Pre-Need Cemetery Trusts
September 13, 2000
by Richard A. Neuman, CPA
Weil, Akman, Baylin & Coleman, P.A.
The Taxpayer Relief Act of 1997 contains many significant provisions
affecting all taxpayers. Perhaps one of the lesser known, but an exceptionally
important area contained within these provisions, involves money that
is kept in a Preneed Funeral Trust used for purposes of paying for one's
funeral. Pursuant to IRS Notice 98-6, the tax treatment of income earned
on funds held in Pre-Need Cemetery Merchandise Trusts is the same as that
of Qualified Funeral Trusts. This article is to help understand the significant
change that 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
Cemetery Merchandise Trusts.
There are several different types of Pre-Need Cemetery Merchandise Trust
deposit contracts. Prior to January 29, 1988, the income earned on many
of these preneed trusts was taxed to the seller, i.e., 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 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 Pre-Need
Cemetery Merchandise 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 is 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 minimal. As such, the committee indicated that the record-keeping
burden on individuals could be simplified if the trusts instead were taxed
at the entry 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 elections 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 Pre-Need Cemetery Merchandise Trust may not
accept contributions from a purchaser in excess of $7,000 ($7,200 for
the calendar year 2000). Contributions for this purpose includes 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 a Pre-Need Cemetery Merchandise
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 trustee 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 significiant advantage to the trustee for making the election to be
treated as a Pre-Need Cemetery Merchandise 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
that exist for trusts are applied on an individual trust level. To illustrate,
lets assume that a particular trust 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 $893. 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 would
create 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 28% bracket. But because
of the provision in the new law which allows each trust to be taxed individually,
the rate for each trust never reaches past the 15% bracket.
In addition, Form 1041-QFT instructions state that estimated tax is only
required if the 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
(as adjusted yearly), 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.
Another interesting area of Pre-Need Trusts is the response of each state
relating to the Federal legislation. One of the important benefits of
the Federal legislation is that each contract within a Pre-Need Trust
is treated as a separate trust. This means that the accelerated tax rates
which exist for most trusts are applied on an individual trust level.
In general, this allows the federal tax rate to be limited to the 15%
tax bracket on income earned by the trust. To date, I have been very pleased
with the response received from the various states for which I have prepared
trust tax returns that have made the Pre-Need Trust election. The states
appear to be allowing the trusts to be treated individually and as such
the income is generally limited to the lowest tax bracket.
In conclusion, the election to be treated as a Pre-Need Cemetery Merchandise
Trust is a major decision that 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.
- Richard A. Neuman, CPA
Richard A. Neuman, CPA
is a Principal with Weil, Akman, Baylin & Coleman, P.A., in Timonium,
Maryland. He is a member of the Maryland State Funeral Suppliers Association
and has significant experience in the death care industry. Mr. Neuman
provides seminars regarding taxation issues and can be reached at: (410)
561-4411.
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