Tax Issues for Trusts — Simplified

JULY 29, 2013 VOLUME 20 NUMBER 28

Judging from the questions and comments we get here, taxation of trusts is one of the most confusing issues we regularly write about. We’re going to try to collect the most important rules here for your convenience. Note that we will not try (in this summary) to touch on every exception, every caveat — we want to try to spell out some of the major categories of trusts and of taxation, and see if we can help you figure out what tax issues you have to face. We will try to give very concise answers, a little explanation and a warning about some of the more common or important exceptions in each category.

Do I need to get an EIN for my revocable living trust?

Short answer: no.

More detail: if you created a trust, put your money in it, and retained the right to revoke it — the IRS doesn’t think of it as a trust at all. It is not a separate taxpaying entity. Not only do you not need to get an Employer Identification Number, you can’t get one. A revocable living trust is always a grantor trust, and it does not file its own tax return.

Important exception: if you are trustee of a revocable living trust created by someone else, you can get an EIN but you are not required to do so. Even if you do get an EIN, the trust does not file a separate trust tax return.

I am setting up a special needs trust for my child, who has a disability. I plan on leaving his share of my estate to the trust. Does it need an EIN?

Short answer: probably not — yet.

More detail: while you are still alive you probably will be the “grantor” of the trust for tax purposes — and that may even be true if the trust is irrevocable. Probably you will pay the taxes on any income the trust receives (note: your contributions to the trust are not “income” for tax purposes). But probably this is not important — you really are probably asking about what happens when you die and your estate flows to this trust. THEN it will need an EIN and it will file its own tax returns. Probably it will be what the IRS calls a “complex” trust.

Important exception: if the trust is both irrevocable and immediately funded, it probably does need an EIN even before you die and leave a larger share of your estate to it.

My daughter’s special needs trust was funded with money from a personal injury settlement. Does it need an EIN?

Short answer: almost certainly not.

More detail: even though it is irrevocable, and even though your daughter is not her own trustee, this trust is almost unquestionably going to be a grantor trust for tax purposes. That means it does not need to have a separate EIN; it uses your daughter’s Social Security number as its taxpayer identification number.

Important exception: although it does not have to get an EIN, this kind of trust may get an EIN. But even if it does, the trust does not file a separate income tax return — all the trust’s income gets reported on your daughter’s individual return.

My father established a revocable living trust to avoid probate, and he died earlier this year. Do I need to get an EIN for his trust? Can I just keep using his Social Security number?

Short answer: Yes, you do. No, you can’t.

More detail: With your father’s death his trust became a different entity. It is no longer a “grantor” trust, so should be filing its own income tax returns for the rest of the calendar year of his death and for the future (if the trust continues).

Important exception: While the trust should have its own EIN, it will only have to file a return if it earns $600 in income in any one year after his death. So if the trust gets resolved fairly quickly, and/or does not hold any income-producing property, it may not need a tax return. In that case, and that case only, it may also not need to have a separate EIN.

As a separate exception to the general rule, note that there are some limited circumstances in which your father’s trust may not have to use a calendar year. That can have significant favorable income tax consequences, so be sure to discuss the tax issues with your accountant and/or attorney.

My wife and I created a joint revocable living trust. She died two years ago, and I was simply too busy dealing with everything to do anything about the trust. Are there tax issues I need to resolve, or am I going to get into trouble for not doing anything quickly?

Short answer: You probably are not in any serious trouble, but you should talk with an accountant and/or attorney soon. Don’t continue to put it off, please.

More detail: It may be that nothing needs to be done regarding your trust. It may be that your trust was supposed to be divided into two shares upon the first death. It may be that such a division no longer makes tax sense — but it might still be necessary to deal with it. It’s too hard to generalize about all those possibilities, and your lawyer needs to look at the trust document AND know how assets are titled. Make an appointment and start gathering information. If you don’t do anything before your own death, your children (or whomever you have named as ultimate beneficiaries) will have a much more complicated time dealing with it than you do now. Incidentally, in our experience it is fairly rare that a surviving spouse does not want to make any changes whatsoever — even if all you want to do is to accelerate the pace at which your children receive your estate, it is a good idea to meet with your attorney.

Important exception: If you are certain that your trust does not require division into separate shares on the first spouse’s death, AND you still want the same people to administer your estate, AND you still want everything divided the same way as the original document provides, then it may not be necessary to make any changes. Most lawyers will tell you that it still makes sense to update powers of attorney and your will to remove your late wife’s name (just so your back-up agent doesn’t have to produce a death certificate before banks and doctors will talk with her), but it may not be critical to do so. Still, talking with lawyers is kinda fun, and almost everyone should do it more often.

There you have it. Our most-asked-about trust taxation questions, with simplified answers. Please be careful about this information, though — there is a lot of nuance we have glossed over. Talk to your accountant and your lawyer to confirm what we have told you here before relying on it. Our goal is to give you a bit of a roadmap, not to answer complex legal questions with oversimplified generic answers. But we hope we have helped.

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3 Responses

  1. Ben

     /  August 26, 2016

    The $600 exemption described in the article is for an estate, not a trust. For a “simple” trust, which has provisions requiring it to distribute all income in the current year received, the exemption is $300. For all other trusts, except for a qualified disability trust, the exemption is $100.

  2. Ben:
    Almost correct, and it’s very easy to see where the confusion comes from. The article addresses when a return has to be filed at all, and no income tax return has to be filed for an irrevocable, non-grantor trust if its income is less than $600 (and no tax would be due, of course).

    Once you get past the threshold question about whether a return has to be filed, then the amount of the personal exemption available to the trust does, as you describe, depend on the terms of the trust. This confusion points out one of the things we try to deal with here: the law — and tax issues especially — can be extremely confusing and it’s all to easy to get caught up in the minutiae and lose sight of the larger picture. Our original point was about trying to keep focus on the larger picture, and we were just saying that a may not have to file an income tax return at all if it does not realize much income.

    Thank you very much for the comment, and the chance to dig a little more deeply into one of the complications we mentioned at the outset. Also, as Ben would no doubt caution any reader, remember that these rules are federal tax rules — your state income tax rules might be different (though they are not different in Arizona, where we practice).

    Robert Fleming
    Fleming & Curti, PLC
    Tucson, Arizona

  3. Ben

     /  August 29, 2016

    Thank you for clarifying that there are two separate considerations involved in determining the need for filing a fiduciary tax return for a trust.

    As pointed out, the first question is whether filing is required. It seems beneficial to look at the actual IRS criteria. The IRS states this threshold as follows:

    The fiduciary (or one of the joint fiduciaries) must file Form 1041 for a domestic trust taxable under section 641 that has:
    1. Any taxable income for the tax year,
    2. Gross income of $600 or more (regardless of taxable income), or
    3. A beneficiary who is a nonresident alien.
    [Instructions for Form 1041 (2015), p.4.]

    Thus, filing is required if any of the above conditions are true. The next question is the amount of exemption to be applied, which affects the determination of taxable income as criteria (1) above, and affects whether filing is required:

    Trusts required to distribute all income currently. A trust whose
    governing instrument requires that all income be distributed currently
    is allowed a $300 exemption, even if it distributed amounts other than
    income during the tax year. [Also called “simple” trusts.]

    Qualified disability trusts. … [not relevant here.]

    All other trusts. A trust not described above is allowed a $100
    exemption. [Also called “complex” trusts.]
    [Instructions for Form 1041 (2015), p.25.]

    Therefore, if you apply both of the above to an irrevocable non-grantor trust required by its terms to accumulate all income into trust corpus, you see that total gross income of $101 in any tax year, in the absence of any deductions, will give a taxable income of $1, and will require filing of a return by rule (1) of the filing criteria above. For this type of trust an exemption of $100 will apply. Total gross income thus needs to be $100 or less to avoid the need for filing. For total gross income of $100 or less the taxable income will be zero or negative after applying the exemption, and filing will therefore not be required since none of the three filing rules will be true.

    On the other hand, if you apply the same rules to an irrevocable non-grantor trust required by its terms to distribute all income currently to a trust beneficiary, you see that total gross income as high as $599 will not require filing of a return, again assuming an absence of deductions for trust expenses. The income will all be distributed to a trust beneficiary and deducted from trust income, which will then be equal to zero. Thus, none of the three filing rules will be true, and filing will not be required. As a side note, the income amount of $599 may include capital gains up to $300, which will fall within the exemption and still not require filing. (This assumes the general rule that capital gains are excluded from distributable net income.)

    As Mr. Fleming points out, the complexity and potential confusion involved in making these determinations must be apparent here. But it should also be clear that tax return filing may not be required when the financial amounts are at the very low end. Such may occur on rare occasions during a period when a trust is largely dormant in regard to taxation but still in effect. But again, these are complex situations and need to be dealt with accordingly.

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