§645 Election- What is it and How is it Used?
A §645 election can be used to combine the trust and estate into one entity for tax purposes, so only one IRS Form 1041 needs to be filed.
A revocable living trust becomes irrevocable at the death of the grantor and causes the trust to require separate income tax reporting for any income attributable to it. Though both the trust and the estate use an IRS Form 1041 to report their income, the income tax reporting of the trust is separate and distinct from the general requirement for an estate to file an income tax return.
For example, if a decedent died on September 15th, the following income tax returns needing to be prepared for the year of the decedent’s death are as follows:
- Final IRS Form 1040 for the Decedent’s last year alive. (Income from Jan 1st - September 15th)
- IRS Form 1041 for the Estate of the Decedent (Income from September 15th - December 31st)
- IRS Form 1041 for the (now irrevocable) Revocable Trust (Income from September 15th - December 31st)
… and this is just for income taxes, let alone the “death taxes” (i.e., estate tax and inheritance tax) which also must be reported in many cases.
There is where the §645 election comes into play. A §645 election can be used to combine the trust and estate into one entity for tax purposes, so only one IRS Form 1041 needs to be filed.
The trustee of a standard revocable trust (that is characterized as a grantor trust until the decedent dies)(1) and the executor of the estate can use a §645 election to treat the trust as a part of the estate rather than as a separate trust for federal income tax purposes.
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 if the § 645 election is made, even though legally, the trust, rather than the estate, continues to hold the assets. Certainly, the income and expenses of the estate continue to be reported by the estate on the estate’s income tax return.
Benefits of Using a §645 election
In addition to streamlining the administrative burden of preparing and filing two returns, there are a number of other potential advantages to using §645 election to treat the trust as part of the estate for tax purposes. These include the following:
- Fiscal Year Selections: Without the §645 election, non-grantor trusts are required to adopt a calendar tax year. Estates, on the other hand, can select a fiscal year. A §645 election allows a qualified revocable trust to use that fiscal year for tax reporting. This allows you to shift the trust’s income in a way that can defer the trust’s income tax burden from one reporting year to another.
- Example: Decedent dies on December 1, 2019.
- Without a §645 election: Decedent’s Trust would file an income tax return for the year ending December 31, 2019 (the decedent's year of death) and pay the income tax due by April 15, 2020.
- With a §645 election: For tax purposes, the trust and estate are combined into one entity. The executor now can elect a fiscal year ending November 30, 2020. The same income would now be deferred and not due until the following tax year of 2021.
- 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 §645 election allows you to treat a trust as an estate for tax purposes, trusts can enjoy using the deduction in years beyond only the current year. In most cases, trusts are limited to taking a charitable income tax deduction for donations made in that current year only.
- Loss Allowal without proof of Active Participation: The §645 election enables an estate to take up to $25K in passive losses without having to show active participation, unlike a trust. Individual taxpayers are automatically considered “active participants” in rental real estate activities, which allows them to take up to $25K passive losses each year without having to meet any participation thresholds or standards. Trusts and other entities (LLCs, S Corps, etc.) must meet certain thresholds of participation to take losses on passive activity. However, though an estate is not an individual, the IRS allows estates to enjoy automatic treatment as an active participant for the first two years after a decedent’s death.
- Increased Personal Exemption: Trusts have an exemption of $100 or $300, whereas estates have an exemption of $600. Because a §645 election combines the trust with the estate for tax purposes, the trust can now have the increased exemption of $600, combined with the estate.
- Extended Payment Deadlines: A §645 election allows the trust to have extended payment deadlines. Though they still must timely file, estates do not need to make estimated income tax payments until the tax year ending two years following the decedent’s death. They are also not subject to underpayment penalties during this time. This is not the case for trusts.
- Extended S Corp Stock Holding Periods: A §645 election enables the trust to hold S corp stock beyond the two-year deadline without having to make a QSST or ESBT election if the estate is still being administered beyond that time period. If a revocable trust owns S Corp stock and then the grantor dies, the Trustee only has two years from the grantor’s date of death to “own” the stock as an S shareholder, and then it must dispose of the stock or make a QSST or ESBT election, if applicable, in order to prevent the termination of the corporation’s S-election. However, an estate is allowed to own S corporation stock for as long as it takes to administer the estate, which provides more flexibility if the administration is drawn out.
How do I make a §645 Election?
A §645 election must be made on IRS Form 8855. IRS Form 8855 is the “Election to Treat a Qualified Revocable Trust as Part of an Estate” and both the executor and trustee must sign. This election is irrevocable and due by the date of the estate’s initial income tax return (IRS Form 1041), including any extensions taken on such return. An EIN must be obtained by both the electing trust and the related estate.
How do I end the §645 Election?
It depends on the estate and whether an estate tax return (IRS Form 706) was filed, as well as the terms of the trust itself. In cases where no estate tax return is required, the §645 election ends the day prior to the 2 year anniversary of the decedent’s death at the latest. However, termination can occur sooner if all of the assets of the trust and estate were already distributed. When an estate tax return is required, the §645 election terminates on the later of two years from the date of death or six months after the final determination of the estate tax liability. There are nuanced and complicated rules set forth in the treasury regulations for dealing with this case-specific nature of 645 election terminations, which every tax preparer should review prior to drawing a conclusion about how to handle the termination. It is important to note that the general “feel” for the rules is to allow the fiduciaries to enjoy the election during the time period in which they are doing the estate administration and terminating the election upon completion of that estate administration.
Once the election is terminated, the trust must start to file its own separate income tax return (IRS Form 1041), and the reporting for that trust reverts back to a calendar year basis. If the estate is still open and filed on a fiscal year basis, it can continue to do so.
(1) It must be a Qualified Revocable Trust under IRC 676.