The 2010 calendar year proved a welcomed change for many trust funded preneed programs. The 2008 collapse of the home mortgage market triggered a melt down of bonds that lingered well into 2009. The press provided extensive coverage of how the situation impacted our 401k accounts. Stories about value declines of 25% to 33% were fairly common. But, most preneed trusts suffered a similar experience. Preneed fiduciaries were forced to examine fixed income portfolios for impaired assets, and some mortgage backed securities (long the staple of preneed trusts and endowed care trusts) had to be sold off.
In 2008 and 2009, many preneed trusts experienced capital losses that exceeded realized income. For the preneed trust reporting pursuant to a Federal Form 1041QFT, this black cloud had a silver lining: capital losses could be carried over to future years. With trusts seeing 2010 returns in the high single digits (and some double digit returns), the capital loss carry over provides fiduciaries an opportunity to reduce (or eliminate) the trust’s tax liability in 2010.
The manner in which a fiduciary applies the capital loss carry over (or CLCO) depends on how the 1041QFT was prepared in prior tax years. The QFT return contemplates individual trust accounts with a composite return, but IRS commentary suggests that a significant portion of QFT returns is prepared as a single, unified trust (see our August 9, 2008 post titled “The Section 685 QFT amendment: Supporting Soldiers’ Survivors”). With a composite return, the tax rate rarely exceeds 15%. With the unified trust, the tax rate will generally be 35% (when the trust income as a whole exceeds $11,200).
With the composite return, the CLCO is allocated among the individual accounts, and may be carried over in multiple years. With unified trust, the CLCO will be applied to the entire trust. In either case, the tax savings could be substantial.
Getting the 2010 return right may be more important than ever. As we will report in an upcoming post, the NPS collapse (and perhaps the IFDA/Merrill Lynch debacle) has caught the IRS’ attention. After twenty years of slumber, our tax regulator has reason to take a closer at how preneed is taxed.