Serving as the fiduciary of a trust or estate requires specialized knowledge, organizational skills, time and meticulous attention to financial details. Individuals and corporate entities who serve in this role are also legally bound to follow a series of basic principles governing the decisions of fiduciaries including an expectation to act with reasonable care (called the duty of care), acting solely on behalf of the beneficiaries of the trust or estate (the duty of loyalty) and remaining impartial in serving the interests of multiple beneficiaries (duty of impartiality). Fiduciaries must also adhere to a variety of state and federal laws and regulations, which can become complex depending on the types of assets held by the estate or trust.
Fiduciary accounting is how fiduciaries demonstrate transparency to and for others; the fiduciary must maintain records for a variety of financial transactions, which provides information needed by stakeholders including:
- The IRS and state tax agencies: Since a tax return must be filed on behalf of an estate or trust, the value of the assets and the income generated by those assets are all critical to determining tax liability.
- Beneficiaries: Fiduciary accounting provides beneficiaries with the peace of mind to know their assets are being managed in a reasonable and fair manner. When a trust or estate has multiple beneficiaries, fiduciary accounting provides transparency for them to recognize that the fiduciary is acting fairly and impartially.
- State probate courts: Financial transactions for estates passing through the probate system must comply with probate laws in the state in which the estate is held. Probate laws may differ from one state to another.
- Other regulatory agencies: Estates and trusts can include different kinds of assets including business ownership and investments, each of which requires compliance with one or more regulatory agencies. Investments held in trust, for example, must comply with laws governing investments by the Securities and Exchange Commission, while the Department of Labor oversees compliance with employee benefit plans that may be part of a business held by an estate.
Occasionally, a fiduciary may also retain service professionals such as an accountant, an investment advisor or an attorney to navigate tax filing, investment or legal requirements impacting the estate or trust.
A comprehensive list of every possible financial transaction is difficult to put together given their complexity and the unique strategies that determine how each estate or trust is created and governed. However, below is a list of some of the most common fiduciary accounting obligations. A fiduciary must:
- track receipts for incoming funds and disbursements for outgoing funds with distinctions made between the principal and income
- track gains and losses from the sale of trust or estate assets
- oversee valuations performed for the trust or estate (to determine tax liability and reporting requirements)
- report assets and liabilities within the trust or estate
- record the fiduciary’s compensation
Examples of income generated by an estate or trust, which requires fiduciary accounting (and possible reporting on IRS Form 1041) include interest income from bank accounts, bonds and other interest-bearing investments, dividend income received from stocks and mutual funds, rental income, income generated from businesses, capital gains generated from selling estate assets (e.g. stock, investments with appreciated value) and royalties.
Similarly, many expenses must be reported including compensation for the fiduciary and professional service providers supporting the estate (such as those mentioned above), and fees for probate court, brokerage fees and bank fees to maintain a trust or estate account. Estates and trusts must also report to the IRS any income generated by the principal assets, estate taxes on the value of the estate and taxes on real property owned by the estate. Finally, any properties held within an estate or trust may require repairs and maintenance, the payment of insurance premiums or utility costs, which represent other reportable expenses.
Fiduciary Accounting: Individual or Corporate Fiduciary?
As mentioned above, a fiduciary responsible for the trust or estate-related accounting can be an individual or a corporate entity. A variety of factors should be considered when making a choice.
- Individual Fiduciary
The benefits of choosing an individual are many including the individual fiduciary’s personal relationship with beneficiaries and understanding their needs and family dynamics. An individual fiduciary who already has a relationship with the beneficiaries also likely holds a degree of trust and may finally be able to fulfill their role in a less formal manner while also having the ability to accommodate the unique or specific requests of beneficiaries.
- Corporate Fiduciary
While these benefits may be attractive, consideration should also be given to the advantages brought to the fiduciary role by a corporate entity including the expertise available from an accounting or investment advisory firm. A firm that offers professional management of an estate or trust often provides a team with a deep and knowledgeable understanding of the accounting and compliance requirements for an estate or trust. They can help beneficiaries navigate the complexities of laws and regulations related to their holdings while avoiding the time-intensive need for research and reduce the risk of errors or omissions.
While a relationship with an individual fiduciary may be more informal, a corporate firm can provide complete objectivity in its role as fiduciary without concerns about perceived conflicts of interest. Firms that specialize in providing estate and trust accounting also often offer other areas of expertise such as tax planning, financial planning and investment advisory expertise or have relationships with other professional service providers who offer specialized areas of knowledge, such as attorneys. Finally, corporate fiduciaries offer stability and continuous ongoing service that may not be available from an individual fiduciary.
In Conclusion
Fiduciary accounting is critical to effective trust and estate management and involves fully understanding the role of the fiduciary, careful reporting on a variety of financial transactions for multiple stakeholders and ensuring compliance with complex state and regulatory agencies. Choosing an effective and knowledgeable fiduciary is also important to ensure mistakes are avoided and all reporting is handled accurately. Be sure to understand all the considerations when selecting a fiduciary for your trust and estate; you have taken the time to consider the strategies for protecting your assets and making them available to your beneficiaries. Effective management of fiduciary accounting is no less important.
Questions? Contact Thomas Burton via our online contact form.
Councilor, Buchanan & Mitchell (CBM) is a professional services firm delivering tax, accounting and business advisory expertise throughout the Mid-Atlantic region from our office in Bethesda, MD.
