Tax compliance for Form 1041, officially called the U.S. Income Tax Return for Estates and Trusts, can be dizzying, especially since tax law changes periodically. Preparing a U.S. income tax return for an estate or trust involves many issues that are not intuitive and that require some practice to get right.
You must have a practical understanding of the issues involved in preparing Form 1041. Tax attorney Arthur Joseph Werner in his Eli Financial webinar, “The Line-by-Line Preparation of Form 1041,” provides clear instructions on how to tackle Form 1041 and all its reporting complexities.
According to the Internal Revenue Service, Form 1041 is used to report:
- The income, deductions, gains, and losses of an estate or trust;
- The income that is distributed to beneficiaries of the estate or trust—or accumulated/held for future distribution to them;
- Any income tax liability of the estate or trust; and
- Employment tax on wages of household staff.
Filing for Grantor Trusts
While some parts of Form 1041 are fairly straightforward, others are decidedly not. For instance, a fiduciary preparing the form for a grantor trust may consider alternate filing options.
Generally, you will file Form 1041 for a grantor trust; however, you may choose to use another, optional filing method instead if taxable income exceeds the filing threshold of $600, Werner explains. Werner elaborates on the two alternate, optional filing methods you can use when you don’t file Form 1041:
Optional Method One
- The grantor provides the trustee a Form W-9.
- If the grantor and the trustee are not the same, a statement describing income, deductions and credit, and additional information is provided to the grantor.
- The employer identification number (EIN) for the trust is not necessary.
Optional Method Two
- Includes obtaining the EIN for the trust.
- The EIN is provided by the trustee to all payers of income.
- Form 1099s are filed by trustee with the IRS.
- The 1099s show the trust as payer and the grantor as payee.
- Like method one, if the grantor is not the trustee, a statement describing income, deductions and credit, and additional information is provided.
Section Elections: Section 645, 663(b), and 643(e)(3)
Section 645 Election: The Taxpayer Relief Act of 1997 added Internal Revenue Code section 645, which offers a special, temporary entity election for the qualified revocable trust (QRT). Form 8855 is used by QRT trustees and executor of the related estate to make a section 645 election, which allows the QRT to be treated and taxed as part of its related estate for income tax purposes.
Returning to your Form 1041 prep, note that the IRS advises:
- Check item G for a section 645 election
- Provide the taxpayer identification number (TIN) of the electing trust with the highest total asset value
- Attach a statement to Form 1041 providing the following information for each electing trust (including the electing trust provided in Item G):
- The name of the electing trust
- The TIN of the electing trust
- The name and address of the trustee of the electing trust
Section 663(b) Election: Form 1041’s “Other Information” section includes question six related to the section 663(b) election. Distributions made within 65 days of the estates or trust’s subsequent tax year end may be deemed to have been made as of the last day of the tax year, according to Werner, and the estate or trust will still be afforded a distribution deduction.
Section 643(e)(3) Election: Question seven in the other information section relates to the section 643(e)(3) election. The section 643(e)(3) election allows a fiduciary to realize a capital gain inherent in the assets that are subject to distribution, and Werner further explains that the capital gain is recognized by the entity (subject to pass-through to a beneficiary). The beneficiary takes a fair market value basis in the property distributed.
This post provides an overview of some of the less-straightforward parts of the Form 1041. Take note—especially if you’ve never worked with fiduciary reporting and Form 1041 before. Now is the time to acquaint yourself with the form’s requirements— and its not-exactly-intuitive compliance rules.
