Trusts (or estates) with taxable income must complete IRS Form 1041
Revocable trust income is added to the grantor’s personal income
Irrevocable trusts pay their own income tax, but usually only if they had undistributed income during the year
Income distributed to beneficiaries is reported on a Schedule K-1, which beneficiaries use to add trust income to their personal tax returns
A trust is a legal entity into which the trust’s creator, known as the grantor, places assets that can one day be accessed by the trust’s beneficiaries. Income from a trust is still subject to income tax, but how trust income is taxed depends on the type of trust, the type of income, and who is receiving the income.
In general, a trust that earned income during the tax year should file IRS Form 1041 U.S. Income Tax Return for Estates and Trusts. The trustee is responsible for filing the return, though they can seek help from a tax professional, and most deductions or credits allowed to individuals are also allowed to trusts.
Income for a revocable trust is considered the grantor’s income and the grantor must pay income taxes on it; Form 1041 is used simply to report that there was trust income and where that income came from. For irrevocable trusts, the trust must file its own tax return by completely filling out Form 1041, and then it must pay any taxes it owes. If a beneficiary received income from the trust, the trust must send that beneficiary a copy of Schedule K-1.
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A revocable trust is known as a grantor trust for tax purposes because the grantor retains ownership of the trust and of assets in the trust. Any income that trust assets earn will also qualify as income for the grantor and the grantor will need to report that income on their personal income tax return.
The trust should still file Form 1041 if it earned taxable income. Form 1041 reports that there was trust income and attachments to the form allow the trustee to detail how much trust income is taxable for the grantor, where that income is from, and which tax deductions or tax credits may apply to the income. The information on Form 1041 and any of its attachments can then be used to help the grantor complete their tax return (Form 1040 and any necessary attachments).
If any portion of the trust income was not taxable for the grantor, like if some income went to a different trust beneficiary, the trust should send that beneficiary a copy of Schedule K-1. The grantor does not need to receive Schedule K-1. Similarly, if the grantor has a joint trust with their spouse and they also file a joint tax return, trust income for the grantor’s spouse is also included on the personal tax return and neither receives Schedule K-1.
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An irrevocable trust, also called a non-grantor trust, must complete and file its own tax returns if it earned taxable income. Taxable income for a trust includes standard sources of income — like rent collections from a property the trust owns — as well as any interest or gains that weren’t distributed during the year. So if a trust includes funds in a savings account, any interest earned by that account throughout the year is taxable income for the trust unless it is distributed to a beneficiary. If the trust does distribute the income, the beneficiary is usually responsible for reporting it on their own taxes.
Learn more about the difference between revocable and irrevocable trusts.
The trustee is responsible for filing the return and should complete IRS Form 1041 plus any necessary attachments. If a trust disbursed any income to beneficiaries, it must provide each recipient with a copy of Schedule K-1. An income distribution for a beneficiary is deductible for the trust: trusts only pay income tax on income they don’t distribute during the tax year. In general, all tax credits and deductions available to an individual taxpayer are also available to a trust.
Learn more about distribution of trust assets to beneficiaries.
Any irrevocable trust that files a tax return must have its own employer identification number (EIN), which it can get from the IRS. Without an EIN, the trust cannot properly complete its tax return.
There are many types of trusts, each potentially having different tax requirements, so it’s best to seek the help of a tax accountant or other professional when filing trust taxes. Federal income tax forms and state income tax forms may also differ in their content and filing requirements.
Trust income is taxed according to what type of income it was, so a capital gain from selling a stock can be taxed differently from business income. Overall, trust income is also subject to different rates than the personal income tax rates. The trust tax brackets include only four tax rates for 2020 taxes (which you file in early 2021): 10% for income up to $2,600; 24% for income between $2,600 and $9,450; 35% for income between $9,450 and $12,950, and 37% for all income over $12,950.
|TAX RATE||INCOME RANGE|
|10% of every dollar earned between||$0 and $2,600|
|24% of every dollar earned between||$2,600 and $9,450|
|35% of every dollar earned between||$9,450 and $12,950|
|37% of every dollar above||$12,950|
Note that these tax brackets also apply to any estates filing an income tax return, but these are separate rates from the estate tax, which applies to wealthy estates before they are passed on to heirs.
Trusts may also have to pay the net investment income tax (NIIT) if they had any undistributed income from investments (dividend income). NIIT is 3.8% and the amount of income subject to NIIT is either the net value of the undistributed investment income, or the value of the trust’s adjusted gross income that exceeds $12,950, whichever is lower. (Individuals can also pay the NIIT but the income thresholds that require an individual to pay NIIT are significantly higher than they are for trusts.)
Trust beneficiaries must usually pay income tax on any income they receive from a trust. The income from trust distributions is reported to a beneficiary on a copy of Schedule K-1, which the trust sends. The income is then included in the beneficiary’s gross income, but the information on Schedule K-1 will dictate what type of income it is. For example, Schedule K-1 lists how much of the income was from interest, dividends, capital gains, rental income, or ordinary income. It also lists any deduction the beneficiary may qualify for. Recipients of trust income still use Form 1040 as their base federal tax form; beneficiaries never file a 1041 for themselves.
With certain types of irrevocable trusts, the trust is responsible for paying tax on trust income instead of the beneficiary. Tax rules also apply differently when someone receives trust income or trust principal — a trust asset or its original value from when it was transferred into the trust. (Receiving trust principal may require the recipient to pay inheritance tax.)
To better understand trust tax liability, it’s best to speak with an estate planning attorney before setting up the trust, and a tax professional when filing trust taxes.
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