Trustees of Pre-Need Funeral Trusts Can Now Elect Simplified Taxation of Trust Earnings

Article excerpt

The Taxpayer Relief Act of 1997 allows the trustee of a pre-need funeral trust, to the extent the trust would otherwise be treated as a grantor trust, to elect special tax treatment. To qualify for relief under the new IRC section 685, certain conditions relating to the pre-need funeral trust and its beneficiaries must be satisfied.

Pay in Advance

State law typically provides that a decedent's estate or spouse has a legal obligation to pay for the decedent's funeral. In a pre-need funeral arrangement, the purchaser of the funeral enters into a contract with the seller, which is usually a funeral home. Pre-need funeral contracts typically include merchandise, labor, and services performed by the seller, and third party services. Merchandise includes such items as tombstones, caskets, and flowers. Labor and services performed by the seller include removing the decedent from the place of death, caring for the decedent at the necessary facility, and transporting the decedent to the final resting place. Third-party services include fees and charges associated with clerical services, cemetery costs, certified copies of the death certificate, air transportation, religious rituals, and the professional services of other funeral directors if the body is shipped to another funeral home. After selecting the merchandise and services to be provided, the purchaser typically agrees to pay for them in either a lump sum or a series of installments. Upon the decedent's death, the merchandise and services are provided by the seller.

Most states have laws or regulations governing pre-need funeral arrangements. Most states require the seller to deposit a percentage of the money received from the purchaser into a pre-need funeral trust for the use, benefit, and protection of the purchaser. In addition, most states require that the money deposited into the trust be invested and held by the trust until the seller fulfills the contract.

Pre-Need Funeral Trust Arrangements Under Revenue Ruling 87-127

Rev. Rul. 87-127 examines four commonly used pre-need trust arrangements. In all four of these arrangements, the purchaser can cancel the contract with the seller at any time. Rev. Rul. 87-127 describes each of these arrangements as follows:

Situation 1. Income earned on the money deposited in the trust is accumulated. Upon performance, the seller receives all of the purchaser's money that was deposited in the trust and the accumulated income. If the purchaser cancels the contract with the seller, all money deposited into the trust and the accumulated income is received by the purchaser.

Situation 2. Income earned on the money deposited in the trust is paid annually to the seller. Upon performance, seller receives all of the money that was deposited in the trust. If the purchaser cancels the contract with the seller, all money deposited in the trust is returned to the purchaser.

Situation 3. Income earned on the money deposited in the trust is accumulated. Upon performance, the seller receives all of the purchaser's money deposited in the trust and the accumulated income. If the purchaser cancels the contract, the purchaser is not entitled to receive any of the money from the trust but is only entitled to select a new seller to provide the funeral arrangements.

Situation 4. Income earned on the money deposited in the trust is accumulated. Upon performance, the seller receives all of the purchaser's money that was deposited in the trust and the accumulated income. If the purchaser cancels the contract with the seller, all the money deposited in the trust is returned to the purchaser and the accumulated income is paid to the seller.

In each of these situations, Rev. Rul. 87127 treats the purchaser as the grantor of the trust for Federal income tax purposes. Accordingly, any money received from the trust by a seller of a pre-need funeral is a payment for merchandise or services includable in the seller's gross income. …