Acting as a fiduciary isn’t always easy. A fiduciary owes many duties to the beneficiaries, and a breach of a duty can result in liability. One of these responsibilities is the duty to account.
Sometimes an accounting is required by law, requested by a beneficiary or provided by the fiduciary in the ordinary course of the administration of the trust or estate. Whatever the reason, having an accounting is one of the best ways a fiduciary can help protect itself from liability. From the beneficiary’s perspective, an accounting may protect the beneficiary because it forces the fiduciary to realize that she can’t account because of a failure of record-keeping; truthfully account, providing the beneficiaries with evidence of any potential wrongdoings; or falsify the accounts, which the beneficiaries can then disprove. Accountings provide better transparency to how the fiduciary managed the assets in the trust or the estate.
A fiduciary accounting is a comprehensive report of the activity within a trust, estate or conservatorship during a specific time period. It shows all of the receipts and disbursements managed by the executor or trustee, properly allocating all transactions between principal and income. These accountings are regulated by their governing instruments and state law. Many states have adopted the Uniform Principal and Income Act, sometimes with modifications. An accounting differs from traditional financial statements (for example, a financial statement doesn’t allocate between principal and income) and often requires more detailed descriptions of financial transactions. The way in which the information must be presented can vary depending on the nature of the entity, state format requirements and the specific requirements of the courts.
Fiduciary Accounting Income
Properly allocating all receipts and disbursements between principal and income is required to accurately calculate fiduciary accounting income. Some of the rules are complex and not intuitive. How does a fiduciary know how much income there is to distribute to an income beneficiary if the fiduciary doesn’t know the amount of the fiduciary accounting income? Knowing the amount of fiduciary accounting income is also important for determining the taxation of the trust and for tax planning for a beneficiary.
There are many differences in calculating income for tax purposes versus accounting. Generally, 26 U.S. Code Section 61 defines “gross income” as all income from whatever source derived. Fiduciary accounting income is defined by the governing instrument and state law and allocates all receipts and disbursements between principal and income. Accountings report items as income or expense when paid or received. When allocating inventory on the sales of securities, accounting uses the weighted average method, while tax reports using “first in, first out, average basis (for stock in mutual funds or dividend reinvestment) or specific identification. Accountings use the date of death for the estate valuation date; tax uses the date of death or the alternative valuation date. Flow through entities are ignored for accounting purposes. A receipt only occurs when a distribution is received. Cancellation of a debt is treated as income for tax purposes and is deemed a receipt of principal for accountings. These are just a few of the many differences.
Overview of Principles
It’s the responsibility of the trustee or executor to confirm that the information presented in the accounting is accurate. The following is a general overview of principles to keep in mind when reviewing a fiduciary accounting:
- Reason for the accounting. Understanding the purpose of the accounting is paramount. Knowing whether it’s being prepared because of the death of a beneficiary, death or resignation of the trustee, or for a required periodic filing will determine whether distributions are required, additional schedules are needed or final reserves should be retained. Furthermore, different accounting rules apply if an accounting is prepared due to the death or the termination of an income interest.
- Clear and thorough format. The accounting should be easy to read and comprehend, and it must incorporate all standard schedules reflecting beginning and ending assets on hand — receipts, disbursements, gains, losses and capital changes. Although some states and jurisdictions require specific formats (for example, California, Connecticut, Florida, Massachusetts, New Hampshire and New York), the National Fiduciary Accounting Standards format is acceptable in many states.
- Reliance on source data. The accounting should accurately reflect all the information contained in the source data (for example, checking, savings and brokerage account statements; trust statements; and estate settlement documents). Reconstruction may be required to reconcile missing documentation.
- Detailed documentation. Each transaction must be documented on the appropriate schedule and should be itemized with a detailed description. Dividends and interest should be described by source and date. Each disbursement should be listed separately by date and payee, not grouped together in a broad category.
- Asset reconciliation and income collection verification. The accounting should identify and confirm all assets held in the trust or estate. For a first accounting, the opening balance will consist of the list of assets funding the account. For subsequent accountings, the opening balance should exactly match the ending asset values listed on the prior accounting. Assets that have been removed, transferred or disbursed should be documented. All assets that belong to the trust or estate should be disclosed, even if they’re held at outside financial institutions. The income received on investments should be compared with the principal and income investment schedules to verify that all dividends, interest and other income have been properly collected and documented.
- Capital changes. All stock dividends, spin-offs and exchanges should be reviewed to confirm that the inventory values are properly applied, along with details of the assets spun off or exchanged.
- Balance. The total charges should equal the total credits. To confirm that cash and assets have been reconciled properly, they must also be reconciled separately.
In reviewing an accounting, the following common issues need to be observed:
- All statements and supporting documents have been received (for example, related accounts, loans, partnerships, Form 706 exhibits).
- Beneficiary distributions are correct per the governing instrument.
- Distributions to beneficiaries have been equalized if distributed on different dates.
- Fees have been properly allocated between principal and income as required by state law or governing instrument.
- All interest and dividends have been received and properly recorded.
- Nonstandard transactions have been identified and analyzed.
Finally, it‘s paramount for the fiduciary to review and agree with the accounting. Once signed, the fiduciary is responsible for the accuracy of the accounting.
Francine Lee is a senior manager and the business leader for EY’s Fiduciary/Trust & Estate Accounting Services team.