IRS Income Tax Form 1041 for Estates and Trusts
Trusts and estates must pay income taxes when they earn at least $600
IRS Form 1041 is an income tax return, the same as an individual or business would file, but for a decedent's estate or living trust after their death. The return reports income, capital gains, deductions, and losses, but subject to somewhat different rules than those that apply to living individuals.
An Estate's Gross Income
An estate can earn income from the interest of investments that have not been transferred to beneficiaries, or salary earned but not yet received by the deceased. Income received before the date of death is reported on the decedent's final tax return—a separate document that must also be filed by the executor of their estate. Income generated by assets after they're transferred to a beneficiary is taxed on the beneficiary's personal tax return.
Income must go to the estate to be reported on Form 1041. It can be an important distinction because not everything a decedent owned will become part of his estate. A bank or investment account with a payable-on-death designation would go directly to the named beneficiary. The estate would, therefore, not count interest earned by this account as income. The beneficiary would have to report the interest on their tax return, however.
Filing IRS Form 1041
The executor or personal representative of an estate must file Form 1041 when a domestic estate has gross income for the tax year of $600 or more, or when one or more of its beneficiaries are nonresident aliens. In this case, the estate would have to file a return even if it earned less than $600.
Trusts That Must File IRS Form 1041
In most cases, trusts are either simple or complex. A simple trust must distribute income to beneficiaries as it's received; it's not permitted to retain or give bequests from its principal or corpus—the property with which it was originally funded. Capital gains and losses, therefore, stay with the trust and can't be transferred to beneficiaries because they're considered part of the corpus.
The same rule applies to trusts as to estates—an asset producing income must be held and owned by it for that income to be taxable to the trust. Taxes associated with income generated after the asset is passed to a beneficiary would be the responsibility of the beneficiary. The trustee of a living trust must file Form 1041 under section 641 of the Internal Revenue Code if it's a domestic trust and has any taxable income for the tax year.
Allowable Deductions for Trusts and Estates
Executors and trustees can take certain deductions from income when they're preparing the tax return. The trust or estate can take deductions for any amounts transferred to beneficiaries, and the executor of an estate can deduct their fee and administrative costs incurred in settling the estate. These might include expert fees paid from the estate's income, such as for the assistance of an attorney or an appraiser.
An Estate's or Trust's Tax Year
An estate or trust can use December 31 as its tax year-end date, or it can use any other month as long as that first year does not cover more than 12 months. Most estates begin their tax years on the date of death and end them on December 31 of that year, but the executor or trustee can opt to use a fiscal year instead. In this case, the tax year would end on the last day of the month preceding the first anniversary of the decedent's death. In most cases, Form 1041 is due to the Internal Revenue Service within four months of the close of the tax year.
Form 1041 Instructions
Some trusts already have taxpayer identification numbers (TINs), but others report income and losses on the grantor's personal tax return during their lifetime. These are called grantor trusts, and they're different from irrevocable trusts. Grantor trusts and estates should apply for their own TINs after the death of the grantor, and in the case of an estate, the testator. These entities can no longer use the Social Security numbers of their creators after their deaths, and the TIN will be necessary to open bank accounts in the trust's name and to file Form 1041.
Each beneficiary who receives a distribution from the estate or trust should be issued a Schedule K-1 at the end of the tax year, which details the amount and type of any income received from the estate. The beneficiary would then report this income on their own tax return. The trust or estate can take the deduction for the total amount of these K-1s by preparing and submitting Schedule B along with Form 1041.
Discretionary distributions from the corpus of an estate and trust—those that are left up to the trustee or the executor but not required under the terms of the last will or trust documents—are not reported on Schedules K-1, and they're not deductible. Use Schedule D to report gains and losses associated with the sale of any assets. It might occur when an estate must liquidate property to raise cash to settle the decedent's debts. Schedule D must also be submitted with the Form 1041.
State Laws May Be Different
Keep in mind that these rules apply only to federal taxation. States have their procedures and laws, so check with a local accountant or tax attorney to find out if your estate or trust must pay income taxes at the state level as well.