As the baby boomer generation gets older, more taxpayers are handling estate and trust taxes for the first time. According to Accounting Today, the number of income tax returns for estates and trusts (Form 1041) increased by 14.9% between 2020 and 2021.
As an estate or trust beneficiary, figuring out all the tax implications and Form 1041 filing requirements can be daunting. Accurately reporting income made from trusts and estates is essential for tax preparation, so we’ve included some Form 1041 instructions and tips for you below.
At a glance:
Form 1041 is still an income tax report, but it’s different from Form 1040.
When someone dies, their estate becomes a separate entity. Any income earned after the person’s death goes to their estate instead. For instance, if someone passes away before their last payday, the money from their final paycheck will be transferred to their estate. This is income that needs to be reported on Form 1041.
The deceased also needs to have someone (usually a spouse, another close relative, or an attorney) file Form 1040 — this will report all their income earned in the final tax year while they were alive.
In summary, Form 1040 declares income the person earned during the tax year while they were alive, and Form 1041 declares income earned by the estate or trust after the owner’s death. We’ll go into more detail about Form 1041 below.
IRS Form 1041 is used to report income taxes for both trusts and estates (not to be confused with Form 706, used when filing an estate tax return). The form tracks the income an estate or trust earns after the estate owner passes away but before any beneficiaries receive their designated assets.
As we mentioned earlier, income earned before the date of death must be reported on the deceased person’s final tax return (Form 1040). Any assets not held by the estate or trust should not be included in Form 1041 (such as assets passed directly to the beneficiary).
Different forms are required to report various types of income on Form 1041. For example, Schedule D reports capital gains and losses, while Schedule K-1 reports a beneficiary’s share of income.
The estate itself is not responsible for paying income taxes if its assets are distributed to the beneficiaries before earning income. In this case, the beneficiaries are responsible for paying any tax due on that amount. Each beneficiary will receive a Schedule K-1 Form 1041, which tells them the amount and type of income to report on their individual tax returns (Form 1040).
Income generated between the estate owner’s death and the transfer of assets to the beneficiary can come from stocks, bonds, rented property, mutual funds, final paychecks, or savings accounts.
The fiduciary (trustee, executor, or administrator) of the estate or trust files Form 1041 to report any income tax liability of the estate or trust and any income, deductions, gains, losses, or employment taxes on wages.
Not every estate or trust is required to file Form 1041 for the income it earns. No return is necessary if the estate has no income-producing assets or its annual gross income (AGI) is less than $600. The only exception is if one of the grantor’s beneficiaries is a nonresident alien. In that case, the estate’s income total does not matter, and a federal tax return must be filed. The estate executor or personal representative must file the estate tax return using Form 706.
You can e-file Form 1041 for deaths occurring in the current or past two tax years. You can search for prior year forms and instructions on the IRS website.
You do not have to file Form 1041 if the estate generates no taxable income unless one of the beneficiaries is a nonresident alien.
There is an important distinction regarding the filing timeline of Form 1041: The estate tax year sometimes differs from the traditional calendar tax year.
Typically, the estate calendar year starts on the day of the estate owner’s death and ends on Dec. 31 of the same year. The executor, however, can file an election to choose a fiscal year instead. A fiscal year means the tax year ends on the last day of the month before the one-year anniversary of death. The executor then has up to 12 months to file the income tax return. The estate tax return is generally due four months after the close of the tax year.
Here’s an example: Joe passed away on June 1, 2022, and his executor distributed all the estate’s assets by Dec. 15 of the same year. Before the assets were passed on to the beneficiaries, they earned $1,200. This is greater than the $600 exemption, which means the estate must file an income tax return. In this instance, the tax year starts on June 1, 2022, (date of death) and ends on Dec. 31, 2022, unless the executor elects a fiscal year. If a fiscal year is chosen, the tax year would end on May 31, 2023, resulting in more time to file.
The late filing penalty for Form 1041 is 5% of the tax due for each month (or part of a month) that the tax return is late, up to a maximum of 25%.
Trusts are usually classified as simple or complex. Simple trusts must allocate all income earned to their beneficiaries and cannot accrue income. A simple trust cannot designate a charity as its beneficiary or distribute its corpus (principal).
Complex trusts refer to any trust that does not qualify as a simple trust. These trusts offer greater flexibility than simple trusts, especially when dealing with large estates or the added complication of several beneficiaries.
After the grantor’s death, the estate is its own taxable entity. To file IRS Form 1041, the executor must obtain a taxpayer identification number (TIN) for the estate. This can be done easily on the IRS website.
It is important to gather all the financial documents necessary to support the tax deductions you want to claim on Form 1041. Here is a short list of common deductions and exemptions that lower the estate’s taxable income:
When claiming deductions or tax credits, note that you may also have to file Schedule I, which is used to figure alternative minimum tax for estates and trusts.
The estate must send Schedule K-1 to all beneficiaries reporting any asset distributions they received. As a beneficiary, you will refer to Schedule K-1 for the income amount you should report from the estate on your personal income tax return, Form 1040.
Some income categories reported on Schedule K-1 include capital gains, interest earnings, rental real estate, or ordinary business income.
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