Must Small Irrevocable Trust File Tax Return and Issue K-1s?
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Question:
Dad died in 2021 in Florida. He was the grantor of a revocable trust and I (daughter) was the trustee. My understanding is that upon his death, it became an irrevocable trust. When he died (no longer the trust’s grantor) I applied for an EIN for the trust and now I’m the only trustee. Did the trust go back to being revocable or still irrevocable? Dad’s trust documents indicated the beneficiaries and disbursement amounts and those were carried out per instructions (all trust funds totaled less than $75K–no other items/assets but cash in the trust). Do those individual disbursements get recorded via a 1041 and K-1s such that each beneficiary now has to pay tax on that “income” from the trust? The trust was closed upon disbursement of the monies in the trust and all occurred before the end of 2021.
Response:
You did perfectly right. The trust file a first and final 1041 tax return for the trust to let the IRS know it’s been closed out. It seems quite unlikely that it will have to issue K-1s to the beneficiaries since it only needs to do so if there was net income to the trust after payment of costs, such as legal and accounting fees. The only income would be dividends and interest, which probably were non-existent or quite small given the size of the trust, its short duration as an irrevocable trust, and the current low interest rates. Distributions of principal are not considered income to the beneficiaries and do not need to be reported to the IRS. If the trust were larger and had realized income, the K-1s would report such income as passing through to the beneficiaries on a pro rata basis, with each beneficiary reporting his or her share of the income on his or her tax return.
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Hi Harry
My husband died and left me an irrévocable marital trust. It only stock in it. I ask my advisor to distribute all the dividends to me by Dec 31 st. Usually the amount of dividends given to me is about $37,000. But there seems to always have a couple of hundred left in trust. I have to spend $800 or more To do trust tax return.
Is there away to avoid doing tax return each year?
No, you really need to do a tax return for the trust each year even though it will probably never have to pay any taxes. The income will be reported as coming to the trust’s tax identification number and it must file the return to take the deduction for the distribution to you. Then you will receive a K-1 which you have to report on your individual return. That way, you’re taxed on the income rather than the trust, probably at a lower rate.
My parents created an irrevocable life insurance trust that left me as the trustee. Once the insurance money was received I had to apply for EIN number to deposit insurance proceeds into the bank. This was a last to die policy so it was upon the death of my father that any money or funding of the trust began. Once I applied for the EIN from IRS they immediately (less than 2 minutes) sent me a letter telling me that the trust had failed to report it’s creation to the IRS and this happened to be 20 years ago. I wrote numerous letters to the IRS trying to get them to close this out stating the case that there was no money in this trust until the last parent died. It has been 1 1/2 years and the only response is the same letter every 3 months from IRS stating that they need another 3 months to review this case. I did file a 1041 this year being the first year since there is now money in the trust. I also did have my accountant write a letter to them in stating the issue and the fact that there was no funding of the trust during all the years. I am afraid to distribute the funds to the heirs since the IRS has not given me the trustee a clearance
Please advise.
Carole,
That sounds quite frustrating. Of course, the IRS is underfunded and understaffed, which leads to its poor customer service. But it sounds like the trust doesn’t owe anything. What we do in cases like these is to distribute the bulk of the funds to the beneficiaries, retaining a small “closing reserve” to cover any costs (the accountant’s fees) and charges that may accrue. In terms of the size of the closing reserve, usually about 10% of the funds is about right, but you might move this amount up or down depending on the size of the trust — if it’s very small you may need to hold back a larger percentage — and the likelihood of anticipated charges. Your accountant may be able to advise you on the appropriate size of the closing reserve.
Harry
My Mom had created an Irrevocable Trust at the end of December 2022. In Massachusetts where my Mom lives such Trusts are also called Medicaid Trusts. I am its trustee. The Mom’s house and half of her savings, about 200K, were put into this Irrevocable Trust. It has EIN from the very beginning. In 2023 I have not filed a Tax Return for this Trust, since there was absolutely no income in 2022. This year it is about $50 of income from its bank account and nothing from the house because it is not rented, my Mom lives in it. Should I file any tax return now, probably Form 1041, or still nothing? If I should file a Tax Return in 2023, is there any fee for non-filing now?
Andrey,
Technically, yes. Unfortunately, you’re supposed to file a 1041 tax return for the trust despite its minimal income. There will almost certainly be no taxes due since no doubt you’ll have more than $50 worth of trust expenses to deduct. Further, the tax on $50 of net income is just $5 at the 10% tax rate. So, in reality there would be little or no penalty for failing to file the return since the penalty is a percentage of the tax that’s due.
Harry