People commonly make plans for the orderly transfer of their property upon their death to relatives other persons, organizations, or trusts to be set up for the benefit of relatives. Such forethought is known as estate planning and is accomplished under the guidance of attorneys, often working closely with accountants. The attorney's role centers around preparing wills and, in many cases, trust agreements. The accountant's role consists of suggesting planning techniques consistent with the objective of minimizing transfer costs (federal estate taxes, state inheritance taxes, and fees and expenses). In this capacity, an accountant often determines expected transfer costs under various options. An accountant may also play an important role in advising his or her client on accounting matters pertaining to trusts that are to be established.accounting, estate planning, taxation, estate administration

Ştefan Zuca

English

Research Papers in Economics

  18 
THE ROLE ACCOUNTANTS PLAY IN ESTATE PLANNING 
 
Ştefan Zuca
∗ 
 
Estate planning 
 
People commonly make plans for the orderly transfer of their property upon their 
death to relatives other persons, organizations, or trusts to be set up for the benefit of 
relatives. Such forethought is known as estate planning and is accomplished under the 
guidance of attorneys, often working closely with accountants. The attorney's role centers 
around preparing wills and, in many cases, trust agreements (discussed in detail later in 
the chapter). The accountant's role consists of suggesting planning techniques consistent 
with the objective of minimizing transfer costs (federal estate taxes, state inheritance 
taxes, and fees and expenses). In this capacity, an accountant often determines expected 
transfer costs under various options. An accountant may also play an important role in 
advising his or her client on accounting matters pertaining to trusts that are to be 
established. 
Accountants' participation in estate planning is usually limited to cases in which 
individuals are wealthy or moderately wealthy. Under current law, roughly 99.5% of all 
estates are exempt from estate and gift tax laws. An accountant participating in estate 
planning must have substantial expertise in estate and gift taxes—a complex area of the 
tax laws. A detailed discussion of these laws and the use of planning techniques to 
minimize transfer costs is properly the subject matter of a tax course.   
 
The Trust Feature of Estate Planning 
 
Frequently, a will contains a provision for the establishment of a trust, whereby 
certain designated property of the decedent's estate is to be transferred to a trustee when 
the person dies._ The trustee holds legal title to the property and administers it for the 
benefit of one or more other persons, who are called beneficiaries. Thus the trustee serves 
in a position of trust with respect to the beneficiaries. This is a fiduciary relationship, and 
the trustee is commonly referred to as a fiduciary. The person creating the trust is referred 
to as the trustor (also known as the grantor, donor, creator, and settlor). The legal 
document creating the trust is the trust agreement. Trust beneficiaries are of the following 
two classes: 
1.  Income beneficiary. An income beneficiary is entitled to the income earned by 
the trust's assets, referred to as the trust principal, or corpus. 
2.  Principal beneficiary. A principal beneficiary is entitled to the principal, or 
corpus, of the trust, which is distributed according to the terms of the trust agreement 
(usually at the specified termination date of the trust). A principal beneficiary is also 
known as a residuary beneficiary or remainderman. 
The income and principal beneficiaries may or may not be the same person. A 
common arrangement is to name one's spouse as the income beneficiary for his or her 
                                                           
∗ Ştefan Zuca is Associate Professor of Accounting at the Romanian American University in 
Bucharest.   19
remaining life and name one's children as the principal beneficiaries. Another common 
arrangement is to name one's children as both income and principal beneficiaries, with 
some or all of the income to be used for their support and the principal to be distributed to 
them when they reach a specified age. 
 
The Basic Accounting Problem 
 
Regardless of whether the income or principal beneficiaries of a trust are the same 
person or persons, it is necessary to account for the separate interests of each class. 
Accomplishing this task is the subject of this chapter. The requirement of correct separate 
accounting for the interests of each class is the reason for the special theories and 
techniques for accounting for the administration of estates and trusts by fiduciaries. 
Otherwise, quite simple record-keeping procedures are adequate. 
Accounting for the separate interests of each class of beneficiaries is even more 
difficult because a built-in clash of interests exists between the two classes. When the 
principal and income beneficiaries are not the same person or persons, the clash revolves 
around who gets what. When the principal and income beneficiaries are the same person 
or persons, the clash concerns the timing of distributions. Frequently, disputes between 
these interests lead to litigation. 
Although a trust may be established by a transfer of property to the trustee during the 
transferor's lifetime (known as an inter vivos trust), we deal solely with trusts that are 
created by a gift made in the will of a decedent (known us a testamentary trust). Thus we 
must consider the administration of a decedent's estate in connection with the 
establishment of a trust. 
  
The Accounting View 
 
For accounting purposes, we treat the estate and the trust as separate accounting 
entities Further more, we conceptually view each of these separate accounting entities as 
composing two accounting entities: a "principal entity" and an "income entity." Thus, 
conceptually, four accounting entities exist. 
 
The Tax View 
 
For tax-reporting purposes, estates and trusts both are treated as taxable entities. 
They are not legal entities, however, in the sense that corporations are legal entities. 
 
2. PRINCIPAL VERSUS INCOME 
 
When a testamentary trust is established, every transaction must be analyzed to 
determine whether it relates to principal or income. An incorrect determination has 
important legal consequences to a fiduciary. If it is later determined that income has been 
overstated and the fiduciary cannot recover the amount of the overpayment from the 
income beneficiary, the fiduciary must make up the deficiency. In turn, if the error was 
made by the accountant or was based on the bad advice of the fiduciary's legal counsel, 
these persons may be professionally responsible to the fiduciary.   20 
Manner of Analyzing Transactions 
Reference to the Trust Agreement 
 
In determining whether a transaction pertains to principal or income, GAAP is not 
the point of reference. The trustor may create his or her own definition of income. In 
other words, the trustor may specify the receipts that are to be income and the receipts 
that are to be principal. Likewise, the trustor may specify disbursements to be treated as 
charges against income disbursements to be treated as reductions of the principal. 
Accordingly, all transactions must be analyzed as to the decent's intent. 
Because the decedent is not available, the first step is to determine whether the 
decedent's intent is expressed in the trust agreement. Unfortunately, a common 
shortcoming of estate planning is that trust agreements usually do not explain in detail the 
treatment to be accorded specific types of receipts and disbursements. Many potential 
problems can be avoided if the decedent's personal accountant, who should have a 
knowledge of his or her client's properties, participates in the preparation of the trust 
agreement sections that pertain to accounting matters. 
 
Reference to State Law 
 
If the treatment of an item cannot be resolved by referring to the trust agreement, the 
second step is to find out what the state law is on the subject. Again, GAAP is not the 
point of reference. The Revised Uniform Principal and Income Act specifically addresses 
the principal versus income treatment of several items. Much of the impetus for revising 
the original Uniform Principal and Income Act (of 1931) resulted from the development 
of new forms of investment property, the treatment of which was not specified in state 
statutes. The treatment accorded many items specifically dealt with in the act produces 
income results that would be obtained if GAAP is applied. For numerous other items, 
however, the treatment produces results that are quite contrary to GAAP. For example, 
the act provides that the following items be treated as increases and decreases, 
respectively, to the trust principal—not the trust income: 
1.  Gains and losses on the sale of corporate securities. 
2.  Gains and losses on the sale of rental property. 
3.  Bond discounts (with certain exceptions) and bond premiums. 
 
Reference to Case Law 
 
If the treatment of an item is not covered in state law, the third step is to determine 
whether the courts have encountered and ruled on the same problem. If so, the answer is 
found in case law. If the answer cannot be found there, the fiduciary may petition the 
court for a determination. 
 
The Accountant's Role in Analyzing Transactions 
 
When the treatment to be accorded an item is not clearly set forth in the trust 
agreement or state statutes, the accountant does not determine whether an item pertains to 
principal or income. This is the function of the fiduciary, the fiduciary's legal counsel, or   21
the courts. The accountant's role is expanded, of course, when the trust agreement 
specifies that income is to be determined in accordance with GAAP. Such cases, 
however, are the exception—not the rule. 
 
Manner of Record Keeping 
 
Because the interests of the principal beneficiary and the income beneficiary must be 
accounted for separately, it is necessary to identify the assets and transactions pertaining 
to principal and those pertaining to income. Conceptually, we may view the assets and 
transactions pertaining to principal as belonging to a separate accounting entity and do 
likewise for the assets and transactions pertaining to income.   
One method of record keeping is to physically maintain separate journals and general 
ledgers for each accounting entity. An alternate method is to use one set of books for both 
entities but to use separately identified columns in the journals and separately identified 
accounts in the general ledger for principal and income. This technique allows separate 
trial balances to be prepared for each accounting entity, as though two general ledgers 
were used. In practice, this technique is quite simple to work with, largely because cash is 
usually the only type of asset common to both principal and income. 
  
Cash Basis versus Accrual Basis 
At the Beginning and the End of the Income Beneficiary's Rights 
 
In most respects, the Revised Uniform Principal and Income Act provides for the use 
of the accrual basis in determining at the time of the person's death the assets to be 
treated as part of the trust principal. The purpose, of course, is to establish a reasonably 
fair and practical starting point to determine income for the income  beneficiary. 
Specifically, the following items are to be included as part of the trust principal at the 
time of death: 
1.  Amounts due but not paid at the time of death. 
2.  Prorations of amounts not due at the time of death that pertain to periodic 
payments, including rents, interest, and annuities. 
3.  Corporate distributions declared for which the date of record precedes the 
person's death. 
The cash basis is specified for all other items. In a somewhat parallel manner, the act 
provides in most respects for the use of the accrual basis on termination of an income 
interest to effect a reasonably fair and practical cutoff of the income beneficiary's interest. 
 
Accounting Periods between the Beginning and  
the End of the Income Beneficiary's Rights 
 
For accounting periods between the beginning and the end of the income 
beneficiary's rights, the accrual basis in most respects does not fit in with the underlying 
objective of the fiduciary, which is to account for the flow of assets in and out of his or 
her control. Accordingly, with one major exception, the cash basis is considered more 
appropriate for such accounting periods. The accrual basis offers much better measuring   22 
results, however, when determining the income of a business in which principal is 
invested. 
 
At the End of the Estate Administration 
 
When the income rights of the income beneficiary are established at the time of the 
person's death he end of the estate administration is not relevant to the income and 
principal beneficiaries. Using the accrual basis is therefore unnecessary at the end of 
probate administration. Of course  if the trust agreement provides that income rights do 
not start until the end of the estate administration, 
accrual techniques are appropriate.. 
 
References 
 
Aggarwal R., 1980, “Corporate use of sophisticated capital budgeting techniques: a 
strategic perspective and a critique of survey results,” Interfaces, April 
Baker R., Lembke V., King T., 2006, Advanced Financial Accounting, Mc Graw Hill 
Kieso D., Wezgandt J., 2001, Intermediate Accounting, Wiley 
Morris J., 2004, Accounting for M&A, Equity and Credit Analysts, Mc Graw Hill 
Siegel J., Levine M., Qureshi A., Shim J., 2005, GAAP 2006 – Handbook of policeis 
and procedures, CCH 
  
  
 
 
 
 
 
 

Corporate use of sophisticated capital budgeting techniques: a strategic perspective and a critique of survey results,” Interfaces,

The role accountants play in estate planning

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