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The Taxpayer Relief Act of 1997
contains many significant provisions affecting all taxpayers. Perhaps
one of the lesser known, but yet an exceptionally important area
contained within these provisions, involves money which is kept in what
is termed a Pre-Need Funeral Trust used for purposes of paying for
one's funeral. This article is to help understand this significant
change which transpired pursuant to the 1997 Act relating to the tax
treatment of the income earned on the deposits which are being kept in
these Pre-Need Funeral Trusts.
A brief background is in order.
Pre-Need Funeral Trusts exist where a purchaser is arranging for
funeral services from a funeral home or a cemetery in advance of the
individual's death. This individual will enter into a contract with
the service provider, in which the individual selects the type of
service to be provided upon his or her death and agrees to pay for them
in advance. The amounts are held in trust during the individual's
lifetime and are paid to the seller, who is the provider of the
services, upon the death of the individual.
There are various different types
of funeral trust deposit contracts which can exist. Prior to January
29, 1988, the income earned on many of these Pre-Need Trusts was taxed
to the seller, i.e., the provider of the service (the funeral home or
the owner of the cemetery), or the Trust. Revenue Ruling 87-127 made a
dramatic change in the method of taxation for the income earned on
these deposits. This revenue ruling basically stated that in most
cases, for contracts entered into after January 28, 1988, and for
certain retroactive contracts, the purchaser was treated as the grantor
of the trust. As such, the purchaser was required to recognize the
income from the money deposited in these accounts. Depending upon the
particular state law, either a Form K-1 or a Form 1099 was issued to
the purchaser, and the purchaser was required to recognize such
earnings on his or her tax return.
The Taxpayer Relief Act of
1997 essentially reverted (upon election of the trustee) back to the
methodology used prior to January 29, 1988. The trustee of the
Pre-Need Trust may elect to create a ?Qualified Funeral Trust?. This
trust is not treated as a grantor trust, and as such the trustee pays
the tax on the earnings. The Joint Committee Conference Reports
indicate the reason for this change as being that numerous individual
taxpayers were required to account for the trust earnings on their tax
returns even though the earnings with respect to the taxpayer may have
been exceptionally minimal. As such, the Committee indicated that the
record-keeping burden on individuals could be simplified if the trusts
instead were taxed at the entity level, with one ?simplified? annual
return filed by the trustee reporting the income from all such accounts
administered by the trustee. As we will discuss, there are advantages
to the trustee as well as the purchaser of the contract in making the
election to pay the tax at the trust level.
For the election to be made by the trustee, several criteria are required. These include:
The trust must arise as a result
of a contract with a person engaged in the trade or business of
providing funeral or burial services.
The sole purpose of the trust is
to hold, invest, and reinvest the funds in the trust and to use the
funds solely to make payments for the services or property for the
benefit of the beneficiaries of the trust.
The only beneficiaries of the trust are individuals to whom services or property are to be provided at their death.
The only contributions to the trust are contributions by or for the benefit of the beneficiary.
The trustee must make an election which is done by timely filing the Form 1041-QFT (see below).
The
trust, except for the election stated above, would otherwise be treated
as owned by the purchaser of the contract and, as such, the income
would be recognized by the purchaser of the contract.
In addition to the above, a
Qualified Funeral Trust may not accept contributions from a purchaser
in excess of $7,000. Contributions for this purpose include all
amounts transferred to the trust, but do not include income or gain
earned with respect to the property in the trust. However, pursuant to
IRS Notice 98-6, a contract may not be included in the Qualified
Funeral Trust if it is projected that the contract over the life of the
trust will receive contributions exceeding $7,000. This means that not
only must the trust look today to see whether there is $7,000 in the
trust, but it must project whether contributions in the future will
cause the amount to exceed $7,000. In such a case, that account may
not be included in the election discussed above.
Also, for purposes of applying
the $7,000 contribution limit, if a purchaser creates more than one
contract with a trustee, all the trusts are aggregated as one trust.
As such, creating more than one contract will not avoid the $7,000
ceiling mentioned above.
A significant advantage to the
trustee for making the election to be treated as a Qualified Funeral
Trust is that the numerous Form K-1's and Form 1099's would not have to
be sent to the purchasers of the contracts. The trustee may accumulate
all of the names of those qualified purchasers and file one form,
called Form 1041-QFT. Each contract is treated as a separate trust;
this means that the accelerated rates which exist for trusts are
applied on an individual trust level. To illustrate, lets assume that
a particular trustee has 10 trust accounts. If the total taxable
income of the trust accounts were $4,000, the regular Federal tax based
upon the accelerated rates would be $909. However, as stated above,
each one of the contracts is taxed as its own trust. Therefore, in the
prior example, if we were to assume that the 10 trust accounts each
earned $400, each trust would be taxed on $400 of income which, for
each trust would create a tax of $60 for a total tax of $600. This
difference in tax is because the tax rates accelerate quickly for
trusts. As such, if the income were reported in the aggregate, the tax
rate would reach the 31% bracket. But because of the provision in the
new law which allows each trust to be taxed individually, the tax rate
for each trust never reaches past the 15% bracket.
In addition, the Form 1041-QFT
instructions state that estimated tax is only required if the Qualified
Funeral Trust expects to owe $1,000 or more in tax in a prospective
year. However, as stated above, since the tax liability is figured for
each individual purchaser, and not the total tax liability for all of
the accounts reflected on the Form 1041-QFT, a single account would
have to be expected to produce $1,000 or more in tax for estimates to
be required. Considering that the contributions to the account are
limited to $7,000, a somewhat significant rate of return would have to
exist for any particular account to produce $1,000 in tax on a
contribution limit of $7,000. As such, it appears that in the
overwhelming majority of cases, estimated taxes would not be required.
One major area which has not
currently been addressed is whether each state will adapt to the new
law. At this time, it is uncertain as to whether the States will be
following the federal law relating to the various provisions stated
above. It will be interesting to see what the position of each state
will be relating to this new enactment.
In conclusion, the election to be
treated as a Qualified Funeral Trust is a major decision which should
be carefully studied and considered. The effective date for this
election is for taxable years ending after August 5, 1997. The
advantages can be significant, however the costs associated with the
trustee paying the tax on the earnings, as well as the necessary
competent preparation of the Form 1041-QFT and the necessary state
filings, must also be part of the decision process in making this
election.
Mr. Neuman is a member of the
Maryland State Funeral Suppliers Association. He has significant
experience in the death care industry and is providing seminars in this
area. |
