Volume 25 Issue 4 --July/August 2013
Revocable Living Trusts (RLTs) are popular estate and asset planning devices. Typically, while the creator (grantor) of the RLT is alive, the RLT will be a Grantor Trust for income tax purposes, and all income and expenses associated with the assets in the RLT are reported on the Grantorís individual 1040.
What happens when the Grantor dies? Under the terms of typical RLTs, the right to revoke the trust expires when the Grantor dies, meaning that the RLT becomes an irrevocable trust.
For income tax purposes, all income from RLT assets after the date of death must thereafter be reported on a trust income tax form (Form 1041). Of course, if the RLT does not have an EIN, it will need to obtain one. It is also a good idea for the trustee of the RLT to establish a separate bank account for the trust if it does not already have one.
There is often confusion about what to report on the RLT 1041 and what to report on the Grantorís final 1040. If there is a probate estate for assets not included (either intentionally or inadvertently) in the RLT, the Estate may have a separate income tax filing obligation.
All income received by the Grantor prior to the date of death is included on the final 1040. Similarly, all income and expenses with respect to RLT assets prior to the date of the Grantorís death are also included on the final 1040.
Income and expenses associated with probate assets (not in the RLT) are reported on the Estateís 1041. An estate with more than $600 in gross income or a nonresident alien beneficiary must file a 1041.
All income and expenses related to RLT assets after the date of death would be reportable on a 1041 for the RLT. A trust must file a 1041 if it has more than $600 in gross income, has any taxable income, or has a nonresident alien beneficiary.
For example, suppose that Grant Tore who earlier had set up an RLT that owns his residence, some stocks and a rental property died on March 15, 2013. At the time of his death, Grant was also employed by BIG Co. and had a large interest bearing bank account in his own name. At the end of 2013, what income and expenses go where?
Grantís salary and the bank account interest received before his death are reported on his final 1040. Any dividends received on the stock owned by the RLT before March 15, 2013 are also reported on the final 1040 because of the Grantor Trust rules. Similarly, all income and expenses associated with his residence and the rental property before the date of death are reported on the final 1040.
The interest income on the bank account as well as any other income received by the Estate after the date of death is reportable on the Estateís 1041.
The income and expenses associated with the stock, the residence, and the rental property after the date of death are reported on the RLTís 1041.
Typically, Grantors of RLTs have what are called pour-over wills, under which all assets not specifically disposed of by the will pour over into the RLT. When such assets are actually transferred from the probate estate to the RLT, reporting for the income and expenses associated with such assets will then shift from the Estate to the RLT.
There are some planning opportunities here. While trusts are generally required to use a calendar year, estates may elect a fiscal year ending on the last day of any month less than 12 months from the date of death. For example, in Grantís case, the Estate could elect a fiscal year ending at the end of any month between April 2013 and February 2014.
In the case of RLTs that meet certain requirements (called ďqualified revocable trustsĒ) it is possible to elect to treat the RLT as part of the Estate for income tax purposes. This means that the income and expenses of both the Estate and the Trust are reported on one 1041 filed by the Estate. This election is generally effective until the earlier of the date on which the RLT and the Estate distribute all of their assets or until 2 years from the date of death, although it can be longer if there is an estate tax liability.
Unless the RLT requires that all income after the grantorís death be distributed currently, the RLT will be treated as a complex trust for income tax purposes. Estates are usually also taxed as complex trusts. Accordingly, except to the extent that the Estate or RLT income is actually distributed to beneficiaries under the terms of the instrument, the income will be taxed to the Estate or Trust. Distributed income will typically be taxed to the beneficiary.
If you have questions about the taxation of trusts please call the Tax & Business Professionals.
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