Section 645 Election: Combining a Trust and an Estate

When an individual passes away, their financial assets are managed through a decedent’s estate or a trust. An estate comes into existence automatically at death to handle final affairs, while a trust is a separate legal entity created during a person’s lifetime to hold and manage assets. A common tool is the revocable living trust, which allows the creator, or grantor, to control the assets during their life.

Upon the grantor’s death, this trust becomes irrevocable, meaning its terms can no longer be altered. It then functions as a distinct entity for tax purposes, as does the decedent’s estate. This creates a situation where two separate entities must be administered, each with its own reporting obligations.

Understanding the Election to Combine a Trust and Estate

An election under Internal Revenue Code Section 645 permits a qualified revocable trust to be treated and taxed as part of the decedent’s estate for income tax purposes. This merges the two entities for tax reporting, simplifying administration. The executor files one return, Form 1041, U.S. Income Tax Return for Estates and Trusts, covering the combined income and deductions of both.

This election is available only to a Qualified Revocable Trust (QRT). A QRT is any trust the decedent owned at death because they held the power to revoke it, as detailed in Section 676 of the Internal Revenue Code. The election is an irrevocable decision.

Tax Consequences of Making the Election

Fiscal Year Reporting

Trusts are required to use a calendar year-end, but estates have the flexibility to select a fiscal year-end. By making the election, the combined entity can adopt the estate’s ability to use a fiscal year. This flexibility allows an executor to choose a year-end that provides more time to gather records if a person dies late in the year. It can also help align income with expenses, potentially deferring tax liability.

Estimated Tax Payments

Trusts must pay estimated income taxes throughout the year, while estates are exempt from this requirement for their first two tax years. When a Section 645 election is in effect, this two-year exemption is extended to the income generated by the QRT. This improves cash flow during the initial administration period, as funds are not tied up in quarterly payments.

Charitable Deductions

The rules for deducting charitable contributions are more generous for estates. An estate can deduct any gross income permanently set aside for a charitable purpose, even if it is not paid out during that tax year. This “set-aside” deduction is an advantage not available to trusts. Making the election allows charitable payments from the trust’s assets to be governed by these more favorable estate rules, allowing them to be fully deducted without the typical trust limitations.

S Corporation Stock

A revocable trust can hold S corporation stock, but after the grantor’s death, it is permitted to remain a shareholder for only two years. An estate, however, can hold S corporation stock for the entire administration period. The Section 645 election extends this longer holding period to the trust, preventing a forced sale of the stock or an inadvertent termination of the company’s S corporation status.

Passive Activity Losses

An estate can deduct up to $25,000 of losses from rental real estate activities against non-passive income for its first two tax years, a deduction not available to trusts. The election allows the combined entity to take advantage of this rule. This can permit the use of losses from rental properties held by the trust to offset other income.

Information and Requirements for the Election

To make the election, the executor of the estate and the trustee of the QRT must sign IRS Form 8855, Election to Treat a Qualified Revocable Trust as Part of an Estate. If the same individual serves as both executor and trustee, they must sign in each capacity. The form requires the decedent’s name and Social Security Number, and the legal name, address, and Employer Identification Number (EIN) for both the estate and the trust. The names and addresses of the fiduciaries making the election are also required.

Filing and Duration of the Election

Form 8855 is not filed by itself but must be attached to the first Form 1041 filed for the combined entity. The deadline for this initial return, and therefore the election, is the 15th day of the fourth month after the end of the chosen first tax year, with extensions available. The duration of the election depends on whether a federal estate tax return (Form 706) is required.

If no estate tax return is needed, the election period ends on the day before the second anniversary of the decedent’s death. If a return is required, the election period extends until six months after the final determination of the estate’s tax liability. This is often triggered by a closing letter from the IRS.