Our office routinely assists personal representatives in probate matters. We also assist trustees in settling revocable trusts. This post explains the financial reporting involved in those matters, and how we help our clients handle their responsibilities appropriately.
To keep this article simple, we discuss a probate process, in which the decedent leaves an estate, and the administrator is called a personal representative. When the decedent uses a revocable trust as their planning tool, the decedent leaves a trust, and the administrator is called a trustee, but the same reporting rules apply.
Probate Accounting Basics
At its most basic, a probate is a process in which one person distributes money or property according to written instructions left by a person who is deceased. The deceased person is the decedent, and the administrator is the personal representative. The written distribution instructions are found in the will, or, if the decedent did not leave a will, in state statute.
The personal representative’s job is to do what is necessary to wrap up the decedent’s affairs and distribute the remaining funds according to the will. Part of this job is that the personal representative must show her work—that is, she must provide financial reports showing the funds received, funds spent, and funds distributed to the beneficiaries.
A Probate is a Business
For record keeping purposes, an estate is a business. The estate has its own tax ID, its own financial accounts, and its own earnings and losses. The personal representative is the CEO of the business, directing what the estate does with the decedent’s property. The beneficiaries are the owners of the business, where gains, losses, and distributions ultimately accrue.
Like a business, the estate will have its own financial and reporting requirements. Just as the company’s CEO must report to the shareholders, the personal representative must report to the beneficiaries and the court. Just as a business must report to the IRS and (potentially) pay taxes, the estate must do the same.
Business Financials 101
In the business world, two key reports are the company’s income statement and the company’s balance sheet. A balance sheet is a snapshot of the business’s assets at any given time. So, for example, the business might list real estate, cash on hand, equipment, inventory, and so on, each with a value, as of a specific date, perhaps the end of a year, quarter, or month.
The income statement shows the business’s financial performance over time. So, for example, an operating business will (hopefully) earn money from sales (perhaps broken out into different products or lines of business) and from appreciation in its assets. It will spend money on materials, marketing, purchases of equipment, insurance, maintenance, and so on. An income statement shows all funds paid or received, broken out by time period, over the course of a given time period. This time period might be monthly, quarterly, or annually.
Estate Financials
In the probate world, the personal representative must prepare each of these financial reports. The first report is the balance sheet as of the decedent’s date of death. This is called an inventory, and will list all property of the decedent that is part of the probate process and its value as of date of death.
The second report is the income statement, which is called an accounting or final accounting in a probate. That accounting shows all gains, losses, expenses, and distributions from date of death forward. Like a business’s income statement, these expenses will be reported by category. Categories include capital gains and losses, administration expenses, and distributions to beneficiaries.
A very simple example of this would be a probate in which the decedent owned a checking account and a residence. Assume the checking account is $10K and real estate is worth $290K, and the personal representative spends $20K for the realtor, title company, court fees, and attorney fees, then distributes the balance to the decedent’s two children, in equal shares.
Her inventory will show:
$10K checking
$290K real estate
----------
$300K total
Her probate accounting will show:
$20K administration expense
$280K distributions
----------
$300K total
These amounts must be reported to all beneficiaries and the court. Note, of course, that money received must equal money paid.
Tax Reporting
In addition to reporting to the beneficiary, the trustee will usually need to file an income tax return for the trust. This return will report gains and losses by the trust. Note that the value of the decedent’s property on her date of death is not taxable income, but there may be income from other sources (for example, gains on stocks paid after death, or IRAs cashed out by the estate).
Because administration expenses are deductible, in many cases the estate will not have any taxable income. However, to the extent there is taxable income, that income is usually reported by the beneficiaries in proportion to their shares.
Our Process
When we represent personal representatives, our job is to help with the appointment process, give advice as needed on how to handle estate assets, and assist with reporting requirements.
On the reporting side, we like to get ahead of this as much as possible, rather than try to re-create financials at the end. The way this generally works is as follows:
As soon as our personal representatives are appointed, we tell them to set up a bank account for the estate. All estate bills should be paid from this account, and all money received by the estate deposited into this account.
We reach out to our PRs on an approximately monthly basis (depending on what is happening) to review bank statements and update the estate’s books. We keep the estate’s books in QuickBooks on our side.
As the decedent’s assets are liquidated, we ask for statements for the accounts and update the estate’s books accordingly.
Once all assets are liquidated, we prepare the inventory and estate account based on the records provided, and review those with the personal representative.
Once the accountings are reviewed and signed by the personal representative, we make arrangements with a CPA for preparation of the estate’s tax return. As part of this process, the beneficiary receives a tax form showing the income they must report on their individual return.
Tips and Tricks
Our general advice to our personal representatives is to keep things simple from the beginning. That means having a single estate checking account, working with us to update the financials as we go (not waiting), and ensuring all estate funds flow through the checking account. Whenever possible, the PR should avoid paying estate expenses from cash or personal accounts, and should never mix personal funds with estate funds.
Settling an estate can be a lot of work, but a solid foundation for reporting goes a long way in making the process as easy as possible.
Need to settle a family member’s estate? Contact our office for a free consultation.