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Washington Trust Accounting

by David Keene | Nov 03, 2017
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Many practitioners begin their experience with trusts when a client engages them to prepare a Form 1041. Because this engagement is indeed a tax engagement it seems appropriate to approach the process just as we would for a 1040 preparation engagement by gathering and summarizing Forms 1099, scanning the check register for tax items and transferring this tax data to the tax return.

But when the practitioner progresses to Schedule B of Form 1041, where the distribution deduction is computed, the practitioner will likely find that the Line 8 amount (“If a complex trust, enter accounting income for the tax year as determined under the governing instrument and applicable local law”) and Line 9 amount (“Income required to be distributed currently”) reflect no obvious relationship with the taxable income, and soon realize these amounts are instead based on trust accounting income, not taxable income.

Furthermore under IRC §651, the distribution deduction for a simple trust will be the lesser of “[T]he amount of [accounting] income for the taxable year which is required to be distributed currently” or the distributable net income (DNI–an amount based on taxable income). And under IRC §661 the distribution deduction for a complex trust is also based on the amount of accounting income required to be distributed (if any) as well as other distributions (i.e., of principal or of discretionary income) but limited to DNI as well.

So even if you are “just doing the tax return” for a trust you will also need to become familiar with the state law that sets out the rules for determining what cash receipts and disbursements are classified as principal versus those that are instead considered to be income; i.e., be able to determine the trust’s accounting income. In Washington, this law is the Washington Principal and Income Act of 2002, found at RCW 11.104A.

Important Note: The District of Columbia and 46 states, including Washington, have adopted the Uniform Principal and Income Act of 1997 (last amended or revised in 2008). However, many states, including Washington, have made edits to this uniform law. Accordingly, though various treatises and CPE classes provide valuable analyses of this law, be sure to check with the applicable state law before making any final conclusions on how this law should be implemented for any particular case.

Washington Principal & Income Act

The Washington Principal and Income Act of 2002 (WPIA) is required reading for any CPA with trust clients. You might find that assumptions you have made about this law do not hold to be true. For instance, certain classifications that exist under tax law do not hold for this state law. One example of this is that the interest income based on the amortization of OID under tax law (say, from the holding of a zero coupon bond) will be classified as principal under RCW 11.104A.150 if the obligation is to mature more than one year after it is acquired. Likewise, certain dividends classified as dividend income under tax law are not income under WPIA. See RCW 11.104A.100. In this same section of WPIA, distributions from partnerships follow the same principal/income classification rules as applies to corporate dividends.

Although the majority of WPIA is dedicated to defining cash receipts and disbursements as either income or principal, this law includes many other important provisions. One of the more unique of these is that the trust agreement provisions can overrule the provisions of this law.  RCW 11.104A.010(a)(1) states that a trustee or executor “Shall administer a trust or estate in accordance with the terms of the trust or will, even if there is a different provision in this chapter”.

Though the accounting for trusts follows a very different set of rules as compared to the accounting for corporations or partnerships, which many CPAs will be more familiar with, there is no reason practitioners cannot use their existing trial balance or general ledger software to maintain a trust client’s accounting records. One suggestion would be to distinguish principal versus income nominal accounts in the chart of accounts with, say, the 4000 series for income receipts, 5000 for income disbursements, 6000 for principal receipts, and 7000 for principal disbursements.

Another important service CPAs can provide to trust clients, especially for trusts with different principal versus income beneficiaries, is to inform the trustees of their compliance with the accounting and distribution provisions of the trust agreement. In most cases the amount of the accounting income is not determinable until some time after the year-end has occurred, when the source documents become available. Accordingly most trustees will estimate the amount of income during the year as a basis for making required income distributions. A correction is often required after the year-end to adjust required income distributions so they will match the income computed after the year-end has occurred.

Working with trustees by keeping them informed of their obligations to beneficiaries not only makes your services more valuable but also enhances the credibility of the trustee to his or her beneficiaries.

Trust Financial Statements

Practitioners exploring the usual sources for GAAP regarding trust accounting and financial statements will not find much guidance from authoritative accounting pronouncements; no APBs, SFASs, AICPA Statements of Position and the like exist for trust accounting or financial statement issues.  What does exist is from non-authoritative sources as that term is defined by SFAS 168 (The FASB Accounting Standards Codification and Hierarchy of Generally Accepted Accounting Principles).

One such non-authoritative source includes a report issued by the National Fiduciary Accounting Standards Committee which includes a list of the basic objectives and general standards of fiduciary accounting as well as two sample financial statements. Other sources, many derived from templates provided by courts, have found their way into common usage.  A useful source for these different approaches and formats is available in PPC’s Guide to Accounting and Reporting for Estates and Trusts.  
Overall, CPAs have significant latitude as to which source’s guidance they may be able to rely upon for producing  accounting and financial statements for their trust clients. In any case, the ability to produce financial statements and report on them is a source of additional service many practitioners should consider for their trust clients.

Learn More

Attend David’s Trust Accounting Workshop on Friday, November 17 at the WSCPA Learning Center in Bellevue. Register now.

David Keene, CPA, is the owner of  keene.cpa, P.S. in Seattle. He provides consulting services to CPAs, attorneys and other professionals, focusing on estate taxation, fiduciary accounting and fiduciary income taxation. You can contact him at keene.cpa@gmail.com.

This article appeared in the fall 2017 issue of the WashingtonCPA Magazine. Read more here.

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