Estates and trusts are taxed on the income they earn, just like everyone else. A deceased individual might have owned stocks, bonds, rental property, or other interest- and dividend-producing assets at the time of their death. These assets become "owned" by their estate when the individual dies. Any income generated by the assets after the death must be reported by the trust or estate.
The Income Tax Return for Estates and Trusts
Estates and trusts that generate income during the year are subject to IRS-set tax rates. They're required to file IRS Form 1041, the U.S. Income Tax Return for Estates and Trusts. Their tax brackets are adjusted each year for inflation, just like personal income tax brackets. If all income-producing assets pass directly to a beneficiary after death, the Form 1041 is not required. This could include real estate owned jointly with right of survivorship or an IRA account that passes directly to a spouse.
Trusts and estates can take certain deductions on their returns, just as other taxpayers can. They could claim a deduction for any asset that's transferred to a beneficiary.
These income distributions are reported on Schedule K-1, which is sent to the recipient and the IRS. After distribution, the asset is then reportable by the beneficiary as income.
Which Estates and Trusts Must File Form 1041?
The following estates were required to file IRS Form 1041 in 2020:
- Estates with gross income $600 or more for the tax year
- Estates with any beneficiary who is a nonresident alien
The following trusts were required to file IRS Form 1041 in 2020:
- Trusts that have any taxable income at all
- Trusts that have a gross income of $600 or more regardless of taxable income
- Trusts with any beneficiary who is a nonresident alien
An estate must request a tax ID number to file these documents and transact other business. It's called an employer identification number (EIN), regardless of whether the estate actually employs anyone. Estate executors can apply to the IRS for an EIN by mail, fax, or online.
2020 Estate and Trust Income Tax Brackets
The Tax Cuts and Jobs Act (TCJA) changed income tax brackets across the board when it went into effect in January 2018, including those assigned to estate and trust income.
The 2020 rates and brackets were:
- $0 to $2,600 in income: 10% of taxable income
- $2,601 to $9,450 in income: $260 plus 24% of the amount over $2,600
- $9,450 to $12,950 in income: $1,904 plus 35% of the amount over $9,450
- Over $12,950 in income: $3,129 plus 37% of the amount over $12,950
The TCJA also altered the inflation index that annually increases all tax bracket figures. The Internal Revenue Code previously adjusted bracket thresholds according to the Consumer Price Index (CPI). It now uses the chained CPI, which is a bit more complicated, and it generally results in a lesser inflation adjustment.
The 2021 rates and brackets are:
- $0 to $2,650 in income: 10% of taxable income
- $2,651 to $9,550 in income: $265 plus 24% of the amount over $2,650
- $9,551 to $13,050 in income: $1,921 plus 35% of the amount over $9,550
- Over $13,050 in income: $3,146 plus 37% of the amount over $13,050
Income Taxes Aren't the Same as Estate Taxes
These tax rates and brackets shouldn't be confused with estate tax thresholds and exemptions. They apply only to income earned by trusts or estates before assets are transferred to beneficiaries. The estate tax applies to the estate's overall value and requires filing IRS Form 706, the U.S. Estate (and Generation-Skipping Transfer) Tax Return.
In 2021, only estates valued at more than $11.58 million were subject to the estate tax, up from $11.4 million in 2019, $11.18 million in 2018, and $5.49 million in 2017. The TCJA more or less doubled the estate tax exemption in 2018. In 2026, it reverts to pre-2018 levels in the $5 million range.
The 1041-ES (Estimated Income Tax for Estates & Trusts) tax brackets and rates are current for the 2020 and 2021 tax years. IRS Form 706, the U.S. Estate (and Generation-Skipping Transfer) Tax Return is current for 2020; the 2021 IRS Form 706 is expected to be released in August 2021. Please consult with an accountant or an attorney for information regarding prior years. The information contained in this article is not intended as tax advice, and it is not a substitute for tax advice.