Newsletter
Please feel free to read our client newsletter. It is provided to keep you up to date on the latest tax and accounting news.
Articles
Contents
IRS Sends New Notices
Beginning in October 2008, the IRS will issue a new type of compliance letter called a CP 2057. The IRS will mail the CP 2057s to about 31,000 taxpayers with apparent underreported income for the 2007 tax year. The CP 2057s will:
Inform taxpayers that there appears to be an income discrepancy based on information reports received by the IRS.
Instruct taxpayers to file a Form 1040X to correct their return if the information shown on the notice is correct.
The CP 2057 generally replaces the IRS Letter 3957(CG), which became obsolete in February 2008. For many years, the IRS used the 3957 to ask taxpayers to reconcile income discrepancies. Note: Both the IRS Letter 3957(CG) and the CP 2057 differ form the CP 2000, which actually proposes changes to income, payments, or credits.
If a taxpayer receives a CP 2057 and the return is correct, the taxpayer need to do nothing. However, if the tax return is incorrect, the CP 2057 asks taxpayers to correct errors with employers (for W-2 discrepancies) and others (for 1099, K-1, etc., discrepancies).
It explains to taxpayers that the IRS will scrutinize the following year return to see that similar problems crop up. The CP 2057 requires taxpayers to do the leg work in that it does not always specifically list the type of income discrepancy.
The new CP 2057 is automatically generated using an IRS system of computer-matching returns with W-2, 1099, K-1, and other documents a system the IRS also uses for the 2000 notices.
The IRS hopes that the automated nature of the CP 2057s will allow it to run the program at a low cost.
When Must a Beneficiary Pay Tax on an Inheritance?
When a client inherits money, they will most likely ask you if they have to pay tax on that inheritance. Most of the time the answer is no because any tax would have been paid by the estate, but there are some situations in which the beneficiary does have to pay tax.
For example, if a client is given an inheritance through a trust, he will have to pay tax on any income the trust assets earn that is distributed out to him.
Estate taxes v. inheritance taxes
An estate tax is a tax imposed on the deceased estate as a whole. The executor prepares the estate tax return(s) and pays the tax out of the estates funds.
An inheritance tax is a tax imposed on the beneficiaries who receive property from the deceased. The tax is calculated separately for each beneficiary, and each beneficiary is responsible for paying his or her own inheritance taxes.
The federal government does not impose and inheritance tax, although some states do. This article focuses on states like California, where there is no inheritance tax.
When beneficiaries pay tax
Beneficiaries are required to pay income tax on income generated by the assets they inherit. If income is earned on an asset before that item is passed to a new owner, someone has to pay tax on that income. If assets are held in a trust (or estate) for the benefit of a beneficiary, and the income is distributed out to the beneficiary, the beneficiary must pay tax on that income.
What is considered income, and when that income is distributed, will depend on the terms of the trust and applicable state law. The beneficiary will receive a K-1 showing the income and deduction items from the trust that must be reported on his individual return. Unfortunately, in many cases the beneficiary is not aware that they will be subject to tax on their trust distributions.
In the final year of an estate, the estate pays no tax on the income earned during that year. The taxability passes to the beneficiary. Clients often are confused when they receive a share of a decedents estate and then receive a K-1 showing income.
Income in respect of a decedent
A beneficiary may also be subject to tax on any income in respect of decedent (IRD) items that he inherits. IRD is all of the gross income that a decedent would have received had death not occurred and that was not properly includable in the decedents final return.
IRD must be included in the gross estate (Form 706) and in the gross income of:
The decedents estate (Form 1041), if the estate receives the IRD;
A trust (Form 1041), if the right to income is passed directly to the trust in the year(s) the trust receives the IRD; or
A beneficiary (Form 1040), if the right to income is passed directly to the beneficiary in the year(s) that the beneficiary receives the IRD.