purposes, the trust and estate are combined into one entity. The executor now can elect a fiscal year endingNovember 30, 2024. The same income and any related tax would now be deferred and not due until the following tax year of 2025.Even if no income tax is due, the reportable income that is passed through to the beneficiaries will be includible on their 2024 returns with nothing reportable for 2023. It may also be possible that only one 1041 return – a “first and final” return – will need to be filed if the assets have been distributed to the beneficiaries by the end of November 2024.
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Charitable Permanent Set-Aside - Estates are allowed a charitable income tax deduction for amounts permanently set aside for charitable purposes beyond the year of death. This deduction is unique to estates and because a Sec 645 election treats a trust as an estate for tax purposes, trusts can use the deduction in years beyond the current year. Generally, trusts are limited to taking a charitable income tax deduction for donations made in the current year only.
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Passive Loss Allowed Without Active Participation - The Sec 645 election enables an estate, unlike a trust, to take up to $25,000 in passive losses without active participation.Estates receive this automatic treatment as an active participant for the first two years after a decedent’s death.
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Personal Exemption - Trusts have an exemption of $100 or $300, whereas estates have an exemption of $600. Because a Sec 645 election combines the trust with the estate for tax purposes, the trust can now have the increased exemption of $600.
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Estimated Taxes -Estates are exempt from making estimated tax payments for two years following the date of passing. Whereas Trusts may need to make estimated payments depending on the situation. Being combined eliminates the need for estimated tax payments during the first two years.
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S Corp Stock Holding Periods -An estate is allowed to own S corporations stock for a longer period than a trust. Trusts can hold the stock only for the two-year period beginning at the date of death. Estates can hold the stock through the period of administration. This could be an advantage for trusts that own S corporation stock.
Making the Sec 645 Election
The election is made using Form 8855 - Election to Treat a Qualified Revocable Trust as Part of an Estate.
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Both the executor and trustee must sign.
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The election is irrevocable.
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Due by the date of the estate’s initial income tax return (Form 1041), including any extensions taken on such return.
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An EIN must be obtained by both the electing trust and the related estate.
Election Period
The election period is the period during which an electing trust is treated and taxed as part of its related estate. The election period begins on the date of the decedent’s death and terminates on the earlier of:
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The day on which each electing trust and the related estate, if any, have distributed all their assets; or
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The day before the applicable date. To determine the applicable date, you must first determine whether a Form 706 is required to be filed because of the decedent’s death. If the answer is:
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Yes - The later of:
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2 years after the date of the decedent’s death or
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6 months after the final determination of liability for estate tax.
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No - 2 years after the date of the decedent’s death.
Once the Election Period Ends
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The trust must begin to file its own separate Form 1041 income tax return.
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The reporting for that trust reverts to a calendar year basis. Thus, the trust will need to file a return from the end of the fiscal year-end to the calendar year-end following the termination.
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If the estate is still open and filed on a fiscal year basis, it can continue to do so.
The Sec 645 election is covered on page 5 (and other pages) in the 1041 instructions (2023).