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 Grantor’s 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 Grantor’s 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 Grantor’s
death are also included on the final 1040.
Income and expenses associated with probate
assets (not in the RLT) are reported on the Estate’s 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?
Grant’s 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 Estate’s 1041.
The income and expenses associated with the
stock, the residence, and the rental property after the date of death
are reported on the RLT’s 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 Grant’s 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 “qualified revocable trusts”) 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 grantor’s 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.
While designed to be accurate, this publication is not intended to constitute the rendering of legal, accounting, or other professional services or to serve as a substitute for such services.
Redistribution or other commercial use of the material contained in Tax & Business Insights is expressly prohibited without the written permission of Tax and Business Professionals, Inc.
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