Q: Does my accountant need to know about my trust? Do I have to file separate tax returns for the trust?
A: Yes, you should inform your accountant that you created a trust. The type of trust you have determines whether you have to file a separate tax return or report trust income on your personal return.
A “Grantor” or “Settlor” is the individual who creates and funds a trust with their assets. If the Grantor retains specific powers over the trust under IRC §§671 through 677, then the trust is a Grantor Trust. Powers that trigger grantor trust status include the ability to revoke the trust, right to receive income, swap property, or change the beneficiaries. Grantor Trusts are considered disregarded entities under the IRS. Therefore, all income and deductions associated with the trust pass through to the Grantor as taxable income.
Under this scenario, the traditional method is to file a Form 1041 trust income tax return as an “information-only return” which contains only the trust’s name, address, and tax identification number. Because the trust is a Grantor Trust, the Form 1041 will not include items of income, deductions, and credit attributable to the Grantor. Rather, this information is summarized on a separate statement (a Grantor tax information letter) which is attached to the otherwise blank Form 1041 when it is submitted to the IRS. However, there are alternative reporting methods that allow some Grantor Trusts to avoid filing a Form 1041, which your accountant may prefer. That is why it is advisable to keep your accountant in the loop when setting up a trust so that any trust income is properly reported.
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For non-grantor trusts, a completed Form 1041 is required, even if the trust directs income to be paid out to a beneficiary of the trust. When income is distributed, the trust issues a Schedule K-1 to each beneficiary to report their share of the trust’s income, deductions, and credits. When income is distributed to a beneficiary of the trust, the income is written off as a deduction under Form 1041.
Grasping the tax nuances of your estate plan is as vital as the documents themselves. It's essential to keep your accountant informed. Ensure you assemble a proficient team of attorneys and accountants, collaboratively guiding you through the tax intricacies of your present and prospective estate planning.
Nancy Burner, Esq. is the founder and managing partner of Burner Prudenti Law, P.C. focusing her practice areas on Estate Planning and Trusts and Estates. Burner Prudenti Law, P.C. serves clients from New York City to the east end of Long Island with offices located in East Setauket, Westhampton Beach, Manhattan and East Hampton.