Complex Trusts

Overview

A trust (except a grantor type trust) is a separate legal entity for federal tax purposes. A trust may be created during an individual’s life (inter vivos) or at the time of his or her death under a will (testamentary). A trust figures its gross income in much the same manner as an individual. Most deductions and credits allowed to individuals are also allowed to trusts. However, there is one major distinction. A trust is allowed an income distribution deduction for distributions to beneficiaries. To figure this deduction, the fiduciary must complete Schedule B. The income distribution deduction determines the amount of any distributions taxed to the beneficiaries.

For this reason, a trust sometimes is referred to as a “pass-through” entity. The beneficiary, and not the trust, pays income tax on his or her distributive share of income. Schedule K-1 (Form 1041) is used to notify the beneficiaries of the amounts to be included on their income tax returns.

Before preparing Form 1041, the fiduciary must figure the accounting income of the estate under the will and applicable local to determine the amount, if any, of income that is required to be distributed, because the income distribution deduction is based, in part, on that amount.

Form 1041 Complex Trusts – General Information

• A complex trust is any trust that does not qualify as a simple trust
• A complex trust can make charitable contributions
• A complex trust can distribute amounts allocated to the corpus of the trust (generally not shown on Form 1041).

Who Must File

Form 1041 – U.S. Income Tax Return for Estates and Trusts

• Any taxable income, OR
• Gross Income of $600 or more, OR
• A nonresident alien beneficiary

Form 1041-A – U.S. Information Return Trusts Accumulation of Charitable Amounts

• Filed annually for all complex trusts claiming charitable deductions

When to File

• 15th day of the 4th month after the end of the tax year

Extension: IR-2006-29, Feb. 16, 2006

WASHINGTON — The Internal Revenue Service has simplified the process for business taxpayers filing for an extension.

All business taxpayers who previously filed extension forms 8800, 8736, 7004 and 2758 will now only need to file the revised Form 7004, “Application for Automatic 6-Month Extension of Time to File Certain Business Income Tax, Information, and Other Returns,” to request an automatic extension of time to file. The revised Form 7004 grants taxpayers an automatic six-month extension without the need to file intervening forms.

Estimated Taxes

Generally follows individual rules:

• If you expect to owe, after subtracting any withholding and credits, at least $1,000 in tax
• Safe Harbors of: 90% of current year’s tax, OR 100/110% of last year’s tax.

Section 643(g) Election

• The trust can elect under Section 643(g) to allocate part of their estimated payments to beneficiaries using Form 1041-T.

Exceptions:

• Section 645 Election – Decedent’s Estate rules regarding estimates apply and no estimates are due for the first two years

Amended Return

• Form 1041 – Check the Amended Return box on the front of Form 1041
• Form 1041-A – No specific instructions

Final Return

• The trust is terminated when all assets have been distributed
• Trusts must have predetermined lives due to the rule of perpetuities. This limits a trust’s life to the life of the beneficiaries plus 21 years
• All capital losses are released in the final year of the return
• May have an amount on Line 12a of the K-1 “Excess Deductions on Termination” – These should be reported on the Individual Beneficiary’s Schedule A
• Check the Final Return box on the front of Form 1041

Exemption

• $100 exemption

Passive Considerations

• Passive Activity Loss Limitations are imposed at the Fiduciary level
• If a trust distributes an interest in a passive activity, the basis of the property immediately before the distribution is increased by the passive activity losses allocable to the interest. Such losses cannot be deducted